Rocky Brands, Inc. Q2 FY2020 Earnings Call

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands Second Quarter Fiscal 2020 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. I would like to remind everyone that this conference call is being recorded. And we'll now turn the conference over to 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, 2019. In addition, the company may refer to certain adjusted non-GAAP metrics on this call. Explanation of these metrics can be found in the earnings release filed earlier today. And I’ll now turn the conference over to Jason Brooks, Chief Executive Officer of Rocky Brands.

Thank you, Brendon. With me on today's call is Tom Robertson, our Chief Financial Officer. I hope everyone on the call and listening via the webcast is staying safe and healthy. Our thoughts continue to be with everyone affected by this devastating pandemic. Like it has for so many, COVID-19 has created new challenges in our organization. Despite being up against the most difficult operating conditions we've ever experienced, our business exhibited increasing strength as the quarter progressed. Thanks to the work we've done over the past few years, improving the desirability of our brands through impactful marketing programs, enhancing our product lines through innovation, and building out our direct-to-consumer channels, we were able to capitalize on the acceleration in online spending that occurred as a result of the stay-at-home orders. Under the circumstances, our business performed relatively well in our wholesale channel with sell-through on our partners' websites up over last year early in the quarter and then picking up at brick-and-mortar later in the quarter as more stores reopened or resumed more normalized hours of operation. Overall, sales declined approximately 9%, with wholesale, our largest segment, down 16%, somewhat offset by a 16% increase in retail sales. Retail represented approximately 29% of our Q2 sales, up from 23% a year ago. The increase in retail sales helped fuel a 180 basis point improvement in adjusted gross margins. This allowed us to deliver a slight year-over-year improvement in adjusted EPS despite the overall sales decline. With our better-than-expected performance, we made the decision to repay the $20 million we drew down on our credit facility in March as a precautionary measure in response to COVID-19. After the repayment, we still ended the quarter with nearly $26 million in cash and cash equivalents, a 64% increase over a year ago, and zero debt on our balance sheet. Looking at our second quarter results in more detail, starting with our wholesale segment. As we outlined on our Q1 call in late April, we estimated that approximately a third of our wholesale partner doors were temporarily closed while the other two-thirds were designated essential businesses by their respective state governments as they served consumers who must remain on the job to either fight the virus, protect our citizens, or execute functions that need to be maintained during this crisis. Beginning in May, many of the locations that were closed began to reopen, and by mid-June, close to 95% of our wholesale doors were open. This trend, along with the strengthening of the U.S. consumer, which we believe has been driven in part by federal stimulus actions, fueled a meaningful month-to-month improvement in sell-through of our products from the data we received from several of our large retailers. Following a difficult start in April, down almost 30%, sell-through was down only 10% in May and turned positive in June, increasing mid-single digits. In terms of categories and brand performance, work, led by Georgia Boot, was in demand as many consumers who wear our work boots remained on the job during the pandemic. In fact, demand for certain key styles started to outpace supply late in the quarter, and we've been chasing some inventory. Rocky Outdoor enjoyed a strong second quarter also, with people not traveling as much and staying home due to COVID-19, combined with the social distancing measures in place, more people have turned to outdoor activity for entertainment, and our hunting boot business was a beneficiary of this dynamic. Sales were also helped by several compelling new products introduced this year that have strongly resonated with our core consumer. Our Western category, led by Durango, was under the most pressure at wholesale early in the quarter, as many of our key accounts adjusted their assortments to serve the essential workers on the job during the early days of the pandemic. Sales trends did improve as we moved through the quarter, and more consumers started returning to stores, while Western revenue was down. I do want to call out that gross margin was up several hundred basis points, as the amount of markdowns and discontinued product sales were far below last year's levels. Turning to our retail segment, which had a phenomenal quarter, increasing 16% year-over-year. This result was driven by explosive growth in e-commerce sales, both through our own branded websites and online marketplaces. Total web sales were up 144%, with Georgia, Rocky, and durango.com all increasing strong triple digits. As more consumers shifted their purchasing online during the second quarter, we saw a surge in new customer acquisitions along with strong demand from existing customers. I believe the work we've done enhancing the functionality of our branded desktop and mobile sites and expanding our direct-to-consumer efforts, especially our marketplaces, particularly Amazon, where you'll recall we gained seller-fulfilled prime status last year, has provided us the opportunity to capitalize on this change in buyer behavior. Meanwhile, our Lehigh safety shoe business was active, signing up new accounts and responding to a good deal of inbound interest during the quarter. However, the pandemic forced us to adjust our normal operating procedures, requiring us to execute more remote fittings versus our usual on-site iFit events, which unfortunately doesn't drive as much volume. On top of this, many of Lehigh's customers are operating with reduced workforces in order to maintain social distancing. Therefore, demand is softer than usual at the moment. We expect there to be pent-up demand as conditions normalize and we are able to reschedule in-person fittings for existing accounts and schedule initial events for newly signed customers. Lastly, in terms of our manufacturing facilities, both Puerto Rico and the Dominican Republic are running at 100%. Following government-mandated shutdowns early in the pandemic, they reopened in April at reduced capacities to align costs with demand. More recently, we've adjusted productivity in response to the recent increase in sales trends. This ability to dial up and dial down our production schedules in response to market volatility underscores the benefits of our vertically integrated manufacturing structure, which we believe is a key competitive advantage. I am very pleased with how our organization has performed under such difficult conditions. I especially want to thank our distribution center facility teams who haven't missed a shift since the start of the pandemic. While sales trends improved as the second quarter went on, and this positive momentum carried into July, our number one priority continues to be ensuring the health and safety of our employees, our customers, and the communities we operate in. With that in mind, we are proceeding cautiously, but do expect our business during the second half of the year to improve versus second quarter metrics. More specifically, we are expecting overall sales to be roughly flat compared to the second half of 2019. As our wholesale channel continues to recover, and the e-commerce trends remain strong, we have better visibility into the third quarter this year at this point than the fourth quarter. What we can see in our order book indicates retailers are more bullish in the immediate term and a bit more cautious about later in the year. We are certainly expecting things to remain volatile in 2021. While we don't know what the ultimate impact COVID-19 will have on our industry and the overall economy, I am confident that the combination of our people, business model, and balance sheet have positioned Rocky well to navigate the current headwinds and emerge from this period poised for long-term success. I will now turn the call over to Tom to review the financials in more detail.

