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Rocky Shoes RCKY

Rocky Shoes & Boots, Inc. has two subsidiaries: Five Star Enterprises Ltd. a Cayman Islands corporation, which operates a manufacturing facility in La Vega, Dominican Republic, and Lifestyle Footwear, Inc. ("Lifestyle"), a Delaware corporation, which operates a manufacturing facility in Moca, Puerto Rico. These operations give RCKY a significant tax break. New strategies involving outsourcing are removing some of this benefit.

The Business
Wm. Brooks Shoe Company established in 1932 by William Brooks was the forerunner of Rocky. In 1993 Rocky Co., Lifestyle and Five Star were parties to a reorganization, and in 1996, Rocky Co. was merged with and into the company, resulting in the Rocky's present corporate structure.

Footwear is manufactured in facilities in the Dominican Republic and Puerto Rico, and the balance of the footwear, apparel and accessories is sourced from factories in the Far East.

In the past, Rocky has benefited from a relatively low effective tax rate. Rocky and Lifestyle are subject to U.S. Federal income taxes; however, the company's income earned in Puerto Rico is allowed favorable tax treatment. Five Star is incorporated in the Cayman Islands and conducts its operations in a "free trade zone" in the Dominican Republic and, accordingly, is currently not subject to Cayman Islands or Dominican Republic income taxes. Thus, the company is not subject to foreign income taxes.


Product lines consist of rugged outdoor, occupational, military and casual footwear and Rocky branded outdoor gear. ROCKY brand products emphasize quality, patented materials, such as GORE-TEX waterproof breathable fabric, CORDURA nylon fabric, CAMBRELLE cushioned lining and THINSULATE thermal insulation.**Rugged outdoor footwear is the Company's largest product line, representing $41.5 million, or 46.7%, of Fiscal 2002 net sales.

**Occupational footwear, the Company's second largest product line, represented $29.6 million, or 33.3%, of Fiscal 2002 net sales.

**Military Footwear. Sales of military footwear were $6.4 million in Fiscal 2002, accounting for 7.2% of net sales. The military footwear were sold under a now expired contract to the U.S. government.

** Sales of casual footwear were $2.3 million in Fiscal 2002, accounting for 2.6% of net sales.

**In 2002 the Company began marketing outdoor gear consisting of hunting apparel, socks and accessories. Sales of the Company's outdoor gear were $2.7 million in Fiscal 2002, accounting for 3.1% of net sales.

**During 2002 the Company operated factory outlet stores in Nelsonville, Ohio and Edgefield, South Carolina. The Edgefield, South Carolina store was opened in August 2002. Products principally include first quality products, factory damaged goods and close-outs from the Company and Rocky licensed products. In addition, related products from other manufacturers are sold in the stores. For Fiscal 2002, net sales for factory outlet stores were $4.1 million, or 4.6% of the Company's total net sales.

**Rocky's footwear is sold by more than 3,000 retail and mail order companies in the United States and Canada. No single customer accounted for more than 10% of the Company's revenues in Fiscal 2002.

At December 31, 2002, backlog was $4.4 million. At December 31, 2001, backlog was $9.7 million including approximately $6.2 million related to the military contract. Because a majority of the company's orders are placed in January through April for delivery in July through October, the company's backlog is lowest during the October through December period and peaks during the April through June period.

Revenue recognition

Customer sales are recognized when revenue is realized and earned. The company recognizes revenue when the risk and title passes to the customer, generally at the time of shipment. 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.

Results from income statement

**Net sales declined 13.9% to $88,958,721 for 2002 compared with $103,319,806 for 2001. This decline was primarily due to reduced sales of rugged outdoor footwear, which declined $15.0 million to $41.5 million in 2002.

**A number of customers had higher inventories than planned at the end of the 2001 fall and winter seasons due to mild weather conditions. As a result, orders for rugged outdoor footwear in 2002 were adversely affected. Demand increased during the 2002 fall and winter seasons due to more traditional seasonal weather conditions in most regions of the U.S. which resulted in improved sell-through compared with the prior year.

**Occupational footwear sales increased $2.6 million to $29.6 million in 2002. These sales are less susceptible to weather conditions and occur throughout the year. Additional work styles in 2002 were well received by customers.

**Sales of military boots to the U.S. government declined $2.5 million to $6.4 million in 2002 due to fulfillment of a contract that began in 2001 which was completed in the second quarter 2002. These sales are dependent on specific awards from the U.S. government based on a competitive bidding process, which occur from time to time.

**Casual footwear sales declined $2.1 million to $2.3 million in 2002, consistent with the Company's reduced emphasis on this footwear category.

**The Company's factory outlet stores had net sales of $4.1 million in 2002 compared with $4.7 million the prior year. This was primarily due to lower sales in the Company's Nelsonville store.

**Interest expense declined $1,089,037, or 43.7%, to $1,404,496 for 2002 from $2,493,533 in 2001.Improvement in cash from operations, allowed a portion to be used to reduce outstanding debt. Lower interest rates also contributed to the reduction in interest expense in 2002.

