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Rocky Brands, Inc. (NASDAQ:RCKY)

Q1 2012 Results Earnings Call

April 19, 2012 4:30 PM ET

Executives

Brendon Frey – ICR, IR

David Sharp – President and CEO

Jim McDonald – Chief Financial Officer

Analysts

Mitch Kummetz – Robert Baird

Dorsey Gardner – Keslo Management

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands First Quarter Fiscal 2012 Earnings Conference Call. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (Operator Instructions)

I would like to remind everyone that this conference call is being recorded. And I’ll now turn the conference over to Brendon Frey of ICR.

Brendon Frey

Thank you. Before we begin, please note that today’s discussion including the Q&A period may contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Such statements are based on information and assumptions available at this time and are subject to change, risks and uncertainties, which may cause actual results to differ materially.

We assume no obligation to update such statements. For a complete discussion of the risks and uncertainties, please refer to today’s press release and reports filed with the Securities and Exchange Commission, including Rocky’s Form 10-K for the year ended December 31, 2011.

I’ll now turn the conference call over to Mr. David Sharp, President and Chief Executive Officer of Rocky Brands.

David Sharp

Thanks, Brendon. Good afternoon, and thanks for join us. With me on the call is Jim McDonald, our Chief Financial Officer. We’re off to a solid start in 2012, with first quarter sales and earnings that was slightly ahead of our expectations. Our overall performance was consistent with recent quarters. The year-over-year improvement was driven by sales again in our wholesale segment and better operating performance from our retail division.

The first quarter is primarily a re-order period for many of our basic work product lines. In light of the mild temperatures that continued many parts of the country, we are pleased with the level of demand that we experienced. This underscores our belief that the innovative product we brought to market are resonating with consumers and further distinguishing us in the competitive environment.

Our focus on innovation is leading to greater distribution for our brands, both with new accounts and existing customers where, we are gaining sales space and adding doors. The biggest growth driver in quarter though came from our expansion within Tractor supply, already one of our largest national accounts.

In 2011, we were in approximately 700 of their outdoors with between two to six styles of our basic Georgia Boot work product depending on the location. We are now in all 119 locations with full best performing core products, all of which are on the weekly order replenishment program.

This had a very positive impact on Q1 sales, and should continue to positively affect our topline as we move through the year. However, this initial rollout negatively impacted gross margins due to temporary price concessions, [CD] expansion and the high concentration of sales to these large accounts in the quarter. Our initial markups are typically lower Tractor supply as a result of their annual volumes.

As sales to them return to more normalized levels as a percentage of our total sales, we expect to drive our margins to the much less pronounced.

This first quarter of the year is also when we receive initial commitments from retailers for our new fall lines. In addition to growing our core work Western and Hunting an area of focus for us has been on extending our brand into new categories and opening up new channels of distribution.

Much of our recent work around this initiative was centered on our Durango brand. Building on the brand’s authentic position within the Western market. We developed more fashion-forward footwear to appeal to wide commercial orient, particularly in urban centers, where the potential consumer population are obviously much larger.

Some of these products are already at retail where they are performing quite well, which validate that our product is trend right. For example, our zaffels.com, where we enjoy substantial business, our shipment to the accounts were up 23% and our bookings were up 120% year-to-date.

We also encouraged with new accounts that we’ll have Durango in their fall assortment, major retail such as DSW.com, Title IX and Famous Footwear. Further we have seen many of our current Durango accounts, accounts like Shoe Show, Shoe Carnival, increasing their order and placing the new Durango city collection.

Fall pre-books for our outdoor and hunting category are up nicely despite coming off a very mild wet season. Like our Western business, booking has been driven by new product introductions, including our new inspired Rocky Athletic Mobility product line that targets a younger demographic and has led to increase sales base with retails like West Pro Shops, Gander Mountain and Academy Sports.

We also introduced several new core value price products that booked very well with our independent account base.

Lastly, within our wholesale segment, our commercial military business maintained it strong growth trajectory during the first quarter sales increase more than 29% year-over-year. We continued to capitalize on the growing popularity of S2V and C4T Trainer product series by developing our distribution and introducing new style such as a steel toe version to create additional demand.

