| ROCKY SHOES & BOOTS INC ITEM 1A RISK FACTORS Business Risks Expanding our brands into new footwear and apparel markets may be difficult and expensive, and if we are unable to successfully continue such expansion, our brands may be adversely affected, and we may not achieve our planned sales growth |
| 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 |
| 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 |
| Even if we develop and manufacture new products that consumers find appealing, the ultimate success of a new model may depend on our product pricing |
| 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 |
| A majority of our products are produced outside the US where we are subject to the risks of international commerce |
| A majority of our products are produced in the Dominican Republic and China |
| Therefore, our business is subject to the following risks of doing business offshore: • the imposition of additional United States legislation and regulations relating to imports, including quotas, duties, taxes or other charges or restrictions; • foreign governmental regulation and taxation; 11 _________________________________________________________________ [64]Table of Contents • fluctuations in foreign exchange rates; • changes in economic conditions; • transportation conditions and costs in the Pacific and Caribbean; • changes in the political stability of these countries; and • changes in relationships between the United States and these countries |
| If any of these factors were to render the conduct of business in these countries undesirable or impracticable, we would have to manufacture or source our products elsewhere |
| There can be no assurance that additional sources or products would be available to us or, if available, that these sources could be relied on to provide product at terms favorable to us |
| The occurrence of any of these developments would have a material adverse effect on our business, financial condition and results of operations |
| Our success depends on our ability to anticipate consumer trends |
| Demand for our products may be adversely affected by changing consumer trends |
| Our future success will depend upon our ability to anticipate and respond to changing consumer preferences and technical design or material developments in a timely manner |
| The failure to adequately anticipate or respond to these changes could have a material adverse effect on our business, financial condition and results of operations |
| Loss of services of our key personnel could adversely affect our business |
| The development of our business has been, and will continue to be, highly dependent upon Mike Brooks, Chairman and Chief Executive Officer, David Sharp, President and Chief Operating Officer, and James McDonald, Executive Vice President, Chief Financial Officer and Treasurer |
| Brooks has an at-will employment agreement with us |
| The employment agreement provides that in the event of termination of employment, he will receive a severance benefit and may not compete with us for a period of one year |
| None of our other executive officers and key employees have an employment agreement with our company |
| The loss of the services of any of these officers could have a material adverse effect on our business, financial condition and results of operations |
| We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase product costs |
| We purchase raw materials from a number of domestic and foreign sources |
| We do not have any long-term supply contracts for the purchase of our raw materials, except for limited blanket orders on leather |
| The principal raw materials used in the production of our footwear, in terms of dollar value, are leather, Gore-Tex waterproof breathable fabric, Cordura nylon fabric and soling materials |
| Availability or change in the prices of our raw materials could have a material adverse effect on our business, financial condition and results of operations |
| We currently have a licensing agreement for the use of Gore-Tex waterproof breathable fabric, and any termination of this licensing agreement could impact our sales of waterproof products |
| We are currently one of the largest customers of Gore-Tex waterproof breathable fabric for use in footwear |
| Our licensing agreement with WL Gore & Associates, Inc |
| may be terminated by either party upon advance written notice to the other party by October 1 for termination effective December 31 of that same year |
| Although other waterproofing techniques and materials are available, we place a high value on our Gore-Tex waterproof breathable fabric license because Gore-Tex has high brand name recognition with our customers |
| The loss of our license to use Gore-Tex waterproof breathable fabric could have a material adverse effect on our competitive position, which could have a material adverse effect on our business, financial condition and results of operations |
| We currently have a licensing agreement for the use of the Dickies trademark, and any termination of this licensing agreement could impact our sales and growth strategy |
| We have an exclusive license through December 31, 2007 to use the Dickies brand on all footwear products, except nursing shoes |
| The Dickies brand is well recognized by consumers and we plan to introduce value priced Dickies footwear targeting 12 _________________________________________________________________ [65]Table of Contents additional markets, including outdoor, duty and western |
| Our license with Dickies may be terminated by Dickies prior to December 31, 2007 if we do not achieve certain minimum net shipments in a particular year |
| Furthermore, it is not certain whether we will be able to renew our license to use the Dickies brand after the expiration or termination of the current license |
| The loss of our license to use the Dickies brand could have a material adverse effect on our competitive position and growth strategy, which could have a material adverse effect on our business, financial condition and results of operations |
| Our outdoor products are seasonal |
| We have historically experienced significant seasonal fluctuations in our business because we derive a significant portion of our revenues from sales of our outdoor products |
| As a result, a majority of orders for these products are placed by our retailers in January through April for delivery in July through October |
| In order to meet demand, we must manufacture and source outdoor footwear year round to be in a position to ship advance orders for these products during the last two quarters of each year |
