Good afternoon, ladies and gentlemen. And thank you for standing by. Welcome to the Rocky Brands Second Quarter 2022 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. 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. I will now turn the conference over to Mr. Brendon Frey of ICR.

Thank you. And thanks 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, 2021. And I'll now turn the conference over to Jason Brooks, Chief Executive Officer of Rocky Brands. Jason?

Thank you, Brandon. With me on today's call is Tom Robertson, our Chief Financial Officer. We are very encouraged with the continued strong demand we experienced for our portfolio of leading brands during the second quarter, especially in light of the growing pressure on consumers spending from inflation and the other macroeconomic headwinds. Our top line performance year-to-date underscores the desirability of our innovative functional footwear, the strong connections we've forged with our core customers in multiple categories, led by work, western, outdoor, and commercial military. Over the past 15 months, we have integrated our acquisition of Honeywell's performance and lifestyle footwear business, which includes the Muck and XTRATUF brands, and made important infrastructure investments to support growth, most notably, the opening of a new distribution and fulfillment center in Reno, Nevada. At the same time, we have faced certain internal and external challenges that have hampered our ability to fully capitalize on our progress and deliver the profitability this company is capable of generating. Most recently, it has been higher-than-expected cost throughout our supply chain from first cost with our suppliers to inbound freight and port-related logistics expenses. We raised our prices at the start of the year. However, it hasn't been enough to fully offset the continued increases we've experienced, which resulted in second quarter earnings coming in below our expectations. In response, we will be taking our pricing up again on September 1, which along with improved supply chain conditions and the expense synergy savings we announced in early June will put Rocky Brands in a much stronger position to deliver sustained, profitable growth. Tom will go through the numbers in more detail, but I want to spend a few minutes reviewing the highlights for each of our brands from the second quarter, beginning with Durango. The…

Thanks, Jason. As Jason outlined, growing demand and strong inventory to meet that demand drove another solid quarter for Rocky, though operational challenges did hinder our ability to convert that demand into bottom line results. Reported net sales for the first quarter increased 23.1% year-over-year to $162 million. By segment, on a reported basis, Wholesale sales increased 29.7% to $131.2 million, Retail sales increased 16.4% to $26 million, and Contract Manufacturing sales were $4.9 million. Turning to gross profit. For the second quarter, gross profit increased 9.4% to $53.8 million or 33.2% of sales compared to $49.2 million or 37.4% of sales in the same period last year. The decrease in gross margin was primarily attributable to higher-than-expected increases in product cost, inbound freight and other shipping and logistics costs. Gross margin by segment were as follows. Wholesale down 500 basis points to 30.9%. Retail down 80 basis points to 48.9%. And Contract Manufacturing down to 10.5% from 21.8% A year ago. As Jason noted, we're raising prices on September 1. And with this action, along with improving supply chain conditions, we expect gross margins in the second half of the year to improve compared to the second quarter. Operating expenses were $48.2 million or 29.7% of net sales in the second quarter of 2022 compared to $40.7 million or 30.9% of net sales last year. Excluding $2.1 million in acquisition related amortization, integration expenses and restructuring costs this quarter, and $2.3 million in acquisition-related expenses in the second quarter of 2021, adjusted operating expenses were $46 million in the current period and $38.5 million in the year-ago period. The increase in operating expenses was driven primarily by higher outbound freight expenses and higher variable expenses associated with the increase in sales. As a percentage of net sales, adjusted operating…

[Operator Instructions]. Our first question comes from the line of Susan Anderson from B. Riley.

I was wondering, Tom, if you could talk maybe a little bit about just the drivers of the gross margin pressure, maybe if you could bucket it a little bit just in terms of magnitude and when you expect that to fall off. And then in terms of the price increases, how much are you expecting them to be in the back half? And was there any in the first half? And do you expect that to fully offset inflationary pressures?

So, as we look at the rest of the year, I guess starting with the first part of your question, second quarter, we would be – as inventory came in, right, and we talked about in-transit inventory at the end of last quarter, as the on-hand inventory kind of swelled, we had to throttle inventory into the distribution centers. And we ended up incurring more logistics costs than anticipated. And so, we've gotten a lot of that through the P&L at this point. But there's still more to flow through up from the balance sheet. And so, we'll see continued pressure really in the third quarter, and then mitigating a little bit in the fourth quarter. The other driver is, as we noted earlier, we've seen price increases from third-party sourcing factories in Asia. And so, we're working to help mitigate those, whether it be pushing back on those partners or even – and the price increase that we've announced today. In the prepared remarks, we stated we anticipate getting to that 34% mark for the fourth quarter, which is down from where we've previously guided. The price increase more specifically probably averages somewhere between $5 and $7 per pair. And really, the effects of that will lag into Q4. And probably, our larger accounts, you have to give them a little bit more notice. So, likely more see the benefit of that as we move into the first quarter of 2023.