Now turning to retail, there are two very positive story lines going on here. The first being that the profit contribution from this division continues to improve even on lower sales volumes as more and more transaction are executed via the web and we are able to take additional expenses out of the business model.

As a percent of total retail sales, the web direct business increased to 60% in the first quarter of 2012, compared to 42% a year ago, and it was up 24% in total dollar sales over the same period.

Second part of the story, the progress we are making securing new customers in effort to bring more scale to this business model. In the first quarter well we executed contracts to provide safety shoes exclusively through our online Custom Fit program to work at several large national employers, so such as Chesapeake Energy, Boeing, Princess Cruise Lines, Darling International and Grainger to name few.

On more we are converting or signing up new web business as where we price the rate as a year ago. Based on this trend, we expect retail sales to actually increase in Q3 and Q4, the first sales increase, since we began this transaction back in 2009.

I’ll quickly touch on our international operations before turning it over to Jim. The overseas markets continue to be a big opportunity for brands and we are deploying strategies to successfully increase our presence in select countries and regions.

We recently signed a distributor agreement to Durango in the U.K. We will be partnering with our London based PR firm to promote the brand and product lines in both the western and fashion industries.

Elsewhere, demand for our Rocky and Georgia work lines in Middle East, Central America and the Caribbean continues to grow and is expected to increase further as we add more countries to our distribution platform in the near-term.

With that, Jim will now go through the financials.

Jim McDonald

Thanks David. Net sales in the first quarter improved to $53.3 million, compared to $52.3 million for the corresponding period a year ago. Wholesale sales for the first quarter increased 6.5% to $42.4 million, compared to $39.8 million last year.

Our commercial military and western segment posted the strongest percentage gains in the quarter, up 29% and 17%, respectively. While our largest segment work was up 5% led by an 11% increase in Georgia brand sale.

Retail sales for the first quarter were $10.5 million, compared to $11.7 million a year ago, and military segment sales were $4 million versus $0.8 million for the same period in 2011.

Gross profit in the first quarter was $18 million or 33.8% of sales, compared to $19.3 million or 36.8% of sales for the same period last year. The 300 basis point decrease in our gross margin was primarily driven by lower initial markups on the product sales associated with the rollout to all Tractor supply stores.

Selling, general and administrative expenses declined 8.2% to $15.7 million or 31.4% of net sales for the first quarter of 2012, compared to $18.3 million or 34.9% of net sales a year ago. The $1.5 million or 350 basis points improvement was primarily driven -- was primarily due to lower compensation expense and operating costs of our retail business, partially offset by an increase in advertizing expenditures.

Interest expense for the quarter decreased to $0.1 million from $0.2 million in the first quarter of 2011 due to lower borrowings during the period versus the same period last year.

Net income improved $0.2 million to $0.7 million and diluted earnings per share increased 43% to $0.10 in the first quarter of 2012.

Turning to the balance sheet. Our funded debt at March 31, 2012 was down $6.3 million or 22.5% to $21.5 million from $27.8 million at March 31, 2011.

Inventory at the end of the first quarter of 2012 was $64.1 million, an increase of 4% compared to inventory of $61.7 million at the end of last year’s first quarter. The increase in inventory was the result of an increase in cost per unit partially offset by a decrease in units of footwear.

I’ll turn it back to David for his closing comments.

David Sharp

Thanks Jim. In addition to the near-term growth initiatives, I discussed earlier in the call, we continue to develop strategies and leveraging our core competencies into new market segments. This includes healthcare which is projected to have more than 5.6 million jobs over the next decade.

We recently met with two of the largest medical footwear and apparel retailers, Life Uniform and Scrubs & Beyond, to outline our product development concepts and prototypes including our new Rocky For Your Sole clogs for nurses and doctors, who are on their feet for the majority of their shifts.

The response was extremely positive. They felt that we have hit upon some unfulfilled wish.

We believe that we will secure test orders from them and other retailers of medical footwear to shift earlier this year and into early 2013. So in closing, we are very pleased with the pace of our business at the start of the year. We are excited about the many near and long-term opportunities we see ahead for our brands and products.

