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Item 7. Management’s Discussion and Analysis

2023-03-10 compared with 2022-03-15 · 59 added, 66 removed, 152 unchanged (45% of the section changed)

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This Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") describes the matters that we consider to be important to understanding the results of our operations for each of the two years in the period ended December 31, 2022 and 2021, and our capital resources and liquidity as of December 31, 2022 and 2021.

Use of the terms "Rocky," the "Company," "we," "us" and "our" in this discussion refer to Rocky Brands, Inc.

A discussion of the changes in our results of operations between the years ended December 31, 2021 and December 31, 2020 has been omitted from this Annual Report on Form 10-K but may be found in Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on March 15, 2022, which is available free of charge on the SEC's website at https://www.sec.gov/edgar/search/ and our corporate website ( www.rockybrands.com ).

Use of the terms "Rocky Brands," the "Company," "we," "us" and "our" in this discussion refer to Rocky Brands, Inc.

and its subsidiaries.

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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, Muck, XTRATUF, Servus, NEOS, Ranger and the licensed brand Michelin. 

On January 24, 2021, we entered into a Purchase Agreement (the "Purchase Agreement") with certain subsidiaries of Honeywell International Inc.

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The Acquisition was funded through cash on hand and borrowings under two new credit facilities.

Note 8  for information regarding the two new credit facilities.

The Acquisition expanded our brand portfolio to include Muck, XTRATUF, Servus, NEOS and Ranger brands (the "Acquired Brands").

Note 9  for information regarding the two new credit facilities. O n September 30, 2022, we completed the sale of the NEOS brand and related assets.

See Note 4  for additional information. 

The Acquisition expanded our brand portfolio to include Muck, XTRATUF, Servus, Ranger and NEOS brands (the "Acquired Brands").

Our brands have a long history of representing high quality, comfortable, functional and durable footwear and our products are organized around six target markets:

outdoor, work, duty, commercial military, military, and western.

Our footwear products incorporate varying features and are positioned across a range of suggested retail price points from 

$20.00 for our value priced products to 

Our footwear products incorporate varying features and are positioned across a range of suggested retail price points from $26.00 for our value priced products to

$520.00 for our premium products.

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Wholesale, Retail and Contract Manufacturing.

In our Wholesale business, we distribute our products through a wide range of distribution channels representing over 10,000 retail store locations in the U.S., Canada, U.K., and other international markets such as Europe. 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, specialty retailers and online retailers.

Our Retail business includes direct sales of our products to consumers through our business to business web platform, e-commerce websites, third party marketplaces and our Rocky outlet store.

In our Wholesale business, we distribute our products through a wide range of distribution channels representing over 10,000 retail store locations in the U.S., Canada, U.K., and other international markets such as Europe. 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, specialty retailers and online retailers.

Our Retail business includes direct sales of our products to consumers through our business to business web platform, e-commerce websites, third party marketplaces and our Rocky Outdoor Gear Store.

Our contract manufacturing segment includes sales to the U.S.

military, private label sales and any sales to customers in which we are contracted to manufacture or source a specific footwear product for a customer. 

During the quarterly period ended June 30, 2021, we made a change to our reporting segments to change our "Military" reporting segment to "Contract Manufacturing" and to change the composition thereof to continue to include sales to the U.S.

military ("Military Contracts") and to include sales under manufacturing contracts for private label or other specific footwear products sold through our Wholesale and Retail channels ("Private Contracts").

Previously, only Military Contracts were included in this segment.

There has been no change in our total consolidated financial condition, results of operations, or segment information previously reported, as the result of the change in our reportable segments, as we had no Private Contract sales during the quarterly period ended March 31, 2021 or the fiscal year ended December 31, 2020.

See Note 17  for further information.

Our growth strategy is founded substantially on the expansion of our brands into new footwear and apparel markets.

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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.

The impact of COVID-19 and the related economic, business and market disruptions were wide-ranging.

These impacts have had and may continue to cause disruptions from both a manufacturing and distribution standpoint.

As a result of COVID-19, we were required to temporarily close our manufacturing facilities in both the Dominican Republic and Puerto Rico for several weeks spanning through both the first and second quarters of 2020.

