Jul 27, 2011
Executives
Brendon Frey – ICR David Sharp – President and CEO James McDonald – EVP, CFO and Treasurer
Analysts
Mitch Kummetz – Robert W. Baird Reed Anderson – D.
A. Davidson Mark Cooper – Pacific Ridge Capital Partners LLC
Operator
Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands Second Quarter Fiscal 2011 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 given 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. Thank you.
You may begin.
Brendon Frey
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, risk 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 the reports filed with the Securities and Exchange Commission, including Rocky’s Form 10-K for the year-ended December 31, 2010. I’ll now turn the conference over to Mr.
David Sharp, President and Chief Executive Officer of Rocky Brands.
David Sharp
Good afternoon, and thanks for joining us. With me on the call is Jim McDonald, our Chief Financial Officer.
Today, for the first time, since the company entered the public market in 1993, Mike Brooks will not be joining us on the call. As we previously announced, Mike transitioned to the role of Chairman of the Board on July 1.
While he is not involved directly with this earnings call he is still very much a part of our company, just as he is been for almost 40 years. And the management team here at Rocky Brands is looking forward to benefit from Mike’s guidance and wisdom in the years ahead.
Now to the second quarter, which represented our 8th consecutive quarter of increased earnings on a year-over-year basis. We’re particularly pleased with our recent results as a significant increase in net income on a non-GAAP basis was achieved through improved operating performance highlighted by a 6% rise in wholesale sales or 11% increase from continuing operations, which excludes Dickies and higher gross margins in both the wholesale and retail divisions.
If you look at our current profitability turnaround in stages, the first stage was driven primarily by reductions in operating expenses because we trim costs from all areas especially in our retail business as part of that division’s restructuring. In 2010, selling, general and administrative expenses were down more than $24 million, compared with 2007.
The next stage of our earnings growth was fueled by a significant reduction in interest expense. We improved our balance sheet during 2009 and 2010 by retiring our high interest term loan.
We retired the loan with cash flow from operations, proceeds of our successful follow-on offering and funds from a new lower interest credit facility. Our debt level at the end of last year was $35 million, down $68 million, or 66% versus the end of 2007.
And our interest expense in 2011 is projected to be approximately $1.5 million, compared to $11 million in 2007. More recently our bottom-line improvement has been aided by higher gross margins as our own wholesale brands, which carried the highest gross margins in our portfolio have become a larger percentage of our total sales.
Gross margins have also benefited from sales programs instituted in early 2010, which encourage our retailers to purchase their (inaudible) on a weekly or bi-weekly basis instead of waiting for us to stimulate the sales through price promotions. Additionally, gross margins have increased from a combination of higher average selling prices in our wholesale and retail divisions, and improved efficiencies in our company-owned manufacturing facilities.
For the second quarter, gross margins were up 480 basis points, compared to a year ago. Over the past three years, we have created a very lean, more efficient company with the heavy lifting on expenses, and the balance sheet improvements complete, we now have the financial flexibility to invest in our brands, and create new opportunities to grow our top and bottom lines.
Our research and development efforts over the past 12 months have yielded some positive results. We’ve been encouraged by the response of several new product introductions, particularly in our commercial line of military boots, and we continue to build momentum with our brand extensions in the DURANGO and ROCKY brands.
This has led to increased shelf space with several of our domestic retail partners, and we think there is still opportunity to expand our brands within their existing work, western, and hunting footwear categories. With that said, these categories have been growing at fairly low rates in the United States over the last several years.
Therefore, we’ve identified and prioritized other key vehicles to also expand our business in the future. The first of these involves growth in new markets.
In 2010, we generated $7.9 million in sales outside the United States through direct operations in Canada and distributors in the European Union, Russia and Central and South America. This compared to international sales of $5.7 million in 2009, an increase of 40%.
We’re confident that our brands and high quality products will continue to resonate with consumers in other countries. And we will benefit from increased distribution and new partners.
Through six months this year, our sales in international markets are maintaining the 40% sales velocity we’ve achieved last year. The second is growth in new categories.
And this includes both footwear and apparel. We think our brands have the heritage and authenticity to extend into complementary categories.
For example, as a leader in hunting, the Rocky Brands has natural opportunities in other areas of the broader outdoor footwear markets beginning with fishing and camping. Similarly, we have a successful line of hunting apparel.
We now need to do a better job exploiting this competency and take advantage of our retail relationships to penetrate new clothing initiatives. For example, this fall, we’ll ship work apparel to select accounts complements our successful Long Range western and work program.