I just want to add on there. We did take a price increase at the beginning of the year. Obviously, it was not enough of a price increase. We do believe this one is more appropriate. We will have to reevaluate that as we come in to the end of the year and if there will need to be any more price increases going into 2023.

Maybe if you could just talk about the Wholesale order book, kind of what you're hearing there, from your wholesale partners for the back half. It looks like you're expecting sales to be at the low end now, but then also going into 2023.

I'll start off here. I'm sure Tom will add some color. But we are still going into the Q3 and Q4 pretty positive. We saw a little slow at-once business in July, but nothing too awful scary. I think we tend to look at our product in its more functional than fashionable, and people are still working, people are still in need of the types of products we have. So we still feel pretty good about Q3 and Q4. And then, to go out into 2023, to try to predict anything right now is really complicated, I think. Are we going to get back to, what is new normal and how does that kind of flow through? I think it's got to level off. I think we have to find a new normal here. And hopefully, we can get back to something in 2023.

Just to add on a little bit there. We obviously follow our bookings really closely. We've not seen any significant cancellations. And so, what we're trying to ascertain really is, as Jason alluded to, we saw a little bit of softness in our at-once business, which is a large portion of our business, but nothing too concerning. And so, I think we're being, I'll call it, cautiously optimistic for the last half of the year. That's why we're not really taking down our guidance. We're just kind of going to the lower end of the range we previously provided.

Our next question comes from the line of Camilo Lyon from BTIG.

This is Mackenzie Boydston on for Camilo. My first question is just on supply chain. I know that you said Q2, you saw some higher costs. But I'm just curious, in terms of transit times and freight costs, could you just kind of talk about what you're seeing now versus maybe what you saw earlier this year? Just trying to understand, like if you're seeing anything maybe come down from Q2 into the back half or is understanding when you think transit times and costs might peak for you?

I just want to be clear. We are definitely seeing costs come down. It's not coming down as fast as it went up. But we are seeing costs come down. I think where we talked about the cost in Q2 was we anticipated that may be coming down a little quicker. And so, they stayed up there a little longer than we anticipated. So we are definitely seeing that a little bit. And then, in-transit times are starting to get a little more normalized. And I would say 30, 45-day in-transit times are more common today. And that's kind of what we used to see really before COVID and all the mess. We still have some outliers occasionally where you have a high expense and then maybe a 90-day transit time, but we definitely are seeing it come down a little bit and more normalized, I guess. from a transit time,

I think an important call out here, Mackenzie, some of the transportation costs that were incurred in the second quarter really relate to kind of our inventory position and us having to manage through all the logistics of getting the inventory into the DC. And so, the takeaway from that is that some of these costs are really just temporary, right. And so, as this inventory position works its way down, as we're planning for Q3, but really for Q4, we'll see those, we'll call them, extra type of logistics costs, import costs, we should see those come down. And so, that's the optimistic point of view on this, is that some of these costs will go away as the inventory position gets better.

Just your brands, both your legacy and your acquired, can you talk about – I know you talked about you continuing to see demand be strong across your brands. But just any noticeable difference or call-outs by income, demographic, customer, product type, just anything you could talk about from a demand perspective across your portfolio would be helpful.

I think this is a great question. Because of the type of products, the demographics of it, are pretty consistent, right? These are blue collared workers, we might have some outliers occasionally here or there. But we sell all of the brands throughout all of the same kind of retail stores. When you look at farm and ranch, you look at work boot stores, you look at outdoor hunting store. So, we really don't see a lot of difference in that area. And I would tell you that our work boot business is still very strong. The western boot businesses maintaining and doing very well in both Durango and Rocky. there's been anywhere that we've seen a slight adjustment is XTRATUF. It has a very functional side to it. And then it also has a little bit more of a – I hate to call it fashion, but it has a little bit of a fashion side to it. So, we've seen a little bit there from a slowdown standpoint, but nothing that's too awful. So the demand for our brands is still pretty strong right now.

Our next question comes from the line of Jonathan Komp from Baird.

Maybe just a follow-up question on the outlook for revenue growth at the low end of the prior range. I think you're implying something close to flattish in the second half to get the 21% growth for the year. So can you maybe just confirm that's what you're thinking and any additional perspective you could add on sort of change versus strong growth you just delivered in Q2?

