ROCKY BRANDS, INC. 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW During the first quarter of 2023, we divested the Servus brand. The gain of approximately $1.3 million on the sale of the Servus brand during the first quarter of 2023 was recorded within Interest Expense and Other - net in the Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2023. The Servus brand was sold to allow us to focus on our more profitable core brands and allocate resources toward growth and development of additional opportunities with those brands moving forward. In 2023, we were also awarded a new multi-year contract with the U.S. Military pursuant to which we will produce and ship a minimum numbers of pairs to the U.S. Military through 2026, with the option to extend. The sales under this contract are included in our Contract Manufacturin g segment. The first quarter of 2024 is the first full quarter in which shipments were made to the U.S. Military under this new multi-year contract. FIRST QUARTER 2024 FINANCIAL HIGHLIGHTS COMPARED TO FIRST QUARTER 2023 ● Net sales increased 2.2% to $112.9 million; ● Gross margin decreased 50-basis points to $44.1 million; ● Operating income increased 92% to $8.0 million; ● Net income increased to $2.6 million, or $0.34 per diluted share; ● Inventory decreased 26% to $165.1 million; and ● Total debt, net of debt issuance costs, decreased 29% to $156.0 million. RESULTS OF OPERATIONS The following tables set forth, for the periods indicated, information derived from our Unaudited Condensed Consolidated Financial Statements. The discussion that follows each table should be read in conjunction with our Unaudited Condensed Consolidated Financial Statements as well as our annual report on Form 10-K for the year ended December 31, 2023 . Three Months Ended March 31, ($ in thousands) 2024 2023 Net sales $ 112,906 $ 110,445 Cost of goods sold 68,757 66,686 Gross margin 44,149 43,759 Operating expenses 36,166 39,604 Income from operations $ 7,983 $ 4,155 Gross margin for the three months ended March 31, 2024 was $44.1 million, or 39.1% of net sales, compared to $43.8 million, or 39.6% of net sales for the three months ended March 31, 2023. The decrease in gross margin was due to a net tariff refund of $1.3 million received in the first quarter of 2023. When excluding the net tariff refund, gross margins increased 70-basis points compared to the first quarter of 2023. The increase was primarily driven by the divestiture of the Servus brand in March 2023, which carried lower margins than the rest of our product portfolio (see Note 4 ). Operating expenses for the three months ended March 31, 2024 were $36.2 million, or 32.0% of net sales, compared to $39.6 million or 35.9% of net sales, for the three months ended March 31, 2023. The decrease in operating expenses was due to cost-saving reviews and operational efficiencies achieved through strategic restructuring initiatives implemented throughout 2023 as well as lower outbound freight expenses. Income from operations was $8.0 million or 7.1% of net sales for the three months ended March 31, 2024, compared to $4.2 million, or 3.8% of net sales for the three months ended March 31, 2023. The increase in operating income as a percentage of sales was due to the aforementioned operating expense savings. Three Months Ended March 31, ($ in thousands) 2024 2023 Inc./ (Dec.) Inc./ (Dec.) NET SALES: Wholesale $ 79,791 $ 80,050 $ (259 ) (0.3 )% Retail 30,408 29,510 898 3.0 Contract Manufacturing 2,707 885 1,822 205.9 Total Net Sales $ 112,906 $ 110,445 $ 2,461 2.2 % Wholesale net sales for the three months ended March 31, 2024 were $79.8 million compared to $80.1 million for the three months ended March 31, 2023. When excluding Servus brand net sales, Wholesale net sales increased 7.0%. The increase in Wholesale net sales excluding Servus brand net sales for the first quarter of 2024 was a result of inventory levels continuing to stabilize at our retail partners, positively impacting our sell-in. Retail net sales for the three months ended March 31, 2024 were $30.4 million compared to $29.5 million for the three months ended March 31, 2023. The increase in Retail net sales for the first quarter of 2024 was due to growth in our direct-to consumer e-commerce business as we focused on our targeted marketing efforts, primarily through digital marketing. This led to increased brand awareness and allowed us to engage more directly with consumers, which resulted in increased traffic on our branded websites and increased sales for the three months ended March 31, 2024 compared to the prior year period. Contract Manufacturing net sales for the three months ended March 31, 2024 were $2.7 million compared to $0.9 million for the three months ended March 31, 2023. The increase was due to a new multi-year contract awarded with the U.S. Military in the fourth quarter of 2023. 