Rocky Brands, Inc. (NASDAQ:RCKY) Q3 2023 Earnings Call Transcript

Rocky Brands, Inc. (NASDAQ:RCKY) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands Third Quarter 2023 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 will now turn the conference over to Brendon Frey of ICR.

Brendon Frey: 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, 2022. I'll now turn the conference over to Jason Brooks, Chief Executive Officer of Rocky Brands. Jason?

Jason Brooks: Thank you, Brendon. With me on today's call is Tom Robertson. After Tom's and my prepared remarks, we will be happy to take questions. We are pleased with our third quarter results, which were highlighted by a meaningful top-line improvement compared with the second quarter and a significant increase in profitability on both a sequential and year-over-year basis. As we outlined on our Q2 call, we anticipated that our performance would start to rebound beginning in the second half, thanks to the sustained consumer demand we've seen all year for our product offering. It's important to remember that while 2023 got off to a difficult start. Much of the top-line pressure was experienced, was related more to macroeconomic headwinds and industry dynamics, notably excess channel inventory along with tough comparisons versus the strength and desirability of our brands.

In fact, our sell-through has held up relatively well despite persistent inflation that has impacted consumer discretionary spending. This performance, combined with early actions by retailers to better align overall inventory levels with the current demand environment drove an acceleration in at-once orders from many of our key wholesale partners as the third quarter progressed. While third quarter sales did not reach our year ago levels, the work we've done enhancing our distribution and fulfillment capabilities, along with lower expense levels, including reduced freight rates allowed us to translate a 13% decrease in revenue into a 40% increase in operating income on an adjusted basis. Tom will cover the numbers in more detail shortly. But before that, I would like to spend a few minutes reviewing the drivers of our recent top-line performance.

Starting with Work. Our four brands that make up this category, Georgia, Rocky, Muck and XTRATUF, collectively delivered a sequential sales increase in the third quarter after selling-in was severely impacted by high retail inventories in the first half of 2023. And on a year-over-year basis, the decline moderated significantly from what we experienced in the first and second quarters. Momentum for the Georgia built throughout the quarter with sales turning positive in the month of September, as many key customer accounts began returning to more consistent ordering as their inventories further normalize. At the same time, low pricing on a certain Georgia styles, which is the result of recently realized cost savings that we passed along to customers has spurred a notable pickup in demand.

Looking ahead, we are optimistic about the brand's growth prospects. Consumer response to the Georgia's Fall 2023 line has been very positive. While wholesale bookings for Spring have been much stronger than we've seen in quite some time. Our Rocky Work brand had a bit more challenge in the Georgia this quarter, with excess inventory levels continuing to impact replenishment orders. However, there were some bright spots, particularly with strength in our own e-commerce channel, along with solid success with new key independent retailers, driven by new product introductions. Shifting to our rubber-based work product, both the Muck and XTRATUF brands delivered solid results. While warm weather weighed on category demand and elevated inventories continue to impact sell-in, we saw a steady improvement in Q3 compared to the first six months of this year.

Of note, Muck's new Fall collection featuring 12 new styles and supported by a new marketing campaign that targets the brand's core consumer is performing well at the gate, setting the stage for continuing success in the months to come. With XTRATUF, shipments were up year-over-year for the first time in 2023, as we deliver the brand's highly anticipated new Fall product. Inventory levels for our key partners have [Technical Difficulty] growing wholesale demand. As we finalize our Spring '24 booking season, we are seeing continued success for the brand in both existing and new channels and expect this positive trajectory to continue into the fourth quarter and next year. Turning now to our Western business. While inventory levels with some key account partners were again a hurdle, we saw steady sales improvements in the third quarter over the first half of the year.

With Durango, strength in our direct-to-consumer channel and increases in our special makeup business helped offset a portion of the lower selling compared to a year-ago. In terms of sell-through, lower MAP pricing on certain key products, which is the result of the affirmation cost efficiencies that we were able to pass through to customers, help drive demand and further reduce on-hand inventory levels for several retailers. We also saw notable improvement with our Rocky-branded Western product driven by new distribution with key Western retailers. Along with these new partnerships, updates to long-standing Rocky Western best sellers drove new interest in the brand this quarter. Looking ahead, the Durango and Rocky Western teams are focused on launching of existing new collections in Q4 and ensuring that the right wholesale partners have the right product to meet the needs of our consumers.

Outdoor, which includes under Rocky, Muck and XTRATUF brands was again the category most impacted by retailer inventory levels in the period. A poor 2022 for industry created greater carryover than normal, which led to reduced bookings for new products ahead of this year's primary Fall season. Hunting boots and apparel were most affected by carryover, and this was compounded by one large sporting goods retailer exiting the category altogether. That said, as I mentioned, when discussing our Work product, both the XTRATUF and Muck brands delivered a notable improvement in this quarter, driven in part by new penetration of the outdoor product and more outdoor-focused markets. Last but not least, within our Wholesale segment, Commercial Military was a bright spot in the third quarter as orders from several suppliers to the U.S. Army and the United States Marine Corps drove the strongest Q3 in recent memory for the business.

