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Rocky Brands, Inc.

RCKY US

Rocky Brands, Inc.United States Composite

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Q3 2016 · Earnings Call Transcript

Oct 25, 2016

Executives

Brendon Frey - ICR Mike Brooks - Chairman and Interim Chief Executive Officer Jim McDonald - Executive Vice President, Chief Financial Officer

Analysts

Mitch Kummetz - B. Riley Jonathan Komp - Robert W.

Baird

Operator

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Rocky Brands Third Quarter Fiscal 2016 Earnings Conference Call.

At this time all participants are in a listen-only mode. [Operator Instructions] I would now like to remind everyone that this conference call is being recorded.

I'll now turn the conference over to Brendon Frey of ICR.

Brendon Frey

Thanks and thanks everyone for joining us. 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, 2015. And I'll now turn the call over to Mike Brooks, Chairman and Interim Chief Executive Officer of Rocky Brands.

Mike?

Mike Brooks

Thank you, Brendon. With me on the call today is Jim McDonald, our Chief Financial Officer.

I’m excited to be back in the CEO role in an Interim basis while we search for permanent Chief Executive Officer. During the third quarter our wholesale business started to stabilize following a difficult past 12 months for Work, Western and Hunting Boot categories.

The impact of last winter’s warm weather lingered longer than expected. The sluggish retail environment during the first half of 2016 made it difficult for our retail partners to clear through their entire excess inventory.

As the third quarter progressed channel inventory levels begin to normalize and we started to experience a pickup in our at once business. As a result, the decline in wholesale sales modified meaningfully from earlier in the year.

At the same time, Military segment sales nearly doubled leaving to a 5% increase in our overall revenue. We are pleased with our improvement top line trends however, the selling environment for our core Work, Western and Hunting product lines remains challenging.

The growth of ecommerce continues to negatively impact store traffic. While at the same time it was led to more competitive pricing across the industry.

In response to shifting market dynamics, we’re putting place several strategic initiatives to better position Rocky for the future. First, we extend our reach into larger and less weather dependent casual footwear market.

Our acquisition of Creative Rec brand in late 2013 and a development of our 4EurSole line, we’ve established a solid foundation to go after what we believe a compelling market opportunities for both brands. Second, we invested in new machinery and new labor at our Puerto Rican facility in order to capitalize on our current strong demand for military footwear.

Like casual footwear, military boot sales are not reliant on optimal weather. While we experience some temporary challenges during the recent ramp up on our production for not these investments wouldn’t be able to grow military segment sale by over 75% this year.

Nor we’d have been in the position to win military contract we announced last week that has an estimate annual shipping value of $16 million. And confident that we will be able to deliver this latest order in much more profitable manner.

Finally, recognizing on to prospects for our core wholesale business in the near to mid-term remains challenged. We recently reorganized our operating structure to gain improved efficiency and boost profitability which resulted in approximately $3.6 million of annualized savings.

While we are disappointed in our recent performance and pleased that we are addressing our challenges head on. I’m confident the combination of efforts to reduce our dependence on optimal weather, enhancements over manufacturing capabilities and right-sizing of our organization will contribute to more profitable growth and greater shareholder value in the years ahead.

Now I will turn the call over to Jim.

Jim McDonald

Thanks Mike. Net sales for the third quarter were $73.2 million an increase of 4.6% compared to $70 million for the corresponding period a year ago.

By segment, wholesale sales for the third quarter decreased 3.2% to $52.9 million compared to $54.7 million last year. Retail sales for the third quarter were essentially flat compared to a year ago at $10.3 million and Military segment sales increased to $10.1 million versus $5.1 million for the same period in 2015.

Within wholesale our Work category grew low single digits driven by a nice improvement in Georgia Boot sales. Western was up slightly versus a year ago led by Durango, while Hunting was down double digits as the category continues its slow rebound after a very warm winter.

Commercial Military sales which are within the wholesale category and separate from our Contract Military segment increased mid-teens on the strength of our popular S2V boot and our new C7 Lightweight trainer. Lastly on Creative Recreation sales were down year-over-year and were below our expectations.

We believe the slow fall [ph] was primarily due to retailers reluctance to take on additional inventory until the current environment for footwear and apparel showed some improvements. Moving down the P&L, gross profit in the third quarter was at $19.8 million or 27% net sales compared to $22.1 million or 31.6% of sales in the same period last year.

