Rocky Brands Inc (RCKY) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands Third Quarter Fiscal 2010 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. 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 we'll now turn the conference over to Brendon Frey of ICR.

Thanks. 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, 2009.

I'll now turn the conference over to Mr. Mike Brooks, Chairman and Chief Executive Officer of Rocky Brands.

Thank you and thanks to everyone for joining us this afternoon. With me on today's call are David Sharp, President and Chief Operating Officer, and Jim McDonald, Chief Financial Officer and Treasurer.

We're very pleased with our third quarter results, which followed a much improved first half of 2010. Over the past two years, we have detailed a number of changes we have made to our operating platform, which has helped drive our enhanced profitability and report our best earning results in more than 16 quarters.

These have included restructuring our retail business, right-sizing our headcount, and improving the efficiency of our Company-operated manufacturing facilities. During this time, we also undertook the task of recapitalizing the Company, a process that included a successful secondary offering in May, from which we used proceeds to pay down a portion of our high-interest senior term loan. And just yesterday, we finalized our new credit agreement with PNC Bank. Jim will go into more detail on this shortly, but this will complete the current recapitalization and significantly reduce our interest expense going forward.

While a good deal of attention has been focused on the cost side of the business, we have and will continue to invest the time and resources to expand our top line. I think something that has gone lost this past few years as everyone has been focused on expenses, given the challenging economic conditions, is the powerful portfolio of brands we continue to operate.

David will discuss growth plans in more detail shortly, but I want to spend a few moments reviewing what drove our solid sales increase this past quarter.

Within our wholesale division, we experienced strong gains in our Work segment, led by our Georgia Boot and Rocky brands. These increases were driven by better weekly sell-through rates of our product lines throughout our strong network of independent accounts and national retail chains.

In 2010, we have introduced several new and innovative work products into the market, and the response from customers has been very positive. We have been successful at leveraging Georgia Boot and Rocky's long history of authenticity to gain market share with updated boots that are lighter, more comfortable, and more durable. These are very important features when our targeted consumers are evaluating their footwear needs and purchases.

Our Duty segment also posted solid growth in the third quarter, as we continue to win business outside the base business, Centralized Military Procurement System. Demand for our Special Forces Rocky S2V boot continues to grow, and we have quickly added resources to capitalize on this new sales channel, which includes the Army and Air Force Exchange Services worldwide.

Lastly, while our Western segment was only up modestly this quarter, we are encouraged by the early reads on recent brand extensions under our Durango line. Utilizing our proficiency in creating lightweight footwear, we have developed what we believe is the lightest Western boot on the market, and we are excited about the future potential of this compelling new collection. As we move into the fourth quarter and look out to 2011, we expect the recent sales trends we have experienced will continue to drive our top line expansion.

Jim will now review the financials, and David will discuss our growth plans in more detail. Jim?

Thanks, Mike. Net sales for the third quarter increased 12.3% to $74.8 million compared to $66.6 million for the corresponding period a year ago. Wholesale sales for the third quarter increased 9% to $59.4 million compared to $54.5 million last year. The sales increase was driven by a 16.5% gain in our Work category, with our owned brands, Georgia Boot and Rocky, increasing 12% and 56%, respectively, partially offset by a 35% decline in our licensed brand, Dickies. Our Duty sales also grew nicely, up 18% in the third quarter, while our Western sales increased 2% and our Hunting sales decreased 6%.

Retail sales for the third quarter were $11.1 million compared to $11.5 million a year ago. Finally, Military segment sales were $4.3 million versus $600,000 for the same period in 2009. The increase in Military sales was driven by shipments of footwear under our contract with the GSA that was announced in August 2009 and began shipping late in the third quarter of last year.

Gross profit in the third quarter was $27.2 million, or 36.4% of sales, compared to $24.7 million, or 37.1% of sales, for the same period last year. The 70-basis-point decline in gross margin was driven by the increase in Military sales, which carry lower gross margins than our wholesale and retail businesses.

Selling, general, and administrative expenses were $19.2 million, or 25.6% of sales, for the third quarter of 2010 compared to $18.6 million, or 27.9% of sales, a year ago. The increase is primarily due to additional selling costs and incentive accruals, which were partially offset by decreases in other expenses.

