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Rock Brands, Inc (NASDAQ:RCKY)

Q3 2012 Earnings Call

October 24, 2012 4:30 pm ET

Executives

Brendon Frey – IR

David Sharp – President, CEO

Jim McDonald – CFO

Analysts

Mitch Kummetz – Robert W. Baird

John Sullivan – Olstein Capital Management

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rock Brands third quarter fiscal 2012 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and 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, I will 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 Securities and Exchange Commission, including Rocky’s Form 10-K for the year ended December 31, 2011.

I will now turn the conference over to Mr. David Sharp, President and Chief Executive Officer of Ricky Brands.

David Sharp

Thank you, Brendon. Good afternoon and thanks for joining us. With me on the call is Jim McDonald, our Chief Financial Officer. Our third quarter sales performance included double-digit percentage increases in several areas of our business, helping drive footwear sales up over 9% over a year ago.

Many of the initiatives we put in place over the past 12 to 24 months continued to deliver strong gains, these include one, compelling new products within our traditional western business, two, the expansion of our recently introduced Durango City Line of fashion boots, and three, expanded distribution for our commercial military business.

Overall, western footwear sales were up 42% during the third quarter with our traditional Durango and Rocky business up 26%, while our Durango City Line (inaudible) footwear doubled from a year ago. We continued to experience increase sales volume with our existing base of western retails such as Cavender’s, Boot Barn and RCC Western along with academy sport which has quickly become a much more meaningful account for us, thanks to the performance of our new Flag Boots.

At the same time, Durango City is opening up new distribution opportunities like DSW, Rack Room and at the etailer onlineshoes.com. We’ve also experiencing expansion at several accounts including zappos.com, allowing us to target a whole new consumer. Importantly the strong selling results have been followed up by equally strong sell through the past few months.

Commercial military sales were up 23% in the third quarter, filled by increased demand for a popular S2V series and C4 trainers. Leveraging the early success of the initial S2V boot, we’ve expanded this category through product expansions including a steel-toe version, a new distribution with the broader military exchange stores on the military basis.

Looking at the rest of our business, sales were a bit softer than we expected, which resulted in a shock fall versus our top line target for the third quarter. We believe some of the missed sales were related to external factors, while execution issues would also explain. Work, which is our largest segment was flat with the year ago, anticipated sales gains were hampered by production delays on some key new products which resulted in last sales, and potential reorder activity in the quarter.

On a more positive note, we experience solid gains with several of our large FARM & RANCH change, most notably track to supply and costal form at home, from continued door growth and assortment expansion. Unfortunately, these gains were partially offset by declines in sales smaller independent work retailers, some of whom have either gone out of business or struggling with credit issues.

Similar to work, our hunting business was flat compared with last year’s third quarter. The issue here was weather, which always plays the major role in the performance of this category. And with the warm dry September much of the country experience, we didn’t see the level of that one sources we had projected because sell through has been slow to develop.

Finally, our apparel business which was about 5% of overall sales last year, declined approximately $2 million, the shipments to one key customer continue to decline. The after effects of last year’s mild winter are still impacting our retailers by cold weather apparel, especially camouflaged hunting outer wear. We’ve seen sell through pick up over the past few weeks as parts of the country experienced cold spell. However, we remain cautious about the near term prospects for this business until we get a more prolonged period of colder and weather conditions.

Now turning to our retail business, the trend of improved profits on lower sales volumes making progress shifting a greater percentage of retail sales to our lower cost web based model. The quarter wet sales represented 70% of total retail sales, up from 55% a year ago. This technology continues to reshape the retail landscape, we believe we’re well positioned to process from the emergence of omni-channel and the changing ways businesses and consumers conduct transactions.

I’ll now turn the – turn the call over to Jim.

Jim McDonald

Thanks David. For the third quarter, net sales increased $1.5 million to $72.5 million from $71 million in the corresponding period a year ago. This included wholesale sales of $62.9 million this year compared to $60.2 million last year, representing a 4.5% increase. Wholesale sale were driven by a 9% increase in footwear sales, partially offset by declining in the sale. Retail sales for the third quarter were $9.6 million compared to $10.3 million a year ago, and we had no military segment sales this third quarter versus $0.4 million last year.