A 460 basis point decrease was primarily due to increase cost related to ramp up in our internal production capabilities to meet the increased military footwear demand. As a reminder military segment sales carry lower gross margins than our wholesale and retail segment.

Therefore the increase in Military segment sales in the quarter reduced the overall blended margin. By segment, wholesale gross margin was 28.6% compared to 30.8% a year ago.

Retail gross margin was 44.2% compared to 44.6% from a year ago and military was 0.9% which compares to 13.9% from a year ago. Selling general and administrative expenses were $17.7 million or 24.2% of sales for the third quarter of 2016 compared to $19.2 million or 27.5% in the year ago period.

The $1.5 million decrease in SG&A was primarily related to a reduction in advertising expenses, lower salaries and lower variable expenses associated with the decrease in wholesale sales. During the third quarter we incurred a one-time pre-tax charge of $1.2 million associated with the reorganizational activities.

Excluding this one-time charge net income for the quarter was $1.2 million or $0.16 per diluted share compared to $1.8 million or $0.24 per diluted share last year. Turning to the balance sheet, we are very pleased with a number of improvements starting with our funded debt which decreased $14.1 million or 31.2% to $30.9 million compared with $45 million a year ago.

At the same time, inventories decreased $8.1 million or 9.2% to $79.9 million while our accounts receivable declined $11.1 million or 17.8% to $51.3 million. This is during the period when the sales increased approximately 5%.

That concludes our prepared remarks, operator we are now ready to take questions.

Operator

[Operator Instructions] our first question comes from the line of Mitch Kummetz of B. Riley.

Please proceed with your question.

Mitch Kummetz

Mike, let me begin with you and you mentioned comments about the environment starting to normalize and that led to some pick up in at once or and obviously your Work business look good below single digit. So can you maybe just elaborate on that and especially how we should think about that into the fourth quarter, you’re obviously up again an easy comparison there where the business was pretty challenged last year on some weak at once orders so.

Mike Brooks

Mitch, good talk to you again and here it goes. [Indiscernible] opened at the third quarter and there is some real positive and some strange things that went on especially in our Puerto Rican, but to answer your question specifically.

I think we’ll see low single-digit increases in the Work categories there’s some good new product in the Georgia area and Rocky as well. So I think a conservative position was single-digit number increases in Work.

Mitch Kummetz

Okay, and then, go ahead.

Mike Brooks

I think we were focused on Work only, correct.

Mitch Kummetz

Well I guess I’m curious to see, your wholesale business in general. It seems like soft and sequential improvement on the Western side as well.

I know that Hunting remains difficult but if - if let’s say Work is up low single digits, is your Wholesale business good.

Mike Brooks

I think there is positive in the Commercial Military obviously there is a great, there is a really strong opportunity in regular Military once we work some of the kinks up of Puerto Rican operation with bringing up the workforce and running a second shift, so that’s been a challenge but I’m confident that we’ve got a handle on it but it will take some weeks or months to work it all out, it’s not an easy solution Puerto Rico is difficult to manufacturing.

Mitch Kummetz

Okay. And then maybe the follow-up there to Jim.

Obviously we’ve seen a couple of quarters worth of gross margin on Military been pretty challenged and that there was an expectation that begins to abate in the fourth quarter, so how is that, how is that set up margins on that set up in Q4?

Jim McDonald

Yes, I think that we had thought earlier when we talked last 90 days ago that we would be back closer to normalize margins around 13% maybe little bit less than that, but approaching double digit. So I think the improvements have been a little slower than we had anticipated when we spoke back in July and we didn’t really start to see improvements significantly until more into late into September and so far this month.

So I think our margins will be more in the mid single to low single digits again in the last quarter. But we think that by the end of the year we’ll be in a position that we’ll have this thing working while that we won’t have any overhang as we move into next year.

Mitch Kummetz

Got it. Thanks.

And as we think about next year and I know it’s still early but I’m just trying to make sure that I have kind of all the military contracts in my head the right way. So you just pick up this new contract, which I think you said on an annualized basis is probably somewhere in the $16 million range.

Remind me what, you’ve got going on now that carries forward and how the overall sort of military volume should shape up next year.

