Brendon Frey - MD, ICR, LLC Jason Brooks - President, CEO & Director Thomas Robertson - VP, CFO & Treasurer.

Jonathan Komp - Robert W. Baird & Co..

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to Rocky Brands Second Quarter Fiscal 2018 Earnings Conference Call. [Operator Instructions]. I would now like to remind everyone this call is being recorded. And we will now turn to the -- conference over to Brendon Frey of ICR. Please go ahead..

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, our reports filed with the Securities and Exchange Commission, including our 10-K for the year ended December 31, 2017. And now I'll 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. We delivered another strong quarter, highlighted by high single-digit growth in wholesale sales, continued expansion of our retail business and a significant increase in earnings. Our performance was again partially shaped of a sale of Creative Rec.

The decision to divest the brand in late 2017 has been a headwind to top line growth year-to-date, while benefiting our bottom line results, which will continue until we anniversary the transaction in the fourth quarter.

Our success has been driven by our commitment to strengthening our consumer connections, introducing innovative new products, supporting our retail partners and striving for operational excellence across the organization.

The process we've made on each of these initiatives is fueling our improved financial performance, while also strengthening the company's foundation to support long-term growth and enhanced profitability.

I'll walk through the key drivers of our Q2 sales performance by segment and touch on why we think our momentum will continue into the second half of the year. Tom will then review the numbers in more details, after which we will be happy to take any questions.

Starting with wholesale, where we experienced our highest year-over-year growth in sometime as sales increased 7.3% or 9.8% excluding the Creative Rec brand.

Consumers continue to respond favorably to several recent product introductions across our brand portfolio, which we believe is being fueled by new innovations and enhanced marketing programs that are generating increased awareness and demand.

At the same time, improved collaboration and execution with our retail partners, along with investments in inventory is allowing us to better capitalize on our opportunities in the marketplace. By brand, Georgia Boot experienced strong sell-through in reorders on our Carbo-Tec work western collection, which debuted earlier this year.

The second quarter was also highlighted by the successful launch of our new logger collection of boots into the farm and ranch channel. Both of these collections, along with the expansion of our popular Athens work line features new easy-on, easy-off technology.

We're supporting the introduction of this innovative new feature with enhanced in-store point of purchase materials as well as social media programs, aimed at driving traffic to our participating retail partners and georgiaboot.com.

We continued to see positive results as we shift our marketing spend from broad-spectrum national campaigns to more digital grassroots initiatives that bring us closer to our customers.

Looking ahead, the combination of select door expansion and increased shelf space at key accounts such as Tractor Supply and Boot Barn have Georgia Boot well positioned for a very strong finish to the year. Moving to Durango.

Q2 sales increased nicely, driven by deliveries of key collections, led by the Rebel series for both men and women and new styles such as the Maverick western work series, which booked extremely well.

The brand has been on a great run with large retail partners such as Cavender's, Boot Barn's and Cabela's as well as smaller field accounts, all increasing their assortments due to the strength of the new products. And based on our current bookings, we expect to see continued strong sell results for Durango over the remainder of the year.

Now to the Rocky brand, we recently completed the reshaping of the sales force configuration in order to create a more holistic approach to managing the brand's entire footwear and apparel offerings By establishing one Rocky brand advocate per account, our teams are now in a much better position to cross-sell our categories, especially in the independent channels and provide better service to our retail partners.

With this transition now complete, we are starting to see the early benefits of the new structure in the form of increased second half bookings for Rocky Western work, outdoor and apparel lines.

With respect to Q2, the brand's performance was highlighted by the largest quarter ever for our commercial military division, as sales increased 55% over the prior year period. In the U.S., sales were up 20-plus percent, while international growth was even stronger.

Our ongoing investment in commercial military inventory, particularly our popular S2V boot, has allowed us to take advantage of the recent surge in demand for tactical equipment as the U.S. and it's allies continued to bolster their military strength. Historically, we haven't called out Rocky’s public service business.

However, there have been some positive developments in this business recently that are worth mentioning as we believe they will generate momentum as we move into 2019. First, in conjunction with restructuring Rocky sales force, we've added 3 independent sales reps that are focused solely on public service end of the market.

This includes independent uniform retailers, public service retailers, municipality departments and contract bids.

Second, we are introducing exciting new footwear in the back half of this year, including 2 United States Postal Service certified styles along with our code blue line of athletically inspired shoes and boots targeting police forces, EMS and private security.

Shifting to our retail segment, beginning with our Lehigh business, which continues to generate strong growth through expansion of its CustomFit model. Excluding sales to the New York Transit Authority, sales were up high single digits, driven by key account growth and improved participation and retention with existing counts.

As we announced on our Q1 call in April, which included a multiyear agreement with the New York Transit Authority on March 31, while this will be a headwind to sales until we anniversary the termination, it will benefit operation margins as it allows us to reduce SG&A by taking our remaining five global shoe centers off the road.

