Rocky Brands Inc (RCKY) 2013 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 2013 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 now we'll turn the conference over to Mr. Jim McDonald, Chief Financial Officer of Rocky Brands. Thank you, sir, you may begin.

Thanks, everyone, for joining us. 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 our 10-K for the year ended December 31, 2012.

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

Thanks, Jim. In addition to our third quarter results, we also announced today that we've signed a definitive purchase agreement to acquire the Creative Recreation brand trademark, with other assets and liabilities which Jim will detail shortly. I'll first discuss our recent performance and then talk about the acquisition. I'll talk about the reasons behind our decision to deploy capital to purchase the Creative Recreation brand and why we believe this acquisition will help positively shape our future performance.

We're obviously disappointed with how the third quarter came together. After a very good second quarter, when all of our business segments posted solid gains, sales momentum slowed in several categories. The good news is that we believe this was due to a combination of temporary factors, including a change in timing on certain deliveries versus a year ago, and not indicative of the health of our brands.

First, it's been another mild, dry fall thus far, the third consecutive year of less-than-favorable selling conditions for our outdoor category in the third quarter. After the second quarter, in which most of our outdoor retail partners restocked their inventory positions ahead of the season after operating with relatively lean levels, sell-through volumes didn't materialize to levels expected, and that's reflected in a soft reorder business. While work is not nearly as weather-dependent as outdoor, the category is still sensitive to warm temperatures, and this third quarter was warmer than expected.

Second, the operating environment proved to be more challenging than we anticipated. With the potential government shutdown looming throughout the quarter, consumers and retailers, especially in our commercial military and work boot businesses, became much more cautious with demand. With this overhang now gone, we expect sales trends to slowly pick up as the fourth quarter progresses.

Finally, new product introductions, primarily in our Durango City line, were delivered in early Q4 this year compared to Q3 a year ago. This shift was offset by another quarter of strong gains for our Durango Western business, which was up 27% in the third quarter.

Following very good sell-through in the first half of the year, retailers planned for momentum to continue into the busier second-half selling season. Based on what many retailers have recently reported, it's clear that traffic was challenging as consumers decided to pull back on discretionary purchases of apparel and footwear. Therefore, we remain confident about our current product offering and believe our third quarter performance was largely due to the combination of timing and external events beyond our control that appear to have impacted most of the industry.

Year to date, our teams have worked hard to drive growth in our work, western, outdoor, and commercial military categories through compelling new product introductions and an improved selling platform. While I still feel good about the future prospects of our core footwear business, the reality is we don't currently operate in high-growth areas, making it difficult to consistently expand our top line and generate the leverage we need to deliver sustainable increases in profitability.

This is the primary reason we set out to explore a potential acquisition. We were looking for a brand that had significant growth potential, that didn't overlap with our existing brands, and provided entree in a much broader casual market -- a brand that targeted a different consumer and was available at a reasonable price.

In Creative Recreation, we believe we have found a business that fits all these criteria. Creative Recreation is not a typical casual brand; it's unique within the space, differentiated by footwear collections which, up until a few years ago, had not been available in the marketplace -- a fashion-forward, upscale sneaker fusing style and versatility. The brand easily transitions from the college campus to the club, from the beach to the boardroom, and from the street to the red carpet. Its consumer is much younger, much more of a city dweller than any consumer Rocky currently targets with our existing brands, say, Durango, which has made a push in this direction the past few years with its lifestyle collection. I expect there to be some selling and distribution synergies for these two brands going forward.

Creative Recreation's diversified assortment of products and high perceived value has enabled them to target a wide range of distribution and retail partners throughout various price points and channels. They currently sell in several leading accounts where we currently don't do business, including Barney's, Nordstrom, Bloomingdales, Journeys, The Buckle, and Tilly's, to name a few. The brand has also enjoyed popularity in Asia and Europe.

We feel Creative Recreation, led by co-founder Robert Nand, has made tremendous progress carving out a brand-new niche in casual footwear in a relatively short period of time with limited resources. With our well-developed sourcing, manufacturing, and logistics capabilities and access to capital, we believe we are the right partner to help Robert and his team unlock the brand's potential and strategically expand their lifestyle footwear sales, both domestically and overseas. At the same time, we will look to leverage their design expertise across our existing brands and product lines to drive growth and improve the consistency of our annual performances.

I'll now turn the call over to Jim.