14 Table of Contents Three Months Ended March 31, ($ in thousands) 2024 2023 Inc./ (Dec.) GROSS MARGIN: Wholesale Margin $'s $ 29,031 $ 29,308 $ (277 ) Margin % 36.4 % 36.6 % (0.2 )% Retail Margin $'s $ 14,802 $ 14,379 $ 423 Margin % 48.7 % 48.7 % (0.0 )% Contract Manufacturing Margin $'s $ 316 $ 72 $ 244 Margin % 11.7 % 8.1 % 3.6 % Total Margin $'s $ 44,149 $ 43,759 $ 390 Margin % 39.1 % 39.6 % (0.5 )% Wholesale gross margin for the three months ended March 31, 2024 was $29.0 million, or 36.4% of net sales, compared to $29.3 million, or 36.6% of net sales for the three months ended March 31, 2023. When excluding the $1.3 million net tariff refund received in the first quarter of 2023, Wholesale gross margins increased 140-basis points. The increase in Wholesale margins excluding the net tariff refund was due to the divestiture of the Servus brand in March 2023, which carried lower gross margins than the rest of our product portfolio, as well as product mix. Retail gross margin for each of the three months ended March 31, 2024 and 2023 remained consistent at 48.7% of net sales. Contract Manufacturing gross margin for the three months ended March 31, 2024 was $0.3 million, or 11.7% of net sales, compared to $0.07 million, or 8.1% of net sales for the three months ended March 31, 2023. The increase was due to a new multi-year contract awarded with the U.S. military in the fourth quarter of 2023. Three Months Ended March 31, ($ in thousands) 2024 2023 Inc./ (Dec.) Inc./ (Dec.) OPERATING EXPENSES: Operating Expenses $ 36,166 $ 39,604 $ (3,438 ) (8.7 )% % of Net Sales 32.0 % 35.9 % (3.8 )% Operating expenses for the three months ended March 31, 2024 were $36.2 million or 32.0% of net sales compared to $39.6 million, or 35.9% of net sales for the three months ended March 31, 2023. The reduction in operating expenses in the first quarter of 2024 compared to the first quarter of 2023 was attributable to restructuring and cost-savings initiatives implemented in 2023. Following the complete integration of an acquisition that occurred during the first quarter of 2021, we identified a number of operational synergies and cost savings opportunities, including a reduction in workforce. In addition to the savings generated from the restructuring efforts, we experienced reduced freight rates during the three months ended March 31, 2024 compared to the year ago period, leading to lower outbound freight expense for the current period. Three Months Ended March 31, ($ in thousands) 2024 2023 Inc./ (Dec.) Inc./ (Dec.) INTEREST EXPENSE AND OTHER - NET: Other (Expense) Income $ (4,654 ) $ (4,664 ) $ 10 (0.2 )% Interest expense and other - net for the three months ended March 31, 2023 included a $1.3 million gain on the sale of Servus. When excluding this gain, interest expense and other - net was $4.7 million for the three months ended March 31, 2024 compared to $6.0 million for the three months ended March 31, 2023. The decrease was due to lower debt levels in 2024 compared to 2023 as total debt decreased 29% in the first quarter of 2024 compared to the first quarter of 2023. Three Months Ended March 31, ($ in thousands) 2024 2023 Inc./ (Dec.) Inc./ (Dec.) INCOME TAXES: Income Tax (Benefit) Expense $ 779 $ (111 ) $ 890 (801.8 )% Effective Tax Rate 23.4 % 21.8 % 1.7 % The increase in our effective tax rate in the first quarter of 2024 compared to the same year ago period was primarily driven by a shift in the mix of the Company's domestic and foreign earnings. LIQUIDITY AND CAPITAL RESOURCES Overview Our principal sources of liquidity have been our income from operations. During the three months ended March 31, 2024 , our primary use of cash was payments on our credit facilities. Our working capital consists primarily of trade receivables and inventory, offset by short-term debt and accounts payable. 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 can fluctuate significantly throughout the year. 15 Table of Contents Our capital expenditures relate primarily to projects relating to our corporate offices, property, merchandising fixtures, molds and equipment associated with our manufacturing and distribution operations and for information technology. Capital expenditures were $1.2 million and $1.3 million fo r the three months ended March 31, 2024 and 2023, respectively. We lease certain machinery, a distribution center in Reno, Nevada, and manufacturing facilities under operating leases that generally provide for renewal options. We believe that our ABL Facility, coupled with cash generated from operations will provide sufficient liquidity to fund our operations and debt obligations for at least the next twelve months. Our continued liquidity, however, is contingent upon future operating performance, cash flows and our ability to meet financial covenants under our credit facility. For more information regarding our credit facility see Note 9 and Note 15 of our Notes to Unaudited Condensed Consolidated Financial Statements. Cash Flows Three Months Ended March 31, ($ in millions) 2024 2023 Operating activities $ 17.4 $ 20.8 Investing activities (0.3 ) 16.9 Financing activities (18.5 ) (38.4 ) Net change in cash and cash equivalents $ (1.4 ) $ (0.7 ) Operating Activities. Net Cash provided by operating activities for the three months ended March 31, 2024 and March 31, 2023 was $17.4 million and $20.8 million, respectively. Adjusting for non-cash items, net income provided a cash in-flow of $6.7 million and $1.6 million for the three months ended March 31, 2024 and 2023, respectively. The net change in working capital and other assets and liabilities resulted in an increase to cash provided by