This apparel carries the same long-term comfort and durability guarantees, just like our Long Range footwear offering. Third piece of our current growth strategy involves an acquisition.
With a healthier balance sheet, and improved cash flow, we are now in a position to evaluate acquisition targets. While we have no immediate plans to add to our portfolio, we are keeping our eyes open for the right company, should it cross our radar screen.
To give you an idea of what we are thinking, this would be something much smaller than our acquisition of EJ Footwear, who would provide us with an entrance into a larger higher growth category. It wouldn’t overlap with our current businesses, but it would diversify our current sales in terms of distribution and target consumers.
I will now turn the call over to Jim, who will review the financial details of the second quarter. Jim?
James McDonald
Thanks, David. Net sales for the second quarter were $52.3 million, compared to $55.2 million for the corresponding period a year ago.
Wholesale sales for the second quarter increased 6% to $40.8 million, compared to $38.5 million last year. The sales increase was driven by a 17% gain in our western category offset by a decline in our work category due primarily to the discontinuation of our license agreement with Dickies at the end of 2010.
We also experienced a significant increase in our commercial military business versus a year ago. Retail sales for the second quarter were $10.9 million, compared to $11 million last year and military segment sales were $0.6 million versus $5.7 million for the same period in 2010.
The decrease in military sales was attributable to the completion of our initial order under our contract with the GSA before the start of this year. Gross profit in the second quarter was $20.6 million, or 39.6% of sales, compared to $19.1 million, or 34.6% of sales for the same period last year.
The 480 basis point improvement in gross margin as a percentage of sales was primarily attributable to the decrease in sales in our military segment, which carry lower gross margins than our retail, and wholesale segments. We also benefited from 290 basis point increase in our wholesale segment and 250 basis point increase in our retail segment driven by higher averaging selling prices and improved manufacturing efficiencies.
Selling, general and administrative expenses were $16.9 million, or 32.2% of sales in the second quarter of 2011, compared to $16.2 million, or 29.3% of sales a year ago. The increase was primarily attributable to an increase in planned advertising expenses.
Income from operations increased $3.8 million, or 7.2% of sales for the period, compared to $2.9 million, or 5.3% of sales in the prior-year period. Interest expense for the second quarter decreased to $0.3 million from $2.1 million in the second quarter of 2010.
Last year’s expense included onetime fees of approximately $0.9 million pre-tax associated with the early prepayment of a portion of our senior term loan. Excluding the one-time fee from a year ago, the decrease is attributable to lower interest rates as a result of the new $70 million revolving credit facility signed in October 2010.
We reported net income of $2.3 million, or $0.30 per diluted share versus net income of $0.5 million, or $0.08 per diluted share. On a non-GAAP basis excluding the aforementioned onetime fee of $0.6 million net of tax, net income for the second quarter of 2010 was $1.1 million, or $0.17 per diluted share.
I’ll quickly touch on a few of the highlights from our year-to-date results. For the six-month period ended June 30, 2011, wholesale sales increased 5.5% and excluding Dickies wholesale sales were up 10.6%.
Gross profit margin improved 410 basis points to 38.1% with the wholesale gross margins up 210 basis points and retail gross margins up 310 basis points. Interest expense was down $3.3 million and net income improved over $2.8 million and diluted EPS was $0.38 per share, compared to a loss a penny last year for the same period.
Turning to the balance sheet, our funded debt was $39.5 million at June 30, 2011 versus $36.9 million at June 30, 2010. Inventory increased 20.4% to $74.4 million at June 30, 2011, compared with $61.8 million on the same date a year ago.
The increase in inventory is primarily the result of an increase in cost per unit. We feel comfortable with our current inventory position as we head into our busiest selling period of the year.
Operator, we are now ready to take questions.
Operator
Thank you. (Operator instructions) Our first question comes from the line of Mitch Kummetz with Robert W.
Baird & Company. Please proceed with your question.
Mitch Kummetz – Robert W. Baird
Yeah. Thanks, and congratulations on a good quarter.
Few questions, Jim, I’ll start with you. On the gross margin, I know you talked about mix and military dropping as a percentage of your overall sales, first of all, could you just remind us what the military gross margin was in the quarter?
Was it kind of in that 13% range like it’s trended historically or?
James McDonald
Yeah, it was 12.9% for the quarter.
