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Rocky Brands, Inc.

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Q4 2011 · Earnings Call Transcript

Feb 16, 2012

Executives

Brendon Frey – Investor Relations, ICR David Sharp – President and Chief Executive Officer Jim McDonald – Chief Financial Officer

Analysts

Mitch Kummetz – Robert W. Baird Sam Bergman – Bayberry Asset Management Mark Cooper – Pacific Ridge

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands fourth quarter and fiscal 2011 yearend earnings conference call.

At this time all participants are in 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 will now turn the conference over to Brendon Frey of ICR.

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, risks and uncertainties, which may cause actual results to differ materially. We assume no obligation to update such statements.

For a complete discussion of the risks and uncertainties, please refer to today’s press release and reports filed with the Securities and Exchange Commission, including Rocky’s Form 10-K for the year ended December 31, 2010. I’ll now turn the call over to Mr.

David Sharp, President and Chief Executive Officer of Rocky Brands.

David Sharp

Thank you. Good afternoon and thanks for joining us.

With me on the call today is Jim McDonald our Chief Financial Officer. We are very pleased with our fourth quarter performance.

We ended the quarter on plan which given the mild weather throughout much of the country in December was an encouraging end to 2011. Sales trends were very similar to the first three quarters of the year mainly was driven by demand for our new product introductions in the work, hunting and western categories.

We continued to experience increased sales velocity under our fast growing commercial military segment. To properly evaluate sales in our fourth quarter and full year we believe it is prudent to include our non-recurring operations namely our military segment this is the big business invested by the departments of defense and also excludes the Dickies license business, because that was discontinued at the end of 2010.

To the point of reference, we reported military segment sales of $17 million in 2010 versus $2.2 million in 2011. Dickies sales were $7.6 million in 2010 moving on to just $200,000 in sales of Dickies in 2011.

I should note that after dramatically improving our balance sheet and significantly reducing our expense structure we have more recently been able to free up resources and once again put more emphasis on growing our top line. While we have identified several long-term growth vehicles that I will discuss later in the call the initial phase of expansion centered on leveraging our core strength and product innovation to develop new and compelling footwear that feels of our brands for customers.

So let’s focus on our own wholesale brands Georgia, Rocky and Durango and our retail division. During the long history, our brands have established leadership positions in the respected categories by consistently being at the forefront of innovation and delivering the latest in durability, comfort and functionality.

Due to the internal and external challenges we faced a few years ago including integrating two sides of the organizations I believe less focus and brought to market some inspiring collections during that time. With that said, I’m confident with the operational changes we’ve implemented, which included new product development system have made our R&D platform stronger than ever and this is reflected in the lease and performance of our new products.

To underscore this point approximately 28% wholesale sales this past year came from products introduced in the last two years. A few of the standings included our redesign of improved blizzards or cold weather boots that despite the unfavorable warm winter sold well in the sporting goods channel at national and regional players like Dick's Sporting Goods, Caballus, Wholesale Sports and (Inaudible).

Our Georgia boot brand continued to gain overall shelf space during the most part like sales of our new cross ridge styles, the hiker inspired work collection featuring the vibrant moving out sole that also performs well in the rugged out course. Sales have been particularly strong in the North West for the Georgia brand where we saw solid gains in the farm and ranch channel at locations like coastal fireman home and multi store work wear accounts like whistle work wear.

In Western it was women’s fashion product as well as our new little Durango kid’s line of boots that has allowed us to increase business at whole market multi store retailers like Cavender's Boot City and RCC Western. We also changed production whole year on our newly launched Rocky branded fun range collection.

Many of our key retailers experienced expanding unforecasted demand for the line throughout the year including in the sporting goods channel as well as western stores at accounts like West Pro Shops. At the same time we have seen a great response for the fully drainable boot we developed for the U.S.

Navy Seals and a height and light weight boots that people just like to wear on base when they are traveling in uniform. As a reminder, this is a high margin business and should not be confused with our whole margin government contracts that we received from time to time, which we report as our military segment.

