Rocky Brands - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ   NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o               Accelerated filer  þ               Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o   NO þ

As of October 23, 2007, 5,488,413 shares of Rocky Brands, Inc. common stock, no par value, were outstanding.

See notes to the interim unaudited condensed consolidated financial statements.

NOTES TO THE INTERIM UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED
SEPTEMBER 30, 2007 AND 2006

The following table sets forth, for the periods indicated, information derived from our Interim Unaudited Condensed Consolidated Financial Statements, expressed as a percentage of net sales. The discussion that follows the table should be read in conjunction with our Interim Unaudited Condensed Consolidated Financial Statements.

Net sales. Net sales for the three months ended September 30, 2007 were $82.3 million compared to $78.1 million for the same period in 2006. Wholesale sales for the three months ended September 30, 2007 were $64.1 million compared to $63.4 million for the same period in 2006. The $0.7 million increase in wholesale sales is the result of an increase in sales in our work footwear category partially offset by decreases in our hunting and western footwear and apparel categories. Retail sales for the three months ended September 30, 2007 were $18.2 million compared to $14.6 million for the same period in 2006. The $3.6 million increase in retail sales results from the growth in market share experienced as a result of the bankruptcy of a leading competitor. Military segment sales, which occur from time to time, for the three months ended September 30, 2007, were zero compared to $0.2 million in the same period in 2006.

Gross margin. Gross margin for the three months ended September 30, 2007 was $29.3 million, or 35.6% of net sales, compared to $32.1 million, or 41.1% of net sales, in the same period last year. Wholesale gross margin for the three months ended September 30, 2007 was $20.0 million, or 31.3% of net sales, compared to $24.4 million, or 38.5% of net sales, in the same period last year. The 720 basis point decrease reflects a decrease in sales price per unit for competitive reasons, as well as an increase in manufacturing costs from both our company operated facilities and third party manufacturers. Retail gross margin for the three months ended September 30, 2007 was $9.2 million, or 50.8% of net sales, compared to $7.7 million, or 52.7% of net sales, for the same period in 2006. The 190 basis point decrease reflects an increase in manufacturing costs at third party manufacturers. Military gross margin for the three months ended September 30, 2007 was zero compared to less than $0.1 million or 17.0% of net sales, for the same period in 2006.

SG&A expenses. SG&A expenses were $25.1 million, or 30.5% of net sales, for the three months ended September 30, 2007, compared to $22.6 million, or 28.9% of net sales for the same period in 2006. The net change primarily reflects increases in salaries and commissions of $0.7 million, benefits of $0.3 million, show expenses of $0.3 million, vehicle expenses of $0.5 million and freight and handling charges of $0.5 million.

Interest expense. Interest expense was $2.9 million in the three months ended September 30, 2007, compared to $2.9 million for the same period in the prior year.

Income taxes. Income tax expense for the three months ended September 30, 2007 was $0.2 million, compared to $2.5 million for the same period a year ago. We provided for income taxes at an estimated effective tax rate of 37% for the three months ended September 30, 2007 and 2006. During the three months ended September 30, 2007, we recognized a prior year state income tax refund of $0.3 million which reduced the effective tax rate to 15.4%.

Net sales. Net sales for the nine months ended September 30, 2007 were $202.8 million compared to $192.9 million for the same period in 2006. Wholesale sales for the nine months ended September 30, 2007 were $150.6 million compared to $147.1 million for the same period in 2006. The $3.5 million increase in sales is the result of increases in sales in our work, duty and, outdoor footwear categories, offset by decreases in our western footwear and apparel categories. Retail sales for the nine months ended September 30, 2007 were $51.8 million compared to $44.8 million for the same period in 2006. The $7.0 million increase in retail sales results from the growth in market share experienced as a result of the bankruptcy of a leading competitor. Military segment sales, which occur from time to time, for the nine months ended September 30, 2007, were $0.4 million, compared to $1.1 million in the same period in 2006.