Mitch Kummetz – Robert W. Baird
Okay 12.9%. And then when you look at the benefit or the improvement that you saw both on the wholesale, and the retail side, could you maybe speak to some of the benefits that you saw there in terms of Dickies coming out of the mix, and then some of the things you are doing on the Dominican and in terms of production?
And then maybe what the impact is kind of the net impact of cost increases versus what you’re doing on the pricing side?
James McDonald
Yes, I think that Dickies – the mix certainly with Dickies on the wholesale is at about a substantial play there where we – we were net – we were recognizing about net 20% gross margins on the Dickies business versus approximately 40%, almost double on the other business, our own company-owned brands. And so that definitely played a role in it and were fairly significant, as well as our improved efficiencies down at the factory, where we’ve increased production quite a bit.
And we’ve been able to offset by moving some of our production from our factories in China, our third-party factories in China we’ve been able to increase the margins on those by lowering the prices, by lowering the cost on those. So, I would say that would be the second piece.
And then the third would be that we’ve had better transactions, as David talked about with the way we’re doing – having our customers order and have it be less promotional. So, I think that’s the ranking of how they affected this quarter.
Mitch Kummetz – Robert W. Baird
Okay. And so – and then can you just remind us where you guys stand in terms of your price increases?
I know you took some in the first half of the year, I know you are contemplating taking some in the back half. And I mean, to start that, could you just say kind of what was the net impact of costs versus the price increases in the first half, and how you are viewing that in the back half?
James McDonald
Well, I think our – we raised our prices approximately 5%, which was in line with our cost increases that we saw. We headed into the beginning of this year and that price increase was effective mid-December of last year.
We’re reevaluating now because cost have gone up from the beginning of the year on our source products, so we are reevaluating that and looking at a potential price increases we move to the back half of this year.
Mitch Kummetz – Robert W. Baird
And what are the price increases – I’m sorry – the cost increases on the back half? Are they up like 10%?
James McDonald
No. I think we’re looking more in the 3% to 5% range.
Mitch Kummetz – Robert W. Baird
Okay.
James McDonald
In the back half.
Mitch Kummetz – Robert W. Baird
Got it. And then, David, in your prepared remarks, you talked a little bit about what you’re doing on the international side.
I know it’s still a small part of your overall business, but can you maybe talk about where you are in terms of where you’ve built out your international business? What distributors are online now?
What’s in the pipeline? Where’s that 40% growth coming from year-over-year?
David Sharp
Yeah. I think we’re pretty well distributed now in hunting in Europe, and the Baltic and Balkan states.
And now we’ve really turned our focus to work boots and western boots. And we seem to be getting some traction in South America and Central America there.
And in fact, we are currently in discussions with a manufacturer in Brazil that would be licensing our brands. So, depending on the region of the world, Mitch, we’re looking for the business transaction that would bring the consumers the best value.
So, in some cases, it might be a licensing arrangement or a distributorship arrangement. But we’re on track to deliver what we have planned – pretty aggressive plan for international sales through the end of this year.
Mitch Kummetz – Robert W. Baird
Okay. And then lastly, on the retail business, I know you’ve been going through that transition there in terms of shifting out of the mobile stores to the web.
Could you just remind us where you are, how many mobile stores you still have, where’s that headed to the end of this year? And then how much of your – what percentage of your revenues, maybe Q2, were on the web, and what the plan is for – by year-end?
David Sharp
We’re running – currently close to 30% of our revenues are coming through – the rest are coming through the trucks and through direct sales. We’re operating about 60...
48 mobile stores right now, trucks. And we’re in a position now that we’re able to know just how profitable they are through our investments in technology.
And when they become – if they become that unprofitable, they’ll be retired. Obviously, our plan is to leverage this investment we’ve made in the web just as much as we can.
So, that’s where we’re focused now.
Mitch Kummetz – Robert W. Baird
Okay. All right.
Thanks a lot. Good luck.
David Sharp
Thanks.
James McDonald
Thanks.
Operator
Thank you. Our next question comes from the line of Reed Anderson with D.A.
Davidson & Company. Please proceed with your question.
Reed Anderson – D. A. Davidson
Good afternoon, and let me also add my congratulations. A couple of questions.
David, you’ve talked about, or just in the last questions, you had mentioned again the licensing opportunity in footwear. You’ve done some other things in accessories.
We’ve seen some recent announcements. But clearly, there’s more of an emphasis on licensing.
And I’m just curious, I don’t know if you want to quantify it, but just give us a sense of how that might play out here over the next year? Or what the opportunity is for that to boost sales and profits, et cetera.
David Sharp
Well, here in the U.S., we’ve been working with a third party and trying to leverage particularly in what Rocky stands for in outdoor market. So, you saw some of those announcements we made.
And we’re in discussions now for more licenses in some other consumer products categories that will bring more revenue this year. I think that that’s a little speculative though, I don’t think we’d want to put a number on that right now, Reed.
Reed Anderson – D. A. Davidson
Sure, no that makes sense. But clearly, it’s kind of a new avenue you’re pursuing to get some additional growth, it sounds like?
David Sharp
Yes, it is.
James McDonald
Reed, just the licensing revenues we report as other income, so we don’t report those as top line sales.
Reed Anderson – D. A. Davidson
Okay, that was going to be my next question, so that’s – so we’ll kind of watch it there. That’s good.
I think that’s a good development, though. And secondly, David, in your prepared remarks, you kind of articulated some of the strategic focus, et cetera, and talked about acquisitions.
And I guess my question there is when you’re thinking about what’s a good fit, would you want something that’s all in and would run itself or stands alone? Or would you just look be more – be looking to get a brand or something like that, that you could just strap onto your existing platform and existing channels, that kind of thing?
What would be – give us some thoughts there, please.
David Sharp
Well, I think what we’re looking to do is to not do more of what we’re doing to get into the casual markets. And obviously, we’ve developed a pretty nice sourcing and manufacturing and distribution capability.
And if there was a company that would be a good fit with us that had the front-end pretty well accomplished. I think that would be a good fit for us.
Reed Anderson – D. A. Davidson
Okay. That makes sense.
On the western business, I think, Jim, you said that was up about – it was 17% in the quarter?
James McDonald
Correct.
Reed Anderson – D. A. Davidson
And I guess my question there is does that reflect just a lot of some of the newer products and some of the demand or excitement around that? Or is it more distribution?
A combination of both? Just clarify that, please.
James McDonald
That was almost entirely attributable to new products in the Rocky line, a new product called Long Range.
Reed Anderson – D. A. Davidson
Okay.
James McDonald
– Which has been very well-received. And now is at retail and retailing really well, too.
We’re getting nice reorders.
Reed Anderson – D. A. Davidson
That’s great. And then my last question is just, thinking about the timing, now you’re coming up, or you’re in your big quarter of the year, if you will.
We’ve got probably got an early read on that outdoor channel. That’s going to be more important.
I’m just curious, David, what your thoughts are. I mean, a lot of the people in that area seem to be performing well.
Are you seeing that look equally good at this point? I’m obviously just a little ways out yet, but I’m just curious, your initial thoughts here.
David Sharp
Yes, I think that we are cautiously optimistic. Last year was a very good year, which produced very strong comps.
We had weather early in the season was sustained throughout the season. So, we think that we – the back half wholesale will – can hold about the same trend that we’ve achieved in the first half, there is no surprises in the economy.
Reed Anderson – D. A. Davidson
That’s great. Best of luck.
Thank you.
David Sharp
Thank you.
Operator
Thank you. (Operator Instructions) Our next question comes from the line of Mark Cooper with Pacific Ridge Capital Partners.
Please proceed with your question.
Mark Cooper – Pacific Ridge Capital Partners LLC
Hello, I wanted to come back to the inventory comment that you mentioned, I think inventories – you suggested they were up entirely due to pricing, not to actually units held, is that correct?
James McDonald
I think – Mark, this is Jim, we – it was primarily a result of that. Probably about 75% of the increase is because the as we’ve been talking about, cost per unit have gone up pretty substantially over the last year, which we offset with a price increase.
So, that’s about 75% of the increase. The other 25% is related to more units.
At this time, last year, we were still in a position where we – two things, we were in a position where we didn’t have really an adequate supply in our wholesale and retail businesses. And then the other thing we were shipping a substantial amount of military business last year, which is basically you make it and ship it, so you don’t carry any inventory.
So, although our overall sales are down, our wholesale, particularly, business is up, so we need some more inventory to support that.
Mark Cooper – Pacific Ridge Capital Partners LLC
Okay. All right.
Thank you.
Operator
Thank you. (Operator Instructions) It appears there are no further questions at this time.
I’d like to turn the call back to management for any closing comments.
David Sharp
Okay. Well, thanks for joining us on the call this quarter.
We look forward to speaking to you again in 90 days. Thank you.
Operator
Thank you. Ladies and gentlemen this concludes today’s teleconference.
You may disconnect your lines at this time. Thank you for your participation.