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RCKY > SEC Filings for RCKY > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for ROCKY BRANDS, INC.

Form 10-K for ROCKY BRANDS, INC.


6-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This Management's Discussion and Analysis of Financial Condition and Result of Operations ("MD&A") describes the matters that we consider to be important to understanding the results of our operations for each of the three years in the period ended December 31, 2013, and our capital resources and liquidity as of December 31, 2013 and 2012. Use of the terms "Rocky," the "Company," "we," "us" and "our" in this discussion refer to Rocky Brands, Inc. and its subsidiaries. Our fiscal year begins on January 1 and ends on December 31. We analyze the results of our operations for the last three years, including the trends in the overall business followed by a discussion of our cash flows and liquidity, our credit facility, and contractual commitments. We then provide a review of the critical accounting judgments and estimates that we have made that we believe are most important to an understanding of our MD&A and our consolidated financial statements. We conclude our MD&A with information on recent accounting pronouncements which we adopted during the year, as well as those not yet adopted that are expected to have an impact on our financial accounting practices.

The following discussion should be read in conjunction with the "Selected Consolidated Financial Data" and our consolidated financial statements and the notes thereto, all included elsewhere herein. The forward-looking statements in this section and other parts of this document involve risks and uncertainties including statements regarding our plans, objectives, goals, strategies, and financial performance. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of factors set forth under the caption "Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995" below. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements made by or on behalf of the Company.

Certain amounts from prior year related to royalty income have been reclassified to conform to current year presentation. In 2013, we began reporting royalty income as a component of net sales.

Creative Recreation

In December 2013, we completed the acquisition of certain assets of Kommonwealth, Inc. including the Creative Recreation trademark. Headquartered in Los Angeles, California, since 2002, Creative Recreation was first to create and market versatile footwear brand that could easily transition between casual and more formal environments. Creative Recreation's collections of upscale sneakers quickly gained strong acceptance and support from a wide array of key influencers across multiple categories including music, sports, and acting. Creative Recreation's ability to successfully fuse style and versatility across a diversified assortment of products has created a wide target demographic and a strong distribution network that spans multiple channels and price points.

We believe by combining Rocky's strong operating platform and access to capital with Creative Recreation's design expertise we can strategically expand their business both domestically and overseas. At the same time, this transaction provides us with a compelling vehicle to penetrate the casual end of the market to complement our work, western and outdoor categories.

The total purchase price was approximately $8.7 million including cash and assumption of certain liabilities. This purchase price is subject to a working capital adjustment. The acquisition was funded by our existing cash balances and funds available under our existing revolving credit facility. We did not have any sales in 2013 related to this acquisition and the business incurred approximately $0.2 million of operating expenses during 2013. In addition, we incurred approximately $1.2 million of related acquisition expenses that were reflected in the results of operations for the year 2013. In addition, we recorded a gain on bargain purchase of $0.6 million related to this acquisition.

EXECUTIVE OVERVIEW

We are a leading designer, manufacturer and marketer of premium quality footwear and apparel marketed under a portfolio of well recognized brand names including Rocky, Georgia Boot, Durango, Lehigh, Creative Recreation and the licensed brand Michelin.

Our products are distributed through three distinct business segments:
wholesale, retail and military. In our wholesale business, we distribute our products through a wide range of distribution channels representing over ten-thousand retail store locations in the U.S. and Canada as well as in several international markets. Our wholesale channels vary by product line and include sporting goods stores, outdoor retailers, independent shoe retailers, hardware stores, catalogs, mass merchants, uniform stores, farm store chains, specialty safety stores and other specialty retailers. Our retail business includes direct sales of our products to consumers through our Lehigh mobile stores and our websites. We also sell footwear under the Rocky label to the U.S. military.

Our growth strategy is founded substantially on the expansion of our brands into new footwear and apparel markets. New products that we introduce may not be successful with consumers or one or more of our brands may fall out of favor with consumers. If we are unable to anticipate, identify or react appropriately to changes in consumer preferences, we may not grow as fast as we plan to grow or our sales may decline, and our brand image and operating performance may suffer.

