Rocky Brands, Inc. (RCKY) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands’ Third Quarter Fiscal 2017 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. [Operator Instructions] I would like to remind everyone that this conference call is being recorded. And we will now turn the conference over to Brendon Frey of ICR.

Thank you Hector and thanks 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, 2016. And I will now turn the conference over to Jason Brooks, Chief Executive Officer of Rocky Brands.

Thank you, Brendon. With me today on the call is Tom Robertson our Chief Financial Officer. Our third quarter results highlight the work that we have done creating a more efficient operating structure combined with our focused on expanding margins in a period, where revenue was down year-over-year and slightly below our expectations. We increased earnings per share fivefold to $0.30. Tom will go through the financials in more detail shortly. But in short, we achieve these levels of profitability by improving gross margins 300 plus basis points and reducing the SG&A nearly $3 million. We are encouraged by our ability to once again significantly increased profitability especially in light of a software top-line trend. And what has us excited in the fact that sales have recently accelerated setting the business up for a strong finish in the year. I’m going to walk through the key drivers of our third quarter segment performance and provide some color on our prospects for growth. Beginning with wholesale, we were expecting third quarter sales to be down due to primarily the private label program we discontinued this time last year. However, the decline was more than planned as each of our brands posted modest shortfalls versus projections. We believe this was due to a combination of factors including lower discounting as we place a greater emphasis on full price selling, as well as the trend of brick and mortar buying closer to need as they move more of their business online and don’t need the additional time to flow product to their stores, which is shifting some sales out of Q3 in the Q4 near to the holiday season. This was partially offset by solid growth with our E-tail partners which indicates that our recent efforts to increase the size of this channel our gaining traction. Looking in our performance by category. Sales of our branded work footwear were down slightly with the Georgia Boot brand and Rocky Work off a couple of hundred thousand dollars. The same was true for the Western category. However, Durango sales were flat compared last year, while products margins improved 300 basis points as higher full price selling offset less discount sales. Our Hunting business was the most challenge in the quarter as warm dry weather in several regions in the U.S. per demand for your insulated waterproof hunting boots. Our hunting apparel also struggle to sell-through and while this is relatively small business for us the decline versus last year was meaningful to our results. We are hopeful that our Cold Snap could help improve these trends as we move through the fourth quarter. Finally, Commercial Military sales were down due largely to one large customer shifting an order it has historically taken in the third quarter to the fourth quarter this year. Going forward, this business will also benefit from a recent introduction of a new S2V Predator into the market which is superb product at an outstanding price. Shifting to retail. Sales increased approximately 8% in the third quarter, as our team continues to do very good job adding new accounts to our Lehigh Outfitters custom fit program. In the last few months, we have signed up a national Company such as a Whirlpool, Fiat Chrysler, Blue Diamond to name a few and we are working on closing deals with other firms with large numbers of employees that require safety footwear. Now to our Military segment. As we previously disclosed, our factory in Puerto Rico was without power for an extended period of time due to the impact of hurricane Maria had on the Island. Thankfully, none of our employees and their families were injured during the storm. However, the loss of property was widespread and as many of you have likely seeing in the news, the rebuilding effort is moving slowly. We were fortunate that our facility sustained no damage during the hurricane and that we had diesel generators in place, which allowed us to resume operation in early October. With respect to the impact on our third quarter, about $1.7 million in contract military orders were delayed until the fourth quarter. While at the same time, we occurred approximately $1 million in additional expenses which Tom will talk through in a moment. Even with the temporary shutdown, we believe we are still on schedule to ship approximately $40 million contract military orders in 2017. That said, given the factors beyond our control on the ground in Puerto Rico, I could see the portion of this ship sales shifting into early 2018. Before I turn the call over to Tom, I want to briefly recap the opportunities I see for our business and why we are cautiously optimistic about our prospects for growth. As I stated during my first earnings call last quarter, we own some of the most authentic brands in the work, western and in the outdoor categories. By investing the appropriate amount of resources and product innovation and more marketing, primarily digital programs that strengthen our consumers' connections, we believe broaden awareness and interest in our branded product offerings and drive increased demand consistently over the long-term. This includes true brick and mortar where we are working to gain more shelf space and even more show online with accounts like Amazon where our runway for growth is significant. Moving to retail, our Lehigh business is uniquely positioned to capitalize on the growth number of fulfillment workers and the other labor based industries that require safety footwear for their workforces. Our proven custom fit model allows employers to affordably manage their safety footwear programs increased productivity, gain greater compliance. Our third quarter results speak to the progress we are making on expanding Lehigh’s reach. However, I believe we are just beginning to scratch of the surface of the model’s whole potential. At the same time, we continue to serve our direct B2C customers by offering a broad selections styles with a strong focus on functional footwear to our individual branded websites. The continued development of our B2C strategy will allow us to further strengthen our consumers connections while complement the growth of our B2C custom fit model. Last but not least, military will continue to be a very important focus for us. We will continue to aggressively bid on all military contracts that make sense with the current capacity in our Puerto Rican manufacturing facility, while also striving for better efficiencies to increase segment margins. Collectively our three segments provide the Company with a realistic roadmap to expand our top line and with the work we have done to reduce expenses combined our focus on expanding product margins. I’m confident that Company is well positioned to deliver increased profitability, great value to our shareholders over the long-term. Now, I will turn it over to Tom.