Looking ahead, the plan is continue the course. We set for this business beginning our differentiated services offering in front of more companies by increasing the number of sales calls and site visits we make on a daily basis. Our recent legwork has produced positive returns, and we're confident that we can build on Lehigh's current momentum.

Turning to our direct-to-consumer business. Our branded e-commerce websites collectively posted a double-digit sales gain in Q2, as this channel capitalizes on recent investments aimed at increasing traffic and conversions, while enhancing the consumers' experience.

The rich content produced by each brand, including videos, images and banners are being utilized to improve the look, the feel of our websites as well as part of our social media efforts, aimed at directly reaching new and existing consumers to drive awareness and purchase intent.

Finally, as we expected, the military segment sales were down in the second quarter as a couple of contracts expired in late 2017. However, gross profit dollars were up as margins increased significantly, driven by improved efficiencies in our Puerto Rican factory.

Like we discussed on our recent earnings call, this segment faces some headwinds in 2018 in addition to expiring contracts. We plan to utilize the excess capacity to expand our commercial military business in the U.S. and overseas, while continuing to aggressively bid on all available contracts that make financial sense for the company.

I'll now turn the call over to Tom..

wholesale 32.7%; retail 44.9%; and military 18.5%. Selling, general and administrative expenses were $16.2 million or 27.8% of sales for the second quarter of 2018 compared to $15.9 million or 27.2% in the period a year ago.

Income from operations was $3.4 million or 5.8% of sales, an increase of 50.7% compared to income from operations of $2.3 million in the prior year period. Net income increased 81.6% to $2.6 million or $0.35 per diluted share compared to net income of $1.5 million or $0.20 per diluted share. Turning to the balance sheet.

As of June 30, 2018, we had no funded debt compared to $8.6 million at June 30, 2017. Inventory at the end of Q2 2018 was $72.6 million, down 4.8% compared with $76.3 million on the same date a year ago. I'll now turn it back to Jason for his closing comments..

Thanks, Tom. We are very pleased with the strength exhibited by our business year-to-date. And I'm confident that we can continue to drive further improvements in our top and bottom line over the long term. With that, operator, we are now ready to take questions..

[Operator Instructions]. We'll take our first question from Jonathan Komp with Baird..

I wanted to start off by asking about the wholesale revenue trajectory. You're seeing up 7% reported and even better than that at a like-for-like basis. Could you maybe talk through some of the moving parts when you look across the product segments in terms of where you're seeing the strength? If you could quantify that, it would be helpful..

So Tom can probably maybe give more on that. I would tell you from the quantification part, we're seeing across every branding category increases, some higher, some lower. But all the brands are kicking along pretty nice right now. Durango is seeing some really interesting things. Georgia has got some nice things going and then even Rocky is doing well.

The outdoor category in Rocky looks really strong for this fall. The bookings we've got for this fall in all the categories look pretty good. So the -- all the categories are looking pretty strong right now..

Yes, Jon, to pile on that a little bit. If you look at our 3 biggest categories from a Q2 perspective, work, western and commercial military, we're kind of -- we're up mid-single digits in the work category. Western was up really substantially, it was up about 20%.

And part of that was led by a kind of a onetime opportunistic buy for our western category. With that being said, I mean, pulling that out that onetime buy, I mean, western still would have been up double digits there as well. And then our commercial military business has kind of led the charge for us in Q2 as it did in Q1 being up just over 50%.

So when you look at that from a commercial military perspective, we've talked a little bit on the previous call about the lumpiness of the international business.

But even domestically, as Jason stated, our commercial military business was up 20%, and that's on a much bigger -- it's an easy -- it's a much bigger number domestically than it was internationally in the prior year. So from a percentage standpoint, international blew prior year away, but the real dollars are in the U.S. domestic side..

Okay, great. And maybe just following up there. On the domestic side of the business, looks like work and western, even underlying maybe accelerated quarter-over-quarter.

And is there any broad themes you can pull away from that, like how much might be industry-specific? I'm curious your thoughts on the drivers there versus all the initiatives you have going on internally as well across the brands..

Yes, I think we would be crazy to think that it's all us. That we're brilliant -- we came out with brilliant new product and -- but that's really the truth? No. Jon, I think we've got great new product that we've introduced. We've got really great new processes internally that are making things happen, great new marketing programs.

But obviously, the economy and what's going on in the U.S. is changing this. We are also seeing a huge reaction from our dealer partners in what we're bringing to them and how we are partnering with them and how we are presenting with them. And I guess, it really is surprising to me how quickly they can change the market as well.

So we got great relationships happening with our dealers right now. And I think it's a very positive thing throughout the whole organization..

Okay, great.

And when you look forward for the wholesale business, understanding you still have that Creative Rec headwind on the top line at least for a couple of quarters, do you think kind of a mid-single reported growth rate is sustainable for the wholesale, especially given some of the commentary around the bookings for parts of the business or any thoughts there would be helpful?.