This higher margin business segment is going to be very significant. Sales were almost $20 million in 2011 versus $8.6 million in 2010.

There is still upside here, which I will discuss later. The second major area of focus has been on remaking our retail division.

It has a multiyear process switching our high cost sales through our legacy mobile platform for a more efficient web based direct ship model. Since its debut in late 2008 we have made steady progress transitioning customer sales to the internet, which has allowed us to decommission more than 50 trucks including 18 last year and we have shut all the three but 40 stores supporting the mobile business.

In the third quarter of 2011, our retail business an important inflection point. It generated a positive operating profit and higher gross margins and lower expenses and for the first times ever both Manhattan sales came from the web in our call center.

This trend accelerated in the fourth quarter and for the full year division performed way beyond their expectations and operating plan. Jim will now go through the financials in detail and then I will return to discuss our growth strategies for 2012 and beyond.

After that we will be happy to take questions. Jim?

Jim McDonald

Thanks David. As we announced last quarter and detailed in today’s earnings release we recorded a one-time non-operational charge of $3.7 million net of tax associated with the termination of our define benefit pension plan.

To recap the define benefit pension plan was a predecessor to our current 401-K program and was frozen at the end of 2005. The assets in the pension plan have underperformed expectations over the past several years and the expense associated with this underperformance have been capitalized on our balance sheet.

This expense would have been recognized over the next 10 years. Therefore we made the decision to terminate the plan instead of letting the gap between the asset value and the commitments continue to widen and in turn increase the ultimate expense to be recognized.

By closing the plan, the company will save approximately $200,000 in annual maintenance fees. So following discussion excluding the impact of the pension charge for a reconciliation of our GAAP results please see the table that accompany today’s announcement.

Now to our results, net sales for the fourth quarter were $64 million compared to $66.7 million for the corresponding period a year ago. Wholesale sales for the fourth quarter were $51.7 million compared to $52.5 million last year.

We experienced significant growth in our commercial military business, which more than doubled versus the year ago, while at the same time our Durango brand posted a 9% growth in the quarter. This was offset by decline in our work categories due primarily to the discontinuation of our license agreement with Dickies at the end of 2010 and softness in our hunting category as a result of the mild weather late year.

Retail sales for the fourth quarter were $11.9 million compared to $12.4 million a year ago and military sales were $0.4 million versus $1.8 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 2011.

Gross profit in the fourth quarter was $22.5 million or 35.1% of sales, compared to $24.3million or 36.5% of sales for the same period last year. The 140 basis point decrease in our gross margin, which primarily driven by a non-reoccurring inventory adjustment resulting from our annual physical inventory, excluding the adjustments gross margins in the fourth quarter were 36.3%.

Selling general and administrative expenses declined 11.7% to $16.7 million or 26.2% of net sales for the fourth quarter of 2011, compared to $19 million or 28.4% of net sales a year ago. The $2.2 million or 220 basis point improvement was primarily due to lower compensation expense, professional fees and operating costs of our retail business.

Interest expense for the fourth quarter decreased to $0.2 million from $1.7 million in the fourth quarter of 2010. As a reminder in the year ago period we recorded a non-cash charge of approximately $1million associated with deferred financing cost relating the extinguishing our previous credit facility and the repayment of our senior term loans.

The remaining decrease in interest expense was due to lower interest rates versus the same period last year. Our effective tax rate for the fourth quarter of 2011 was 29.4% compared to 24% in the fourth quarter of 2010.

For fiscal year 2011 our effective tax rate was 30.9% compared to our previous estimate of 32.6%. The lower effective tax rate was the result of additional permanent capital investments we made in our Dominican Republic operations during the fourth quarter.

We reported net income of $3.9 million or $0.52 per diluted share versus net income of $3 million or $0.41 per diluted share. This represents an increase of 27%.