Shifting to our Retail segment, where sales were up 5% over last year, thanks to a very solid quarter from our direct e-commerce channel. Each of our branded sites, Rocky, Georgia, Durango, Muck and XTRATUF were up double-digits which more than offset expected declines in marketplace transactions. Through enhanced digital marketing efforts, we've been successful fostering more direct engagement with consumers, and we expect this trend to continue going forward, which should positively impact the segment's growth and margin portfolio. Shifting to our B2B Lehigh business. Sales were in line with the year-ago levels. The temporary headwind from upgrades to our security protocols that we spoke about on our last earnings call in August are now fully behind us, and based on recent event bookings, we are optimistic about the return to growth in the fourth quarter.

An executive in sleek dress shoes behind a corporate desk, symbolizing the corporate culture of the footwear retailer.

We are still very positive about our Lehigh business and the opportunity it provides in 2024 and beyond. While overall market conditions remain challenging, we are confident that our top-line is positioned for further improvement on a sequential basis in the fourth quarter, with channel inventories continuing to come down and the demand for our durable, innovative and accessibility priced Work, Western and Outdoor footwear pick up. The difference between our sell-through and sell-in is nearly parity. This dynamic, along with an improved balance sheet sets us up for a good finish to 2023 and a strong start to next year. I'll now turn the call over to Tom. Tom?

Thomas Robertson: Thanks, Jason. As Jason shared, an improving wholesale inventory landscape, along with our greater ability to convert sales into year-over-year earnings growth allowed us to deliver better-than-expected results in the third quarter. Net sales for the third quarter decreased 14.8% year-over-year or 12.7% on an adjusted basis to $125.6 million. By segment, on a reported basis, Wholesale sales decreased 17.4% or 14.9% on an adjusted basis to $99.7 million. Retail sales increased 4.7% to $24.5 million and Contract Manufacturing sales were $1.4 million. Turning to gross profit. For the third quarter, gross profit was $46.5 million or 37% of sales compared to adjusted gross margin of $50.8 million or 35.3% of sales the same period last year.

The 170 basis point increase in adjusted gross margin as a [Technical Difficulty] pricing actions taken in 2022 as well as lower inbound logistics costs compared with the same period last year. A higher mix of Retail saving sales, which carry a higher gross margin than Wholesale and Contract Manufacturing segments also contributed to the expansion in overall gross margins. During Q3 this year, we capitalized on some strategic opportunities to move certain discontinued products in our inventory. While these sales were dilutive to gross margins versus our plan, this decision puts us on track to come in below our initial year-end inventory target and sets us up to begin 2024 in a much cleaner position. Gross margins by segment were as follows: Wholesale, up 160 basis points to 34.7%, Retail, down 70 basis points to 48.0% and Contract Manufacturing down 390 basis points to 11.5%.

Operating expenses were $32.3 million or 25.7% of net sales in the third quarter of 2023 compared to $40.3 million or 27.3% of net sales last year. On an adjusted basis, operating expenses were $30.7 million this year and $39.5 million a year ago, with the decrease driven primarily by lower outbound freight expense, improved distribution center efficiencies and other variable expenses associated with lower sales volumes. As a percentage of adjusted net sales, adjusted operating expenses improved 290 basis points to 24.5% in the third quarter of 2023. Income from operations was $14.3 million or 11.4% of net sales compared to $11.6 million or 7.9% of net sales in a year ago period. Adjusted operating income was $15.8 million or 12.6% of net sales compared to adjusted operating income of $11.3 million or 7.9% of adjusted net sales a year ago.

For the third quarter of this year, interest expense was $5.8 million compared with $4.2 million in the year ago period. The increase reflects increased interest rates on interest payments on our senior term loan and credit facility. On a GAAP basis, we reported net income of $6.8 million or $0.93 per diluted share compared to net income of $5.7 million or $0.77 per diluted share in the third quarter of 2022. Adjusted net income for the third quarter of 2023 was $8 million or $1.09 per diluted share compared to adjusted net income of $5.5 million or $0.74 per diluted share in a year ago period. Turning to our balance sheet. At the end of the third quarter, cash and cash equivalents stood at $4.2 million, and our debt totaled $213.9 million.

We've made good progress in paying down our debt over the last 12 months with total indebtedness down 24.9% from the end of last September and down 16.7% since the end of 2022. A big part of the debt paydown has been driven by our ability to strategically reduce inventory levels. At the end of the third quarter, inventories were $194.7 million, down 26.5% compared to $265.1 million a year ago, and down 17.3% compared with the end of 2022. Our plan is to now exit 2023 with inventories of approximately $175 million compared with our prior target of $185 million. Now to our outlook. Based on our year-to-date results and current view of the fourth quarter, we are reiterating our guidance for 2023 net sales to be approximately $470 million. This implies fourth quarter sales improved sequentially from Q3 and decline in Q4 on a year-over-year basis, further moderates compared to recent trends.

Following the discontinued inventory reduction actions we took in the third quarter and some planned promotions to move certain non-core products in the fourth quarter. We now expect full-year adjusted gross margins to be in the 38% to 39% range compared with 36.6% in 2022. For comparative purposes, it is important to remember that in Q4 of last year, gross margins benefited by 230 basis points from a onetime tariff overpayment recovery. SG&A is now expected to only deleverage approximately 100 basis points from 2022's adjusted level and interest expense is now projected to be around $23 million due to higher interest rates. All of this implies that the fourth quarter adjusted earnings per share will be similar to both third quarter of this year and fourth quarter of 2022.

That concludes our prepared remarks. Operator, we are now ready for questions.

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