Yes. I've used this word a lot every quarter, we're optimistically cautious. We think that there is definitely some good things happening coming in the future. 3%, 4%, 5% seems very reasonable. So in and around that area..

Okay, great. And maybe the other parts of the business, retail and the contract military.

Any big changes in those businesses relative to a few months ago? When you look at those two, obviously different drivers there, but just trying to level set as you look at the rest of the business?.

Yes. So from a retail standpoint, the Lehigh business is still chugging along pretty nice, like you can see had a reasonably good quarter, small -- was single-digit increase..

6%, 7%..

6%, 7%. So yes, I think that's fine. And then you mentioned the contract military business. We are still in the same place we were really at the end of 2017 and then Q1 of 2018. We have not even had an opportunity to bid on any new contracts that have come out.

And it all goes back to the same conversation that we've been having about us being the only large business in this business category now. So if the small business groups can pick that up, then we don't even get to bid on the contracts. We have had many conversations with government officials, trying to figure this thing out and understand it.

But right now, we're doing what we're doing. And like I said, we're going to really focus on our commercial military and making sure that, that factory is efficient. And as you can see, we're doing a great job.

The people in Puerto Rico just amaze me every week with what they've had to go through and how resilient they've been and what they've been able to accomplish, not just for our company, but for themselves. And so we're going to keep fighting down there and really focus on the commercial military S2V the side of the business..

Yes, Jon, real quick, just to kind of add on there from a retail perspective, I think when we're trying to look at our retail business, it's important to take into consideration that New York City Transit headwind.

I mean, if you look at Lehigh -- the Lehigh business, we believe our big growth opportunity with Lehigh is to CustomFit this digital model.

If you look at the CustomFit model, that was a -- it was a double-digit increase this year -- or this quarter, but we had the headwind of New York City Transit, which we'll continue to have for the rest of the year. So just kind of keep that in mind from a modeling perspective..

Okay, great.

And was there any lumpiness to that business? Or was it pretty equal throughout the year?.

In the retail?.

I would say it's pretty equal, maybe slightly heavier the first half of the year, but not much..

Okay, great. And then maybe a broader question on the margin performance. Thinking kind of first half, second half, if I look, I think you have been up more than 250 basis points on the operating margin line in the first half.

And wanted to maybe think through the puts and takes around that line kind of the operating margin line as you see it in the second half..

Yes. I mean, from our perspective, we want to continue this kind of momentum we have from an operating margin standpoint. And the Q4 always presents some more operating costs, just as we're shipping, freight cost and all the expenses around marketing, around the holiday season and all that. So we have generally our operating expenses tick up in Q4.

So that has an impact on our operating margin. But we totally anticipate trying to continue this momentum moving forward..

And just to elaborate, Jon, we've really been digging in and finding little nuggets throughout the whole company in this operational excellence initiatives and in saving money and becoming more efficient all over the company. And so those have been really nice things that the team here has worked hard to find and make happen..

Understood.

And how do you think about kind of the underlying business separate of the initiatives you have going on, like what's the normalized top line growth that you might need in order to gain overall operating leverage?.

It's a great question, Jon..

Yes, I think when we think about it, we've kind of internally targeted 3% to 4% sales increase moving forward and we'll be very happy with that. Obviously, when we get a big win like we did these last two quarters from an international commercial military standpoint, we come in higher than that. But yes, that 3% to 4% range is kind of what we target..

And maybe 1 or 2 more, but just following up on that, is there any way to gauge like how long you have additional margin drivers that are kind of outside of that typical model? So you still have a couple of quarters of Creative Rec.

But maybe less clear how long the benefits from the internal excellence initiatives might continue?.

I think every quarter there is less and less, but I think there is always ways to improve, right? We can always find ways to do things better, new technology, new ways to look at things. So I definitely would tell you that I think there are few -- lesser coming.

But I always think there is going to be ways to be more efficient and find ways to do it in a more cost-effective way. And then, as you stated about the Creative Rec thing, that all went down in late 2017. So that's really through Q4. So really when we get into Q1, that goes away..

Understood. Maybe last one just balance sheet related. Obviously, the cash has been strong and certainly reflected in the balance sheet. So I'm wondering if you have any updated thoughts on the best use on the capital there..

We haven't really historically given guidance towards our plans for our cash. And obviously, it's probably the same things we've talked about before and we increased the dividend a little bit last quarter, as you're well aware. We obviously on a regular basis discuss and analyze the share repurchase programs that we have.

And also, we're sitting here and we're not actually pursuing any kind of acquisitions at the moment, but we think having the cash and having to sit in a good position where if the right one came along, we could take advantage of it..

And with no further questions in the queue, I would like to turn the call back over to management for any additional or closing remarks..

Well, thank you for taking the time to listen to our Q2 results. We're excited about where we're at and where we're going, and look forward to having the call at the end of Q3. Thank you very much..

This does conclude today's conference. We thank you for your participation. You may now disconnect..