Rocky Brands, Inc. (RCKY) Q4 2016 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Rocky Brands Fourth Quarter Fiscal 2016 Earnings Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. [Operator Instructions] I would now like to remind everyone that this conference is being recorded. And I will now turn the conference over to Brendon Frey of ICR.

Thank you 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 conference over to Mr. Mike Brooks, Chairman and Chief Executive Officer of Rocky Brands.

Thank you, Brendon. The fundamentals of our business continue to improve during the fourth quarter, which was an encouraging finish to a challenging year. There were some bright spots for 2016. Our overall results were disappointing in response to the top-line and margin pressures we dealt with over the past twelve months. We implemented a number of changes throughout the company that we believe will improve our earnings power going forward. Starting with revenue. Our performance varied meaningfully by segment. Wholesale sales were down mid-teens as demand for our Work, Western and Hunting categories were softer than the prior year especially in the first half. The strength of our Georgia Boot Durango and Rocky brands were not enough to offset the headwinds caused by the warmer temperatures, weakening local economics tied to oil and gas and challenging store traffic levels. It’s worth noting as we got deeper into the year, trends within each of these categories begin to stabilize. Meanwhile, our Military segment had a terrific year from a sales perspective increasing triple digits to a record $37 million. This performance would not have been possible if we hadn’t made the decision to invest in additional machinery and increase the labor force in our Puerto Rican manufacturing facility. The increased capacity has as well positioned to capitalize on a growing demand for Military for years to come. Unfortunately, it was more cost than expected to initially increase production due to the inefficiencies in our plant, primarily during the first three quarters of the year, gross margin for our Military business was below historical levels. Overall, gross margins were further pressured by the need to increase our promotional activity to help clear out Work, Western, and Hunting wholesale channels of inventory carried over in 2016 by many retailers following the warm winter of the prior year. Adding to this headwind was the fact that store traffic was and continues to be down for the majority of our brick and mortar accounts as consumers increasingly shift their shopping to online. While we have responded to this dynamic change in buying behavior by increasing investments in our own branded B2C websites including more digital advertising and many of our independent accounts currently have limited ecommerce capacities. With selling conditions remaining challenging, we implemented a number of organizational changes aimed at reducing our expense structure and gaining greater efficiency in order to better succeed in the current environment. These included, resizing our US headcount, reorganizing our sales teams and reducing our level of raw materials and finished goods. In total, these actions generated approximately $5 million in annualized savings with approximately $1.5 million already realized in the fourth quarter. While there were some difficult decisions to make, we are confident they were the right decisions and in the best long-term interest of the company and its shareholders. Since our financials are well detailed in the earnings release we issued earlier this afternoon, I am going to only touch on a few metrics in my prepared remarks that I believe help shape and understand – understanding of all of our full year performance. For 2016, sales decreased 3.4% to $260.3 million. By segment, Wholesale sales decreased 14% to $177 million. Retail sales were essentially flat at $46 million and Military sales increased 115% to $37 million. Gross margins were 29.5%, compared to 33.9% in the prior year and SG&A excluding extraordinary charges was $75.6 million, down $2.8 million or 3.5% from $78.4 million in 2015. Turning to the balance sheet. Inventories were in great shape at the end of the year, down 10.2% to $69.2 million while our funded debt decreased 38.5% or $9.1 million to $14.6 million, our lowest level in many years. Looking ahead, we believe we have sound plans in place to improve on each of our businesses – on each area of our business. With respect to the Work, Western and Hunting boot categories, 2017 is off to a better start than 2016, thanks to more operable weather conditions combined with easier comparisons. On top of this, we are encouraged by a number of new product introductions that we believe will resonate with our core consumers. However, the retail environment for these categories remains challenging, so we are proceeding cautiously until we see a sustained improvement in sales trends. Our Military segment is projected to grow on top of the record year posted in 2016. We currently have approximately $40 million in contract military orders scheduled for delivery in 2017. With our expanded domestic manufacturing facility, now fully optimized, we are confident we can return Military segment gross margin to at least their historic low teen levels and possibly exceed them long-term. At the same time, we are planning to further expand our Commercial Military business as demand for our popular S2V continues to grow among in listed soldiers. Finally, we are exploring additional sales opportunities for our Military footwear overseas, which we’d produce in our Dominican Republic facility at even higher margins due to lower labor rates compared to Puerto Rico. Turning to our retail segment, we are focused on growing our ecommerce business by further expanding the merchandize assortment available through this channel. We also plan to drive higher traffic to our websites and increase demand for our product lines by shifting more of our marketing investments to online campaigns. Finally, our Lifestyle category. The team has done a tremendous amount of heavy lifting to improve the operations and infrastructure at Creative Recreation. Since we acquired the brand in late 2013, unfortunately the selling environment has made it more difficult than expected to hit the revenue projections necessary to achieve operating profitability. Therefore, we have adjusted our go to market strategies and are introducing less fashioned forward products at more accessible price points which we believe will attract a broader customer audience and potentially open up new channels of distribution for the brand. At the same time, we have executed a licensing agreement for Creative Rec with JD Sports, a major UK-based footwear retailer. We are excited about this partnership and believe this is a right vehicle to accelerate the brand’s expansion into Europe while reducing our overhead and inventory risk and providing the company with a high margin revenue stream. In closing, I want to thank the entire Rocky organization for their hard work over the past twelve months. It wasn’t easy a time, budget perseverance in the phase of multiple headwinds has what guided us this year and has us well positioned to improve on our recent performance. In addition, we are close to strengthening our senior management team with an appointment of an internal candidate for the company’s next Chief Financial Officer. We look forward to formally announcing this news in the coming weeks. Despite the recent setbacks, I am confident Rocky Brands is on the right course towards delivering sustained profitable growth and generating increased value for its shareholders. Thank you. Operator, we are now ready to take questions.