Thanks, Jason. Net sales for the third quarter were $64.7 million compared to $73.2 million in the corresponding period a year ago, a decrease of 11.7%. By segment, wholesale sales for the third quarter decreased 12.9% to $46 million compared to $52.9 million last year. The prior year period included approximately $2.2 million in sales from a private label program that was discontinued. Retail sales for the third quarter increased 7.8% to $11.1 million compared to $10.3 million a year ago and military sales were $7.6 million versus $10.1 million for the same period in 2016. As Jason discussed, approximately $1.7 million in footwear shipment shifted out of this, this year’s third quarter and into the fourth quarter. Gross profit in the third quarter was $19.5 million or 30.2% of sales compared to $19.8 million or 27% of sales in the same period last year. Included in this year’s Q3 gross margin is approximately $1 million of additional expenses related to payroll and overhead cost that could not be capitalize into inventory due to lower than usual production volumes in our Puerto Rican facility because of the disruption from hurricanes, Maria and Irma. Excluding this expense gross margins increased 470 basis points driven by significant improvements in both wholesale segment and the military segment margins. The adjusted gross margins by segment were as follows. Wholesale 31.1% up 250 basis points versus last year driven by the combination of better full price selling and less discounting retail 44.1% versus 44.2% last year and military gross margins were 17.1% compared with 0.9% a year ago. Selling, general and administrative expenses decreased 15.2% to $16 million or 24.8% of sales for the third quarter of 2016 compared to $18.9 million or 25.8% in the year ago period. The third quarter of 2016 included an approximate $1.2 million charge related to reorganization activities. Excluding this charge SG&A decrease $1.7 million year-over-year, primarily related to lower compensation expenses following the workforce reductions we made during the third quarter of 2016. Income from operations for the third quarter was $3.5 million or 5.4% of sales compared to $900,000 or 1.2% of sales last year. For the third quarter interest expense decreased to $110,000 compared to $181,000 last year as a result of the significant reduction in debt year-over-year. Net income for the quarter it was $2.2 million or $0.30 per diluted share compared to net income of $400,000 or $0.06 per diluted share. On an adjusted basis net income was $2.9 million or $0.39 per diluted share for the third quarter of 2017 versus adjusted net income of $1.2 million or $0.16 per diluted share than the prior year period. Turning to the balance sheet, our funded debt at September 30, 2017 was $11.6 million a decrease of $19.3 million or 62.5% from $31 million at September 30, 2016. Inventory at the end of the third quarter was down 3.8% to $76.9 million compared with $79.9 million in the same date a year ago. This concludes our prepared remarks. Operator we are now ready for questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jonathan Komp, with Baird. Pleased proceed with your question.

Yes great, hi, thank you. Jason just wanted to start-off and just ask I know you have been at the homes now for five or six months, and then curious kind of you had a little bit of a state of the union kind of update on the experience you have had so far and kind of key learning and I know you shared some of these in the prepared remarks, but just curious how you are viewing the business today?

Hi, Jonathan, yes. So, I would tell you that I have learned a lot in my short period of time, so one of the statements we talk about around here is we are running the business on adrenalin right now and so we are making decisions and we are doing all the right things in the cost savings in the cost cuttings in controlling our expenses. And what we really need to do is find the way to grow the top line and as you see here in Q3, we weren’t able to do that at the level we were hoping and we have got some things in place to make that change in my opinion in Q4 slightly and then Q1 of next year we are pretty positive on our spring ’18 bookings for all free of the brands. And so we are moving things in the right direction. We have got a great team here. We are all really rallying around each other and making things happen. So we are pretty excited about the future and in building the brands we have.

And when you look at the wholesale business specifically. I know, it sounded like this it missed your internal projection a little bit. But what do you make of some of the recent volatility and I’m not sure if you are willing to share kind of your thinking on what the fourth quarter performance might look like and when you think more of a sustained growth trajectory might be possible?