| Accordingly, average inventory levels have been highest during the second and third quarters of each year and sales have been highest in the last two quarters of each year |
| There is no assurance that we will have either sufficient inventory to satisfy demand in any particular quarter or have sufficient demand to sell substantially all of our inventory without significant markdowns |
| Our outdoor products are sensitive to weather conditions |
| Historically, our outdoor products have been used primarily in cold or wet weather |
| Mild or dry weather has in the past and may in the future have a material adverse effect on sales of our products, particularly if mild or dry weather conditions occur in broad geographical areas during late fall or early winter |
| For example, an unseasonably warm and dry winter in late 2004 and early 2005 throughout the Midwest significantly decreased demand for our outdoor products |
| Also, due to variations in weather conditions from year to year, results for any single quarter or year may not be indicative of results for any future period |
| Our business could suffer if our third party manufacturers violate labor laws or fail to conform to generally accepted ethical standards |
| We require our third party manufacturers to meet our standards for working conditions and other matters before we are willing to place business with them |
| Moreover, we do not control our third party manufacturers or their respective labor practices |
| If one of our third party manufacturers violates generally accepted labor standards by, for example, using forced or indentured labor or child labor, failing to pay compensation in accordance with local law, failing to operate its factories in compliance with local safety regulations or diverging from other labor practices generally accepted as ethical, we likely would cease dealing with that manufacturer, and we could suffer an interruption in our product supply |
| In addition, such a manufacturer’s actions could result in negative publicity and may damage our reputation and the value of our brand and discourage retail customers and consumers from buying our products |
| Our future tax rates may not be as favorable as our historical tax rates |
| In past years, our effective tax rate typically has been substantially below the United States federal statutory rates |
| We have paid minimal income taxes on income earned by our subsidiary in Puerto Rico due to tax credits afforded us under Section 936 of the Internal Revenue Code and local tax abatements |
| However, Section 936 of the Internal Revenue Code has been repealed so that future tax credits available to us are capped in 2005 and terminate in 2006 |
| In addition, our local tax abatements in Puerto Rico are scheduled to expire in 2009 |
| In 2004, we elected to repatriate dlra3dtta0 million of earnings and accrued dlra157cmam000 of related taxes under the American Jobs Creation Act of 2004 |
| During 2005, the dlra3cmam000cmam000 of previously undistributed earnings were repatriated |
| At December 31, 2005, approximately dlra8dtta7 million of undistributed earnings remain that would become taxable upon repatriation to the United States |
| No income taxes are provided for the remaining undistributed earnings |
| As a result of the acquisition of EJ Footwear, our effective tax rate for 2005 increased to 32dtta5prca compared to 28dtta8prca for 2004, as a higher percentage of profits are taxed at US tax rates |
| Our future tax rate will vary depending on many factors, including the level of relative earnings and tax rates in each jurisdiction in which we operate and the repatriation of any foreign income to the United States |
| Increases in effective tax rates or changes in tax laws may have a material adverse effect on our business, financial condition and results of operations |
| 13 _________________________________________________________________ [66]Table of Contents The growth of our business will be dependent upon the availability of adequate capital |
| The growth of our business will depend on the availability of adequate capital, which in turn will depend in large part on cash flow generated by our business and the availability of equity and debt financing |
| We cannot assure you that our operations will generate positive cash flow or that we will be able to obtain equity or debt financing on acceptable terms or at all |
| Our revolving credit facility contains provisions that restrict our ability to incur additional indebtedness or make substantial asset sales that might otherwise be used to finance our expansion |
| Security interests in substantially all of our assets, which may further limit our access to certain capital markets or lending sources, secure our obligations under our revolving credit facility |
| Moreover, the actual availability of funds under our revolving credit facility is limited to specified percentages of our eligible inventory and accounts receivable |
| Accordingly, opportunities for increasing our cash on hand through sales of inventory would be partially offset by reduced availability under our revolving credit facility |
| We face intense competition, including competition from companies with significantly greater resources than ours, and if we are unable to compete effectively with these companies, our market share may decline and our business could be harmed |
| The footwear and apparel industries are intensely competitive, and we expect competition to increase in the future |
| A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do, as well as greater brand awareness in the footwear market |
| Our ability to succeed depends on our ability to remain competitive with respect to the quality, design, price and timely delivery of products |
| Competition could materially adversely affect our business, financial condition and results of operations |
| We currently manufacture a portion of our products and we may not be able to do so in the future at costs that are competitive with those of competitors who source their goods |
| We currently plan to retain our internal manufacturing capability in order to continue benefiting from expertise we have gained with respect to footwear manufacturing methods conducted at our manufacturing facilities |
| We continue to evaluate our manufacturing facilities and third party manufacturing alternatives in order to determine the appropriate size and scope of our manufacturing facilities |
| There can be no assurance that the costs of products that continue to be manufactured by us can remain competitive with products sourced from third parties |