Gross margin. Gross margin in the nine months ended September 30, 2007 was $79.3 million, or 39.1% of net sales, compared to $81.1 million, or 42.0% of net sales, in the same period last year. Wholesale gross margin for the nine months ended September 30, 2007 was $51.3 million, or 34.1% of net sales, compared to $57.0 million, or 38.8% of net sales, in the same period last year. The 470 basis point decrease reflects a decrease in sales price per unit for competitive reasons, as well as an increase in sales of discontinued products at lower margins and an increase in manufacturing costs from both our company operated facilities and third party manufacturers. Retail gross margin for the nine months ended September 30, 2007 was $26.7 million, or 51.5% of net sales, compared to $23.9 million, or 53.4% of net sales, for the same period in 2006. The 190 basis point decrease reflects an increase in manufacturing costs at third party manufacturers. Military gross margin for the nine months ended September 30, 2007 was $1.3 million compared to $0.2 million for the same period in 2006. The gross margin for 2007 results includes a $1.2 million reduction of cost of goods sold from the reimbursement of contract related expenses incurred in prior periods.

SG&A expenses. SG&A expenses were $70.2 million, or 34.6% of net sales, for the nine months ended September 30, 2007, compared to $65.2 million, or 33.8% of net sales for the same period in 2006. The net change primarily reflects increases in salaries and commissions of $1.6 million, professional fees of $1.0 million, bad debt expense of $0.7 million, co-op advertising of $0.4 million, depreciation and amortization of $0.4 million, utilities of $0.5 million, freight and handling of $0.7, and vehicle expenses of $0.8 million, partially offset by a decrease in benefits of $0.2 million and advertising expense of $1.0 million. SG&A expenses for 2006 include a gain on the sale of a company-owned property of $0.7 million and pension expense of $0.4 million relating to the pension curtailment relating to the freezing of the non-union pension plan in 2006.

Interest expense. Interest expense was $8.8 million in the nine months ended September 30, 2007, compared to $8.3 million for the same period in the prior year. The increase reflects the accelerated amortization of $0.8 million of deferred financing costs under the Note Purchase Agreements with GMAC and ACAS, partially offset by a reduction in interest expense resulting from a decrease in average borrowings.

Income taxes. Income tax benefit for the nine months ended September 30, 2007 was $0.2 million, compared to an expense of $2.9 million for the same period a year ago. Our estimated effective tax rate was 37% for the nine months ended September 30, 2007 and 2006. During the nine months ended September 30, 2007, we recognized a prior year state income tax refund of $0.3 million which when combined with the income tax provision of 37% resulted in the recognition of the aforementioned tax benefit.

Our principal sources of liquidity have been our income from operations, borrowings under our credit facility and other indebtedness.

Over the last several years our principal uses of cash have been for our acquisitions of EJ Footwear and certain assets of Gates-Mills, as well as for working capital and capital expenditures to support our growth. Our working capital consists primarily of trade receivables and inventory, offset by accounts payable and accrued expenses. Our working capital fluctuates throughout the year as a result of our seasonal business cycle and business expansion and is generally lowest in the months of January through March of each year and highest during the months of May through October of each year. We typically utilize our revolving credit facility to fund our seasonal working capital requirements. As a result, balances on our revolving credit facility will fluctuate significantly throughout the year. Our capital expenditures relate primarily to projects relating to our property, merchandising fixtures, molds and equipment associated with our manufacturing operations and for information technology. Capital expenditures were $4.7 million for the first nine months of 2007, compared to $4.6 million for the same period in 2006. Capital expenditures for all of 2007 are anticipated to be approximately $6.0 million.

In May 2007, we entered into a Note Purchase Agreement, totaling $40 million, with Laminar Direct Capital L.P., Whitebox Hedged High Yield Partners, L.P. and GPC LIX L.L.C., and issued notes to each for $20 million, $17.5 million and $2.5 million, respectively, at an interest rate of 11.5% payable semi-annually over the five year term of the notes. Principal repayment is due at maturity in May 2012. The proceeds from these notes were used to pay down the GMAC Commercial Finance term loans which totaled approximately $17.5 million and the $15 million ACAS term loan. The balance of the proceeds, net of debt acquisition costs of approximately $1.4 million, was used to reduce the outstanding balance on the revolving credit facility. The Note Purchase Agreement is secured by a security interest in our assets and is subordinate to the security interest under the GMAC line of credit.