Income from operations increased 31.1% to $8 million, or 10.7% of net sales for the period compared to operating income of $6.1 million, or 9.2% of net sales, in the prior year. Interest expense decreased $1 million, or 50%, to $1 million for the third quarter of 2010. The decrease is a result of debt reductions over the past 12 months, combined with lower interest rates compared to the same period last year.

Net income for the third quarter increased approximately $1.9 million to $4.7 million, or $0.63 per diluted share compared to net income of $2.8 million, or $0.50 per diluted share, in the third quarter of 2009.

Turning to the balance sheet, funded debt as of September 30, 2010, decreased 36%, or $30 million, to $53.4 million compared to $83.4 million at September 30, 2009. Inventory decreased 7.6% to $62.9 million at the end of the third quarter compared with $68.1 million on the same date a year ago.

Finally, as Mike mentioned earlier, yesterday we closed on our new credit facility with PNC Bank. We filed an 8-K earlier today that contains the full details of the loan agreement, but I'll quickly review some of the highlights of this transaction.

It's a five-year agreement with availability to borrow up to $70 million, so it secures the Company's financing out until 2015. The interest rate is very favorable at LIBOR plus 1.75%. We are locked into this interest rate through the end of the year, with the ability to go as low as LIBOR plus 1.5% based on performance.

With these funds, we are retiring the $11 million remaining on the senior term net loan, which carries an interest rate of 11.5%, and paying off the GMAC borrowings, which carry an interest rate of LIBOR plus 3%.

Based on today's interest rates, we expect our 2011 interest expense to be approximately $1.5 million compared to an expected interest expense of $6.8 million in 2010. Included in our 2010 projection is a one-time non-cash charge of approximately $1 million associated with the deferred financing costs related to the repayment of debt that will occur in the fourth quarter.

We have obviously made significant progress reducing our debt level, not only this year, but over the last four years as well. If you look back to 2006 and 2007, our annual interest expense in both years was north of $11 million. We are extremely pleased to have secured this new financing at such favorable terms. I'd note that we would not have had the access to these rates had we not completed our successful secondary offering earlier this year and paid down a portion of our senior term loan back in May.

Going forward, we are now in a much better position to generate free cash flow that can be utilized for working capital purposes versus previous years, when we needed to borrow the majority from our credit facility.

David will now update you on the growth initiatives we are working on for next year. David?

Thanks, Jim. As we discussed on our previous earnings calls, we currently have four distinct growth initiatives. The first involves brand and line extensions of our Georgia, Durango, and Rocky brands. The second involves capitalizing on the growing popularity of our military boots. The third involves customer segmentation, and the fourth involves leveraging our brand equity worldwide.

First I'll touch on the brand and line extension of our Georgia, Durango, and Rocky brands. This is the fourth consecutive quarter that our sales of Rocky and Georgia work boots have increased in the strong double digits. As Jim just highlighted, in the third quarter we grew sales of Rocky work boots more than 55% versus the prior year period. Just as impressive was the 17% increase in our Durango business in the quarter versus the prior year quarter.

But the core of these impressive results is our more frequent and highly streamlined product introduction schedule. As our competitors continue to operate with one or two new product introductions each year, our rollout calendar now includes four introductions. In this light less than retail climate, the sales increase is evidence that our customers have an appetite for this calendar. And further validation that we are on the right track is the fact that year to date, 26% of our wholesale sales have been from products introduced to our retail customers this year. Last year, in 2009, only 13% of our sales were from products that were introduced in that year.

Bolstered by these new products, shipments to our three major traditional farm store buying groups are up from 12.1% to 33.4%. We're also capturing new customers. We recently shipped Nordstrom four styles for a test in 10 Northwest stores. Further, we now have 55 independent shoe stores testing our Giant By Georgia brand extension, along with a test commitment from DrJays in New York.

Continuing with this frequency and focused theme, this coming weekend we have a national sales meeting where we'll unveil an exciting new Rocky Branded product called La Range, which bridges all four product categories--that is, Work, Western, Duty, and Outdoor. As its name suggests, these products will be guaranteed durable as well as comfortable. The warranty will be 60 days for comfort, 180 days for outsole durability, and if its orthotic insert should ever break down, we'll replace it for the life of the product.