Yes. That’s certainly what to our goal is. We are cautiously optimistic about that ability and so we talk really small numbers around here from a growth and if we can sustain that over a long period of time and find some great opportunities to see maybe double-digit increases. We definitely need to do that and find great products to introduce in the market. But as you have kind of indicated, right. The marketplaces weird right now. This brick and mortar thing and then the ecommerce thing and how fast it is changing over and then what are the consumers looking for, what are the retailers are looking for. So we are excited about where we are at. We think we can see some growth, but it’s going to be very modest growth.

Okay. And then another question on the wholesale business. When you look at the work side of the business. I’m curious just shorter term and there is a separate of that Puerto Rico hurricane in fact. But when you look that the business impact this and in the South. Do you think, you have any impacts from the hurricane on the work business either positive or negative? And then I know you made a comment about implying some improvement to-date in the fourth quarter. I’m just hoping you might be willing to give a little more color there?

So I will answer the Texas kind of question and then I will let maybe Tom give you a little bit of insight on Q4. So in my opinion from what I have talked to our sales leaders - it’s a positive and a negative. The negative is obviously the retail stores have this impact of where they are not open or they are not selling. So we saw that and then, it’s awful gosh, I guess to kind of say, but the fact that a lot of the stores get flooded, the inventory is damaged and then they open their doors back up. So there is some positive to it in that way, but it’s not a huge difference. So it’s not a huge upswing, it’s just there is some of that happening.

Yes, John, then just add to the kind of the shift, I think we are seeing from Q3 to Q4. What I believes is going on is that it’s more and more of our wholesale customers are kind of moving to an online platform. I believe that we are seeing some of our shifts that we traditionally would or some of our sales that we would traditionally seen happen in Q3 that they are creeping into Q4 or a little bit more and more as they are trying to get the inventory closer to the need. We talk about retail and how top retailers right now in their cash flows. I think everybody is just trying to be conservative in getting the product closer to the need in the holiday season. So I believe we're seeing the small shift from Q3 to Q4.

Okay. And just to follow-up there. I don't know if this is something you can tell or not, but separate of those shifts in terms of that timing. Any way that you can sense for your customer kind of sell-through trends. Do you think you've seen any notable changes or is it more just the shift that you called out?

So I think this shift is a big piece of it. We have definitely seeing pretty good sell-through in the Durango brand. We're also seen a reasonable sell-through in the Georgia brand. As I kind of mentioned, one area that the sell-through has just not been there is the Rocky Outdoor, and the Rocky Outdoor Apparel. And I'm not sure, as we get closer to hunting season where our guy actually needs something, then maybe we will see that pick up in the same way that we have seen in these other areas, where they're buying closer to the actual time of need instead of carrying the inventory they just dropped shipping out of our warehouse. So maybe that happens here in the next couple of months. How Pennsylvania, West Virginia all of these big hunting areas will start seeing bear season which is a big one more in the November timeframe.

Okay great. And then two more yet for me if you don't me. But just on the contract military side. I know one of your large competitors recently changed ownership, and at this period how you are viewing that positively or negatively or any change in terms of how that impacts your military business.

It really doesn't. It actually takes the competitor out of the marketplace right. So there is a few less of us out there to bid on it. And like I say, we are going to aggressively go after any and all contracts that get offered to us or presented to us. And we will work diligently to make those happen for us in the production capabilities that we have in Puerto Rico without over bidding. So I don't think it's a big deal for us. It was an interesting sale and buy but didn't really affect us either way.

Yes, Jon in my opinion I view our Puerto Rican facility as kind of competitive advantage when it comes to the contract military business. So I hope we can still see some solid wins from a bid perspective.

Okay, great. And then kind a last one from me, maybe a bigger picture question around the operating margin. If I just look at the last couple of years, two years ago you had a 4% margin last year some of the issues is close to flat and now this year seeing a nice rebound again. So you are below kind of the long-term level that you've seen. I'm just curious structurally how you are thinking about the right margin profile for the business?

More.

I knew you would say that.

Should you imagined if I said less?

Jon I think from our perspective, I think that Jason and I are still continuing to look at ways of maximizing our operating margin and I think that we're kind of had a lot of discussion about long-term here and what that means and what kind of objectives we need to complete. So I would like to say I think it's going to get better in 2018, I think we have made a lot of improvements in 2017, but there is always room for improvement.

Yes. The only thing I would add is the market place is very difficult right now and you have to be competitive from a wholesale price point therefore a retail price point. So it’s a balancing act, we talk a lot around here like if we are going to miss the top line we better darn well sure make their bottom line. And so, we are very aware of it and we will continue to be very aware it and where we can find ways to increase that we certainly will.

