Rocky Brands, Inc. (RCKY) Q4 2017 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands' Fourth 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. I will now turn the conference over to Brendon Frey of ICR. Please go ahead.

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, 2016. In addition, the company may refer to certain adjusted non-GAAP metrics on this call. Explanation to these metrics can be found in the earnings release filed earlier today. I'll now turn the conference over to Mr. Jason Brooks, President and CEO of Rocky Brands.

Thank you, Brendon. With me on today's call is Tom Robertson, our Chief Financial Officer. We are pleased with our fourth quarter results which represent a strong finish to a productive year for Rocky Brands. There are a number of highlights from our recent performance which we'll walk through on today's call but from a high level we have experienced solid top line trends in our branded footwear wholesale business, achieved mid-single-digit growth in our direct channel and delivered a record year in our military segment. At the same time, the initiatives we've implemented to expand margins including driving more full price selling in improving the efficiency of our Puerto Rican manufacturing facility combined with our expense optimization efforts allowed us to dramatically improve our profitability year-over-year and further, strengthened our balance sheet. I'm going to walk through the key drivers of our fourth quarter segment performances and provide some color on our prospects for growth in 2018. Then Tom will review the financials in more details, after which we'll be happy to take some questions. Beginning with wholesale, sales growth accelerated and turned positive in the fourth quarter fuelled by some consumer demand for our core work, western and outdoor categories. Coupled with the fact that we're no longer cycling against the private labeled program that we discontinued in the third quarter of 2016, we were particularly encouraged to see that our gains were broad-based in terms of our distribution with key brick-and-mortar accounts and even more so, E-tailored partners experienced solid sell-through of our product portfolio. As we've talked about on our recent earnings calls throughout 2017, we worked hard to excite our consumers with great product, increased brand awareness and stimulate demand through improved marketing with an emphasis on digital and provide excellent retail support. I believe our fourth quarter wholesale performance indicates the initial progress we've made on each of these critical fronts. One note before moving on, as we previously announced, we sold the Creative Rec brand to a private investment group last November. Tom will go through the financial impact of this transaction in his section but from a strategic perspective, the divestiture allows us to focus 100% on our profitable work western hunting in military categories where we believe our most important growth opportunities lie. Now to our performance by category. Sales for our branded work footwear increased approximately 10% led by double-digit improvement in Georgia Boot. There were a number of successes from the quarter such as our essence collection of durable leather work footwear and the amplitude of our premium work hiker series. We also benefited from early selling of certain key spring work styles which we launched late in the year to get ahead of the major voucher company subsidy season which occurs in early Q1. At the same time, early reach on our recently launched line of western work boots have been positive in the Georgia line. Turning to western, this category also grew double-digits during the fourth quarter fueled by strong gains for both our Durango and the Rocky Brands. Much of Durango's recent success is attributed to the compelling products that we introduced for the spring and the fall season including key launches with the Rebel and Ultra-Lite collections. By focusing on the work segment of the western market, we've been able to more than offset the industry-wide slowdown in demand for women's fashion boots. Durango's work style sold through very well with key retailers like Boot Barn and Cavender's and generated strong replenishment orders through Q4. Durango's online business also enjoyed a very good holiday season thanks to additional marketing investments and driving sales during the key Black Friday, Cyber Monday shopping period. Following our decision earlier in the year to implement more aggressive pricing for hunting footwear, sales increased modestly year-over-year added in part by cold weather throughout much of the fourth quarter. On the top of the pricing adjustment in favorable temperatures, our commitment to bring great new collections to market and support the brand with increased marketing has led to improved retailer support and increased shelf space for our core hunting products. After a challenging year for commercial military business, due primarily to higher channel inventory following the heavy sell-in late in 2016 when retailers stocked up on product following the U.S. military mandate color change. We recently received good news from the U.S. Air Force, the human system program office certified fix Rocky S2V styles under their shape defined program authorizing pilots and air crew members to wear S2Vs during the flight operations. This is accumulation of a 6-year ongoing projects. Congrats to the team in this important win. Shifting to retail; sales increased mid-single-digits in the fourth quarter and for the full year. We are very pleased with the momentum in our direct channel which is being fuelled by further expansion of our Lehigh Outfitters custom fit program. Late in the year, we began shipping product to several new national accounts such as Whirlpool, Fiat Chrysler and Blue Diamond to name a few. These latest account wins will provide a tailwind to the business as we start 2018 and we are confident that we can build on our recent success by closing deals with other companies that have large numbers of employees requiring safety footwear. Now to our Military segment; 2017 marked a record year in terms of revenue and margins for our contract military business despite the numerous challenges our employees faced following the devastating impact Hurricane Maria had on Puerto Rico in September. The fact that we were able to ship over 8 million of product during the fourth quarter in difficult conditions is a testament to the resiliency of our people on the ground and the entire population as everyone is working hard to repair the islands infrastructure and resume normal day to day life. Before I turn the call over to Tom, I want to touch on our current outlook for each segment. Starting with wholesale, our largest segment, and where we own some of the most authentic brands in Work Western outdoor categories, following a solid fourth quarter, we began the New Year with good momentum which is contributing to our cautious optimism for continued growth. The plan is to stay the course, that means continuing to invest appropriate amount of resources and product innovation, marketing, primarily digital programs that strengthen our consumer connections, increase awareness of our brands and products and drive increased demands consistently over the long-term. In terms of distribution, our focus is on both brick-and-mortar where we have opportunities to continue gaining shelf space and online with accounts like Amazon and KOLs [ph] where we believe our brands are underpenetrated and our runway for growth is significant. Moving to retail; our Lehigh business is uniquely positioned to capitalize on the growing 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 and gain greater compliance. Our 2017 results speak to the progress we are making on expanding Lehigh's reach. However, I believe we are just beginning to scratch the surface of the model's full potential. At the same time, we continue to serve our B2C customers by offering a broad selection of 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 complementing the growth in our B2C custom fit model. Finally, military; on top of being up against a tough comparison after last year's record result, the business faces some additional headwinds in 2018. First, we've had a contract expire in late 2017. Second, the U.S. military demand for footwear is being tampered a bit by their current inventory levels. And finally, due to the changes in the competitive landscape, Rocky is currently the only player in this space not classified as a small business, putting us at a disadvantage as it relates to the federal contracting guidelines. We will continue to aggressively bid on all U.S. military contracts available to us while at the same time expanding our commercial military business, especially internationally. To take advantage of the increased capacity, we've added over the past few years at our Puerto Rican manufacturing facility. In summary, we are excited about the direction that the company is headed. I'm confident that our focused strategies which center on exciting new products, exceptional marketing, great customer service and operational excellence will result in long-term profitable growth and increased value for our shareholders. I will now turn the call over to Tom.

Thanks, Jason. Net sales for the fourth quarter were $67 million, essentially flat with the year ago period as gains in our wholesale and retail segments were offset by lower military sales due primarily to the lingering effects of Hurricane Maria. By segment, wholesale sales for the fourth quarter increased 4.7% to $44.4 million compared to $42.4 million last year. Retail sales increased 4.9% to $14.4 million compared to $13.7 million a year ago, and military sales were $8.2 million versus $10.9 million for the same period in 2016. Gross profit in the fourth quarter increased 7.1% to $23.3 million or 34.8% of sales compared to $21.8 million or $32.5 million of sales in the same period last year. The 230 basis point increase in gross margin was driven by three factors; first, higher wholesale margins as we improved full price selling and reduced the level of discounting. Second, higher military margins as we benefited from improved efficiencies in our Puerto Rican manufacturing facility compared with the year ago period. And lastly, a lower percentage of military sales which carry lower gross margins than our wholesale and retail segments. Selling, general and administrative expenses were $19.6 million in the fourth quarter of 2017 which includes approximately $300,000 of transaction expenses related to the sale of creative recreation compared to SG&A expense of $19.9 million a year ago. As a percentage of sales, SG&A improved 50 basis points to 29.3% year-over-year. Income from operations was $3.7 million compared to an operating loss of $1.2 million in the year ago period. On an adjusted basis which excludes the aforementioned transaction expense related to the Creative Recreation sale in Q4 this year and a $3 million non-cash impairment charge related to the Creative Recreation brand we recorded in the fourth quarter 2016, operating income was $4 million or 6% of sales compared with $1.8 million or 2.8% of net sales a year ago. First quarter interest expense decreased to $109,000 compared to $157,000 last year as a result of the significant reduction of the debt year-over-year. Net income for the quarter was $4.4 million or $0.59 per diluted share compared to a net loss of $600,000 or $0.09 per diluted share last year. There were a number of items that influenced our bottom line performance in both periods, namely the loss on the disposition of Creative Recreation in the impact of tax reform in the fourth quarter of 2017 and the impairment charge on Creative Recreation in the fourth quarter of 2016. With regards to tax reform, in short, we've realized the significant tax benefit from the remeasurement of our deferred tax liabilities on the balance sheet which was partially offset by a one-time toll charge related to the repatriation of earnings associated with our Dominican Republic operations. Excluding all the charges outlined in our prepared remarks and the impact of tax reform, adjusted net income was $2.8 million or $0.37 per diluted share compared to net income of $1.3 million or $0.18 per diluted share a year ago. We've included a reconciliation table in today's press release that bridges our GAAP to non-GAAP results. Turning to the full year, let me quickly summarize the highlights of 2017. Wholesale sales excluding the discontinued private label program from both years decreased $3.8 million or 2.1% comparatively. Retail sales increased 5.3% to $48.4 million and military sales increased 2.1% to a record $38.2 million. Adjusted gross margins increased 280 basis points. SG&A as a percentage of net sales improved 190 basis points to 27.2%. Adjusted operating margins increased 470 basis points to 5.2%. Adjusted earnings per share improved to $1.16 from $0.08 per share in 2016, and our funded debt decreased significantly, down 85% to $2.2 million. With respect to 2018 we want to share a few things to keep in mind as you update your models. First, as a reminder we'll be cycling against Creative Recreation sales for the first 11 months of the year which can be approximate $5.5 million headwind. Second, as Jason mentioned, we are facing some challenges in our military segment from expiring contracts and changes in the market dynamics and therefore we expect military segment sales to be down approximately $12 million in 2018 compared with 2017. Finally, following the passage of the tax cuts and jobs act, we expect our effective tax rate to be between 20% and 22% for the full year. That concludes our prepared remarks. Operator, we are now ready for questions.