In response to COVID-19, we have incurred incremental costs associated with protecting the health and safety of our global workforce, enhanced sanitization of our global operating facilities, and information technology capabilities for employees operating remotely.

Beginning in March 2020, restrictions imposed by various governmental authorities on both domestic and international shipping and travel have caused a disruption to the timing of delivery of raw materials and finished goods resulting in negative impacts to our financial position, results of operations and cash flows.

The duration and severity of the outbreak and its long-term impact on our business are uncertain at this time.

We are unable to predict the impact that COVID-19 will have on our future financial position, results of operations and cash flows.

Net sales and related cost of goods sold are recognized at the time products are shipped to the customer and title transfers.

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

We also incurred significant operating expenses associated with the Acquisition during the twelve months ended December 31, 2021.

Percentage of Net Sales

We also incurred significant operating expenses and acquisition amortization and restructuring costs associated with the Acquisition during the twelve months ended December 31, 2022.

Percentage of Net Sales 

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

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Total Net Sales

Included in Wholesale net sales is $160.0 

million of net sales attributed to the Acquisition. Additionally, Wholesale sales increased due to strong demand for our products as consumers continued to respond favorably to our recent product introductions and we were able to capitalize on our strong inventory position which allowed us to gain additional market share and shelf space. 

Included in Retail net sales is $17.6 m illion of net sales attributed to the Acquired Brands.

Retail sales with our legacy brands increased primarily due to strong growth in our direct to consumer e-Commerce and marketplace businesses in the first half of the year.

Included in Wholesale net sales for the twelve months ended December 31, 2022 is $216.9 mill ion of net sales attributed to the Acquired Brands and $3.6 million of inventory net sales related to the divestiture of the NEOS brand during the third quarter of 2022.

Included in Wholesale net sales for the twelve months ended December 31, 2021 is $160.0 mill ion of net sales attributed to the Acquired Brands.

Adjusted Wholesale net sales for the year ended December 31, 2022 to exclude the divestiture of the NEOS brand is $481.2 million.  Wholesale sales increased due to strong demand for our products as consumers continued to respond favorably to our recent product introductions and we were able to capitalize on our strong inventory position which allowed us to gain additional market share and shelf space.

Included in Retail net sales for the twelve months ended December 31, 2022 and 2021 is $25.9 and $17.6 m illion, respectively, of net sales attributed to the Acquired Brands.

Retail sales increased due to strong growth in our direct to consumer e-Commerce and marketplace businesses during the year as well as growth in our Lehigh business-to-business platform.

We have increased our targeted marketing efforts and brand awareness, which led to increased traffic on our branded websites.

Included in Contract Manufacturing net sales is $1.4 million of net sales attributed to the Acquisition.

Contract Manufacturing net sales increased as we continued to fulfill our military contracts and we filled orders under multiple private label programs during the twelve months ended December 31, 2021.

Contract Manufacturing net sales decreased due to the expiring contracts with the U.S.

military during the twelve months ended December 31, 2022.

Twelve Months Ended

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Total Margin $'s

Wholesale gross margins remained flat year over year.

On an adjusted basis, to exclude the one-time inventory fair value adjustment associated with the Acquisition of $3.5 million, Wholesale gross margins for the year ended December 31, 2021 were approximately 36.7%.

On an adjusted basis, to exclude one-time COVID-19 related expenses of $1.3 million, Wholesale gross margins were 36.5% for the year ended  December 31, 2020.

The slight pick-up in adjusted margin for the year ended December 31, 2021 was due to the Acquired Brands carrying a higher margin than our legacy brands.

This is partially offset with increased shipping and freight costs.

Retail gross margins increased primarily due to sales mix.

Our direct to consumer business, which carries higher margins, increased at a faster pace than our Lehigh business, which carries lower margins, for the year ended December 31, 2021.

Contract Manufacturing gross margin increased year-over-year due to higher margin on certain military and private label contracts.

Excluding $1.1 million of gross margin and sales relating to the divestiture of the NEOS brand, Wholesale gross margins were 34.1% for the year ended December 31, 2022. On an adjusted basis, excluding a one-time inventory fair value adjustment associated with the Acquisition of $3.5 million, Wholesale gross margins were 36.7% for the year ended  December 31, 2021.

