Rocky Brands - 10-Q quarterly report FY

(Mark One)

For the quarterly period ended March 31, 2011

OR

For the transition period from                                                 to                                       

Commission file number:  001-34382

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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ¨     No ¨

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

As of April 22, 2011, 7,489,995 shares of Rocky Brands, Inc. common stock, no par value, were outstanding.

See notes to the interim unaudited condensed consolidated financial statements.

See notes to the interim unaudited condensed consolidated financial statements.

See notes to the interim unaudited condensed consolidated financial statements.

NOTES TO THE INTERIM UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE-MONTHS ENDED MARCH 31, 2011 AND 2010

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 March 31, 2011 were $52.3 million compared to $56.1 million for the same period in 2010.  Wholesale sales for the three months ended March 31, 2011 were $39.8 million compared to $37.9 million for the same period in 2010.  The $1.9 million increase in wholesale sales was the result of a $3.1 million or 62.0% increase in our duty footwear category, a $1.4 million or 7.6% increase in our work footwear category (excluding Dickies) and a $0.4 million or 16.2% increase in our outdoor footwear category, which was partially offset by a $1.7 million decline of our Dickies licensed business and a $1.2 million or 15.2% decrease in our western footwear category.  Our licensing agreement with Dickies expired on December 31, 2010.  Retail sales for the three months ended March 31, 2011 were $11.7 million compared to $12.9 million for the same period in 2010.  The $1.2 million decrease in retail sales resulted from our ongoing transition to more internet driven transactions and the decision to remove a portion of our Lehigh mobile stores from operations to help lower operating expenses.  Military segment sales for the three months ended March 31, 2011, were $0.8 million, compared to $5.2 million in the same period in 2010.  Shipments in 2010 were under the $29.0 million contract, issued in July 2009.

Gross margin.  Gross margin for the three months ended March 31, 2011 was $19.3 million, or 36.8% of net sales, compared to $18.8 million, or 33.4% of net sales, in the same period last year.  Wholesale gross margin for the three months ended March 31, 2011 was $13.3 million, or 33.5% of net sales, compared to $12.2 million, or 32.1% of net sales, in the same period last year.  The 140 basis point increase is primarily the result of higher average selling prices as well as higher sales of company owned brands which carry higher gross margins than licensed brands.  Retail gross margin for the three months ended March 31, 2011 was $5.8 million, or 49.6% of net sales, compared to $5.9 million, or 45.7% of net sales, for the same period in 2010.  The 390 basis point increase is primarily the result of higher average selling prices.  Military gross margin for the three months ended March 31, 2011 was $0.1 million, or 13.2% of net sales, compared to less than $0.7 million, or 12.9% of net sales, for the same period in 2010.

SG&A expenses.  SG&A expenses were $18.2 million, or 34.8% of net sales, for the three months ended March 31, 2011, compared to $18.0 million, or 32.1% of net sales for the same period in 2010.  The net change primarily reflects increases in compensation and benefits of $0.4 million, advertising expenses of $0.1 million and insurance costs of $0.1 million, which was partially offset by decreases in bad debt expense of $0.2 million and professional fees of $0.2 million.

Interest expense.  Interest expense was $0.2 million in the three months ended March 31, 2011, compared to $1.6 million for the same period in the prior year.  The decrease of $1.4 million is primarily the result of the repayment of a $40.0 million term note carrying interest at a rate of 11.5%.  This repayment was made with $14 million of proceeds from our May 2010 equity offering as well as $26 million of borrowings from our line of credit which generally carries an interest rate of LIBOR plus 150 basis points.

Income taxes.  Income tax expense for the three months ended March 31, 2011 was $0.3 million, compared to an income tax benefit $0.3 million for the same period a year ago.  We provided for income taxes at effective tax rates of 35% in 2011 and 36% in 2010.  The decrease in the estimated effective tax rate for 2011 is the result of our anticipation of making permanent capital investment in 2011 in our operations in the Dominican Republic, which reduced the amount of dividends that we need to provide for U.S. income taxes.

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

Over the last several years our principal uses of cash have been 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, retail sales fleet and for information technology.  Capital expenditures were $2.1 million for the first three months of 2011, compared to $1.3 million for the same period in 2010. Total capital expenditures for 2011 are anticipated to be approximately $6.0 million.