Based on current visibility, we expect the sales growth in our wholesale division to accelerate from Q1 levels and increase in the high single digits over the remainder of the year compared to the same period last year. We also expect our retail performance to improve versus the decline we reported in the first quarter.

With sales projected to be up slightly during Q3 and Q4, it should be flat for the year. Military segment sales are expected to be immaterial for the remainder of 2012.

With regard to gross margin percentages, they should be down slightly, particularly in the second quarter for two reasons, one we are not yet fully recognizing the positive variances that we’re currently experiencing in our plans due to our significantly improved efficiencies and two, it is in the back half of the year while we won’t have all customers converted to enterprise list.

With respect to SG&A for the balance of the year, we expected to only increase in proportions of the variable portion of our incremental sales. We look forward to updating you on our progress when we report second quarter results in July.

Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instruction) Thank you. Our first question comes from the line of Mitch Kummetz with Robert Baird. Please proceed with your question.

Mitch Kummetz – Robert Baird

Thank you. Thanks for taking my questions. Let’s see -- let me start with the tractor supply expansion. You talked about the impact of gross margins over the quarter. Can you talk about what volume it added in terms of revenues for the quarter, kind of, what do you see that addings for the year and then how should we think about gross margin impact on our business over the balance of the year? You didn’t really talk about your gross margin expectations for the second half. You kind of talked about pressure in Q2 or so.

David Sharp

While I touch to the volume, mention that generally with Jim on the margin. We -- it is about $1 million a quarter.

Mitch Kummetz – Robert Baird

Okay.

David Sharp

And last year, we did approximately $5 million with that account. This year we expect to do, like $7 million.

Mitch Kummetz – Robert Baird

Okay. Should also speak the margins?

David Sharp

Mitch, I think you -- we had planned our margin percentages to be down slightly for the year based on the price increase and the cost increase that we had last year and the price increase that we took. So but I think that -- we’re trying to be down slightly based on that. This will be down. Not as certainly as dramatic in the first quarter but it will be – may be half a point, 50 basis point effect on the margins as we move to the back half.

With the second quarter, the primary thing there is our recognition of the positive variances that we -- in the factories. We’re still recognizing the inefficiencies we had last year and that will continue through second quarter and that will start to realize some of the positive variances we move into the back half of the year.

Mitch Kummetz – Robert Baird

Okay. It’s helpful. And then on the SG&A, David you mentioned that you expect the variable piece for SG&A to grow, kind of, in line with the variable piece for the balance of the year but in Q1, SG&A was down by $1.5 million despite wholesale up. So imagine your variable expense was up, but there were other pieces of the SG&A that were down. I mean, you’re still going through this retail transition. So I would think that could help you, so may be you can speak to that a little bit?

David Sharp

In 2011, we took a lot of actions in terms of reducing head count. In fact, we reduced our sales force by 50%, and also we took centers and top down operation in the first quarter of last year but we didn’t realize the savings because of severances in closing comments. So you’re seeing a little bit of tail there year-over-year?

Mitch Kummetz – Robert Baird

Okay. All right. Can you give comments on the variable.

David Sharp

Yeah. The variable, Mitch, as I mentioned in the first quarter, we should have seen some more variable but our increase in sales there primarily came from these key accounts. Supply being about half of it, and those accounts, the variable expense is pretty low, just some distribution expense. There is no freight expense as they take up their own good and no salesman commissions on those because they're in-house salespeople. We didn’t have experience of significant increase in variable expense based on those increased sales.

Mitch Kummetz – Robert Baird

Got it. And then, Jim, could you just quickly run through the segment margins for the quarter?

Jim McDonald

Sure. The first quarter was 30.5 for wholesale 40.3 and 4% over the military (inaudible).

Mitch Kummetz – Robert Baird

Okay. And then -- one last question on -- you provided a wholesale outlook for the balance of the year. It sounds like you’re feeling pretty good about the order book. It sounds like -- I think in the last call, you already answered how the hunting business might play out but it sounds like that order book is turning well.

The western book is turning well and now the commercial, military. Could you speak to, kind of, what the overall backlog looks like at the end of Q1? And am I correct to assume that your backlog shows increases in all three of those businesses?