The decrease in margin is mainly attributable to increased shipping and freight costs.

Retail gross margins decreased due to increased product costs and freight costs for the year ended December 31, 2022.

Contract Manufacturing gross margin decreased for the year ended 2022 compared to 2021 due to increased product costs.

Gross margin also decreased due to the expiration of certain contracts with the U.S.

military during the twelve months ended December 31, 2022.

Twelve Months Ended

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% of Net Sales

Operating expenses increased year-over-year due the Acquisition.

We incurred significant one-time operating expenses as we integrated the businesses.

We incurred approximately $11.9 and $0.7 million of operating expenses related to the Acquisition during the years ended December 31, 2021 and 2020, respectively. 

Excluding $5.7 million of Acquisition-related amortization and integration costs, restructuring costs and disposition of assets in 2022 and $11.9 million in Acquisition-related amortization and integration expenses in 2021, adjusted operating expenses were $175.5 million or 28.7% of adjusted net sales in the current year and $146.6 million or 28.5% of net sales in the prior year.

The decrease in operating expenses as a percentage of net sales was driven primarily by a decrease in discretionary spending and improved distribution center efficiencies compared with the year ago period.

Twelve Months Ended

($ in thousands)

OTHER EXPENSES:

Other (Expense) Income

Other expenses increased due to higher interest expense in connection with the debt we incurred to fund the Acquisition.

INTEREST AND OTHER EXPENSES:

Other Expense

Other expenses increased due to higher interest rates on outstanding borrowings on both our senior term loan and credit facility.

Twelve Months Ended

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Effective Tax Rate

The effective tax rate for the year ended December 31, 2021 decreased primarily due to the one-time benefit arising from the release of valuation allowances on state net operating losses and an increase in foreign tax credits.

The effective tax rate for the year ended December 31, 2022 increased primarily due to the one-time benefit received for the year ending December 31, 2021 arising from the release of valuation allowances on state net operating losses and an increase in foreign tax credits. 

LIQUIDITY AND CAPITAL RESOURCES

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Capital expenditures were $7.3 million for 2022 and $25.8 million in 2021.

Capital expenditures for 2022 are anticipated to be approximately $11.5 million.

Capital expenditures f or 2023 a re anticipated t o be approximately $7.1  million. 

We lease certain machinery, equipment, and manufacturing facilities under operating leases that generally provide for renewal options.

Future minimum lease payments under non-cancelable operating leases are outlined in further detail in Note 9 .

Future minimum lease payments under non-cancelable operating leases are outlined in further detail in Note 10  of our Consolidated Financial Statements

We believe that our 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 facility.

For more information regarding our credit facilities please see Note 8 .

Refer to Note 3 for additional information regarding our recent Acquisition.

For more information regarding our credit facilities please se

Note 3  of our Consolidated Financial 

Statements fo r additional information regarding our recent Acquisition.

Cash Flows and Material Cash Requirements

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Operating Activities.

The principal use of net cash in 2021 was increased inventories and accounts receivable, partially offset by increased accounts payable.

The principal sources of net cash in 2020 included increases to accounts payable and accrued liabilities.

These sources of net cash were partially offset by an increase in trade receivables and inventories.

Our operating activities during 2022 mainly consisted of proceeds from operations offset by a decrease in accounts payable .

The principal use of net cash in 

2021  was increased inventories and accounts receivable, partially offset by increased accounts payable. 

Investing Activities.

The principal use of net cash in 2021 was to fund the Acquisition.

The principal uses of cash in 2020 were related to investments in molds and equipment associated with our manufacturing operations, investments in information technology and improvements made to our distribution facility.

The principal use of net cash in 2022 was related to investments in molds and equipment associated with our manufacturing operations, investments in information technology and improvements made to our distribution facility.

The principal use of net cash in 2021 was to fund the Acquisition. 

Financing Activities.

Our financing activities during 2021 mainly consisted of proceeds from and payments on our two new debt facilities that we incurred to fund the Acquisition and other working capital requirements.