Furthermore, achieving market acceptance for new products will likely require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative, or SG&A, expenses, and there can be no assurance that we will have the resources necessary to undertake such efforts. Material increases in our SG&A expenses could adversely impact our results of operations and cash flows.

We may also encounter difficulties in producing new products that we did not anticipate during the development stage. Our development schedules for new products are difficult to predict and are subject to change as a result of shifting priorities in response to consumer preferences and competing products. If we are not able to efficiently manufacture newly-developed products in quantities sufficient to support retail distribution, we may not be able to recoup our investment in the development of new products. Failure to gain market acceptance for new products that we introduce could impede our growth, reduce our profits, adversely affect the image of our brands, erode our competitive position and result in long term harm to our business.

FINANCIAL SUMMARY

Net sales of the wholesale segment increased $6.7 million in 2013 over prior year primarily as a result of increased sales in our work footwear and western footwear categories. The increase in the work footwear category was the result of higher sales of private label footwear in 2013.

Net sales of the retail segment increased $1.8 million in 2013 from the prior year primarily as a result of higher sales from our business and consumer web platforms.

Net sales of the military segment increased $7.8 million in 2013 from the prior year. From time to time, we bid on military contracts when they become available. Our sales under such contracts are dependent on us winning the bids for these contracts. We have received an order to fulfill a contract to the U.S. Military to produce "Hot Weather" combat boots. The first year of the contract includes a minimum purchase amount of $3.0 million and a maximum of $15.0 million. Shipment of the boots began in the first quarter of 2013. The contract includes an option for four additional years with the same terms.

Gross margin of the wholesale segment increased $1.4 million in 2013 over the prior year as a result of the higher sales, which was partially offset by decreased margin as a percentage of sales.

Gross margin of the retail segment increased $0.4 million in 2013 from the prior year as a result of higher overall sales.

Gross margin of the military segment increased $1.2 million in 2013 over the prior year due primarily to higher sales.

Selling, general and administrative expenses increased $5.8 million in 2013 from prior year primarily as result of higher selling expenses and acquisition related expenses related to the purchase of the Kommonwealth assets.

Net interest expense increased slightly in 2013 from the prior year due to slightly higher levels of debt.

Net income decreased $1.5 million in 2013 from prior year results primarily due higher selling expenses and expenses associated with the acquisition of the Creative Recreation brand, partially offset by the gain on bargain purchase.

Total debt at December 31, 2013 was $38.4 million or $15.0 million higher than the prior year. Total debt minus cash and cash equivalents was $34.2 million or 20.1% of total capitalization at December 31, 2013 compared to $19.4 million or 13.0% of total capitalization at year-end 2012.

Our cash from operating activities decreased $20.4 million in 2012 from the prior year, primarily the result of higher working capital, primarily inventory and accounts receivable.

Net sales. Net sales and related cost of goods sold are recognized at the time products are shipped to the customer and title transfers. Net sales are recorded net of estimated sales discounts and returns based upon specific customer agreements and historical trends. Net sales include royalty income from licensing our brands.

Cost of goods sold. Our cost of goods sold represents our costs to manufacture products in our own facilities, including raw materials costs and all overhead expenses related to production, as well as the cost to purchase finished products from our third-party manufacturers. Cost of goods sold also includes the cost to transport these products to our distribution centers.

SG&A expenses. Our SG&A expenses consist primarily of selling, marketing, wages and related payroll and employee benefit costs, travel and insurance expenses, depreciation, amortization, professional fees, facility expenses, bank charges, and warehouse and outbound freight expenses.

Percentage of Net Sales



The following table sets forth consolidated statements of operations data as
percentages of total net sales:



                                   Years Ended December 31,
                                 2013         2012        2011
Net sales                          100.0 %     100.0 %     100.0 %
Cost of goods sold                  65.9 %      64.8 %      63.2 %
Gross margin                        34.1 %      35.2 %      36.8 %
SG&A expense                        29.1 %      29.2 %      29.1 %
Acquisition related expenses         0.5 %       0.0 %       0.0 %
Pension termination charges          0.0 %       0.0 %       2.2 %
Income from operations               4.5 %       6.0 %       5.5 %