**Income tax expense of $953,000 for 2002 compared with an income tax benefit of $93,438 for 2001. The effective tax rate for 2002 was 25%, which is lower than the statutory rate of 35% due to proportionately more income being earned in offshore jurisdictions and the decision to not repatriate foreign earnings to the U.S. The income tax benefit recognized during 2001 resulted primarily from an abatement of Puerto Rico tollgate taxes on all earnings subsequent to June 30, 1994. This resulted in a deferred tax benefit of $408,000.

**Net margins are improving. In the July-Sept quarter they approached 8%.

**Revenue declined in 2002 due to reasons stated above. In 2003 the company has had markedly improved sales across most of its product lines. The share price has also climbed in response to the improvement. However, they are off the 52 week high by $12.They reached a high of $31.95 in January. It was on heavy volume and there seems to be no apparent reason. On Feb 5 they announced record net sales for the 2003 4th quarter of $29 M and confirmed that revenue would be $106 M in 2003 compared to $89 M in 2002. There was no corresponding increase in price with this earnings report.

Results from the balance sheet

**Inventory declined by $4,531,675 or 16.4% to $23,181,989 at December 31, 2002 compared with $27,713,664 on the same date of the prior year. This decrease resulted from improved forecasting and scheduling systems that allowed footwear to be manufactured closer to actual delivery dates. In addition, the Company's product lines included fewer styles for 2002.

**Assets and working capital declined, but that was due largely to big decreases in inventory
**Current and quick ratios are high showing some liquidity
**Returns on assets, equity and capital are not good, but are improving
*Book value high
**Reasonable amounts of debt
**Increasing cash per share
**It takes two months to collect receipts
**Accounts receivable growth is declining for second year in a row
**Inventory not turned as fast as in 2001, but much better than 1999-2000
**There is a large deferred liability in pension fund costs. It should be monitored to see that the company addresses it and that it doesn't continue to grow. This is especially true today, since the investments in the plan should have done much better in 2003. This would be an important figure to check when available in the 2003 10K.

**Capital expenditures were $2,338,388 for 2002 versus $1,172,365 for 2001. Capital expenditures for the foreseeable future are expected to be similar to 2002, as sourced manufacturing continues to increase as a percentage of products sold.

**Financing activities during 2002 and 2001 were primarily in support of future growth and the purchase of a portion of the Company's common stock.

** During 2002, the Company purchased $84,540 of the its common stock, and from January through March 6, 2003, it acquired an additional 483,000 of its common shares for approximately $3,100,000.
**RCKY believes it will be able to finance capital additions, share repurchases and meet operating expenditure requirements for 2003 through net income, borrowings under its credit facility and other indebtedness.

**At December 31, 2002, a provision has not been made for U.S. taxes on the accumulated undistributed earnings of Five Star through December 31, 2002 of approximately $6,575,000 that would become payable upon repatriation to the United States. It is the intention of the company to reinvest all such earnings of Five Star in operations and facilities outside of the United States

Pension plans

It's amazing to see a pension fund in a company this size. Undoubtedly, its a hold over from the original footwear company set up in the 1930's.

**The assets of the plans consist primarily of common stocks, bonds, and cash equivalents. The assets of the plans include 117,900 and 81,400 shares of the Company's common stock with a market value of $872,460 and $416,768 at September 30, 2002 and 2001, respectively.Interesting they have their own stock in the plan. If the stock goes back to it's 52 week low of around $5, the plan will be seriously in arrears. If it appreciates to it's 52 week high of $31.95, some of the deficit will be offset. Interesting thing to watch.

**Discount rate appears to be in line --6.5%
**Returns are realistic 8.0%
**Pension fund is $2 million in arrears and that is not an inconsequential sum of money for this small company. This would be acceptable for GM, but may pose problems in future liquidity for RCKY.

Third quarter 2003 results

**35% increase in revenue--in spite of lost military contract
**Net margin increased to 8.5% from 7.9%

**Net sales increased $10,896,281, or 35.8%, to $41,349,824 for the quarter ended September 30, 2003 compared to $30,453,543 for the same period a year ago. The increase reflects improved performance within each sales category. Most notable were an increase within ROCKY(R) branded footwear sales of 20.7% (approximately $5,200,000) and $5,415,173 net sales of the recently acquired of GATES(R) brand. The acquisition appears ot be worthwhile. This company is going to need catalysts such as acquisitions to add to their product. The outdoor and sportsman's gear is profitable in its own niche, but unless it becomes trendy foot wear, it is not enough to grow rapidly.

**Net sales of ROCKY(R) Outdoor Gear more than doubled compared to the third quarter 2002. A portion of the sales increase was due to slightly higher prices on certain branded products principally due to raw material price

**Gross margin improved to a record 31.6% of net sales, or $13,085,792, for the
third quarter 2003 compared with 29.1%, or $8,852,358, for the same period last
year. The principal factor contributing to the record gross profit margin was an
increase in sourced products, which were 73.2% of net sales for the third
quarter 2003 versus 57.8% for the same period last year. The move to sourcing fabrication to China is improving margins noticeably.