We believe that this product introduction will capture the attention of the industry and will become a new standard in these categories. And when our retailers represent all categories, our consumers will be captivated by the broad but focused display around one product concept.

Our second initiative, capitalizing on the growing popularity of our military boots, is just starting to bear fruit, now growing at a very strong pace, with sales at a rate of nearly twice that of 2009. The Army and Air Force Exchange Service business has challenged our supply chain, as the growth rates have exceeded our forecasts. We have responded with retaxing production resources to achieve spare capacity to fill current demand. Longer term, demand will be met with reallocating resources in our Puerto Rico manufacturing facility.

We continue to invest in and build our commercial military business with new products. Those products include basic military combat footwear with improved comfort features, and another fast-growing category, featherweight boots that soldiers wear when traveling and training, which are not meant for wear in theater, but meet uniform requirements. Overall, three new styles were introduced in September, which had nominal effect on Q3 results, but should yield a positive impact on Q4 sales.

Now turning to our third initiative of customer segmentation. This continues to serve us well. Perhaps the largest benefit of this initiative has been the streamlining of processes enabled by our business-to-business Rocky Brands Connects website, where our highest customer served dealers can bypass our Customer Service Department and find products and delivery information to place orders.

Starting with modest sales of under $100,000 in January of this year, when we launched the site, we met a major milestone last month in September, bypassing $1 million of sales in that month. As we have mentioned on prior calls, we can attribute some of the reduction to our day sales outstanding to this set of customers. They're now incentivized to prepay their shipments with a credit card.

Another part of the segmentation initiative involves loyalty programs for our high growth potential customers. We've seen a growing interest in this program, and next year we'll focus our efforts on incentivizing these customers to buy across our brand product segments, not just to grow within a brand. This is where we believe Rocky Brands has significant unrealized potential. A great deal of this initiative will be managed with customer relationship management software, which we've used successfully in our retail business over the past two years, and which we have customized for our wholesale business, specifically to aid this initiative.

Our last initiative is enabling international growth of our Georgia, Rocky, and Durango brands. As you may be aware, there's a great deal of upside for us globally, and we've been focused on developing this business through a network of experienced and visible distributors.

In the third quarter, we continued to build on our prior successes. Through September, we have shipped $6.1 million internationally versus $4.6 million in the same period last year. We now have two distribution agreements in the UK, five in Europe, and one in the Caribbean. We also have agreements pending in Japan and Israel.

In closing, we're pleased to report on these growth initiatives and their significant results. During 2011, we'll broaden and deepen these initiatives as well as bring new focus on optimizing inventory levels, leveraging customer relationships to sell more customers all of our brands, and to continue to leverage our technology investments to grow operating income.

I'll now turn the call back to Mike for some closing remarks.

Thank you, David. Our third quarter and year-to-date performance is very rewarding. During the past several years, we have faced a number of challenges, both internal and external, and tackled them head-on. Today's financial results underscore our efforts to create a more efficient organization, strengthen our balance sheet, and take advantage of our core competencies and portfolio of popular brands to expand our market share.

While we are certainly pleased by the recent financial improvements we have delivered, we are committed to building on our current momentum to drive future gains across the board. We believe there are many growth opportunities still in front of us, and we are continuing to work hard at maximizing the full potential of this business. We look forward to updating you on our progress when we report our year-end results in February.

With that, operator, we are now ready to open the call for questions.

Thank you. (OPERATOR INSTRUCTIONS.) Our first question comes from Mitch Kummetz from Robert W. Baird.

Yes, thank you, and congratulations on the quarter on the new financing. I've got a few--well, actually, I have a variety of questions. I'll just jump into them. First, on the Work business, David, you mentioned that you've seen some pretty strong results there now. I think you said four quarters in a row. So does that business get tougher as you anniversary that, or do you still feel good about the new product that you have in place or the new calendar, that you expect continued acceleration of that business? Or how do you view Work at this point?