Thanks, Jason. As Jason said, under the circumstances, we are pleased with our second quarter performance, which included sales and earnings coming in ahead of our most recent expectations. Net sales for the second quarter ended up declining 9.3% to $56.2 million, with a difficult start to the quarter due to COVID-19, somewhat offset by improving trends in May and even more so in June. By segment, wholesale sales decreased 15.6% to $34.3 million. Retail sales increased 15.8% to $16.3 million, and military sales decreased to $5.6 million from $7.2 million. Gross profit in the second quarter was $19.5 million or 34.6% of sales, compared to $21.4 million or 34.6% of sales for the same period last year. This quarter's gross margin includes approximately $1 million in expenses related to the temporary closure of our manufacturing facilities due to COVID-19. Excluding these expenses, gross margin for the second quarter of 2020 was 36.4%. The 180 basis point increase in adjusted gross margin over last year was driven primarily by a higher percentage of retail sales, which carry higher gross margins than our wholesale and military segments, as well as higher retail margins year-over-year due to the higher proportion of e-commerce sales within our retail segment. This was partially offset by lower wholesale and military margins year-over-year. Gross margins by segment were as follows: wholesale 31.4%, retail 48.1%, and military 14.9%. Adjusted gross margins were as follows: wholesale 33.3% and military 20.9%. Selling, general, and administrative expenses were $16.4 million or 29.1% of sales in the second quarter, compared to $17.5 million or 28.2% of net sales last year. Including the decrease we saw in variable expenses tied to sales in the second quarter, we've taken steps to reduce our expense structure, and we have eliminated approximately $1.7 million from our 2020 budget. Income from operations decreased to $3.1 million or 5.5% of sales, compared to $3.9 million or 6.4% of net sales in the year-ago period. Adjusted operating income, which excludes the expense from the manufacturing facility shutdown, was $4.1 million or 7.3% of net sales. Net income for the quarter was $2.4 million or $0.33 per diluted share, compared to net income of $3.2 million or $0.42 per diluted share. Adjusted net income for the year was $3.2 million or $0.44 per diluted share. Turning to our balance sheet, which at the end of the second quarter, continued to be in a very strong position, cash and cash equivalents at June 30, 2020, totaled $25.8 million compared to cash and cash equivalents of $15.7 million at the end of Q2 2019, an increase of 64.4%. During the second quarter of 2020, we generated cash flow from operations of $4.7 million. Based on this result, combined with our current outlook for the business, we made the decision to repay our $20 million draw on our credit facility at the end of the second quarter, which leaves us with zero debt on our balance sheet. Inventories at June 30 were $74.5 million, compared to $77.5 million at the end of the second quarter last year. Our inventory is in very good shape, with the majority being core products in line year-over-year. In fact, we are low and even out of stock on some styles for which we have wholesale orders in hand. While we are not reinstating the outlook we provided at the start of 2020, we do feel like we have more visibility into the near-term trends than we did at the Q1 call. This is a volatile environment, and things are changing quickly. Assuming there isn't another wide-scale lockdown, we do expect our business to perform better from both a top and bottom line perspective in the second half of the year compared with the first half, with Q3 likely outperforming Q4 based on our current wholesale order patterns. That concludes our prepared remarks. Operator, we are now ready for questions.