In May 2010, we amended the terms of our revolving credit facility with GMAC Commercial Finance (“GMAC”) to advance $15 million to the Company under the existing revolving portion of its credit facility to prepay amounts due under term loans with Laminar Direct Capital L.P. and Whitebox Hedged High Yield Partners, L.P.  After the prepayment, principal under the term loans total $11 million in the aggregate.

Also in May 2010, we completed a public offering of 1.8 million shares of common stock at a price of $8.40 per share.  We received net proceeds from the offering of $14.1 million after deducting $0.9 million in underwriting discounts and $0.1 million in expenses. The proceeds were used to prepay amounts due under term loans with Laminar Direct Capital L.P. and Whitebox Hedged High Yield Partners, L.P.

In October 2010, we entered into a new financing agreement with PNC Bank (“PNC”) to provide a $70 million credit facility that replaced the existing revolving credit facility with GMAC.  In addition, the new financing agreement with PNC was used to repay the remaining balance of approximately $11 million under the term loans. The term of the new credit facility is five years and the current interest rate is generally LIBOR plus 1.50%.

In April 2011, we repaid the remaining balance of approximately $1.8 million on our mortgage loans by borrowing under a sub-facility on the PNC credit facility.  The sub-facility is secured by the real estate owned by us.  In connection with this transaction, we incurred approximately $0.1 million of prepayment and other fees that will be reported as additional interest expense in the second quarter of 2011.

Our credit facility contains a restrictive covenant which requires us to maintain a fixed charge coverage ratio.  This restrictive covenant is only in effect upon a triggering event taking place (as defined in the credit facility agreement).  At March 31, 2011, no triggering event had occurred and the covenant was not in effect.

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 March 31, 2011, we had $25.9 million in borrowings under this facility and total capacity of $58.9 million.

We believe that our existing credit facility 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 facility.

Operating Activities.  Cash provided by operating activities totaled $6.9 million for the three months ended March 31, 2011, compared to $11.8 million in the same period of 2010.  Cash provided by operating activities for the three months ended March 31, 2011 was primarily impacted by reductions in accounts receivable and increases in accounts payable, partially offset by increases in inventory.  Cash provided by operating activities for the three months ended March 31, 2010 was primarily impacted by reductions in accounts receivable and inventory.

Investing Activities.  Cash used in investing activities was $2.1 million for the three months ended March 31, 2011, compared to $1.3 million in the same period of 2010.  Cash used in investing activities reflects an investment in property, plant and equipment of $2.1 million in 2011 and $1.3 million in 2010. Our 2011 and 2010 expenditures primarily relate to investments in molds and equipment associated with our manufacturing operations and for information technology.

Financing Activities.  Cash used in financing activities for the three months ended March 31, 2011 was $7.0 million and reflects a net reduction under the revolving credit facility of $7.2 million and repayments on long-term debt of $0.1 million. Cash used in financing activities for the three months ended March 31, 2010 was $8.8 million and reflects a decrease in net borrowings under the revolving credit facility of $8.7 million and repayments on long-term debt of $0.1 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, 2010.

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 uncollectible 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.  The allowance for uncollectible accounts is calculated based on the relative age and size of trade receivable balances.

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.  We perform such testing of goodwill and indefinite-lived intangible assets in the fourth quarter of each year or as events occur or circumstances change that would more likely than not reduce the fair value of the asset below its carrying amount.

In assessing whether indefinite-lived intangible assets are impaired, we must make certain estimates and assumptions regarding future cash flows, long-term growth rates of our business, operating margins, weighted average cost of capital and other factors such as discount rates, royalty rates, cost of capital, and market multiples to determine the fair value of our assets.  These estimates and assumptions require management’s judgment, and changes to these estimates and assumptions could materially affect the determination of fair value and/or impairment for each of our other indefinite-lived intangible assets.  Future events could cause us to conclude that indications of intangible asset impairment exist.  Impairment may result from, among other things, deterioration in the performance of our business, adverse market conditions, adverse changes in applicable laws and regulations, competition, or the sale or disposition of a reporting segment.  Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

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 December 31 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 10, “Retirement Plans,” to the unaudited condensed consolidated financial statements for the quarterly period ended March 31, 2011. Actual results would be different using other assumptions.  Management records an accrual for pension costs associated with our sponsored non-contributory 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.

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, 2010, 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 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, 2010.

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 March 31, 2011, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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.