Results of Operations

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net sales. Net sales increased 7.1% to $244.9 million for 2013 compared to $228.5 million the prior year. Wholesale sales increased $6.7 million to $192.9 million for 2013 compared to $186.2 million for 2012. The increase in wholesale sales was primarily the result of a $9.0 million or 11.4% increase in our work footwear category and a $6.3 million or 21.2% increase in our western footwear category, which were partially offset by a $3.3 million or 34.2% decrease in apparel and accessories, a $3.2 million or 14.7% decrease in our commercial military footwear category and a $3.2 million or 14.3% decrease in our outdoor footwear category. During the first quarter of 2013, we began shipping to Tractor Supply under an agreement to produce boots under their trade name C.E. Schmidt. During 2013, we had sales of $10.3 million under this agreement that is included in the work footwear category. Retail sales increased to $43.1 million for 2013 compared to $41.3 million for 2012. The $1.8 million increase in retail sales resulted from increased sales in our business-to-consumer ecommerce web platforms. Military segment sales, which occur from time to time, were $8.9 million for 2013 compared to $1.0 million in 2012. From time to time, we bid on military contracts when they become available. Our sales under such contracts are dependent on us winning the bids for these contracts. We have received an order to fulfill a contract to the U.S. Military to produce "Hot Weather" combat boots. The first year of the contract includes a minimum purchase amount of $3.0 million and a maximum of $15.0 million. Shipment of the boots began in March 2013. The contract includes an option for four additional years with the same terms. Average list prices for our footwear, apparel and accessories were higher in 2013 than 2012 as we increased our list prices to offset higher manufacturing and sourcing costs.

Gross margin. Gross margin increased to $83.5 million or 34.1% of net sales for 2013 compared to $80.5 million or 35.2% of net sales for the prior year. Wholesale gross margin for 2013 was $62.4 million, or 32.4% of net sales, compared to $61.0 million, or 32.8% of net sales in 2012. The 40 basis point decrease was primarily the result of sales of C.E. Schmidt work footwear in 2013 which carries lower margins. Retail gross margin for 2013 was $19.9 million, or 46.1% of net sales, compared to $19.5 million, or 47.2% of net sales, in 2012. The 110 basis point decrease in 2013 from the prior year was largely due to lower average selling prices on our internet driven transactions than our mobile store transactions. Military gross margin in 2013 was $1.3 million, or 14.3% of net sales, compared to $0.1 million, or 4.2% of net sales in 2012.

SG&A expenses. SG&A expenses were $71.4 million, or 29.1% of net sales in 2013 compared to $66.7 million, or 29.2% of net sales for 2012. The net change primarily reflected higher selling and distribution expenses of $2.0 million and higher advertising costs of $0.9 million.

Acquisition related items. Acquisition related items in 2013 included expenses of $1.2 million related to the aforementioned acquisition of the Creative Recreation brand, which are included as a component of income from operations. In addition, a gain on bargain purchase of $0.6 million was recorded and is included as a component of total other income and expenses.

Interest expense. Interest expense was $0.7 million in 2013, compared to $0.7 million for the prior year.

Income taxes. Income tax expense was $3.4 million in 2013, compared to $4.2 million for the same period a year ago. The decrease in income tax expense for 2013 was due to a $2.3 million decrease in pretax income and a decrease in the effective tax rate. The effective tax rate for 2013 was 31.8% compared to 32.3% for 2012. The effective tax rate for 2013 is less than the federal statutory rate due principally to our permanent capital investment in the Dominican Republic which reduces the amount of dividends that we need to provide for U.S. income taxes.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Net sales. Net sales decreased 4.8% to $228.5 million for 2012 compared to $240.0 million the prior year. Wholesale sales decreased $6.7 million to $186.2 million for 2012 compared to $192.9 million for 2011. The decrease in wholesale sales was the result of a $5.2 million or 6.1% decrease in our work footwear category, a $4.3 million or 16.1% decrease in our outdoor footwear category, a $3.2 million or 25.2% decrease in apparel and accessories, a $1.4 million or 9.7% decrease in our duty footwear category and a $1.0 million decrease in other footwear, which were partially offset by a $5.2 million or 21.0% increase in our western footwear category, a $2.9 million or 39.7% increase in our lifestyle footwear category and a $0.4 million or 1.8% increase in our commercial military footwear category. Retail sales were $41.3 million in 2012 compared to $44.8 million for 2011. The $3.5 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, which occur from time to time, were $1.0 million for 2012 compared to $2.2 million in 2011. From time to time, we bid on military contracts when they become available. Our sales under such contracts are dependent on us winning the bids for these contracts. Recently, we received an order to fulfill a contract to the U.S. Military to produce "Hot Weather" combat boots. The first year of the contract includes a minimum purchase amount of $3.0 million and a maximum of $15.0 million. Shipment of the boots is expected to begin in March 2013. The contract includes an option for four additional years with the same terms. Average list prices for our footwear, apparel and accessories were higher in 2012 than 2011 as we increased our list prices to offset higher manufacturing and sourcing costs.