The total amount available under our revolving credit facility is subject to a borrowing base calculation based on various percentages of accounts receivable and inventory. As of September 30, 2007, we had $79.7 million in borrowings under this facility and total capacity of $93.1 million. Our credit facilities contain certain restrictive covenants, which require us to maintain a minimum fixed charge coverage ratio and limit the annual amount of capital expenditures. As of September 30, 2007, we were in compliance with these restrictive covenants.

We believe that our existing credit facilities coupled with cash generated from operations will provide sufficient liquidity to fund our operations for at least the next twelve months. Our continued liquidity, however, is contingent upon future operating performance, cash flows and our ability to meet financial covenants under our credit facilities.

Operating Activities. Cash used in operating activities totaled $7.3 million in the first nine months of 2007, compared to $18.1 million in the same period of 2006. Cash used in operating activities was primarily impacted by the seasonal buildup of both inventories and accounts receivable.

Investing Activities. Cash used in investing activities was $4.9 million for the first nine months of 2007, compared to $2.9 million in 2006. Cash used in investing activities in 2007 reflects an investment in property plant and equipment of $4.7 million. Our 2007 expenditures primarily relate to investments in molds and equipment associated with our manufacturing operations and for information technology. Cash used in investing activities in 2006 primarily relates to investment in property, plant and equipment of $4.6 million, offset by the sale of the Harper Street warehouse facility for $1.9 million.

Financing Activities. Cash provided by financing activities for the nine months ended September 30, 2007 was $11.2 million, reflecting an increase in net borrowings under the revolving credit facility of $4.9 million, repayments on long-term debt of $32.7 million, offset by proceeds from the exercise of stock options of $0.4 million and the issuance of long term debt of $40 million, less debt financing costs of $1.4 million. Cash provided by financing activities for the nine months ended September 30, 2006 was $21.7 million and reflects an increase in net borrowings under the revolving credit facility of 30.2 million, a new $15.0 million term loan, and proceeds from the exercise of stock options of $0.3 million partially offset by repayments on long-term debt of $23.2 million and debt financing cost of $0.6 million.

We cannot determine the precise effects of inflation; however, inflation continues to have an influence on the cost of materials, salaries, and employee benefits. We attempt to offset the effects of inflation through increased selling prices, productivity improvements, and reduction of costs.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” discusses our interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these interim condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the interim condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. A summary of our significant accounting policies is included in the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2006.

Our management regularly reviews our accounting policies to make certain they are current and also to provide readers of the interim condensed consolidated financial statements with useful and reliable information about our operating results and financial condition. These include, but are not limited to, matters related to accounts receivable, inventories, pension benefits and income taxes. Implementation of these accounting policies includes estimates and judgments by management based on historical experience and other factors believed to be reasonable. This may include judgments about the carrying value of assets and liabilities based on considerations that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our management believes the following critical accounting policies are most important to the portrayal of our financial condition and results of operations and require more significant judgments and estimates in the preparation of our interim condensed consolidated financial statements.

Revenue principally consists of sales to customers, and, to a lesser extent, license fees. Revenue is recognized when the risk and title passes to the customer, while license fees are recognized when earned. Customer sales are recorded net of allowances for estimated returns, trade promotions and other discounts, which are recognized as a deduction from sales at the time of sale.

Management maintains allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Management also records estimates for customer returns and discounts offered to customers. Should a greater proportion of customers return goods and take advantage of discounts than estimated by us, additional allowances may be required.

We record a reduction to gross sales based on estimated customer returns and allowances. These reductions are influenced by historical experience, based on customer returns and allowances. The actual amount of sales returns and allowances realized may differ from our estimates. If we determine that sales returns or allowances should be either increased or decreased, then the adjustment would be made to net sales in the period in which such a determination is made.