Now I will quickly touch on a few highlights from our full year results. For the fiscal year ended December 31, wholesale sales excluding Dickies increased 6.5%.

Gross profit margin excluding the inventory adjustment improved 160 basis points to 37% with retail gross margins up 200 basis points. Operating income improved $1 million or 70 basis points as a percentage of sales.

Interest expense was now $5.5 million. Net income improved $4.3 million and diluted EPS increased 40% to $1.60 compared to a $1.14 last year.

Turning to the balance sheet, funded debt of $35 million at December 31, 2011 versus $35.1 million at December 31, 2010. Inventory increased 10.5% to $65 million at December 31, 2011, compared with $58.9 million in the same date a year ago.

The increase in inventory was a result of decreasing cost per care per units partially offset by a decrease in units of footwear. David?

David Sharp

Thanks Jim. We are pleased with the top and bottom line results generated by our core wholesale and retail segments and with our momentum that we start 2012.

Building on the successful introductions from 2011 the product pipeline for this year particularly the second half is quite strong. We are confident we have the capabilities to increase our total market share through higher sales volumes in our existing lines of business and by extending our reach further into new categories, new distribution channels and new geographies.

With regard to new categories, there are two main areas of focus the first being the healthcare industry, which is projected to add more than 5.6 million jobs over the next 10 years, leveraging our existing hospitality and duty product line technologies we’ve created new footwear and developed sales strategies to go after this large and growing market. Two initiatives we are particularly excited about are in new boots targeting E&G workers (Inaudible) blood-borne-pathogen protection and our new Rocky (Inaudible) for nurses and doctors who are on their feet for the majority of the shift.

The second category expansion is in the outdoor space that involves going after the survivalist and adventurous segment with a similar product that has been very successful with hunters and military personnel. A lot of these we can volley as plain environment where the cold benefits we provide like light weight, durable, drainable, water proof really makes perfect sense for them.

Next is new distribution channels, and this primarily involves Durango through product line extensions that contain a higher element of fashion we are opening up the brand to mainstream retailers in more metropolitan locations. We introduced our newest Western collection at the Fanny’s show in New York late last year and the response was very positive.

So far we’ve received commitments from notable retailers like zaffels.com, tradehome stores, Shoe Show and Fingerhut. Product will be on their shelves this fall we are optimistic that consumers will respond favorably.

Geographic expansion is another initiative we’ve been working on and continued to make solid progress penetrating select international markets. In 2011, sales outside the U.S.

increased 19% to $10.2 million with the majority of the growth coming through direct operations in Canada and European distributors of our hunting products. We recently signed new distributors for the Rocky brand in Finland and for the Georgia brand in the United Arab Emirates and we are looking for other partners to fill out the map in the years ahead.

I want to close today’s prepared remarks by thanking all of the employees of Rocky Brands for all of the hard work that went into making this past year a success. We tackled the challenges for 2008 and 2009 head on and we are now in a much better position to take advantage of our strong brand portfolio.

And thanks also to all our vendors, suppliers and all of our other stack holders for their continued support. Operator, we are now happy to answer questions.

Operator

Thank you. (Operator Instructions) our first question comes from the line of Mitch Kummetz from Robert W.

Baird. Please proceed with your question.

Mitch Kummetz – Robert W. Baird

Thank you and congratulations on the quarter. I’ve got probably a handful of questions here I will try to get through this quickly.

But David let me start with you, you mentioned the commercial military business but it was up it was double versus last year on the quarter. Could you say where that business is now for the full year 2011 and what your plans are in terms of expected growth for 2012?

David Sharp

I think the numbers we just read were $20 million for the year and it’s about 8.2 in 2010 and obviously I think it’s going to be hard to replicate that kind of growth in 2012. However, we are launching three new extensions at the (Inaudible), which has driven a lot of these business jungle boot version and all leather aviator version for the U.S.

air force and the steel soul version that the army has been asking for. And we are also right now the business really is contained in the U.S.