During 2020, principal uses of financing activities were payments of dividends, proceeds from stock option issuances and repurchases of our common stock.

 The principal use of our net cash during 2022  was payments on the term loan. During 2021, financing activities mainly consisted of proceeds from and payments on the revolving credit facility and term loan. Both debt facilities were incurred to fund the Acquisition and other working capital requirements.

On March 8, 2021, we announced a new $7,500,000 share repurchase program, which expired on March 4, 2022.

For additional information regarding this share repurchase program, see Note 12 .

F or additional information regarding this share repurchase p rogram, see Note 13  of our Consolidated Financial Statements. 

T here has not been an announcement for a new repurchase program since the expiration of the prior program in March 2022.

Contractual Obligations and Commercial Commitments

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We are contingently liable with respect to lawsuits, taxes and various other matters that routinely arise in the normal course of business.

We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities, also known as "Variable Interest Entities." Additionally, we do not have any related party transactions that materially affect the results of operations, cash flow or financial condition.

See Note 20 of our Consolidated Financial Statements for further discussion of legal matters. We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities, also known as "Variable Interest Entities." Additionally, we do not have any related party transactions that materially affect the results of operations, cash flow or financial condition.

OFF-BALANCE SHEET ARRANGEMENTS

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The preparation of financial statements in conformity with GAAP requires us to establish accounting policies and make estimates that affect amounts reported in our Consolidated Financial Statements.

Note 1 of the Notes to Consolidated Financial Statements, which is incorporated by reference into this MD&A, describes the significant accounting policies we use in our Consolidated Financial Statements.

Note 1 of the Notes to Consolidated Financial Statements, which is incorporated by reference into this MD&A, describes the significant accounting policies and estimates we use in our Consolidated Financial Statements.

An accounting estimate requires assumptions and judgments about uncertain matters that could have a material effect on the Consolidated Financial Statements.

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Revenue principally consists of sales to customers, and, to a lesser extent, license fees.

See Note 15  for additional information regarding revenues.

See Note 16  of our Consolidated Financial Statements for additional information regarding revenues.

Accounts receivable allowances

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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.

Sales returns and allowances as a percentage of sales for the years ended December 31, 2021 and 2020 were 2.6% and 4.8%, respectively.

Sales returns and allowances as a percentage of sales for the years ended December 31, 2022 and 2021 w ere 6.7% and 2.6%, r espectively.

Management identifies slow moving 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 at amounts above cost through our factory outlet stores or through various discounts to customers and e-commerce channels.

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 at amounts above cost through our factory outdoor gear stores or through various discounts to customers and e-commerce channels.

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 as required.

See Note 4  for additional information regarding inventories.

See Note 5  of our Consolidated Financial Statements for additional information regarding inventories.

Intangible assets

Intangible assets, including trademarks and patents, are reviewed for impairment annually, and more frequently, if necessary.

We perform such testing of 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.

See Note 6 for additional information regarding intangible assets and the annual impairment analysis.

Intangible assets, including goodwill, trademarks and patents, are reviewed for impairment annually, and more frequently, if necessary.

We determined the fair values of the indefinite-lived intangibles were in excess of their carrying values.

There is no goodwill allocated to our Contract Manufacturing segment.

As of December 31, 2022, goodwill allocated to our Wholesale and Retail reporting segments was $25.4 million and $24.8 million, respectively.

See Note 1 and 

Note 7  of our Consolidated Financial Statements for additional information regarding intangible assets and the annual impairment analysis.

Management records 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.

For additional information see Note 11 .

For additional information see Note 12  of our Consolidated Financial Statements.

RECENT FINANCIAL ACCOUNTING PRONOUNCEMENTS

Note 2 to Consolidated Financial Statements discusses new accounting pronouncements adopted during 2021 and the expected impact of accounting pronouncements recently issued but not yet required to be adopted.

Note 2 to Consolidated Financial Statements discusses new accounting pronouncements adopted during 2021 and the expected impact of accounting pronouncements recently issued but not yet required to be adopted.

To the extent the adoption of new accounting standards materially affect financial condition, results of operations, or liquidity, the impacts are discussed in the applicable section of this MD&A and the Notes to Consolidated Financial Statements.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis