Rocky Brands, Inc. (RCKY) Q3 2019 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Rocky Brands Third Quarter Fiscal 2019 Earnings Conference Call. [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, sir.

Thanks, Hector and thank you to 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, 2018. And I will now turn the conference over to Jason Brooks, Chief Executive Officer of Rocky Brands.

Thank you, Brandon. With me on today’s call is Tom Robertson, our Chief Financial Officer. Our third quarter and year-to-date results have been driven by our ability to capitalize on the key growth opportunities we’ve identified for the company. With three distinct business segments: wholesale, retail and military, and multiple categories within the wholesale, there are several avenues of growth that we can pursue. While we are encouraged about the future prospects for each of our brands and channels, we have prioritized our efforts and resources to go after the opportunities that we believe provide the most upside and are margin accretive. On a quarterly basis, the main growth drivers might change a bit due to seasonality, the timing of shipments and new customer additions or marketplace factors beyond our control. However, we are confident that the collective performance of our brands and channels will drive consistent top line growth and more importantly, enhance profitability over the long term. For a high level, the third quarter was marked by another strong period of growth for our retail division, as well as a high single digit gains for several of our branded wholesale categories. As expected, military segment sales were down as we recently conducted looted a multi year contract which needed our overall growth rate. However, the higher gross margins in all three segments versus a year ago combined with the increase penetration of retail, which is our highest margin channel, adjusted operating income grew approximately 12% and adjusted earnings per share increased to approximately 13% to $0.68. I’ll go into more detail about our sales results by segment, and then Tom will review the financials in more detail. After which, we will be happy to answer any questions. Starting with wholesale, sales were up 0.5% compared with a year ago. While this growth is slightly below our target of low single-digits for the division, year-to-date wholesale sales are up 2.4%. The softness in the quarter came primarily from Georgia, where we had some shipments slip into the fourth quarter. The remainder of the decline was due to lower than expected reorders from a handful of accounts despite many of our products, including new styles, like the revamp Romeo and the eagle one series continuing to sell through well. We think this could be the result of the warm fall weather in several areas of the country and reluctancy by retailers to take more inventory until temperatures turn colder. Reinforcing our belief that consumer demand remained solid is the fact that Georgia’s e-commerce business was up mid teens during the quarter. Moving to Durango, sales were up low double-digits versus last year, which follows a high single-digit gain in Q2. Like last quarter, the brand’s strong performance was due largely to the success at key accounts, like Boot Barn, Tractor Supply and Cavender’s. Specific to each of these accounts, Boot Barn launched new status of the brands popular Maverick boot in Houston, a major Western market and supported the rollout with billboard campaign throughout the city. At the same time, Cavender’s expanded its offerings of the Rebel Pro series for men, women and children, while Tractor Supply introduced a new children’s program, which is performing well across the chain. Turning to the Rocky brand, our Rocky sales rep – our One Rocky sales rep strategy, which allows us to better service accounts with one point of contact for all categories, continues to pay dividends. On a combined basis, Rocky sales were up mid-single digits, led by ongoing strength in outdoor. Across the brand, our independent channel exhibited the strongest growth, while our outdoor styles also sold through well in the larger accounts, like Bass Pro and Dick’s Sporting Goods. We have made a bigger effort recently to engage consumers and it appears that our marketing investments aimed at driving brand awareness and in-store demand are working. With respect to our commercial military business, we continue to experience solid demand at each of our U.S. Military exchanges, led by AAFES, the Army and Air Force exchange services. As you’ll recall, we started selling through the Navy and Coast Guard exchanges last quarter. And in Q3, we welcomed aboard the United States Marine Corps’ exchange. We are honored that Rocky commercial footwear is now represented in all the major military exchanges in the U.S. Now to retail which delivered another strong quarter with sales up more than 20%, our Lehigh custom fit safety shoe model continues to demonstrate strong, sustainable growth driven by continued improvements in account retention as well as new operational processes, introduced and enhanced our onsite iFit ordering events. At the same time, new account acquisition continues at a strong rate outpacing last year. During Q3, we have brought online two large national accounts, Genuine Parts Company and Menzies Aviation, both of which contributed to our growth in the quarter. Our partnership with Aetrex also continues to strengthen. We have seen steady growth in orthotic sales via the use of the specialized foot scanning equipment. This technology capability is enhancing our business model and augmenting our managed safety footwear programs with a health and wellness component. The additional offering is being well received by our customers as they’ve increased their focus on developing the healthy active workforce. Turning to e-commerce, we continue to see strong growth as we drive more traffic to our own branded websites, with new and exciting marketing programs. Additionally, we have recently been adding web-exclusive products to our own lines, giving consumers a reason to visit our websites more often. We are also having good success expanding our business on several marketplaces, particularly Amazon, as we’ve recently gained seller fulfilled Prime status, which allowed us to make our entire catalog Prime eligible and capture those consumers that only shop Prime eligible products on Amazon. Finally, Military segment sales were down approximately $1.6 million versus a year ago, in line with our expectations. The decrease was due to the combination of the ongoing industry headwinds we continue to face as the only non-small business competing for U.S. military footwear contracts along a previous multiyear contract that we concluded shipping in the second quarter of this year. Looking ahead, we will start delivering our general safety boots under the United States Navy contract that we received from the Defense Logistics Agency in May. Based on the terms of the purchase agreement, the DLA has a right to purchase approximately $27 million of these boots through May of 2022. In closing, we are pleased with our third quarter and year-to-date performance by continuing to execute the key strategy initiatives, we outlined for the company over 2 years ago, we have been able to consistently achieve improved financial results and generate increase value for our shareholders. In the near term, we will face some pressures on our bottom line due to the tariff increases on Chinese footwear imports that went into effect in September. This is a fluid situation. We are closely monitoring current events and exploring all options to mitigate these headwinds, including negotiating better terms with our suppliers, sourcing product from outside of China and selectively raising prices. Regardless how this trade war plays out, I am confident that the strength of our brand portfolio, our margin-enhancing growth prospects and internal manufacturing capabilities will allow us to deliver increased profitability over the long-term. I will now turn the call over to Tom. Tom?

Thanks, Jason. Net sales for the third quarter were $67.2 million compared to $65.9 million in the corresponding period a year ago, an increase of 1.9%. By segment, wholesale sales for the third quarter increased 0.5% to $47.2 million, retail sales increased 21.6% to $14.5 million, and military sales decreased $1.6 million to $5.4 million. Gross profit in the third quarter increased to $25 million or 37.2% of sales compared to $22.4 million or 34% of sales in the same period last year. The 320 basis point increase was driven by higher percentage of retail sales, which carry higher gross margins than our wholesale and military sales combined with higher wholesale, retail and military margins. The third quarter of 2019 also benefited from a $725,000 hurricane-related expense reimbursement. Excluding net gain, gross margins were up 220 basis points year-over-year. Adjusted gross margins by segment were as follows: Wholesale, 34.3%; retail, 45.5%; and military, 26.8%. Selling, general and administrative expenses increased to $18 million or 26.8% of sales for the third quarter of 2019 compared to $16.8 million or 25.5% in the period a year ago. The $1.2 million increase in SG&A expense was driven primarily by increased investments in marketing and personnel to support future growth as well as higher variable expenses associated with the increase in retail sales. Income from operations, inclusive of the hurricane expense reimbursement, was $7 million or 10.4% of sales compared to income from operations of $5.6 million or 8.5% in the prior year period. Net income increased to $5.6 million or $0.75 per diluted share compared to net income of $5 million or $0.67 per diluted share in the prior year period. Adjusted net income, which excludes the hurricane reimbursement from this year’s third quarter and a tax-related adjustment in a year ago period, was $5 million or $0.68 per diluted share in 2019 versus $4.5 million or $0.60 per diluted share in 2019. Turning to the balance sheet, as of September 30, 2019, we had cash and cash equivalents of $6.4 million, an increase of 53% compared to September 30, 2018. We had no funded debt at the end of both periods. Inventory at the end of Q3 2019 was $82.9 million, up 5.7% compared with $78.4 million on the same date a year ago. Regarding our outlook for 2019, based on our year-to-date performance, we still expect revenues to increase in the mid-single-digit range over 2018. Since our last earnings call is in July, another tranche of goods, which include a large portion of footwear resource from China were subject to increased tariffs. As Jason outlined earlier, we think we’ll be able to mitigate this headwind through a series of initiatives. However, it will likely take until early 2020 for these to positively impact our income statement. In the meantime, we are anticipating some short-term pressure on gross margins, which will make it difficult to improve profitability over a year-over-year basis in the fourth quarter. That concludes our prepared remarks. Operator, we are now ready for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Jonathan Komp with Baird. Please proceed with your question.

Yes. Hi, thanks. This is Steve on for John. I was just wondering maybe if you could start off giving us a little more insight on some of the wholesale shifts. I know you called out Georgia and what gives you confidence that it’s just timing related. If you can isolate it to a particular region or customer and maybe anything else really impacting that part of the business right now?

So yes, Steve, this is Jason. I think if you dig back through, you’ll see Georgia was really the brand in Q3 that didn’t perform up to the level that we were expecting. And one customer in particular, which is Tractor Supply really had a timing difference in regards to when they wanted some business – when they wanted some orders delivered. So we’re pretty comfortable that those orders just fell to Q4, and we believe that that’s going to come back there a little bit in Q4 from a top line side of it.

Great. That makes a lot of sense. So maybe just as a follow-up, a little – if you can share a little more color on, I guess, how to think about total wholesale growth going forward, if that low single digit is what should we still be expecting here?

Yes, Steve, this is Tom. When we looked at the whole year, we realized that Q3 came in a little lighter than we anticipated. And to Jason’s point, we think some of that has shifted into early Q4. But I think we are still comfortable on – in kind of giving guidance to wholesale and we think that it’ll be in that low to low mid-single-digit range for the year. And so that’s kind of our plan as we move into Q4, and we expect that to continue.

I think Steve, we said that year-to-date, we’re still at a 2.4%, 2.5% sales increase. And that’s just for Q4, which we think we missed – I’m sorry, Q3, which we believe we missed Q3 a little bit. So I think if you think of it in that way, Q4 comes in – I think those low single digits are still pretty strong.

That makes sense. And then maybe if you could talk a little bit about some of the tariff impacts, I guess what level of unmitigated impact you expect this year and then to the extent you’re willing to look forward to 2020 a little bit. And maybe just any leverage you think you have in the model whether that’s pricing that you think retailers would accept or ability to flex production? If you could just give a little more color on some of those.

Yes. So Steve, I hate to give you kind of a firm number on the impact for Q4, the reason being as that as Jason said, it’s a really fluid percentage changing on a daily basis. And we’re negotiating with our partners in China about – just over about half of boots are brought from China. So, we are working to get that number down and anybody who follows the forward markets should know that your orders are out anywhere from 90 or 120 even 180 days in some cases. So some of that we are not going to be able to mitigate until the – till the beginning of 2020. With that being said, we feel – we’re very confident that we’re going to increase our capacity in the Dominican Republic. We think that’s a huge advantage that Rocky has over some of our peer group. And we’re going to be able to increase the capacity there, move higher volume styles as needed and where it makes sense from China to the DR. We’re also exploring other countries outside of China. But we’re not in a – we don’t want to jeopardize the quality of the footwear. There’s a lot of challenges that come with moving footwear from one factory to another. So we’re very – we’re going to do it very cautiously and we’re going to do it as quickly as possible. But we don’t want to jeopardize the brands we’re trying to transition something too fast. And then also, as we’ve talked about earlier in this call, we think a small or modest price increase will help with the margin impact as we move into 2020. And we expect our Chinese partners to continue to give us discounts as we move forward.

I think the other area that you probably aren’t hearing a lot about is our vendor partners, right? Our suppliers of leather, our suppliers of waterproof, the raw material side of it. Everybody is aware of the tariffs. So when you walk up and say, guys, I need an additional percent discount, people are least willing to talk to you about it, where before if you couldn’t explain it, then they didn’t won’t even discuss it. I think our retail partners are also going to be good partners and say, okay, some of it is going to have to move on to the consumer. And then some of it, they’re going to eat it as well. So I think it’s really important how we look at every style and how it is affected by the price increase that we are going to apply to it in the marketplace. But we are beating this one to death.

Yes. Steve, another point to kind of get across too is that with our Lehigh business with us selling to other third parties, we get kind of a sneak peek into what other brands are doing from a price increase standpoint. So we’re trying to leverage that information that we know to make sure that we position brands as good as possible in the market.

That all makes sense. And then maybe just switching over to the retailer side of the business here, obviously, it seems like really, really good momentum there. So I know you’re just cycling kind of a tough comparison in Q4 and there was some favorable weather last year. And just kind of piecing all that together, I was wondering how you’re thinking about your ability to kind of keep the momentum up here into the fourth quarter?

Yes. So I think when we look at the retail space, I think, we internally and I think probably almost everybody has high expectations for our retail category, just given its growth over the last couple of years. But as you hit the nail on the head there, we’re starting to come up to some tougher comps. And so we’re kind of cautious to throw out growth rates that we’ve been hitting over the last few quarters. But I still think that a low double-digit increase is definitely doable in the fourth quarter. And so I think that’s kind of where – I guess we’re kind of expecting it to come in.

Great. Maybe just a couple more for me really quick, so could you maybe just give a little bit of color on – how you’re feeling about inventory. I know it’s been coming down a little bit here over the last few quarters, but still maybe slightly elevated. So just trying to get a better sense of your comfort with that?

Yes. Steve, to be honest with you, I feel probably more comfortable about our inventory today than I did when I joined the team three years ago. I know the dollar amounts are up, but our discontinued inventory is at a lower level, both dollar and percentages than what it was certainly last year. And I think with our new Amazon seller fill Prime warehouse that it gives us a whole another channel to sell a product that’s coming to the end of its life. And so hopefully, that’ll drive up the margins of our discontinued boots when we do sell them. However, I am not sure we’ll get the same margins that we currently get in retail. But I still think that it will be a net margin gain.

Great. And then maybe just one last one for me, you made some comments about maybe some of your retail partners being a little more tepid here, just given maybe the warmer start to fall here. And I know there’s been some macro noise. I just wonder if you could talk through some of that. And if that’s something you think starts to flip once the weather gets a little colder here? And maybe just on an unrelated note, I know you talked about some better efforts here with some of your e-commerce players, like Amazon and others. So just how you’re thinking about the contribution from that looking ahead into the fourth quarter?

Yes. Sure. So the weather is a crazy piece of our puzzle that affects really every category, except for our retail side. So if you think about a guy who works in the outdoors, if it’s nice and sunny and kind of cool out, he is going, I can get another three months out of my boots. And – so if that turn isn’t happening in the retail floor, then the retailer pushes back on us to say, I’ll take it in another 30 days. And same thing with hunting boots, if it’s not wet and nasty out, they’ll push that purchase out a little bit longer. So we definitely think it had somewhat of a – an issue with it. I’m not concerned at all. Our retail partners are sharing with us. A lot of very good positive things going on in the marketplace. So I think the Q4 is going to come together pretty good under that circumstance. And obviously, if we can get some cold, rainy, snowy weather, it will also clean up some inventory and may accelerate some sales if we could get that here pretty quick though. And then, you had asked – the other question was about Amazon and e-commerce. I think that is a ever-evolving learning process for us, and we are finding new things, new nuggets every day that are allowing us to see increases there. And not just on Amazon but a lot of the other marketplaces and really being able to partner with some of the other companies out there to help us position ourselves in the right places to get those sales. So we’re pretty excited about that area as well.

Great. Thanks for all the time and best of luck.

Absolutely. Thank you.

[Operator Instructions] 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 any closing remarks.

Great. Thank you very much. Appreciate everybody’s support and questions about the direction of the company. We are looking forward to Q4 and wrapping up ‘19 and heading into a great 2020. Thank you, guys. Talk to you next quarter.

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