Army and we are aggressively after the U.S. Navy and the National Guard units in ’12.

Probably this business our largest customers the MCSS the Military Clothing Sales and Service stores that are on base around the world and we are about 25% of the unit sales that are now and about 18% of dollar sales. And obviously some stores do a lot better than others so we are really targeting those stores that we haven’t had great volume with and trying to improve sales that are also.

So we are very optimistic that we continue to grow the business but not at the rate we grew.

Mitch Kummetz – Robert W. Baird

Got it. And then on the international you highlighted that as one of the growth opportunities for the company you said $10.2 million in 2011.

What do you think that business can do this year given some of the new markets that you are going in?

David Sharp

Well as I mentioned we recently signed two new distributors we are talking to three currently about signing up, you know I think this is great as we spent a lot of time in Europe and is a great deal of services in there right now. We are going to continue talking to folks there so that when things do turn around there finally you don’t have to start all over again.

But we are focused right now on South America and Central America and have something cooking there. I think we, our plan is to grow that business 10% this year.

Mitch Kummetz – Robert W. Baird

Okay. And then Jim on the cost side first of all could you say for 2011 what the gross margin impact was from input cost I’m assuming there were some drag or maybe not and then kind of what your thinking is on 2012 in terms of the input cost outlook to gross margin.

Jim McDonald

Well its 50 the drag came late in the year here as we when we really started to recognize the increased cost. Now we have taken a price increase that we think will offset that increase next year.

So I would, I would say that in our gross margins all those flat where they were in 2011 by segment basis.

Mitch Kummetz – Robert W. Baird

Okay, got it. And then also checking how are you guys thinking about budgeting SG&A in 2012 excluding maybe the variable piece on whatever sales growth you might be looking for.

Jim McDonald

I think that we are, we certainly have reached with the knee high business we take in most cost of all the big severance cost that we’ve had are behind us now and they are behind us getting it last year. So I think we are looking probably for flattish on the other SG&A because maybe even slightly up a little bit as we because we are investing in these new product line we have with marketing and sales things like that, which is what we need to do a little bit.

Mitch Kummetz – Robert W. Baird

And then just quickly last question just housekeeping item. But can you tell me what the gross margins were the segment margins were on the quarter.

Jim McDonald

The wholesale was 33.8%, the retail was 47.8% and military was 14.3%.

Mitch Kummetz – Robert W. Baird

Okay.

David Sharp

It was a very little sale there.

Mitch Kummetz – Robert W. Baird

Right, okay. Great.

Thanks and good luck.

David Sharp

Okay.

Jim McDonald

Thank you.

Operator

(Operator Instructions) our next question comes from the line of Sam Bergman from Bayberry Asset Management. Please proceed with your question.

Sam Bergman – Bayberry Asset Management

Good afternoon gentlemen. Few question the new Durango line that’s being launched what retail stores are going to have that product is Macy’s one of them?

David Sharp

Well we are currently approaching Macy’s. I can tell you that today we were in New York City at a major departmental store chain and we had a very, very favorable meeting.

And we think we will have a, we will be there in some measures. It’s just too early to speak about it.

What we are looking for here is them as new channels of distribution and that Middle America main street is some, today we don’t penetrate at all. So we’ve been focused there and I think in the prepared streams we talked about we received commitments from four retailers, large retailers that you would know Fingerhut, Shoe Show two others hence that were.

Jim McDonald

Zaffels I believe.

David Sharp

Yeah, zaffels.com is one of them that’s about it. So and platform this week also and I can tell you that I spoke about 3:00 PM today I spoke with the sales folks today and they are very, very pleased with the outcome exceeded our expectations we both in new accounts and about half of the orders have been written to risk channel distribution that we today that we don’t sell.

So there is a lot of upside there.

Sam Bergman – Bayberry Asset Management

I think last quarter there was tremendous amount of inventory and the inventory came down this quarter. Was any of the inventory increase still related to the weather in the fourth quarter?