Gross margin. Gross margin decreased to $80.5 million or 35.2% of net sales for 2012 compared to $88.3 million or 36.8% of net sales for the prior year. Wholesale gross margin for 2012 was $61.0 million, or 32.8% of net sales, compared to $67.3 million, or 34.9% of net sales in 2011. The 210 basis point decrease was primarily due to an increase in product costs and higher customer promotions in the current year. Retail gross margin for 2012 was $19.5 million, or 47.2% of net sales, compared to $20.7 million, or 46.2% of net sales, in 2011. The 100 basis point increase in 2012 over the prior year was the result of the $0.8 million inventory adjustment in the fourth quarter of 2011 resulting from our annual physical inventory. Military gross margin in 2012 was less than $0.1 million, or 4.2% of net sales, compared to $0.3 million, or 13.4% of net sales in 2011.

SG&A expenses. SG&A expenses were $66.7 million, or 29.2% of net sales in 2012 compared to $69.9 million, or 29.2% of net sales for 2011. The net change primarily resulted from decreases in compensation and benefits expenses of $3.5 million and Lehigh mobile and store expenses of $1.5 million, partially offset by increases in advertising expenses of $1.3 million and freight expenses of $0.5 million.

Interest expense. Interest expense was $0.7 million in 2012, compared to $1.0 million for the prior year. The decrease of $0.3 million resulted primarily from lower average borrowings in the current year. The interest expense for 2011 included $0.1 million of prepayment penalties and other fees from the early repayment of our mortgage loans in April 2011.

Income taxes. Income tax expense was $4.2 million in 2012, compared to $3.7 million for the same period a year ago. The increase in income tax expense for 2012 was due to a $0.5 million increase in pretax income and an increase in the effective tax rate. The effective tax rate for 2012 was 32.3% compared to 31.0% for 2011. The increase in our effective tax rate for 2012 was due principally to a lower permanent capital investment in 2012 in our operations in the Dominican Republic as compared to 2011. Our permanent capital investment in the Dominican Republic reduces the amount of dividends that we need to provide for U.S income taxes.

LIQUIDITY AND CAPITAL RESOURCES

Overview

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

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 working capital increased to $118.2 million at December 31, 2013, compared to $105.4 million at the end of the prior year.

Our capital expenditures relate primarily to projects relating to our corporate offices, property, merchandising fixtures, molds and equipment associated with our manufacturing operations and for information technology. Capital expenditures were $7.7 million for 2013 and $6.1 million in 2012. Capital expenditures for 2014 are anticipated to be approximately $8.4 million.

In October 2010, we entered into a financing agreement with PNC Bank ("PNC") to provide a $70 million credit facility. The term of the facility is five years and the current interest rate is generally LIBOR plus 1.50%.

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 December 31, 2013, we had $38.4 million in borrowings under this facility and total capacity of $70 million.

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 December 31, 2013, there was no triggering event and the covenant was not in effect. Our credit facility places a restriction on the amount of dividends that may be paid. During 2013, we paid dividends on our common stock totaling $2,254,935. No dividends were paid during 2012 or 2011.

We believe that our 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.

Based on our expected borrowings for 2013, a hypothetical 100 basis point increase in short term interest rates would result, over the subsequent twelve-month period, in a reduction of approximately $0.4 million in income before income taxes and cash flows. The estimated reductions are based upon the current level of variable debt and assume no changes in the composition of that debt.