Jim McDonald

That is correct. Despite the weather, the carry weather and rest of course you see in the outdoor business, we have bookings of about 5% in footwear that’s down a little bit in apparel, there was more carryover in the channel there. Western -- we’re very, very pleased with where our western order book is, particularly in Durango and the work businesses are pretty solid too.

Mitch Kummetz – Robert Baird

Okay. That’s helpful. Thanks guys. Good luck.

David Sharp

Yeah. Thanks.

Operator

Our next question comes from the line of Dorsey Gardner with Keslo Management. Please proceed with your question. (Operator Instruction)

Dorsey Gardner – Keslo Management

Thank you for taking my call. Clearly, the inventories were 4.5%, sales were up, I guess, 2% in the quarter. Inventory looked pretty heavy going into the quarter, the end of last year, again with the pressure on margins due to markdowns on inventory, I guess my first question.

Second question is with the military business decline -- really migrating, we think that gross margins would go up going forward but in fact there is continued pressure on gross margins.

And then third, I think it’s really early in the day but could you comment on the outlook for the Internet business and I think you can do there. And also is there a push back from your normal channel, that people feel that perhaps they shouldn’t carry your lines because they are selling them now direct or what kind of reactions you get on that, I guess, it’s just -- the times have changed and everybody is doing that and actually already, but I guess, that’s a lot of question? Thank you.

David Sharp

Yeah. With respect to inventory 70% of our business comes at once, in other words, customer calls they need a size and they shift the same day. So inventory is perhaps higher than some of our competitors, but it’s because of the nature of our business, year-on-year we are pretty pleased with where the inventory is right now.

It is now some obsolete inventory in the quarter, particularly in our western business. We liquidated some inventory there but our discontinued inventory at this point is extremely low. So we’re happy with the inventories.

With regard to -- at the end of the year, our units of footwear year-over-year were down about 95,000 pairs and at the end of the first quarter year-over-year, they are down about 140,000 pairs. So we continue to make profits, bringing the units down and the increase year-over-year is smaller at the end of the first quarter that was end of the last year. So it’s all related to the price increase very significant increase in our cost last year and we all anniversary there. So we get to after the quarter.

So and then with respect to margins, we don’t -- we gave you a lot of transparency into the margins. And we report them by segments, and we just let through that as we answered Mitch’s questions and I think we explain pretty fully wide, what will happen with the margin this first quarter. It wasn’t due to military, it was due to our wholesale business in this large shipments, very large customer with (inaudible).

And then with respect to your question about direct business, our direct business is really not allowed our wholesale brands. We have retail business that we’re transforming to model web based delivery system and in fact now 60% of the business is direct through the web.

We very bullish on this business as the operating margins are twice what they were in the first quarter of 2011. We are pleased with it and we’re investing in it. And we don’t think it affects our wholesale business, there are two separate businesses.

Analyst

Do you feel it’s incremental businesses and I mean did you expect in couple of years to be doing $50 million in this business or what’s possible?

Jim McDonald

We currently doing, I think the plan this year is more than $40 million and it’s about business today. We’re remaking it, retiring in old business model, it was very labor intensive and very capital intensive. And we are getting this inflection now in the sale -- true -- as we’ve been remaking it since 2008.

We had decline in sales but improving operating margin and within the back half of this year without forecasting the sale, it’s actually the sales strength down trend to reverse. So the business is going to be much larger than it is today.

Dorsey Gardner – Keslo Management

Did I see some of your product and example, is that do you felt through them or end of that work?

David Sharp

zaffels.com is the large customer, yes.

Dorsey Gardner – Keslo Management

I think you – do you drop shift for them I mean do they – refer new shipment, how does that work?

David Sharp

We ship for many dotcoms but in zaffels’ case, they actually stopped the product.

Dorsey Gardner – Keslo Management

(inaudible) when I went.

David Sharp

Yeah.

Dorsey Gardner – Keslo Management

Well, that’s encouraging. Thank you very much.

David Sharp

Yeah. Thank you.

Operator

Thank you. (Operator Instructions) Mr. Sharp, there are no further questions, at this time. I would like to turn the call back over to you for closing comments.

David Sharp

We thank you for you interest and your questions and we look forward to speaking with you in other 90 days. Thank you.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time.

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