Rocky Brands Inc (RCKY) 2022 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands Second Quarter 2022 Earnings Conference Call. (Operator Instructions) I would like to remind everyone that this conference call is being recorded. And now I will turn the conference over to Mr. Brendon Frey of ICR. Please go ahead, sir.

Thank you, and thanks to everyone joining us today. Before we begin, please note that today's session, 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 changes, 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 our reports filed with the Securities and Exchange Commission, including our 10-K for the year ended December 31, 2021. And I'll now turn the conference over to Jason Brooks, Chief Executive Officer of Rocky Brands.

Thank you, Brendon. With me on today's call is Tom Robertson, our Chief Financial Officer. We are very encouraged with the continued strong demand we experienced for our portfolio of leading brands during the second quarter, especially in light of the growing pressure on consumer spending, from inflation and the other macroeconomic headwinds. Our top-line performance year-to-date underscores the desirability of our innovative, functional footwear, the strong connections we forged with our core customers in multiple categories led by work, western, outdoor, and commercial military.

Over the past 15 months, we have integrated our acquisition of Honeywell's performance and Lifestyle Footwear business, which includes the Muck and XTRATUF brands and made important infrastructure investments to support growth, most notably, the opening of a new distribution and fulfillment center in Reno, Nevada. At the same time, we have faced certain internal and external challenges that have hampered our ability to fully capitalize on our progress and deliver the profitability this company is capable of generating.

Most recently, it has been higher than expected costs throughout our supply chain from first cost with our suppliers to inbound freight and port-related logistic expenses. We raised our prices at the start of the year. However, it hasn't been enough to fully offset the continued increases we've experienced, which resulted in second-quarter earnings coming in below our expectations. In response, we will be taking our pricing up again on September 1, which, along with improved supply chain conditions and the expense synergy savings we announced in early June will put Rocky Brands in a much stronger position to deliver sustained, profitable growth.

Tom will go through the numbers in more detail, but I want to spend a few minutes reviewing the highlights for each of our brands from the second quarter beginning with Durango. The brand continued to experience robust demand and finished up double digits for the eighth quarter in a row. We saw strength in both key and field accounts driven by strong sell-through and better on-hand inventory levels, with particular out performance in our farm and ranch channels. While we saw broad-based strength across our core Durango styles, we also shipped new styles, our very popular Maverick XP, Westward Series, and Rebel Pro, adding to the tremendous strength with our field accounts. In summary, the Durango brand continues to have major momentum and is poised for further gains as we continue to capture new shelf space with new and existing customers.

Turning to Georgia. The brand continued its strong performance with strong double-digit gains this quarter, fueled primarily by growth in the field accounts. We are particularly pleased with the headway we've made diversifying the Georgia business, while the Original Wedge, Georgia Giant, Romeo, and Muddog all represent major volume for the brand, we are also having success with newer items with more features and comfort. In response to certain competitor supply chain constraints, both large and small pharma and ranch accounts increasingly stock Georgia Loggers and work western styles to fill vacant shelf space.

Additionally, we saw the new AMP LT Wedge, a more modern take on our classic wedge grow almost 50%, and our work hikers grew 74%, fueled by strength in our Pacific Northwest accounts, an area usually dominated by our Logger and classic Romeo styles. The diversifying of regionality and new styles bodes well for the success of Georgia even as market forces weigh on the industry.

The Rocky brand, which brands work, outdoor, Western, commercial military and public service footwear also had another solid quarter. Outdoor and Western, in particular, were areas of strength while in work, the timing of key orders in the year-ago period that we didn't anniversary was nearly offset by new distribution we've added this year. Importantly, the honey season got off to a strong start, especially our outdoor apparel as many retailers were under inventory this time last year. Overall, the outlook for Rocky Work Outdoor and Western for the balance of 2022 remains solid. With respect to Rocky Commercial Military and Public Service division, the categories registered high teens year-over-year growth, one of the best quarters on record as the teams capitalized on growing market momentum, better product availability, coupled with increased deployments and training helped commercial military sales continue the positive trend established in the last quarter.

At the same time, our public service business had a terrific quarter, as the team adeptly executed its comprehensive sales strategy that focuses on proper forecast and on-time delivery for factory direct orders as well as increased customer contact informing them of our in-stock position for key Alpha force styles. With both groups, the growing demand and improved inventory positions, along with the closing of the U.S. Government fiscal year in September bodes well for a continuation of the strong momentum.

Our Muck and XTRATUF brands both posted solid gains in the second quarter. For month, the logistics and distribution challenge experienced in Q4 and Q1 dramatically improved this quarter. As a result, total shipments were up 41% year-over-year. Looking at the competitive landscape for Muck, the category is currently overstocked, but the Muck brand continues to perform very strongly with double-digit sell-through at some of our key farm and ranch accounts. With the rising cost of energy in key Muck markets, the natural resources industries are booming, which is driving opportunity for our work in industrial Muck products. XTRATUF also continues to see positive momentum, especially with the brand's key outdoor and fishing retail partners. In addition to demand for XTRATUF core offering, new styles such as the Omni Sandal and the Kids Ankle Deck Boots, which provided brand entry into 2 new product categories have performed well since arriving at retail stores in the second quarter.

Turning now to our Retail segment, there were some very positive developments in the second quarter. Most significant was the implementation of our Reno, Nevada distribution center singles processing function. This allowed us to bring live much-needed inventory for both Muck and the XTRATUF U.S. sites as well as enable our ability to fulfill those orders within one to 2 business days. We went live with this new processing function at the end of April. And since then, we have seen average daily sales for those 2 e-commerce sites double compared to last quarter. Unfortunately, at the same time, we were continuing to experience extended carrier delivery times. To help mitigate this, we expanded our expedient shipping options at checkout on some of our sites and continue to send tracking information so that customers can be more closely monitored shipping process. We will also soon be going live with alternative payment methods such as PayPal on our Canadian Muck and XTRATUF sites, which should lead to increased conversion and overall revenue capture.

Equally important, we saw double-digit increases in our Rocky, Georgia, and Durango brands on their respective e-commerce sites. Average order volume on full-priced items increased mid-teens year-over-year due to strong full-price selling and new price increases that went to effect. Looking ahead digital-first marketing programs, enhanced online user experience, and compelling new product launches have us optimistic about the growth prospect for this channel.

Meanwhile, our Lehigh B2B retail business had another strong quarter, driven again by significant growth in both new and existing accounts. With prices going up across the footwear industry, many of our customers have increased subsidy amounts for their employees, helping fuel our top-line performance. Additionally, many accounts are beginning to view providing safety PPE such as footwear, orthotics, and compression stocks as a tool to drive employee retention. With its wide offering of safety products, Lehigh has been able to organically drive additional revenue with existing accounts. And as Covid concerns have continued to abate our number of on-site iFit events is gaining pace, which, combined with our e-mail and SMS strategy is driving higher account participation rates and increasing our account revenue and penetration rate.

Overall, I'm very pleased with our top-line results and momentum in the midway point of 2022. While we are cognizant of the impact of certain micro economic factors that have on our overall industry demand in the near term, we believe our comprehensive portfolio of leading brands and continued focus on operational improvements puts us in a great position to continue capturing market share and to start driving enhanced profitability. I'm very excited for what the future holds for Rocky Brands, and we look toward to a solid finish to the year. I'll now turn the call over to Tom. Tom?

Thanks, Jason. As Jason outlined, growing demand and strong inventory to meet that demand drove another solid quarter for Rocky. Though operational challenges did hinder our ability to convert that demand into bottom-line results. Reported net sales for the first quarter increased 23.1% year-over-year to $162 million. By segment, on a reported basis, wholesale sales increased 29.7% to $131.2 million, retail sales increased 16.4% to $26 million, and contract manufacturing sales were $4.9 million. Turning to gross profit, for the second quarter, gross profit increased 9.4% to $53.8 million or 33.2% of sales compared to $49.2 million or 37.4% of sales, the same period last year. The decrease in gross margin was primarily attributable to higher-than-expected increases in product costs, inbound freight, and other shipping and logistics costs.

Gross margin by segment were as follows: Wholesale, down 500 basis points to 30.9%, retail down 80 basis points to 48.9%, and contract manufacturing down to 10.5% from 21.8% a year ago. As Jason noted, we are raising prices on September 1, and with this action, along with improving supply chain conditions, we expect gross margins in the second half of the year to improve compared to the second quarter.

Operating expenses were $48.2 million or 29.7% of net sales in the second quarter of 2022 compared to $40.7 million or 30.9% of net sales last year. Excluding $2.1 million in acquisition-related amortization, integration expenses, and restructuring costs this quarter, and $2.3 million in acquisition-related expenses in the second quarter of 2021, adjusted operating expenses were $46 million in the current period and $38.5 million in the year-ago period. The increase in operating expenses was driven primarily by higher outbound freight expenses and higher variable expenses associated with the increase in sales. As a percentage of net sales, adjusted operating expenses improved 80 basis points to 28.4% in the second quarter of 2022 compared with 29.2% in the year-ago period and improved 70 basis points compared to 29.1% in Q1 of this year.

Income from operations was $5.6 million or 3.5% of net sales compared to $8.4 million or 6.4% of net sales in the year-ago period. Adjusted operating income, which excludes the expenses related to the acquisition and restructuring charge in both periods was $7.7 million or 4.8% of sales compared to adjusted operating income of $13 million or 9.9% of net sales a year ago. For the second quarter, interest expense was $4.3 million compared with $3.4 million in the year-ago period. On a GAAP basis, we reported net income of $0.9 million or $0.12 per diluted share compared to net income of $3.9 million or $0.52 per diluted share in the second quarter of 2021. Adjusted net income for the second quarter of 2022 was $2.5 million or $0.34 per diluted share compared to adjusted net income of $7.4 million or $0.99 per diluted share in the year-ago period.

Turning to our balance sheet. At the end of the second quarter, cash and cash equivalents stood at $5.8 million, and our debt totaled $284.6 million, consisting of $125.9 million senior secured term loan facility and $158.7 million borrowings under our senior secured asset-backed credit facility. As of June 30, 2022, we had $38.2 million of borrowings available on our credit facility. Inventory at the end of the second quarter was $287.8 million compared to $143.5 million a year ago and $289.2 million at March 31, 2022. The increase in inventory was driven by overall cost increases and strong sales growth, combined with additional inventory on hand as a result of increased in transit times and distribution and fulfillment challenges experienced in the second half of 2021.

While inventory at the end of June was higher than we like, inventories are down from the end of last quarter slightly, including a $45 million reduction in-transit inventory as we expect to realign inventory levels with sales growth and inventory purchasing strategies over the coming quarters. With respect to our outlook, based on a more challenging macroeconomic backdrop, we now expect full-year net sales to be towards the low end of our previous range of 21% to 24% growth over 2021.

In terms of gross margin, the recent pressures we've discussed today will continue to weigh on wholesale margins in the second half of the year with some improvement compared to the second quarter as the price increases go into effect and start flowing through the income statement. Based on the outlook for wholesale margins and our projected sales mix by segment, we now expect overall gross margins to be approximately -- of approximately 34% by the fourth quarter, this year.

With the $3 million to $4 million in annualized savings from the cost-saving actions we announced in June kicking in, we will experience significant improvement in leverage compared with the first half of this year. With third and fourth quarter SG&A as a percent of sales dropping down to the mid-20% range. For full year, we are now targeting cement achieving approximately 100 basis points in expense leverage over 2021 adjusted levels and making further progress next year. This will help transform our top line success into stronger earnings, which, along with the cash generated by reducing inventories, put us in a good position to begin paying down our debt. That concludes our prepared remarks. Operator, we are now ready for questions.

(Operator Instructions) Our first question comes from the line of Susan Anderson from B. Riley.

I was wondering, Tom, if you could talk maybe a little bit about just the drivers of the gross margin pressure. Maybe if you could bucket it a little bit just in terms of magnitude and when you expect that to fall off? And then in terms of the price increases, how much are you expecting them to be up in the back half? And was there any in the first half? And do you expect that to fully offset the inflationary pressures?

Yes, Susan. Yes, good question. And so as we look at the rest of the year, I guess we'll start with the first part of your question, in the second quarter, we were -- as inventory came in, right, and we talked about in-transit inventory at the end of last quarter. As the on-hand inventory kind of swelled, we had a throttle inventory into the distribution centers, and we end up incurring more logistics costs than anticipated. And so we've gotten a lot of that through the P&L at this point, but there's still more to flow through from the balance sheet. And so we'll see continued pressure really in the third quarter and then mitigating a little bit in the fourth quarter.

The other driver is, as we noted earlier, that we've seen price increases from third-party sourcing factories in Asia. And so we're working to help mitigate those whether it be pushing back on those partners or even -- and the price increase that we've announced today.

And so it was -- in the prepared remarks, we stated, we anticipate getting to that 34% mark for the fourth quarter, which is down from what we had previously guided. The price increase more specifically, probably averages somewhere between $5 and $7 per pair. And really the effects of that will lag into Q4 and probably our larger accounts, we have to give them a little bit more notice. So likely more see the benefit of that as we move into the first quarter of 2023.

I just want to add on there. We did take a price increase at the beginning of the year. Obviously, it was not enough of a price increase. We do believe -- this one is more appropriate. We will have to reevaluate that as we come into the end of the year and if there will need to be any more price increases going into 2023.

Okay. Great. And then maybe if you could just talk about the wholesale order book, kind of what you're hearing there from your wholesale partners for the back half. It looks like you're expecting sales to be at the low end now, but then also going into 2023.

Yes. I'll start off here. I'm sure Tom will add some color. But we are still going into the Q3 and Q4 pretty positive. We saw a little slow at-once business in July, but nothing too awful scary. I think we tend to look at our product and it's more functional than fashionable. And people are still working. People are still in need of the types of products we have. So we still feel pretty good about Q3 and Q4 and then to go out into 2023 to try to predict anything right now is really complicated, I think. And are we going to get back to what is new normal and how does that kind of flow through? I think it's got to level off. I think we have to find a new normal here. And hopefully, we can get back to something in 2023.

Yes. Just to add on a little bit there. We obviously follow our bookings really closely. We've not seen any significant cancellations. And so what we're trying to retain really is, as Jason alluded to, we saw a little bit of softness in our at-once business, which is a large portion of our business, but nothing too concerning. And so I think we're being, I'll call it, cautiously optimistic for the last half of the year. That's why we're not really taking down our guidance, but just kind of going to a little lower end of the range we previously provided.

Our next question comes from the line of Camilo Lyon from BTIG.

This is Mackenzie Boydston on for Camilo. My first question is just on supply chain. I know that you said Q2, you saw some higher costs. But I'm just curious in terms of transit times and freight costs. Could you just kind of talk about what you're seeing now versus to what you saw earlier this year, just trying to understand like if you're seeing anything maybe come down from Q2 into the back half or is understanding like when you think transit times and costs might peak for you?

Yes. So I just want to be clear. We are definitely seeing costs come down. It's not coming down as fast as it went up, but we are seeing costs come down. I think where we talked about the cost in Q2 was we anticipated them maybe coming down a little quicker. And so they stayed up there a little longer than we anticipated. So we are definitely seeing that a little bit. And then in transit times are starting to get a little more normalized. And I would say 30, 45 days in transit times are more common today. And that's kind of what we used to see really before Covid and all the mess. We still have some outliers occasionally where you have a high expense and then maybe a 90-day time on time. But we definitely are seeing it come down a little bit and more normalize, I guess, from a transit time.

Yes. I think an important call out here, Mackenzie, is that some of the transportation costs that were incurred in the second quarter really relates to kind of our inventory position and us having to manage through all the logistics of getting the inventory into the DC. And so the takeaway from that is that some of these costs are really just temporary, right? And so as this inventory position works its way down as we're planning for Q3, but really for Q4, we'll see those, we call them extra type of logistics costs, import costs, we should see those to come down. And so that's the optimistic point of view on this is that some of these costs will go away as the inventory position gets better.

Perfect. That's really helpful. And then on just your brands, both your legacy and you acquired, could you talk about -- I know you talked about your remaining -- you're continuing to see demand be strong across your brands. But just any noticeable difference or call outs by income demographic, customer product type, just anything you could talk about from a demand perspective across your portfolio would be helpful.

I think this is a great question. We, because of the type of products, the demographics of it are pretty consistent, right? These are blue-collar workers. We might have some outliers occasionally here or there. But we sell all of the brands throughout all of the same kind of retail stores when you look at farm and ranch, you look at work boot stores, you look at outdoor hunting stores.

So we really don't see a lot of difference in that area. And I would tell you that our work boot business is still very strong. The Western boot business is maintaining and doing very well in both Durango and Rocky. If there's been anywhere that we've seen a slight adjustment is XTRATUF has a very functional side to it. And then it also has a little bit more of a -- I hate to call it fashion, but it has a little bit of a fashion side to it. So we've seen a little bit there from a slowdown standpoint, but nothing that's too awful. So the demand for our brands is still pretty strong right now.

Our next question comes from the line of Jonathan Komp from Baird.

Maybe just a follow-up question on the outlook for revenue growth at the low end of the prior range. I think you're implying something close to flattish in the second half to get to 21% growth for the year. So could you maybe just confirm that's what you're thinking? And any additional perspective you could add on sort of change versus the strong growth you just delivered in Q2?

Yes. Yes. So we're going to the lower range. I think we are relatively flat. There might be some upside there for the second half. I think just -- from a modeling perspective, John, I think you got to remember that last year was a really tough comp. That was kind of the -- or it was a very easy comp, I should say that was kind of the height of our distribution challenges following the integration. So I think you just need to message the numbers from there as well. But we don't plan to carry in this is as much back orders, if you will, into the fourth quarter either. So just some noise between quarters, but I think you're correct in your assumptions there.

Okay. And maybe a broader question on the sort of the revised margin commentary -- it looks like you're pointing closer to 7% for the year in terms of the adjusted operating margin. Could you just share any perspective as we look forward? Is that a new base to grow off of? And what are the pieces that -- or if you could quantify them sort of that look temporary this year that maybe we shouldn't factor in going forward?

Yes. I think there's a lot of temporary factors going into this year. As we work through this inventory issue, we're going to see efficiencies in several places. One, within the distribution centers themselves as they are jammed pretty tight right now. And so we'll become more efficient as those inventory levels come down, which, again, we anticipate seeing the inventory come down in the fourth -- a little bit in the third but more in the fourth quarter.

Also a lot of -- there's a significant amount of logistics costs around just trying to get move the inventory around between distribution centers, which I don't anticipate having next year, and also the core cost to merge rates, things like that, that were incurred in the first and second quarter as inventory swell that we do not anticipate on a go-forward basis as the inventories right sized. So I would say there's -- a lot of this cost is temporary in nature. Also, the price increases, as we've alluded to or we've spoken to, I should say, will also drive higher margins.

We just have to be patient for that price increase to take effect -- we had taken the approach last year of trying to thinking that the freight was probably going to be a little bit more of a temporary challenge. But when we got price increases from our -- from first cost essentially from Asia, we have to take a more dramatic price increase. And again, as we said, our plan is to try to mitigate those first costs as we move forward as well. So I would say it's more temporary. And for us to get back to LOI numbers, I would say, which would be a very low goal for us in 2023 from an operating margin standpoint. And I think our expectation would be that we would see some improvements.

Okay. That's really helpful. Just a last question for me. Sorry if I missed this, but Tom, is there any way you could give a little more color into the makeup of the inventory? Or just specifically where you see some of the excesses that you want to work through and sort of the plans -- the updated plans to get to that?

Yes. And so it's really clear. If you look inside of the makeup of the inventory, the bulk of our inventory position -- our excess inventory position is really around the acquired brands, particularly Muck and XTRATUF. Fortunately for us, those brands are performing very well. And so our plan is to move through that inventory -- like I said in Q3 and Q4 and right sized this -- and we'll continue to right size that really or optimize it into Q1 and Q2 of next year. We are probably a little bit heavier on inventory in the legacy brands, and that's really being driven by transit times, but also last year with everything going on in retail, we're up against really tough -- a lean operating environment or lean inventory environment for the legacy brands last year. But it's very clear to us, given the distribution challenges we had with the acquired brands in Q3 and Q4 of last year, that's where the inventory position is in the largest in proposition, I should say.

Ladies and gentlemen, our last question comes from the line of Robert Shapiro with Singular Research.

So is there any reason why you're waiting to raise prices until September 1? Is there -- you need to have some lag time? Or why is it a month away?

Yes. So there's typically a timing around that to make sure that we get it communicated with the accounts where we're able to take immediate price increases, we will. But typically, the key accounts are looking for anywhere from 60 to 90-day notices, and then just trying to make sure that we get it in the systems and in the processes. So...

They've been -- Robert, just to be clear, they've been announced. It's just -- we got to give the customers so much notice. And so we're giving our retail partners 30-day notice and thus their contract or agreement specifies longer.

Okay. Makes sense. And are there certain products that you can raise the prices of more than other ones? Or are you raising just a certain amount across the board for the shoes?

So we took the approach and looked at all the brands and all the products. And I think Tom mentioned earlier, it's somewhere between like a $5 and $7 price increase. There are definitely products that just cannot take those kind of increases. I would tell you, service is one of the brands that when you're talking about a price point type shoe to add $5 to would just kill it. So there might be some style specific like that, that we were only able to take a Dollar price increase, but the average for the core brands was 5% to 7%.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would now like to turn the call back to Mr. Jason Brooks for closing remarks.

Thank you very much. First, I'd like to just say thanks to all the Rocky Brands employees and the efforts that they've been putting in, in 2022 to put together a pretty good Q2. I also would like to thank our investors and our analysts. We've got a lot of work to do here, and we are focused on it and moving forward, and we look forward to finishing out a good 2022 and then moving on to an excellent 2023. So thank you for your time, effort, and support here today on the call.

Thank you. The conference of Rocky Brands has now concluded. Thank you for your participation. You may now disconnect your lines.