[Operator Instructions] Our first question comes from the line of Mitch Kummetz with B. Riley & Company. Please state your question. Mitch, please state your question at this time.

Can you guys hear me?

Yes, now.

Okay, sorry about that. I was muted. I got a handful of questions. Let me start with a housekeeping one. Could you give us the Wholesale segment margins on the quarter?

The Wholesale segment margins on the quarter.

I am sorry, the gross margins by segment for the quarter? Sorry I missed that.

Okay. Yes, I can. Wholesale was 33.9%.

Right.

Retail was 45.9% and Military was 10.4%.

Okay. So you’ve seen a nice uptick on the Military side from what it’s been in the last couple of quarters. So, Mike, it sounds like you are expecting it to get back to at least low teens percent, I mean is that kind of where you think it will be for the full year 2017?

Yes, I am very comfortable with that. We had major challenge last year as I stated, but yes, I am comfortable. We will be mid-teens and I am hopeful we will beat mid-teens.

Okay. And can you just kind of maybe speak to that? I mean, I know that, as you are ramping up production, there were obviously some kind of growing pains there. What would allow you to get to a margin that’s above historical norms? Is that just the scale of doing $40 million worth of production?

Well, it’s really – we had more than we could eat or produce last year. So we had to put in three shifts, add two additional, hire 700 new employees. So, you can imagine all the challenges that that gave us. So we had to forecast and realize what our capacities were and build that into our going out and obtaining orders and trying to manage that, so that we weren’t overstressing our factory, but weren’t under stressing the production capacity. So we are confident we have a really good steady flow for 2017 that will produce $40 million in sales and we are confident we can return to mid-teens and as I said, I think there is an opportunity for a little growth there.

Got it. And then, you also mentioned that within the Wholesale business, you are off to a better start in Work, Western, Hunting, but that you also talked about, it’s still being a tough environment. So I was hoping you could maybe reconcile those comments. That business was down roughly 9% in the quarter, I mean there is a better start means a lower decline or is that business actually kind of returned to growth despite the ...

What I was trying to get across was our brick and mortar customers are really being challenged with difficulties to sell the product for all the reasons that we know, from all the retailers in America. And we are working diligently to move to the online sales and capture that market. That’s difficult, because now we are kind of competing against our customers. So, it’s a – we see some success in the first six weeks of this year, but yet we see challenges with retailers going out of business. So, there is no easy path. We are going to change as rapidly as we can and continue to support our retail partners while focusing on expanding our direct to the customer.

Okay, can you say where you are in the process of building your fall order book and ho that might look?

At this time, it’s still a little early. We normally don’t have a real good picture until March, mid-March in that timeframe, we had the short show, I was at the Short Show five weeks ago, four weeks ago. The WESA Show in Denver and there is some inventory needs cleaned out of retail stores. So I’ve seen it better, Mitch and I’ve seen it worse.

Okay, and last question on Creative Rec, you talked about the licensing agreement with JD, what might that do for your business this year. I mean, are there minimums tied to that? How should we think about the contribution to the P&L from that agreement?

Well, there are minimums there, Mitch and I think maybe – I am going to ask Tom Robertson to be with me. He worked with Jim McDonald and when we speak, a little later this afternoon.

Okay, all right. Well, thanks I appreciate it.

Hey, Mitch good to hear from you.

Thank you. And our next question comes from the line of Jonathan Komp with Robert W. Baird. Please state your question.