| We rely on distribution centers in Logan, Ohio and Tunkhannock, Pennsylvania, and if there is a natural disaster or other serious disruption at any of these facilities, we may be unable to deliver merchandise effectively to our retailers |
| We rely on distribution centers in Logan, Ohio and Tunkhannock, Pennsylvania |
| Any natural disaster or other serious disruption at any of these facilities due to fire, tornado, flood, terrorist attack or any other cause could damage a portion of our inventory or impair our ability to use our distribution center as a docking location for merchandise |
| Either of these occurrences could impair our ability to adequately supply our retailers and harm our operating results |
| We may be subject to certain environmental and other regulations |
| Some of our operations use substances regulated under various federal, state, local and international environmental and pollution laws, including those relating to the storage, use, discharge, disposal and labeling of, and human exposure to, hazardous and toxic materials |
| Compliance with current or future environmental laws and regulations could restrict our ability to expand our facilities or require us to acquire additional expensive equipment, modify our manufacturing processes or incur other significant expenses |
| In addition, we could incur costs, fines and civil or criminal sanctions, third party property damage or personal injury claims or could be required to incur substantial investigation or remediation costs, if we were to violate or become liable under any environmental laws |
| Liability under environmental laws can be joint and several and without regard to comparative fault |
| There can be no assurance that violations of environmental laws or regulations have not occurred in the past and will not occur in the future as a result of our inability to obtain permits, human error, equipment failure or other causes, and any such violations could harm our business and financial condition |
| If our efforts to establish and protect our trademarks, patents and other intellectual property are unsuccessful, the value of our brands could suffer |
| We regard certain of our footwear designs as proprietary and rely on patents to protect those designs |
| We believe that the ownership of patents is a significant factor in our business |
| Existing intellectual property laws afford only limited protection of our proprietary rights, and it may be possible for unauthorized third parties to copy certain of our footwear designs or to 14 _________________________________________________________________ [67]Table of Contents reverse engineer or otherwise obtain and use information that we regard as proprietary |
| If our patents are found to be invalid, however, to the extent they have served, or would in the future serve, as a barrier to entry to our competitors, such invalidity could have a material adverse effect on our business, financial condition and results of operations |
| We own US registrations for a number of our trademarks, trade names and designs, including such marks as Rocky, Rocky Outdoor Gear, Georgia Boot, Durango and Lehigh |
| Additional trademarks, trade names and designs are the subject of pending federal applications for registration |
| We also use and have common law rights in certain trademarks |
| Over time, we have increased distribution of our goods in several foreign countries |
| Accordingly, we have applied for trademark registrations in a number of these countries |
| We intend to enforce our trademarks and trade names against unauthorized use by third parties |
| Our success depends on our ability to forecast sales |
| Our investments in infrastructure and product inventory are based on sales forecasts and are necessarily made in advance of actual sales |
| The markets in which we do business are highly competitive, and our business is affected by a variety of factors, including brand awareness, changing consumer preferences, product innovations, susceptibility to fashion trends, retail market conditions, weather conditions and economic and other factors |
| One of our principal challenges is to improve our ability to predict these factors, in order to enable us to better match production with demand |
| In addition, our growth over the years has created the need to increase the investment in infrastructure and product inventory and to enhance our systems |
| To the extent sales forecasts are not achieved, costs associated with the infrastructure and carrying costs of product inventory would represent a higher percentage of revenue, which would adversely affect our financial performance |
| Risks Related to Our Industry Because the footwear market is sensitive to decreased consumer spending and slow economic cycles, if general economic conditions deteriorate, many of our customers may significantly reduce their purchases from us or may not be able to pay for our products in a timely manner |
| The footwear industry has been subject to cyclical variation and decline in performance when consumer spending decreases or softness appears in the retail market |
| Many factors affect the level of consumer spending in the footwear industry, including: • general business conditions; • interest rates; • the availability of consumer credit; • weather; • increases in prices of nondiscretionary goods; • taxation; and • consumer confidence in future economic conditions |
| Consumer purchases of discretionary items, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower |
| A downturn in regional economies where we sell products also reduces sales |
| The continued shift in the marketplace from traditional independent retailers to large discount mass merchandisers may result in decreased margins |
| A continued shift in the marketplace from traditional independent retailers to large discount mass merchandisers has increased the pressure on many footwear manufacturers to sell products to these mass merchandisers at less favorable margins |
| Because of competition from large discount mass merchandisers, a number of our small retailing customers have gone out of business, and in the future more of these customers may go out of business, which could have a material adverse effect on our business, financial condition and results of operations |
| Although progressive independent retailers have 15 _________________________________________________________________ [68]Table of Contents attempted to improve their competitive position by joining buying groups, a continued shift to discount mass merchandisers could have a material adverse effect on our business, financial condition and results of operations |