Jim McDonald

Our current contract that we’re working on is really for the Afghan Army purchased through the US Military that contract will be finished in late February of next year. About the same time this new $16 million contract unless start to deliver, so that overlap in that February time period a little bit.

Now there is multiple other contracts that are anywhere from three to six months have not been let, yet. So expectations are that we’ll go through next year after February 1 with the $16 million contract and now there’ll be some additional add-ons but that’s not been fully determined to-date.

Mitch Kummetz

Got it. Okay and then maybe as a last question.

You mentioned kind of the restructuring and $3.6 million annualized cost savings. So to talk a little bit about kind of how that, I mean is that basically in terms of number we should think about for next year in terms of what this restructuring is enabling.

If you talk a little bit about like where that $3.6 million is coming from?

Mike Brooks

Yes, Mitch we had announced back in August that we had done a restructuring that led to about $3 million that was in some administrative functions here at our corporate offices. And we also restructured our salesforce particularly in the Rocky Brand want to change.

Since then we’ve made some other changes that in - knowing our Senior Leadership team that have resulted in about $600,000 of additional cost savings that a permanent cost saving is not [indiscernible] quite seeing at some point.

Mitch Kummetz

Got it, all right. Okay thanks guys, good luck.

Operator

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

Please proceed with your question.

Jonathan Komp

Mike wanted to maybe first ask maybe a little additional perspective on the CEO transition as you see a claim out. I’m curious if you have any sort of pencil timetable in mind and also if you could talk a little bit about really just what you’re looking forward in terms of the characteristics that you think will be best suited to fill the role permanently.

Mike Brooks

Well Jon, actually I drafted up. I assumed that I will get these questions, so I drafted up a little answer and then I’ll discuss it in more detail, but the Board of governance.

The Board’s Governance Committee is reviewing the characteristic we’d like to see in the future CEO and potential new board members we’re also searching for at least one maybe two new board members. The committee is also exploring have best to go about searching for the right candidate for the CEO and the board member because I’ve stepped into this Interim CEO on a full time basis, we’re not in any emergency to find a new CEO and we’re not going to rush this.

Rather we want to make sure we do it right by finding the best available candidate and making the right choice that fits for Rocky Brands. Picking a new CEO is probably the most important duty of the Board of Directors and I can assure you that our Board is taking this duty very seriously.

That being said that we’ve, if I had to put a timeline on it. I would speak in the terms of four to six months, seven months.

We’re not in a rush, I’m happy to - I love this company, I love this facility. It’s my hometown, it’s my legacy and my father is in - and so, I’m - we’ve got to find the right person to lead this company forward and we will.

We already have a number of strong candidates, we’ll be looking inside and outside the organization. We’re talking with a firm to do a possible search for us, haven’t finally decided a 100% on that so, we’re not in the rush.

Until we’re absolutely comfortable we have the right person.

Jonathan Komp

Okay that’s very helpful perspective, thank you and maybe a follow-up question on some of the restructuring activities that have taken place. I want to just get a better handle of the nature of some of the changes and specifically, I’m wondering has anything that you’ve had to make the difficult decision to cut potentially, would any of those changes impact your ability to grow revenue on the opposite side, so when the environment gets better will you be restrictive at all in terms of your ability and resources to grow the top line.

Mike Brooks

Other than the CEO’s position, my answer to that is no. It won’t - we’ve got strong trustworthy people in those key positions that we eliminated and every one of those positions were filled from the inside with no base salary increase.

So they’re taking on additional responsibility, I don’t know if it’s going to hinder us one bit. I think it’s going to strengthen us and I don’t know if that answered your question, enough for now.

Jonathan Komp

Yes, that’s helpful. Thank you and maybe one more just on the strategy to grow the casual side of the business in the areas that are less weather sensitive.

It sounds like the Creative Recreation brand continues to face some external challenges, is there anything about the results there so far that you’ve seen or even the recent performance that at all changes the confidence and the strategy for that brand?

Mike Brooks

Well, that brand - we’ve had it almost three years now and we still have long-term confidence in it. We’re making, we’re tweaking it a little bit and when I say that we’re reducing the retail price on our development aspect.

We’ve hired Nick Jonas to represent us with some excitement of [indiscernible] for Nick Jonas will do a personal appearance at Nordstorm’s [ph] now how does that relate into dollars in footwear sales, time will tell. But the Shoe Palace is expecting 10,000 people for its personal appearance at their Hollywood store coming up.