David Sharp

Good, well we ended pretty clean with respect to heavy insulated goods. It’s been our standard operating procedure over the last few years to not buy more than our orders for anything over 200 grand.

So that kind played for us well we do have some apparels that they carry over into next year insulated underwear apparel we will be carrying out. But none of the – we don’t have any problem with inventories.

Here I think that our we’ve worked with all of our key accounts and I think overall will be some shift from one account to another but it is all I think our business will be up a little bit in hunting with key accounts and now doing buying group shows, groups like NBS and sports sync and we are not seeing any softness that we couldn’t carry on so. Our inventory of footwear unit’s pair was actually down 96,000 pairs from December of last year so.

Sam Bergman – Bayberry Asset Management

Okay, who is your nearest competitor when it comes to the medical shoe market?

David Sharp

Well, the people that we hope to give a good run for the money is Dansko. We think the we’ve done a little research here we’ve researched this category for the last 12 months we think it’s very underserved these considered very underserved particularly with respect to say with non-slip products that are on hard tile or fluids, we do that kind of products in our hospitality lines and as we think we can build multiple product line as our competitors also.

We will be showing this product line to the trade in about another 60 days.

Sam Bergman – Bayberry Asset Management

Is this a besides the lining surface there are any extensions to the line that you will be showing in the products or it’s a same simple line you had last year.

David Sharp

Well this is a totally new line.

Sam Bergman – Bayberry Asset Management

So that’s the new line that you have with the non-slip technology on it.

David Sharp

That is built specifically for nurses and doctors yes.

Sam Bergman – Bayberry Asset Management

Okay, and the last question in terms of picking up more coverage for the company, which way are you leading to at this time for 2012?

David Sharp

Can you be more specific with that question?

Sam Bergman – Bayberry Asset Management

Well are you planning to do more IR shows versus last year? Are you meeting in more groups in sections like the ICR exchange or perhaps a rough meeting or a dealer meeting going forward?

David Sharp

We will do the Robert W. Baird Conference this year.

We’ve been in contact with some other analysts about the potential of picking up coverage and hopefully they will in the future here.

Sam Bergman – Bayberry Asset Management

Thank you very much again it’s a very nice quarter.

David Sharp

Thank you.

Operator

Our next question comes from the line of Mark Cooper from Pacific Ridge. Please proceed with your question.

Mark Cooper – Pacific Ridge

Good afternoon. Thank you for the call.

Could you elaborate a little more on the inventory adjustment for the year?

David Sharp

We had a, in our retail operations we had, when we took our physical inventory we had shrinkage in our inventory that we needed to that, we had to adjust out. That affected our gross margin by about 120 basis points in the quarter.

Mark Cooper – Pacific Ridge

So, that was in the retail division?

David Sharp

It was yes.

Mark Cooper – Pacific Ridge

So then if I heard your numbers correctly your gross margin in that division was 47.8.

David Sharp

Right. That was assets at inventory charge.

Mark Cooper – Pacific Ridge

Assets at inventory charge. Okay and so then looking at the gross margin on the wholesale side there was no inventory charge to that decline I don’t know a little magnitude there was that.

David Sharp

It was down about 120 basis points both of that was brought here to the increases we’ve had in our cost of our products that took the price increase and if we are getting at October we will get full benefit for that. So that’s really most of that was related to.

Mark Cooper – Pacific Ridge

Okay, and you could mention that – call I appreciate that. What was the cash flow from operations for the quarter?

David Sharp

I don’t have that number with me right now, I can let you know, but I don’t have that number with me right now.

Mark Cooper – Pacific Ridge

Alright, okay. Thank you.

David Sharp

Okay.

Operator

(Operator Instructions) And there are no questions in the queue. I would like to hand it back over to you for closing comments.

David Sharp

Well, thank you we will continue to work hard over the next 90 days and speak with you again in April some time. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation.

You may disconnect your lines at this time and have a wonderful day.

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