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Rocky Brands Inc (NASDAQ:RCKY)
FY 2020 Earnings Call
Jul 28, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Rocky Brands Second Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions] 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]

And we'll now turn the conference call over to Brendon Frey of ICR.

Brendon Frey -- Investor Relations

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. Jason?

Jason S. Brooks -- President and Chief Executive Officer

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 have 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 in 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 in operations.

Overall, sales declined approximately 9% with wholesale, our largest segment, down 16%, somewhat offset by a 16% increase in retail sales. Retail responded -- retail represented approximately 29% of our Q2 sales, up from 23% a year ago. The increase in retail sales helped fuel 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 the 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 sheets.

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 one-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 serve 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 all wholesale doors were opened. This trend along with the strengthening of the US 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 for the data we received from several of our large retailers. Following a difficult start to the quarter with 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 closer to home due to COVID-19, combined with the social distancing measures in place, more people have turned to outdoor activities 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 account 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 the 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 a new customer acquisitions, along with strong demand for 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 on 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 scheduling 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 temporary government-mandated shutdowns early in the pandemic, they've reopened in April at reduced capacities in order to align cost 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 the 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 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 with second half of 2019. As our wholesale channel continues to recover and the e-commerce trends remain strong, we obviously have better visibility into the third quarter at this point than the fourth quarter. And 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. And while we don't know what the ultimate impact COVID-19 will have on our industry and the overall economy, I'm confident that the combination of our people, business model and balance sheet have Rocky well positioned to navigate the current headwinds and emerge from this period poised for a long-term success.

I will now turn the call over to Tom to review the financials in more detail. Tom?

Thomas Robertson -- Executive Vice President and Chief Financial Officer

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 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.

Including these expenses -- or 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.

Excluding 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 $39 million or 6.4% of net sales in a year ago period. Adjusted operating income, which excludes the expense from the manufacturing facility shutdowns 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 -- I'm sorry, 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, were $25.8 million, compared to cash and cash equivalents of $15.7 million at the end of the 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 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 product that is in line year-to-year. In fact, we are low and even out of stock on some styles that we have wholesale orders in hand for. 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 widescale 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 of -- compared with the first half, with Q3 likely outperforming in Q4 based on our current wholesale order patterns.

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

Questions and Answers:

Operator

Thank you. We will now have the question-and-answer session. [Operator Instructions] Our first question comes from Jonathan Komp with Baird. Please proceed with your question.

Jonathan Komp -- Robert W. Baird -- Analyst

Yes. Thanks, guys. I want to ask a couple of questions about the wholesale business. I know you mentioned, you know, the indications you get at sell-through from some partners. Could you maybe just give a sense 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?

Jason S. Brooks -- President and Chief Executive Officer

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.

Thomas Robertson -- Executive Vice President and Chief Financial Officer

Yes. And Jon, just to add on there to it, I think where we do have some visibility is certainly in the work category. We see -- we've seen those results -- or 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.

Jonathan Komp -- Robert W. Baird -- Analyst

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?

Jason S. Brooks -- President and Chief Executive Officer

So I think initially, Jon, our customer base was really not affected terribly. So if you think about how the 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 guy working on oil rigs, the guy working in farm and ranch, he kept working, and so we really didn't see any big decrease there. I think we are concerned, if you look at something like -- I think it was United Airlines has announced they're going to lay off some people in October, that is more concerning for me.

And I think when we talked about, look, Q3 looks the way it does, and 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 -- it's kind of a big question mark.

Jonathan Komp -- Robert W. Baird -- Analyst

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

Thomas Robertson -- Executive Vice President and Chief Financial Officer

Yes. Jon, so from a second half of the year perspective, we're seeing -- we're continuing to see the Georgia bookings looking well. We are also...

Jason S. Brooks -- President and Chief Executive Officer

Rocky Work is doing very well.

Thomas Robertson -- Executive Vice President and Chief Financial Officer

Also think about Rocky Work. And as well as Durango for the second half of the year from a western perspective is coming in stronger than they did in the second quarter, the second -- first half of the year, I'm sorry. One of the areas that's got me a little bit, I guess, complex is in the outdoor space. We're not seeing a ton of bookings from the outdoor space, but we did see our outdoor business do very well in the second quarter, up just over -- in the mid-teens. And so I -- the question we're having is if the social distancing continues, and depending on how the pandemic unfolds for fall during hunting season, or deer season particularly, we're curious to see how outdoor does. And so I think that we've got some potential upside there.

Jason S. Brooks -- President and Chief Executive Officer

Yes. I think the other thing, Jon, is we -- and I don't have any data around this, but I believe it shut down so quick, right, at the end of Q1 and the beginning of Q2. And I think retailers made decisions that were all the right decisions at the time, and I think things have come back a little quicker than we all expected. So I think Q3 is some pent-up demand. And then 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 smooth out in Q4. But if things continue the way they are, who knows what could happen in Q4? But if we get another big shutdown, if different states shutdown, that could change the end of Q3 and then into Q4, too. So it's a lot of variables right now, unfortunately.

Jonathan Komp -- Robert W. Baird -- Analyst

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

Jason S. Brooks -- President and Chief Executive Officer

So I think for us, again, when the retailers really slammed on the brakes, we took some steps backwards and said, OK, let's be a little careful here. And we've been able to turn that back on a little bit quicker, I think, than most people. Again, as I talked in my report, we're able to affect our factories a little bit quicker than we can, our other 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. We've been able to place the orders. We've been able to get the raw material.

The biggest issue we're having right now is in both the -- really more in the Dominican and Puerto Rico is as things change with COVID and the spikes come back up, they may put in a new regulation that says, well, your curfew now is back to 7:00 p.m. And so we have to go to the government and say, hey, can we keep working until 9:00 p.m.? And in most cases, they've given us the OK to do that. But we feel pretty good about that, and we hope that here in Q3 going into Q4, we're going to be in a better place for inventory. But I mean, the way the orders are coming in, it's hard to keep up with it.

Jonathan Komp -- Robert W. Baird -- Analyst

Yes. Great, that's encouraging to hear. Thanks for taking all the questions.

Jason S. Brooks -- President and Chief Executive Officer

Yes, absolutely, Ron [Phonetic]. Thank you. I'm sorry, Jon.

Operator

Thank you. [Operator Instructions] 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.

Jason S. Brooks -- President and Chief Executive Officer

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, and I appreciate everybody's efforts, and I appreciate the support from our customers, consumers and shareholders. And I wish everyone well, and stay healthy.

Operator

[Operator Closing Remarks]

Duration: 27 minutes

Call participants:

Brendon Frey -- Investor Relations

Jason S. Brooks -- President and Chief Executive Officer

Thomas Robertson -- Executive Vice President and Chief Financial Officer

Jonathan Komp -- Robert W. Baird -- Analyst

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