Management identifies slow moving or obsolete inventories and estimates appropriate loss provisions related to these inventories. Historically, these loss provisions have not been significant as the vast majority of our inventories are considered saleable, and we have been able to liquidate slow moving or obsolete inventories through our factory outlet stores or through various discounts to customers. Should management encounter difficulties liquidating slow moving or obsolete inventories, additional provisions may be necessary. Management regularly reviews the adequacy of our inventory reserves and makes adjustments to them as required.

Intangible assets, including goodwill, trademarks and patents are reviewed for impairment annually, and more frequently, if necessary. In performing the review of recoverability, we estimate future cash flows expected to result from the use of the asset and our eventual disposition. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s subjective judgments. The time periods for estimating future cash flows is often lengthy, which increases the sensitivity to assumptions made. Depending on the assumptions and estimates used, the estimated future cash flows projected in the evaluation of long-lived assets can vary within a wide range of outcomes. We consider the likelihood of possible outcomes in determining the best estimate of future cash flows. A significant assumption of estimated cash flows from trademarks is future sales of branded products. Other assumptions include discount rates, royalty rates, cost of capital, and market multiples. An impairment charge may be recorded if the expected future cash flows decline. Based upon our review, none of our intangibles were impaired as of September 30, 2007.

Accounting for pensions involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, extensive use is made of assumptions about inflation, investment returns, mortality, turnover, medical costs and discount rates. These assumptions are reviewed annually.

Pension expenses are determined by actuaries using assumptions concerning the discount rate, expected return on plan assets and rate of compensation increase. An actuarial analysis of benefit obligations and plan assets is determined as of September 30 each year. The funded status of our plans and reconciliation of accrued pension cost is determined annually as of December 31. Further discussion of our pension plan and related assumptions is included in Note 9, “Retirement Plans,” to the unaudited condensed consolidated financial statements for the quarterly period ended September 30, 2007. Actual results would be different using other assumptions. Management records an accrual for pension costs associated with our sponsored noncontributory defined benefit pension plan covering our non-union workers. Future adverse changes in market conditions or poor operating results of underlying plan assets could result in losses or a higher accrual. At December 31, 2005, we froze the non-contributory defined benefit pension plan for all non-U.S. territorial employees. As a result of freezing the plan, we have recognized a charge for previously unrecognized service costs of approximately $0.4 million during the three-month period ended March 31, 2006.

Management has recorded a valuation allowance to reduce its deferred tax assets for a portion of state and local income tax net operating losses that it believes may not be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, however, in the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.

Except for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q include certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, all statements regarding our and management’s intent, belief, and expectations, such as statements concerning our future profitability and our operating and growth strategy. Words such as “believe,” “anticipate,” “expect,” “will,” “may,” “should,” “intend,” “plan,” “estimate,” “predict,” “potential,” “continue,” “likely” and similar expressions are intended to identify forward-looking statements. Investors are cautioned that all forward-looking statements contained in this Quarterly Report on Form 10-Q and in other statements we make involve risks and uncertainties including, without limitation, the factors set forth under the caption “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2006, and other factors detailed from time to time in our other filings with the Securities and Exchange Commission. One or more of these factors have affected, and in the future could affect our businesses and financial results in the future and could cause actual results to differ materially from plans and projections. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, there can be no assurance that any of the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. All forward-looking statements made in this Quarterly Report on Form 10-Q are based on information presently available to our management. We assume no obligation to update any forward-looking statements.

There have been no material changes since December 31, 2006.

Disclosure Controls and Procedures. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, our management, with the participation of our chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 promulgated under the Exchange Act. Based upon this evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were (1) designed to ensure that material information relating to our Company is accumulated and made known to our management, including our chief executive officer and chief financial officer, in a timely manner, particularly during the period in which this report was being prepared, and (2) effective, in that they provide reasonable assurance that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Management believes, however, that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a Company have been detected.

Internal Controls. There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) during our fiscal quarter ended September 30, 2007, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

     None

     There have been no material changes to our risk factors as disclosed in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006.

     None

     None

     None

     None

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.