We're going to the lower range. I think we're relatively flat. There might be some upside there for the second half. I think just from a modeling perspective, John, I think you've got remember that, last year, it was a really tough comp. That was kind of the – or was very easy comp, I should say. That was kind of the height of our distribution challenges following the integration. So, I think you just need to massage the numbers from there as well. But we don't plan to carry in as much back orders, if you will, into the fourth quarter, either. So, just some noise between quarters, but I think you're correct in your assumptions there.

Maybe a broader question on the sort of the revised margin commentary. Guys, it looks like you're pointing closer to 7% for the year in terms of the adjusted operating margin. Could you just share any perspective as we look forward? Is that a new base to grow off of and what are the pieces that – if you could quantify them, sort of that look temporary that's here that maybe we shouldn't factor in going forward.

I think there's a lot of temporary factors going into this year. As we work through this inventory issue, we're going to see efficiencies in several different places, one within the distribution centers themselves. They're jammed pretty tight right now. And so, we'll become more efficient as those inventory levels come down, which, again, we anticipate seeing the inventory come down in the fourth – a little bit in the third, but more in the fourth quarter. Also, there's a significant amount of logistics costs around just trying to get – move the inventory around between distribution centers, which I don't anticipate having next year. And also, [indiscernible] things like that that were incurred and the first and second quarters inventory swelled that we do not anticipate on a go-forward basis as the inventories right-size. So, I'd say a lot of this cost is temporary in nature. Also, the price increases, as we've alluded to, or we've spoken to, I should say, will also drive higher margins. We just have to be patient for that price increase to take effect. We had taken the approach last year of trying to – thinking that the freight was probably going to be a little bit more of a temporary challenge. But when we got price increases for first costs essentially from Asia, we have to take a more dramatic price increase. And again, as we said, our plan is to try to mitigate those first costs as we as we move forward as well. So, I would say it's more temporary. And for us to get back to LY numbers, I would say, which would be a very low goal for us in 2023 from an operating margin standpoint, and I think our expectation would be that we would see some improvements.

Just last question for me. Sorry, if I missed this, but, Tom, is there any way you could give a little more color into the makeup of the inventory? Or just specifically, where you see some of the excesses that you want to work through and sort of the plans – the updated plans to get through that?

It's really clear, if you look inside of the makeup of the inventory. The of our excess inventory position is really around the acquired brands, particularly Muck and XTRATUF. Fortunately for us, those brands are performing very well. And so, our plan is to move through that inventory, like I said, in Q3 and Q4 and we'll continue to right-size that. Really optimize it into Q1 and Q2 of next year. We are probably a little bit heavier on inventory in the legacy brands. And that's really been driven by transit times, but also last year with everything going on our retail. We're up against really tough – a lean operating environment or lean inventory environment for the legacy brands last year. But it's very clear to us, given the distribution challenges we had with the acquired brands in Q3 and Q4 of last year that that's where the inventory position is in – the largest inventory position, I should say.

Ladies and gentlemen, our last question comes from the line of Robert Shapiro with Singular Research.

Is there any reason why you're waiting to raise prices until September 1? Is there – you need to have some lag time or why is a month away?

There's typically a timing around that to make sure that we get it communicated with the accounts. Where we're able to take immediate price increases, we will. But, typically, the key accounts are looking for anywhere from 60 to 90 day notices and then just trying to make sure that we get it in the systems, in the processes.

Rob, just to be clear, they've been announced. We've got to give the customer so much notice. And so, we're giving we're giving our retail partners 30 day notice unless their contract or agreement specifies longer.

Are there certain products that you can raise the prices of more than other ones? Or are you raising just a certain amount across the board for the shoes?

We took the approach and looked at all the brands and all the products – and I think Tom mentioned earlier. It's somewhere between like $5 and $7 price increase. There are definitely products that just cannot take those kinds of increases. I would tell you service is one of the brands that when you're talking about a price point type shoe to add $5 to would just kill it. So there might be some styles specific like that that we were only able to take $1 price increase. But the average for the core brands was $5 to $7.

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

Thank you very much. First, I'd like to just say thanks to all the Rocky Brands employees and the efforts that they've been putting in 2022 to put together a pretty good Q2. I also would like to thank our investors and our analysts. We've got a lot of work to do here and we are focused on it and moving forward. And we look forward to finishing out a good 2022 and then moving on to an excellent 2023. So, thank you for your time, effort and support here today on the call.

Thank you. The conference of Rocky Brands has now concluded. Thank you for your participation. You may now disconnect your lines.