Thanks, David. Net sales for the third quarter decreased 3.3% to $70.2 million compared to $72.5 million for the corresponding period a year ago. Wholesale segment sales for the third quarter were $57.4 million compared to $62.9 million last year, a decrease of 8.8%. By category, western increased 13% and work increased 5%, offset by a 27% decrease in outdoor, a 21% decrease in commercial military, and a 33% decline in lifestyle due to the timing of new product deliveries David mentioned. Retail sales were $9.6 million in both the third quarter of 2013 and 2012. Military segment sales increased to $3.2 million compared to no military sales for the same period in 2012.

Gross profit in the third quarter was $22.7 million, or 32.4% of sales compared to $26.2 million, or 36.1% of sales, in the same period last year. The 370-basis-point decrease was primarily driven by increased military segment sales, which carry lower gross margins than our wholesale and retail segments, and lower wholesale gross margin than a year ago, resulting from lower-margin private-label sales.

Selling, general, and administrative expenses were $18.3 million, or 26.1% of net sales for the third quarter of 2013 compared to $18.2 million, or 25.2% of net sales a year ago. The 90-basis-point increase in SG&A expense as a percentage of net sales was driven by lower sales and approximately $100,000 in expenses related to the acquisition of the Creative Recreation trademark.

Income from operations was $4.4 million, or 6.3% of net sales, compared to $7.9 million, or 10.9% of net sales, in the prior year period. We reported net income of $2.9 million, or $0.39 per diluted share, versus net income of $5.4 million, or $0.72 per diluted share, a year ago.

Turning to the balance sheet, our funded debt as of September 30, 2013, was $42.4 million, an increase of 1.2% from $41.9 million as of September 30, 2012. Inventory at September 30, 2013, was $78.9 million compared to $73 million on the same day a year ago. The increase in inventory year over year was attributable to lower-than-expected sales. Heading into the holiday season, we feel comfortable with the size and quality of our inventory.

Now I'd like to share a few financial details about the acquisition. The purchase price for certain assets included in the Creative Recreation trademark will be approximately $11 million, subject to a working capital adjustment at the time of closing, which is expected to be in the fourth quarter of 2013. We are funding the acquisition from cash available under our existing revolving credit facility. As I said earlier, we incurred approximately $100,000 in expenses related to the acquisition during the third quarter and expect to record approximately $1 million in related expenses during the fourth quarter.

In terms of the acquisition impact on our P&L, we do expect it to be modestly accretive to earnings in 2014, with net sales of approximately $20 million.

I'll turn it back to David for some closing comments.

Thanks, Jim. We feel good about what we've accomplished year to date. While our enthusiasm around our core business is being somewhat tempered in the near term due to a more challenging selling environment, it's being offset by excitement for our pending acquisition of Creative Recreation. The combination of recent innovative product initiatives and the addition of a young, exciting casual footwear brand to our existing portfolio of leading work, western, and outdoor brands has created a solid platform for future growth. We believe we have sound strategies in place to capitalize on the many prospects that lie ahead to deliver increased value for our shareholders.

Operator, we're now ready to take questions.

Thank you. (Operator Instructions.) Mitch Kummetz, Robert W. Baird.

Let's see, I've got several questions. I want to start just on the quarter itself. I know going into it, you guys had said that your fall order book looked pretty good. I think that the orders there were up year on year and that you had said that you were being pretty cautious with your reorder outlook. So I'm just trying to better understand. I get that the weather wasn't cooperative and there were some shifts in the business and all of that, and the government shutdown. But I guess I'm just still at a little bit of a loss for why the numbers came in so much worse than what was expected, given that -- were there cancellations on the order book? And even though you were being cautious on the reorders, did the reorders just come in that much worse than what you were anticipating?

Yes, I think, Mitch, you have to remember that 70% of our business is at once. And so we don't have real visibility into what that's going to be in the future. And it can be really damaged by unfavorable weather. And we did suffer a few cancellations, but it was really the reorder business that didn't transpire as we thought it would.

Okay. And then on the inventory, you mentioned it's up due to the lower-than-expected sales, but that you're comfortable with the size and the quality of it. I'm just hoping you can reconcile that a little bit more for me. I would assume it's higher than you would anticipate because of the lower-than-expected sales. I guess I'm just wondering why doesn't that create a potential problem as you go forward, if you have maybe more inventory than what you would have hoped? I would guess that that might create a situation where you have to close out some product that you weren't anticipating. Is that not really the case?

Yes. Almost the entire increase, or more than the entire increase is, really, in our western business, where we still have a lot of velocity. We were up 27% in the quarter. And then we're very optimistic about what can happen in the fourth quarter with our western business. And in all of the categories it's of good quality, and it's in line with where we want it to be.