Mitch, we can continue to sustain, particularly this year with 25% of the products being new to those customers, so if it clicks, which we're seeing it clicking, that can help us fill it in. You know how that business is. They sell it there and they buy it there, and they sell it there and they buy it. So we would expect to benefit from that going forward.

Okay. And let me ask you about the Hunting business, which was down in the quarter. Is that a reflection of the fall pre-books not coming in very well, or is that more a reflection of some weak in-season orders, maybe due to some warmer-than-expected weather, or how should I think about that?

I think it's the latter. We haven't had the selling activity that we had last year. Last year we got some really cold, wet weather early since anniversary. So, and there was one or two programs that we delivered late, shifting the quarters. So we left dollars on the table, Mitch. We were late in delivering a large program, actually, out of our own facility in Dominican on a timely basis. But many of the components were sourced in China. So that was part of it.

Now, are those dollars you pick up in Q4, or do you lose them?

Well, that's a really good question. We're going to try to pick them up in Q4, but it's difficult. The window is pretty tight, and we won't pick up dollar for dollar. I don't believe we'll pick up dollar for dollar. We haven't taken a lot of bets on inventory in that category this year. We're very focused on growing the Work business.

And then on the Military piece, those numbers came in better than expected, and it sounds like demand outstripped supply due to some constraints there. Does that business continue to build as we go forward?

What we were trying to explain in our written piece was, of course, we're still working on the GSA contract, and we know what we have to build every day, every week, every month, and that's pretty simple. We did not expect--we've had good results for almost a year and a half on this S2V Special Ops boot, but as we moved to distribute in the US through the conventional PX system, we just got a little overwhelmed. We didn't plan, and they don't forecast, and we didn't plan enough. So we've been chasing that, and we see no reason that we will not continue to increase production and increase sales over that product over the next year.

Okay. But does the GSAP start to fall off then?

It does, Mitch. Right now we are through this fourth quarter. We're waiting for a new commitment from them, which we do not have, so yes, the GSA will fall off. That's lower margin. The boot I'm talking about, the S2V, is a Rocky full-margin boot.

Okay.

Mitch, the S2V boot that Mike spoke about, that's actually reported under our wholesale segment. It's a commercial boot.

Oh, okay.

What's under our Military segment is actually the bid business. So that business in fourth quarter, absent us getting any more business, which we don't anticipate for the fourth quarter, it will be roughly $1 million.

Okay. Okay. And then just a few quick other ones. On your retail business, it looks like the declines are starting to moderate there, and I know, Jim, off the last call, you talked about maybe flat to down slightly in the back half. So do you expect those declines to continue to moderate in the fourth quarter or maybe even get to flat or up a little bit in Q4, based on anniversary and some of the getting rid of the trucks last year and switching to the Web?

I think we were basically flat in the third quarter, or a $400,000 difference. So I would anticipate it being similar to that as we move into the fourth quarter.

Okay. And then could you address--I know your gross margin was impacted by the size of the Military business. But could you talk about the overall gross margins per your operating segments for the quarter? It sounds like the wholesale was pretty good.

Yes, the wholesale was up 40 basis points, which I think we mentioned in the earnings release and Mike's opening comments. That was up 40 basis points. And the retail was actually up about 30 basis points also. So they were both up. It was strictly the blend of military products, with our military coming in at just over 15%.

Okay, and then the last question on the SG&A. I know that on the last call, you talked about advertising coming in. I think you said it would be up $2 million in the back half versus last year. It didn't sound like you saw much of an increase there in Q3. Maybe I'm wrong about that. But are you still expecting that to increase in the fourth quarter, then?

Yes. We're still expecting some increase over last year, yes.

Okay. All right, great. Thanks. Good luck.

Thanks, Mitch.

Thank you. (OPERATOR INSTRUCTIONS.) Our next question comes from Reed Anderson from D.A. Davidson.

Hi, guys.

Hey, Reed.

Can you hear me okay?

Yes, sir.

Good. Well, good quarter. A couple of questions. Obviously, given the financial condition and how well things have improved, et cetera, if you look into next year, Mike, you've had a lot of success with new product and compressing that cycle of rolling out new product, et cetera. Is that an area you want to continue to invest in, whether it's people or programs? Just what are your thoughts as we look at next year to keep this momentum going on the product side?