[Operator Instructions] Our first question is from Jonathan Komp from Robert W. Baird. Please go ahead.

I want to ask a couple of questions and start on the wholesale business and the improvement you've seen there. I'm wondering if you could give anymore color on just the overall environment as you see it. And including maybe any specific channel level commentary across the segments, maybe which areas you've seen improvement when you look across the different partners that you sell-through?

We were really fortunate in Q4, we saw nice increases in all of the different brand and categories excluding the commercial military. So we were able to see some nice things happening there and turning for us slightly, some of the brands growing a little bit bigger than others but we saw increases in all of them. And then from a distribution channel, the e-commerce business is obviously growing at a much faster rate than the brick-and-mortar but we were still able to see some decent increases with the brick-and-mortar as well. So, we're still focusing and have our mind wrapped around this e-commerce business and plan on in '18 doing a lot of investment there but we believe we can steal some shelf space in the brick-and-mortar as well, so we'll be focusing on both of those.

Maybe just a follow-up, I don't know if you're willing to comment geographically at all? Are you seeing strength in Texas in some of the oil markets or any color you can give there on the work side for the wholesale business?

Yes, I think obviously you're hearing from a lot of people that the oil business is coming back a little bit. We're seeing some of that but I would tell you that our success in each of the brands is really kind of all over the U.S., we're seeing some nice increases in the Northwest, we're seeing some in the Southwest, we saw some all over the Southeast; so it's kind of all over the place for us, there is not one particular area that was like -- there is a 25% increase happening over here. So we're pretty pleased with that too because that means we're not so dependent on one segment.

When you look forward to 2018 for the wholesale business, I know you mentioned expecting growth for the year; I just wanted to clarify first if the Creative Recreation drag if that's all within wholesale? And then secondly, just confirming you're expecting to grow even despite that kind of call it 3% headwind for the year?

When we look at Creative Rec as a headwind, we threw out that approximate $5.5 million a minute ago. I would say 80% of that is probably wholesale and the remainder would be retail obviously.

And then, even with that headwind do you still feel good about projecting growth for the year in 2018 for wholesale?

From a wholesale standpoint, yes.

And if you could give maybe gross margins by the segments that would be helpful. And also I just wanted to confirm if you see the benefit from more full price selling and wholesale continuing?

Yes, definitely. We think -- we're kind of moving forward with this more full price less discounting strategy and we're continuing that into 2018. So for the fourth quarter of 2017 we had wholesale gross margins at 34.4% for wholesale, retail was at 45.6%, and military margins were 18.3%. So we really saw increases in wholesale and in the military side we had a slight decrease in retail and that's basically related to the bigger proportion of sales that Lehigh has in the retail segment as they've grown at a faster rate than our traditional e-commerce.