operating activities of $10.7 million for the three months ended March 31, 2024 compared to $19.2 million for the three months ended March 31, 2023. Decreases in accounts receivable resulted in a source of cash of $6.0 million and $21.9 million for the three months ended March 31, 2024 and 2023, respectively. The decrease in accounts receivable as a source of cash for the three months ended March 31, 2024 compared to the prior period was due to lower sales during the fourth quarter of 2023 compared to the fourth quarter of 2022 resulting in lower collections in the subsequent quarter as there were less sales to collect upon. Decreases in inventory resulted in a source of cash of $4.1 million and $5.1 million for the three months ended March 31, 2024 and 2023, respectively. The decrease in inventory for each of the three month periods was a result of efforts to optimize inventory levels considering supply needs and sales growth. Changes in accounts payable resulted in a source of cash of $2.8 million for the three months ended March 31, 2024 compared to a use of cash of $4.4 million for the three months ended March 31. 2023. The increase in the first quarter of 2024 compared to the decrease in the first quarter of 2023 was due to increased purchases of certain in demand styles. Changes in other current assets resulted in a use of cash of $2.7 million and $1.6 million for the three months ended March 31, 2024 and 2023, respectively. The increase in other current assets for each of the three month periods was due to timing of prepayments. Investing Activities. Net cash used in investing activities for the three months ended March 31, 2024 was $0.3 million and net cash provided by investing activities for the three months ended March 31, 2023 was $16.9 million. We invested $0.3 million and $0.4 million into capital expenditures related to our manufacturing operations and information technology during the first quarter of 2024 and 2023, respectively. During the first three months of 2023, the sale of Servus provided net proceeds of $17.3 million . Financing Activities. Net cash used in financing activities for the three months ended March 31, 2024 and March 31, 2023 was $18.5 million and $38.4 million, respectively. The use of cash was primarily related to payments on our revolving credit facility and term loan. Net payments on our revolving credit facility and term loan were $17.4 million and $37.3 million during the first quarter of 2024 and 2023, respectively. Proceeds from the sale of the Servus brand were used to pay down our credit facilities during the first quarter of 2023. Litigation The Company is involved in legal proceedings, arising both in the ordinary course of business as well as various other claims and matters incidental to the Company’s business. Unless otherwise stated, we believe that the likelihood of the resolution being materially adverse to our financial statements is remote and as such have not recorded any contingent liabilities within the accompanying Unaudited Condensed Consolidated Financial Statement. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of the Company’s Unaudited Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP, requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an ongoing basis, management evaluates these estimates. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Historically, actual results have not been materially different from the Company’s estimates. However, actual results may differ materially from these estimates under different assumptions or conditions. We have identified the critical accounting policies used in determining estimates and assumptions in the amounts reported in our Management Discussion and Analysis of Financial Conditions and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2023. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES REFORM ACT OF 1995 This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, 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,” “would,” “could” and similar expressions are intended to identify forward-looking statements. Investors are cautioned that forward-looking statements involve risk and uncertainties including, without limitations, dependence on sales forecasts, changes in consumer demand, seasonality, impact of weather, competition, reliance on suppliers, risks inherent to international trade, changing retail trends, the loss or disruption of our manufacturing and distribution operations, cybersecurity breaches or disruption of our digital systems, fluctuations in foreign currency exchange rates, economic changes, as well as other factors set forth under the caption “Item 1A, Risk Factors” in our Annual Report on Form 10- K for the year ended December 31, 2023 (filed March 15, 2024), and other factors detailed from time to time in our filings with the Securities and Exchange Commission. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included herein 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. We assume no obligation to update any forward-looking statements. 16 Table of Contents ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. There have been no material changes to our market risk as disclosed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2023.