Thank you. We will now have our question-and-answer session. Our first question comes from Jonathan Komp with Baird. Please proceed with your question.

Yes. Thanks, guys. I want to ask a couple of questions about the wholesale business. I know you mentioned that the indications you get at sell-through from some partners. Can you maybe just give a sense of what portion of the wholesale business you see the sell-through figures for, maybe as a starting point, just to get a sense of what you're seeing?

Hey, Jon. Thanks for being on. Yes. So it's a pretty small group of accounts that we get that from, but it's a bigger representative of the sales number, right? So, our mom-and-pop customers don't have the ability to give us this kind of information. But the larger accounts that are giving us do pretty good volume with us. So we feel pretty good about those numbers. But it's not a huge representation from an account base.

Yes. And Jon, just to add on there, I think where we do have some visibility is certainly in the work category. We've seen those results. We can see those results in the work category, and also in the outdoor space is where we saw some of the stronger trends from a sell-through perspective.

Okay. That's helpful. And maybe on the work category specifically, I'm wondering if you have a view. It sounds like the business is holding up better than you would normally expect given the employment situation. And I know you called out the stimulus. Do you have any views on the sustainability of what you're seeing there?

So I think initially, Jon, our customer base was really not affected terribly. So if you think about how COVID kind of went across the country and restaurants were closed down and bars were closed down, that's really not our customer base. Those are probably a different kind of footwear. But the construction guy, the person working on oil rigs, the person working in farm and ranch, they kept working. And so, we really didn't see any big decrease there. I think we are concerned. If you look at something like United Airlines, they announced they're going to lay off some people in October. That is more concerning for me. And I think when we talk about Q3 looking the way it does, we are not as comfortable maybe with Q4. I think that's probably why. Until we have more visibility on what's happening there, and we see what the book looks like, it's just kind of a big question mark.

Okay, great. And then related to that commentary on the second half, any other specific call outs either about the magnitude of out-performance you could see in the third quarter versus fourth quarter? Or any other color you're willing to provide in the order book and what you're seeing?

Yes, Jon. So from a second half of the year perspective, we're seeing continued strong trends in our Georgia bookings. We are also thinking about Rocky Work and Durango for the second half of the year from a western perspective, which is stronger than they did in the second quarter, the first half of the year. One of the areas that's got me a little concerned is in the outdoor space. We're not seeing a ton of bookings from that area, but we did see our outdoor business perform very well in the second quarter, just over mid-teens. So the question we are having is, as social distancing continues and depending on how the pandemic unfolds for fall, especially during hunting season, we are curious to see how the outdoor category performs. I think we have some potential upside there.

I think the other thing, Jon, is that we, unfortunately, saw decisions made quickly when the shutdown happened. Retailers made decisions that were right at the time. I think things have come back a little quicker than we all expected. So I think Q3 will see some pent-up demand, and I think you're going to see that kind of level off. So I think there could be a pretty good bump in Q3, and then maybe a little smoothing out in Q4. But if everything continues favorably, who knows what could happen in Q4. If we experience another big shutdown, that could change the dynamics of both Q3 and Q4. So there are many variables at play right now.

That's very helpful perspective. Maybe just one last one for me on inventory; you're in chase mode in a few areas. Could you maybe share more on the state of things, perhaps where you're lighter than you'd hope to be? Are you seeing any production or supply chain bottlenecks that would prevent you from catching up here?

So I think for us, again, when the retailers really slammed on the brakes, we took some steps backwards and said, okay, let's be a little careful here. We've been able to turn that back on a little quicker. Most people, as I talked about in my report, we were able to affect our factories a little bit quicker than we can with our partner factories maybe in the Far East. We have not seen any real issues with any of our partners. We've been able to get the product, place the orders, and obtain the raw material. The biggest issue we're having right now is more in the Dominican Republic and Puerto Rico. As the COVID situation changes and spikes come back up, they may put in a new regulation that affects our hours. For example, your curfew may be back to 7 PM. So we have to go to the government and request to keep working until 9 PM. In most cases, they've given us the approval to do that. But we feel pretty good about our situation. I hope that here in Q3, going into Q4, we're going to be in a better place for inventory. Yet, the way the orders are coming in, it's hard to keep up with the demand.

Great. That's encouraging to hear. Thanks for taking all the questions.

Yes, absolutely, Jon. Thank you.

Thank you. It looks like there are no further questions at this time. I'd like to turn the floor over to Jason Brooks for any closing remarks you may have.

Great. Thank you very much. I just want to reiterate one more time to our team here at Rocky how much I appreciate their efforts and commitment. We have had to go through an amazing time, and everybody has really stepped up and done a wonderful job. I appreciate everyone's efforts, and I appreciate the support from our customers, consumers, and shareholders. I wish everyone well and stay healthy.

Ladies and gentlemen, this concludes today's web conference. You may now disconnect your lines at this time. Thank you for your participation and have a great day.