Gross profit in the third quarter was $26.2 million or 36.1% of sales compared to $25.6 million or 36% of sales for the same period last year. Selling general and administrative expenses increased 1.2% to $18.2 million or 25.2% of net sales for the third quarter of 2012 compared to $18 million or 25.4% of net sales a year ago. The $200,000 increase is primarily due to higher advertising expenses partially offset by lower compensation expense.

Interest expense for the third quarter decreased to $0.2 million from $0.3 million in the third quarter 2011, due to lower borrowings during the period versus the same – during the period versus the same period last year. Our effective tax rate for the third quarter of 2011 was 31.9% compared to 29.7% in the third quarter of 2011. The higher tax rate is the result of more permanent capital investments in our operation in the demonic and republic in 2011 which lowered our effective tax rate in that year.

Net income was $5.4 million or $0.72 per diluted share compared to net income of $5.2 million or $0.70 per diluted share last year.

Turning to the balance sheet, our fund at debt at September 30, 2012 decreased $18.2 million or 30.3% to $41.9 million from $60.1 million to September 30, 2011. We are very pleased with our continued progress in increasing our debt level. Inventory at the end of the third quarter of 2012 was also well managed at $73 million, down 7.4% from $78.9 million at the end of last year’s third quarter.

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

David Sharp

Thanks, Jim. As we exam our performance to the first nine months of the year and then look out over the next several quarters, we believe 2012 will represent the turning point for the company. The emergence of several new growth vehicles has created a lot of excitement within our organization and with our retail partners and we’re confident that the products initiatives we’ve recently brought to market combined with what is currently in the development pipeline can drive our business forward for many years to come.

Clearly, our focus and investments in general sales growth is paying off. Both our western and commercial military segments have performed very well year-to-date and into the fourth quarter with strong momentum. In response to these recent results, we have positioned our inventory and production capabilities accordingly to ensure we are able to fully capitalize on the opportunities we’ve created.

Unfortunately, the two other large and significant pieces of our business work and hunting, haven’t exhibited the same growth characteristics in 2012. With regard to our traditional hunting business we need to get used to this becoming a smaller percentage of our overall business due to the shorter selling season and the continued growth of private label at many of our large national partners.

That said, the opportunity exist to leverage the strength of Rocky Brands into faster growing areas of the outdoor open market. Our new extreme collection is being well received. We just signed up four sales agencies. We’re familiar with the channel and have relationships in the channel and will help us with placements. While private label is presenting challenges in hunting, it’s providing an opportunity in work. We recently signed an agreement with Tractor Supply to manufacture the in-house work footwear program beginning in 2013.

The additional sales will help us set declines from the continued contraction of our independent account base as the uncertain economic outlook makes it more challenging for several of these mom and pop shops and small chains. Importantly, the additional volumes will help drive greater efficiencies in our company-owned factory in the Dominican Republic and therefore improve overall gross margin despite the lower product margin on this new revenue strength.

Given that these new outdoor and work initiatives won’t contribute to our results until next year. Combined with the fact that it’s still unseasonably mild in many parts of the country this late in October for the second consecutive year, we believe it’s prudent to take a slightly more cautious stands with our outlook for the fourth quarter. Based on current expectations, we believe we can achieve diluted earnings per share equal to the non-GAAP diluted EPS $0.52 we reported a year ago.

We’re confident that if we get a normal winter meaning something not as warm and dry as last year, but not as cold and snowy as 2010, we’ll begin 2013 in a good position to grow the categories that have been a bit sluggish this year. On top of this, our faster growing categories lead by western, lifestyle and commercial military along with other new initiatives such as our entrants into the medical industry which is on track to deliver product in the second quarter and providing the foundation for long-term sustainable sales growth and enhanced profitability.

Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting the question-and-answer session. (Operator Instructions) Our first question comes from the line of Mitch Kummetz with Robert W. Baird. Please proceed with your question.

Mitch Kummetz – Robert W. Baird

Yes, thank you. Thanks for taking my question. So I’ve got a few, Jim, I’m going to start with the, just the segment margins for the third quarter if you have those.

Jim McDonald

Sure. Wholesale was 34.6% and retail was 46.1%.