Cash Flows



Cash Flow Summary                          2013        2012        2011
($ in millions)
Cash provided by (used in):
Operating activities                      $  (2.4 )   $  18.0     $  6.5
Investing activities                        (10.0 )      (6.1 )     (7.5 )
Financing activities                         12.6       (11.5 )      0.3
Net change in cash and cash equivalents   $   0.2     $   0.4     $ (0.7 )

Operating Activities. Net cash used in operating activities totaled $2.4 million for 2013, compared to cash provided by $18.0 million for 2012, and $6.5 million for 2011. The principle use of net cash in 2013 was the result of higher working capital primarily increases in inventory and accounts receivable and decreases in accounts payable. The principal sources of net cash in 2012 included higher net income, increases in accounts payable and decreases in accounts receivable, which were partially offset by higher balances of inventory and accrued liabilities. The principal sources of net cash in 2011 included higher net income and decreases in accounts receivable, which were partially offset by the $4.9 million in pension contributions to fund and terminate the defined benefit pension plan, higher balances of inventory and reduced accounts payable.

Investing Activities. Net cash used in investing activities was $10.0 million in 2013 compared to $6.1 million in 2012 and $7.5 million in 2011. The principal use of cash in 2013, 2012 and 2011 was for the purchase of molds and equipment associated with our manufacturing operations and for information technology software and system upgrades. The 2013 amount includes $2.2 million related to the purchase of the Creative Recreation brand.

Financing Activities. Cash provided by financing activities during 2013 was $12.6 million compared to cash used in financing activities during 2012 of $11.5 million compared to cash provided by financing activities of $0.3 million in 2011. Proceeds and repayments of the revolving credit facility reflect daily cash disbursement and deposit activity. Our financing activities during 2013 included net borrowings under the revolving line of credit facility of $14.9 million. The increases in the borrowings were primarily due to the afore-mentioned acquisition and higher levels of inventory. Our financing activities during 2012 included net repayments under the revolving line of credit facility of $11.5 million. Our financing activities during 2011 included net borrowings under the revolving line of credit facility of $1.9 million and repayments on long term debt of $2.0 million. During 2011, we repaid our long-term real estate obligations with borrowings under the revolving line of credit.

Borrowings and External Sources of Funds



Our borrowings and external sources of funds were as follows at December 31,
2013 and 2012:



                                                   December 31
                    ($ in millions)              2013       2012

                    Revolving credit facility   $ 38.4     $ 23.5
                    Less current maturities          -          -
                    Net long-term debt          $ 38.4     $ 23.5

We continually evaluate our external credit arrangements in light of our growth strategy and new opportunities. In October 2010, we entered into a financing agreement with PNC bank to provide a $70 million credit facility. The term of the credit facility is five years and the interest rate is currently LIBOR plus 1.50%.

We lease certain machinery, shoe centers, and manufacturing facilities under operating leases that generally provide for renewal options. Future minimum lease payments under non-cancelable operating leases are $1.1 million, $0.5 million, $0.4 million, $0.4 million and $0.1 million for years 2014 through 2018, respectively, or approximately $2.5 million in total.

Contractual Obligations and Commercial Commitments

The following table summarizes our contractual obligations at December 31, 2013 resulting from financial contracts and commitments. We have not included information on our recurring purchases of materials for use in our manufacturing operations. These amounts are generally consistent from year to year, closely reflect our levels of production, and are not long-term in nature (less than three months).

Contractual Obligations at December 31, 2013:



                                                                      Payments due by Year
                                                                           $ millions

                                                           Less Than                                       Over 5
                                               Total        1 Year         1-3 Years       3-5 Years        Years
Long-term debt                                $  38.4     $         -     $      38.4     $         -     $       -
Minimum operating lease commitments               2.5             1.1             0.9             0.5             -
Minimum royalty commitments                       0.2             0.1             0.1               -             -
Expected cash requirements for interest (1)       2.3             1.3             1.0               -             -
Total contractual obligations                 $  43.4     $       2.5     $      40.4     $       0.5     $       -

(1) Assumes a 3.25% interest rate, which is the highest rate possible as of December 31, 2013 on the $70 million revolving credit facility.

From time to time, we enter into purchase commitments with our suppliers under customary purchase order terms. Any significant losses implicit in these . . .

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