Yes, hi, thanks Mike. My first question is, would you be willing just to kind of address the recent management turnover when you look over the last six months just the motivating factors and then looking ahead it sounds like we’ll get some news on the CFO front shortly, but as you look across the entire team whether no not you’ve got everyone in place. Do you think you need?

Yes, I truly do. As I said, those are difficult decisions, it’s never easy. I think there were – these were hardworking people that they did the best they could. But they were missing some obviously things that the Board felt need to be addressed. So, we have a strong team. We have a young team and this business is tough like any business. And so, I don’t think I would have liked to have been able to announce our Chief Financial officer before this call frankly, But, that wasn’t possible, but - so, I am comfortable we’ve got the right talent and the dedication in the drive from the designers to the sales management, to the marketing. Our associates are focused and driven – self-driven to turn this company around. But that being said, t here are still headwinds out there as I think we are all aware of. So, it’s not a give me atmosphere out there. We are going to have to fight for everything we get.

Got it. Okay, thanks for that, and then, maybe turning to the Wholesale business, a couple of questions there. First, I just want to understand the fourth quarter, it sounded like back in October, you had seen some improvement in the at once business, but yet for the full quarter, the Wholesale revenue declined ended greater than in the third quarter. So I am just wondering what changed in the business or what you saw during the quarter to get to that results for the full quarter?

For the fourth quarter?

Yes.

For the fourth quarter, well, I just hate – the weather, I don’t know weather was like it was constant, but it was pretty mild here in – during hunting season and that’s a strong portion of our business. The working class persons, the Heartland, the Rust Belt Jobs, so and retailers, we amended a little slower to moving to online purchases and at least in my household we are than my wife or the ladies. So it’s a process, it’s a process. And we are working diligently to turn that favorable for our company going forward.

And when you look at some of the major pieces maybe on the work wear side or the work boot side, what are you seeing in the end-markets? And I know, oil prices obviously have stabilized and come up and there is some activity starting to happen again, but what you see at the ground level on the work side?

Well, I think today it is still soft. And I think it’s still soft. I think there is encouragement from the new administration in Washington about infrastructure. I think it’s encouraging. I think you will see the gas and oil business have increases, hire people back and I think you may see some minor cold mining jobs. So I think the so-called rust belt, the upper mid-west the Heartland, I think you are going to see some jobs working-class jobs and so, I am encouraged there. Do I have any proofs that that’s actually happening today. I do not, but I am encouraged. And we’ve got control of our inventories, we’ve got access to our own factories and sourcing. We have downsized our overheads were mean and lean and we are ready to go.

And maybe, a similar line of questioning, just on the western side, maybe a little more color on what you are seeing for that part of the business?

The western side looks about the same as it has been. We have some good products there also that customers were at the Denver Shoe Show in Denver Colorado I was there as well. We had good customers coming in, even customers that you wouldn’t think as Western and as such as Amazon. So, we are focused on – as I said on direct internet business. We do a sizable business with Amazon as of the most people do. So the western business is stable. We do Work, Footwear and Western as well as women’s fashion and we have the American flag boot that’s one of our top sellers and that continues to sell nation-wide.

Okay, great. Maybe one last kind of just big picture, as you would think about 2017, I know you mentioned the Military business should be up again this year, what about when you look at everything else, it’s everything non-military. Do you think it will be up, down or flat for the year? Or any kind of high level perspective?

I think our Work business both Georgia and Rocky will be up single-digits. I think our western will be up, I am positive our commercial military, always forget about this, but that’s amazing on how well we are doing. When is say commercial, I am talking directly to the soldier, it’s not through the US government, but we are going to have increases there in military what we call commercial business. I am comfortable we will hit the $40 million in Military sales to US government. Probably, we’ll beat that a little bit. The challenges Creative Rec with the new designs which are more middle of the road and not near as fast. I think Creative Rec, we are going to spend pretty aggressively on marketing. Our price points will be more middle of the road and not to the upper-end. I think the – I think we’ll have to go through the season to see how that turns out, but we do have a nice revenue stream from JD Sports, a three year contract. So, I think, we’ve got new styles out there that customers – our Wholesale customers like them. Now we just got to get them in front of the consumer and see if they’ll buy them.

Got it. That’s helpful. Best of luck.

Great, Jon. Thank you very much. Look forward to talking to you.

Thank you. Ladies it does conclude our question and answer session. And at this time, I will turn it back to Mr. Brooks for closing comments.

Well, I thank you for listening. I am excited about where we are at today and I look forward to finishing out this year and turning this company around profitably and back into strong earnings and so, I will meet with you in 90 days from now. Thank you very much. Andrea?

This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.