And I guess just a follow-up, I guess the reason I ask is I think looking back to 2011 over last time you had above a 7% margin and your total revenue was below its on pace to be today. So, I guess I’m just wondering, I mean is there a big mix impact there maybe I assume, I know wholesale has been under pressure and military has been a big growth area. I’m just trying to think about so overall the margin is still quite a bit below where you once had, even though the revenue in total is higher?

Yes. I can’t rec about 2007, so I doubt I don’t know what our military business was like back then. So it could be a mix, but…

I think some of the margin decline there was absolutely with the greater recreation brand, we incurred a lot more SG&A expenses with having two separate offices. In July, we talked about how we close that office and we move people to Nelsonville, we are trying to gain some efficiency there. So, I hope that going in 2018 we are going to see some improvements.

Okay. Great. That’s it for me and I will follow-up. Thanks guys.

Okay. Thank you.

Thank you.

[Operator Instructions] Our next question is from with Andy Horowitz with OSP Capital. Please proceed with your question.

Hi. Good afternoon and congratulations on having another putting out a great earnings quarter.

Thank you.

I was wondering if you could talk about your international initiatives and how they are going and in what way do you see them impacting the business in 2018?

Yes. So, we have been having a lot of focus from an international perspective, we made some changes from our sales internationally in 2016 and we have seen some good traction made there. We don’t dive into specifics in these earnings call with regard to international sales, but we have seen some solid growth there and we are really trying to continue to grow that side of our business particularly from a commercial military side.

Okay. So, just on the commercial military side, you are growing international not on the other parts of the business?

We have grown kind of across all of our brands internationally this year. I would say that commercial military system is one of the more bright spots, but we have some great success with Georgia and also Durango. The Rocky is probably the last, the Rocky outdoor and that stuff the Durango and Georgia has done pretty well and the commercial military has been the largest.

Okay. If you took out commercial military, what percent of your business would you say is international at this point.

I would have to get back to you, I don’t have a number in front of me, I apologize Andy.

Yes I mean, I think it’s pretty small Andy, I mean in general our international business just in total even with commercial military relative to our total businesses is pretty small. It’s a big opportunity.

And that’s what I’m referring to. I’m trying to understand, is this an opportunity that you will be targeting in 2018, so it seems to me that you don’t need a lot of sales internationally, for to actually move the needle of the business?

I agree 100% Andy, we agree a 100 percentage absolutely in area that we are focused on, we will be investing more dollars to that area for next area and we believe that we can see a pretty nice movement there next year.

Okay great. And one other thing, you have done a great job over the last couple of years of reducing the debt on the balance sheet, you got to a point where you are pretty close to almost zero not far away let’s say another couple quarters I would assume after the Q4 you could pay down even more debt. Are you looking at acquisitions now, given that the capital structure is I would say a lot firmer?

I think the answer to that is yes in general, we are not actively or aggressively looking at an acquisition, but if something were to come along that we though fit us well and made sense then we would certainly consider the opportunity.

Yes Andy, let me just add to that too. This quarter we got active with our share repurchase program, we are so focused on paying our dividend out quarterly as well, so we are using some of these extra cash flow to returns some capital to our shareholders.

Okay. My final question and I’m just really posing to you guys. Now that you look out and as you mentioned on the call that retail is very different today than it was let’s say a couple of years ago. In terms of your three to five year plan, where you want to see this Company. I’m sure you have ideas. Can you give us a sense of what kind of size Company you want to see, what kind of profitability Company do you want to see over the next three to five years, as you build out this business?

So, bigger and more profitable. Today like I kind of said earlier. We have been running this Company right now, doing all the right things today and managing the business, I call running the Company on adrenalin and we have been working over the last couple of months on a long-term plan, I feel that we will have that put together here by the end of the year, would go a lot of good information and a lot of direction, we have got a great executive team here that’s been a part of that, but I don’t think we are prepare today to - at least I’m not prepare to lay anything out in a lot of details, Andy.

Okay, perfect. The inventory levels, are you comfortable, is it mostly fresh inventory that you are carrying today which is by the way is much lower than it was a year ago and a couple of years ago. It’s a wonderful thing what you are doing in terms of keeping the lower inventories, but would you say it’s very fresh?

Yes I think all of our inventory particularly on the Rocky, Georgia and Durango brands, because it’s not fashion driven, it lasts and we have boots that have been in the line for 25 years, the same exact boot and so for us to carry that inventory is not scary at all. And I feel very comfortable that the majority of our inventory is really in a good place.

Yes and Andy just to add on to that a little bit too. I mean with our increase in margins we have seen this year. We have been able to, kind of unload some discontinued products that we had the opportunity to get rid of. So we have been really focus and driving that inventory level down both from a finished goods perspective and raw materials perspective.

Okay, fantastic, beautiful. Thank you and good luck.

Thank you Andy.

Thanks Andy.

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