Fourth quarter news release

Feb. 5 /PRNewswire-FirstCall/ -- Rocky Shoes & Boots, Inc. today reported record net sales of approximately $29 million for the fourth quarter of 2003 compared to $25.6 million the prior year. As a result, the unaudited net sales for the twelve months ended December 31, 2003 are approximately $106 million versus $89 million for 2002.

The Company reaffirmed its earnings guidance for the full-year 2003, which was provided on October 29, 2003. On that date, the Company stated that if it achieved $105 million in net sales for 2003 then net income is expected to be approximately $1.23 per diluted share for the year. These results are subject to completion of the Company's annual audit.

The Company expects to report its complete fourth quarter and full-year 2003 results before the market opens on Thursday, February 26, 2004. A conference call is planned at 10:00 a.m. Eastern Standard Time on that date to discuss the 2003 financial results and key business trends. Persons interested in listening to a live webcast of the conference call should access the Company's website at . A replay of the conference call will also be available .

**It would seem the company is going to be able to meet their 2003 earnings guidance. The conference call would be a good way to collect information on the future plans and for a discussion on the reasons for improving sales, in spite of the loss of the military money. The call is on Feb.26.If interested in this company, I would make time to listen.

Selected financials
Trailing P/E (ttm): 16.25 low compared to sector
Forward P/E 12.82 anticipates more growth?
Price/Sales (ttm): 0.81 low
Price/Book (mrq): 1.51 low

Return on Assets (ttm): 6.51% low
Return on Equity (ttm): 10.69% low

Diluted EPS (ttm): 1.215 improving
Earnings Growth 85.70%
52-Week High (29-Jan-04): 31.95 Reason for high price unknown
52-Week Low (24-Feb-03): 5.14

Average Volume (3 month): 208,318 low volume
Average Volume (10 day): 214,000

Shares Outstanding: 4.21M

% Held by Insiders: 33.54% high
% Held by Institutions: 34.42%


A DCF done for RCKY gives the following values:
$23.26 @ 15% growth high and 3% stable
$20.34 @ 10% growth high and 3% stable

cost of equity 9.7%
capex exceeds depreciation by 100%
capex, working capital, depreciation grows at same rate as revenue
beta 1
The company is close to fair value currently and may be trading at a slight discount.
Its an interesting stock. The product line is very different from a majority of the big players in the shoe industry: Nike, Reebok, Skechers,& KSwiss.. They concentrate on outdoor footwear and do not compete in the difficult running shoe segment and trendy footwear segment. Companies like Timberland come close to being direct competition with hiking footwear. Timberland is also doing well this year and has sports footwear and boots. La Crosse is another close competitor. WellCo produces miitary footwear and has grown EPS and revenue substantially. This link is to a list of competition:

RCKY compares favorably in price to book and PE. The ROE is not as good as some of the competition, but growth is above the average.
RCKY is doing better this year. Sales of several of their lines are up and a recent acquisition seems to be paying off. They have lowered costs and increased margins by sending some of the production to the Far East--a common strategy in the industry. Unfortunately, it is necessary to do this outsourcing to remain competitive.

They occupy a less competitive niche than running shoe and trendy sports shoe manufacturers. Their shoes are work and outdoor sports oriented and less likely to be subject to the whims of fashion. Teenage girls and junior high boys will not affect the sales as much as for a company like Nike. RCKY will miss some of the momentum generated by a product like Air Jordans, but on the other hand they may be saved from the downside companies like Madden experience. They appear to have a solid useable line of products. Whether this is a market that can sustain double digit growth is beyond my ability to predict. So far, in 2003 and the first quarter of 2004, they are delivering solid gains and improving margins. And they are still reasonably priced compared to the footwear market average.

They are a tiny company. I have not discovered the reason for the large volume trading in January that sent them to a 52 week high of $31.95. One might suspect that with such a thinly traded company with so few shares it wouldn't take much to send them up. Remember the Lifeway spike generated by Rich Smith's article at the Fool a couple of weeks ago? It seems that something similar may have happened to Rocky. There is no news or article that I can find to explain it. It would seem they have corrected a bit and are no longer so over priced as Lifeway has remained. Small caps are very interesting sometimes.

The pension fund bears watching--this is an unusual wrinkle for a small cap. Not something I have seen very often.

Management compensation seems reasonable. The CEO makes $250,000 and the other officers make slightly less. Even though there are a lot of options outstanding, individual awards don't seem excessive. And insiders hold a large percentage of the company.

Impression? Good company currently growing; decent management; price still competitive with other shoe retailers; balance sheet would be improved if there wasn't $2 million due on pensions; low debt but there is debt; ROE and ROIC a little low; can be volatile for reasons not related to the business performance.

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