On the Lehigh business it sounds like better strategy there, certainly starting to come together there. I'm wondering maybe a bigger picture question on how you think about really the overall addressable market for that business and kind of the outlook for growth, both in 2018 and beyond.

So, I think we are really excited about this business model and we are going to invest some -- what we consider to be serious dollars to really kind of catapult that business. We think we've just touched the surface, there are so much business to be add out there and what we needed to do was invest in some -- really some inside sales people to just make more phone calls and say, you guys interested in this, this is what we have to offer, it's a great program. And so we think there is substantial growth there, I would say low double-digits and we think that is a year-over-year -- I think we can do that many years in a row.

We focused a lot on this business in the past on more of a steel tale customer, a hard competitive [ph] customer. There the market is much bigger than that, it doesn't -- we have a lot of stuff to safety footwear needs as well, so we think this market is really large.

And one more on the military business; I'm wondering -- you mentioned down about $12 million for the projection in 2018, is -- to view that more as a temporary setback and then getting to a new base that you can grow up off or some of the headwinds you called out and were structural and longer lasting?

I'm a little concerned about this. I mentioned there has been a change in the marketplace and the government, as they come out with new contracts, if you are considered a small business, the government wants to support small business which I appreciate and value in a big way. Unfortunately, we are not considered a small business so if the group of accounts that are considered small business can actually fill the needs of that contract and the contract never gets bided. So my concern right now is, nothing changed in the marketplace, there is still the same capacity out there but through the year there was a change from the way one of the companies was categorized as large business, because they got sold they are now considered a small business. So I'm concerned about it, I still think there will be some contracts that will get to us but it's going to be less; so our main focus is going to be how can we increase our commercial military, our U.S. postal service shoes that are made in that same factory. And then we're even considering doing USA made shoes in the Puerto Rican facility, maybe work goods, maybe other types of products. So we think -- for our best interest going forward, we want to try to fill the factory up with non-military stuff and hopefully we can do that, start to do that in 2018.

And just a follow-up; would you consider any more drastic changes to business model? I know you've talked about Puerto Rico being an advantage for the military business, so I don't know; perhaps there would be a way to spin something off to -- take advantage as a small business outside of the Rocky umbrella if you will but any potential more broadly strategically there?

So there has been some very, very small conversations about it. It is -- it would be a big strategic direction change, right. So it is not something today that we are aggressively looking at but there have been some small conversations around it. We still have contracts in the military, for this level I believe it's for until 2020. So I don't see a change from this dollar amount over the next three years, so I can't imagine why we would do anything until after that.

I just want to follow-up on the guidance for 2018. I know you mentioned being able to improve the profitability on the lower revenue base and I'm wondering if you're willing to give any color there; kind of a degree of profitability increase? And then within that, how you think about -- obviously with military there is going to be a pretty big mix change impact in between the gross margin. [Technical Difficulty]

Thank you for your patience, the conference will begin momentarily. We'll figure back in the conference now.

Jon, are you still there?

I am. Can you guys hear me?

Yes. I thought you were mad at us.

You can be more subtle and telling me I'm asking too many questions.

No, it just went off, maybe something we did on our end; so sorry about that.

No worries. My last question was really related to the comments about the profitability improvement in 2018; if you could quantify that at all? And then I know there will be a lot of moving parts for gross margin and SG&A with the military mix changing, so if you could give any color across the line items, that would be helpful.

I'm not sure exactly how much color you want to go into for 2018 but you know, from -- with the sale of Creative Recreation we're expecting to see a pick-up in our operating margin this year, somewhere between 0.5% to 1%. So let's kind of believe in using internally in 2018.

I think between the Creative Rec, I think even though the military sales are going to be less, we still think we have a little bit of room there from a margin standpoint. And then obviously, the tax rate change -- we pick up a little bit of stuff there; we're still going to be very conservative with our spending and make sure that we're not doing anything outline there. So we still think there is a little bit of room there, it's not going to be dramatic.

[Operator Instructions] And with no further questions, I'd like to turn the floor back over to management for any closing comments.

I'd just like to say thanks for everybody attending and listening. We appreciate everybody's consideration and have a great day.