And I don't think these are styles, Mitch, that are not going forward. It's just been the way we can bring those inventories down, too, is to cut off the supply a little bit here.

Got it.

So we'll make that happen in fourth quarter. But it should happen as we move to the first quarter of next year.

Okay, that's helpful to know. And then I think it was in the press release. You guys didn't really, I don't think you covered this in your prepared remarks, but in the press release, you talked about a more conservative sales outlook for the fourth quarter. Could you just maybe elaborate on that? What does that mean? Are you looking for sales to be up, down, flat, how much?

Yes. I think in our wholesale business, we're looking for a little bit over mid-single-digit increases. I think retail, there's some upside potential there, 5% to 10% in retail. And then in military, I think military will be, based on the orders we have now, will be just probably around $1 million in the fourth quarter.

Okay, got it. And then, Jim, maybe I didn't hear it, but gross margin by segment on the quarter? Did you cover that?

I don't know that I did -- I don't think I did, but I can give that to you now. Wholesale was 31.2%, retail 45.8%, military 14.1%, for overall (inaudible).

Got it. And then, just quickly on Creative Rec, you mentioned that you expect it to be modestly accretive, and I think you said based on $20 million revenues for 2014. Could you just give us what the run rate's been on that business for the last -- you know, how is that business trending this year? Maybe what it was up last year, just so we get some sense as to what the pace of business has been for them.

On a trailing 12, they're running at about $24 million to $25 million. Some of that is inventory liquidation, because they were in an over-inventory situation, really, for a couple of years due to poor operational execution, really.

So you're expecting the sales to be down in 2014 versus 2013 as you clean that up? Is that how I should think about that?

No, we think the inventory issue, by the time the acquisition transpires, they'll be all clean. So no, we're conservatively planning sales of $20 million. I think when we looked at the $25 million run rate on it, there were several million dollars of those that were sell-outs of discontinued products. And now, with the inventory clean, we won't have those sales. So there will be maybe less sales, but there wasn't much profit in those.

Got it. And Jim, how should I think about the profitability of this business from a gross or operating margin standpoint? Is it comparable?

It will be a little bit better in gross margin than our wholesale business, and similar -- obviously, if they have a fixed SG&A, until we leverage that over a little bit bigger base, but it should eventually be, certainly, as good operating margin than our current business, probably. It should be better, because we'll have a bigger base to leverage the fixed SG&A over.

Okay. And then speaking of the SG&A, are there some opportunities for cost synergies here? I imagine, as you integrate this, you'll keep the front end located in L.A., and there will be some opportunity to, maybe on the back end, move some things over to your end and eliminate some redundancies there. Is that how I should be thinking about that? Is there a cost synergy number that you guys are looking at for 2014?

I think where we're really going to help them is in logistics and sourcing and their organization. In those particular departments, we'll leverage what we do here with them. We don't have a cost synergy savings number yet, no.

Got it. I think that's all I have. Thanks, guys. Good luck.

(Operator Instructions.) Mark Cooper, Pacific Ridge.

Can you give us the cash flow and CapEx number for the quarter?

I have the cash flow for --

Or for the year to date, that's fine.

For the year, it is a use of cash of $11.2 million, and the fixed assets are $5.6 million purchases through three quarters.

Okay. In your comments about the shortfall, you said it's some industry trends. Can you be specific about what you would refer to that would give you some confidence that it's not just a Rocky issue here this quarter?

Yes. We have visibility to some of our key retailers' numbers, and sales numbers, and that is where some of the information is coming from. And we're also in the retail business, so we're pretty sensitive about what's going on in the marketplace in the US. One-fifth of what we do here is retail.

Has there been any competitive change from -- and I know they're not in the same lines that you are, necessarily -- but from LaCrosse since it's been under new ownership for the last year and a half or so?

No. If the question is sort of tilting towards market share, we don't think we've lost any market share, particularly to a brand like LaCrosse. They've had some issues internally with management changes and what-not and sales force changes. So although we're not privy to their numbers, I doubt that they're performing any better than we are.

And then lastly, the acquisition that you're about to do -- is this -- it's cash, it's all paid upfront. Are there any types of earn-outs or any other ongoing performance type payments that will be related to this?

No, there's no performance-related payments other than the one owner, Robert Nand, the President and one of the co-founders, is going forwards, and obviously, he has a lot of performance-based incentives.

Okay, great. Thank you.

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

Well, thank you, and we look forward to speaking to you again in approximately 90 days with improved results. Thank you.

This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.