Mitch Kummetz – Robert W. Baird

46.1%, okay. And then David you mentioned some impacts on production away on the work business in the quarter. Could you quantify the impact to that and could you tell us if those issues have been resolved?

David Sharp

Yeah. Mitch, the issues are resolved. We have the goods now and then with sort of churn of about $2 million.

Mitch Kummetz – Robert W. Baird

Okay. And then on this new Tractor Supply program, can you talk about – what sort of volume are you talking about that? Is the margin structure I would assume it’s a little different than your current wholesale business? And is there opportunity to do this with other accounts maybe on the hunting with some of those customers?

David Sharp

Yeah. The volume we expect in the first year to be around $8 million in that neighborhood and it would initial set in the first quarter in the $2.5 million to $3 million range.

Mitch Kummetz – Robert W. Baird

Okay.

David Sharp

Then regarding margins I really wouldn’t want to discuss those and we from time to time, Mitch, we have done private label for other customers in the hunting market Bass Pro and in fact we still do a little bit for them. Where in terms of the facility in the DR were actually at capacity, next year will be at capacity. So I don’t think we’ll go and chase any private label hunting business.

Mitch Kummetz – Robert W. Baird

Okay. And then lastly, Jim, just if you can give us a little more, give us some color on how to get to the fourth quarter guidance. I know David you said $0.52 as you achieved in last year pro forma. I mean how should we be thinking about that in terms of growth also versus retail? I know for the third quarter, you were talking about sort of mid-teens wholesale growth and you came a little short on that. You talked about those issues, I mean, how should we be thinking wholesale and retail in Q4 maybe gross margin and SG&A in Q4 as well?

Jim McDonald

I think that before in the last call we talked about the third quarter being higher growth based on some of sales we missed in the second quarter and more what we had then experienced which was mid to upper single digit growths on our wholesale business. We think that’ll be a little bit, about half of that now, what we thought before and that’s primarily related to reductions from what we thought before in our hunting footwear and our apparel businesses which are more sluggish than we had thought. We sort of continue based on what’s going on the weather now.

And I think margins on a segment basis will be similar to what we had last year other than we had an inventory adjustment in our – at our retail store last year that we won’t have obviously this year. So I think the retail margins will be similar to what we saw in the third quarter of this year.

Mitch Kummetz – Robert W. Baird

Okay.

Jim McDonald

And with regard to sales we think, for retail, it’ll be flattish with last year and we don’t have any military segment sales there in fourth quarter.

Mitch Kummetz – Robert W. Baird

Okay. What about SG&A? I know as of last quarter you were saying about $3 million of additional SG&A in the back half and for the second quarter it was only up, maybe couple of hundred thousand. So has that outlook change for Q4 kind of what’s implied?

Jim McDonald

I think that the SG&A will be up a little bit more in the fourth quarter with we saw some additional advertising expenses that we’re planning on for the fourth quarter that we’ve already committed to. So I think that $3 million was based on the higher sales projection and the variable SG&A that went along with that. So I think it would be up higher in the fourth quarter than it was in the third quarter, but not as $3 million for the quarter.

Mitch Kummetz – Robert W. Baird

Got it, that’s helpful. All right thanks guys, good luck.

David Sharp

Thanks.

Operator

(Operator Instructions) Our next question comes from line of John Sullivan with Olstein Capital Management. Please proceed with your question.

John Sullivan – Olstein Capital Management

Hi guys. Just going into the fourth quarter be your cash flow kind of quarter I would say or are you really kind of reverse the rest of the year. Do you guys see any issues with the level of cash generation approximating earnings? Now given that I guess the shelter hasn’t been what you’ve been expecting.

David Sharp

I think that our – we’re still going to generate the same amount of cash as we do. It typically happens with our business is our cash need go up mostly through second and third quarter as we buy inventory and then turn it into receivables and then a lot of – particularly in our hunting segment, there is a lot of cash comes due in the fourth quarter, late fourth quarter. So we should – we still anticipate our cash – free cash flow to be equal to our net income with depreciation and capital expenditures being about equal in the low $6 million range.

John Sullivan – Olstein Capital Management

Okay, great thanks.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

David Sharp

Well thank you. We’ll continue to work hard by growing the business in the final quarter. We’ll talk to you next quarter. Thank you.

Operator

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

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