So until that has happened we can only speculate but there is excitement there. We’re making a run in change from high price footwear to more popular price footwear and we think, we can play in that market much longer than.

So I think next year, will still be an average year [indiscernible] until we get our momentum, until we see how see this Nick Jonas collection of footwear works.

Jonathan Komp

Okay, thank you for that.

Mike Brooks

Jim, I don’t know if you have anything to add on that?

Jim McDonald

No, I think that we’re really introducing this new lifestyle footwear of - in [indiscernible] 2017. So it’s been received fairly well so far but the true test obviously is our sales through retail and we’ll know that in four, five months here.

Jonathan Komp

Okay and that’s helpful and last one from me, if I could just the Military business just wanted to follow-up, how to think about next year a little better. I know you have the $16 million annual run rate contract that will start in February of next year.

I’m just curious if you’re willing to provide any other context on the size of the potential other contracts that are out there. Context of my question really is, this year is set to be to see a significant increase year-over-year and come in much higher than the $16 million annualized that you have in place for next year.

So I’m just wondering if you’re expecting a big fall off in that piece of the business overall for next year or if you think the other contracts are big enough to not see much of a decrease.

Mike Brooks

Well that’s a good question, I ask myself that question a lot. I can’t give you specifics because I don’t have them.

I’m confident we’ll get additional contracts and my belief is they will come in at different increments throughout the year. But frankly, we have more business than we could digest last year and that hurt us in the margin and so we will find the right balance, we know what that number is, what we can handle but at the end of the day, we’re going to make a lot more money because we’re going to control the quantity that we take.

We were running three radar [ph] shifts and it never works. So we’re running at two shifts now, we’re making progress.

We’ll convey what we can handle and we’ll pull up factory up with those shoes. I know that didn’t answer your question but we’ll make a lot more money even if we make less shoes, does that make sense to you?

Jonathan Komp

Well, maybe bigger picture on the Military piece. Is there – I know one of your other competitor seeing a significant increases in their business as well.

I’m curious if you think the increase in activity is a temporary phenomenon and sort of restocking or if you think there’s a longer lasting piece of the business that you could see meaningful business for military for several years to come or longer.

Mike Brooks

It goes up and down and it’s never flat, but they’re putting a new building that we’ll be bidding on over and above it’s the ones we already have. I think we have an inside track on that boot and if I knew what a flat number was, I would tell you but when I said our flat number what our optimum production would be, I would tell you.

But it’s been very difficult to come up with that other than guess right now but we’re moving through that and I think by the end of this quarter, we’ll enter the fourth quarter before even the next year we’ll know what that number is and that will be our goal to hit that year in and year out.

Jim McDonald

Jon, I think the contract that we just got is a multi-year contract, although it’s not five years is that, its option years but typically they, the military both the options years. And some of the other contracts that we bid on are also multi-year contracts.

So when we get those, we’ll have a good feel, if we get those or when we get those, we’ll have a good feel of what our production looks like and our sales look like for the next several years and as Mike said, we’re still trying to figure out what level of production we can do in our facility and do it profitably and we have that and then we’ll know that we’ll be able to really do a better forecast than what our - and what our sales will be not only in 2017 but for several years out after that, if we get some of these multi-year contracts.

Mike Brooks

And Jon this may seem, we had so much Military business this year that we missed Commercial Military business or S2V which is some of our highest margin boots, we missed in some Police [ph] boots. So it’s a bad debt - the number is right and forecasting and that’s always, we never hit it right on the head but we were a long way from where we could manage it, but we’re getting there and getting there quickly.

Jonathan Komp

Got it, well fairly makes it interesting for us to forecast but thank you appreciate all the perspective.

Mike Brooks

I’m sorry, can’t help you more right now but [indiscernible]. Stay tuned.

Thanks Jon.

Operator

There are no further questions in audio portion of the conference. I would now like to turn the conference back over to management for closing remarks.

Mike Brooks

Well, this is Mike. We thank you very much.

I’m happy to be back in the top seat. We’re digging in hard.

Jim and I are working well together. [Indiscernible] factories, our sales team and so I’m excited and I feel confident that we’ll turn things around very rapidly.

Thank you.

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