The short answer is that we've got this financial monkey off our back, and it's taken us a long time, but we've digested the acquisition that put us in this position. So I really feel good about the flexibility we have with our new bank and our lowest interest rate. It gives us a lot of breathing room.

It's all about product--innovative new product and branded product. We're asking premiums for our products, and you have to have new, fresh, innovative product. We talked about lightweight, flexible, durable. Those will be the drivers. And we need a little help from the economy. So we're going to get everything that we can help control. David, I don't know if you've got anything?

Well, to your question regarding increased costs, we feel that we can do a lot more business with the infrastructure that we have. We have a lift in sales into some people, we've got the product development, the infrastructure, we've got the customers. We just need to focus and sell those customers more stuff. And we have compressed the frequency, but we've also at the same time streamlined what we're doing. So we're doing a lot fewer things better around product development and product launches. And I think that's where we're seeing this lift in sales.

Thank you, David. We've learned. We've (inaudible) up those people. We're not going to run out, and we want to reap some of our rewards over the next few years, and we're going to remain diligent on costs.

Good. That's good. And so really, it sounds like the shift to, again, the more frequent product add, actually, you just shifted the focus and retooled the way you go to market as opposed to change things in a wholesale fashion. It's not you need to add a lot of bodies. You can keep that going. You're smarter with your resources. Is that fair?

Exactly. That's very fair. Right on target.

Okay, that's good. And to that point about the new products, Jim, are there older lines or older models that are rolling off, or is the SKU count here really expanding quite a bit right now?

One of the things that we've become very cognizant of, as we have added all those new products, is making sure that at the same we're rationalizing older products and we're moving them out of our inventory in the right way. And right now, that's top of mind for us. We're very focused on putting in systems and processes to ensure that we don't get into inventory problems and obsolescence problems with all this new product.

And I think that's proven out, Reed, by looking at our inventory reduction over the last, certainly, four quarters, maybe deeper. No, we're just not expanding to expand. I will tell you that our inventory's cleaner today than it's ever been.

That's great. And then just a couple more. The comments you made, David, on loyalty programs and working with those--I noticed, I'm a Cabela's cardholder, I saw a promotion that you and some other brands are running with them recently where if I bought Rocky Brand boots, I would get bonus points accrued to my account. Is that kind of the thing you're talking about, where you partner up with a leading retailer and find a way to really surgically address certain customers? Is that what you're getting at, or is it something different?

Yes, we're doing that thing, that kind of thing in some markets with some of our dealers. But this is more incentive at the dealer level, incentivizing them to buy more categories from us and more brands. The more loyalty they show towards us, the more incentives that we're willing to give up for them to do that. And specifically for--.

I get you.

Okay, goodbye.

I'm sorry. So I get you. I was thinking it was on the consumer end. It's really, it's with the retailer that's the wholesale customer. That's really what you were talking about?

Yes, yes. We do partner with high-profile retailers in some markets in their rewards programs, yes.

Okay, understood. Now I get it. And then last one, Mike, obviously, international is small, but it's showing some nice growth. You've got a number of things. It looks like you can keep that going. Does it make sense that that can actually accelerate on a growth basis, or is it too early to tell? And I'm really looking into next year.

I'm going to let David answer that. The short answer is that it's been a strategy of ours now for a year and a half, and I think we're finally just starting to see some acceleration, and it will add profits. But David can--.

Yes. I think that it's not unlike trying to grow businesses here in the United States. First, you've got to find a dealer network, a distributor network. And where we're penetrating Europe and the UK pretty nicely now, and we're also focused on South America. So most of these distributors that we talked about are new. They've come onboard in the last 18 months, and of course, they're, given the economic climate, it has been just toes in the water at this point. So they're testing our products, and some of them are having nice successes. And I'm sure we can grow those businesses quite rapidly.

Okay, that's great. That's it for me. Thanks a lot. Good luck.

Thanks, Reed.

Thank you. (OPERATOR INSTRUCTIONS.) We appear to have no further questions. I will turn the call back over to the speakers for any closing comments.

Well, thank you, ladies and gentlemen, for tuning in, and we look forward to speaking with you early next year. Thank you, operator.