Description

LaCrosse Footwear (BOOT), a niche footwear company with attractive core earnings plus significant growth potential driven by strong industry and company fundamentals, is an attractive opportunity for long-term value investors to purchase a great company at a reasonable price. The current stock price provides investors an opportunity to buy the stock at a reasonable value (11x ‘06E EPS, 6.4x ‘06E EBITDA, over 8% FCF yield) with a relatively low-cost option on the Company’s growth potential (mid-teens EBITDA and FCF growth) coupled with a likely takeout premium. Great niche products and brand equity, insider alignment, proven ability by management to effectively execute, favorable industry dynamics, downside protection from attractive valuation coupled with improving fundamentals, and the likelihood for a significant control premium eventually being paid make LaCrosse Footwear an attractive investment.

LaCrosse Footwear is a leading developer and marketer of premium branded footwear for use at work and in the outdoors. The Company’s brands—LACROSSE (established in 1897) and DANNER (established in 1932)—are primarily sold domestically through over 4,000 points of distribution (i.e., very fragmented distribution channel; other than non-recurring sales to the military for which I adjust the data described below, there are no customers over 10%). The mix of revenue between work and outdoor footwear is relatively equal. The market for such footwear in the U.S. is ~$4B (work footwear represents 75% of the market). There are no dominant retailers or brands in the work/outdoor footwear market; the strength of BOOT’s brands coupled with the fragmented distribution channel for such product is a key part of the investment thesis in both the short and long term.

Financial Summary
2004 2005E 2006E 2007E
Revenue 90.6 97.4 104.2 111.5
EBITDA 9.1 11.2 13.0 14.5
Margin % 10.0% 11.5% 12.5% 13.0%

The Company’s work customers include people employed in law enforcement, agriculture, firefighting, construction, industry, military services, and other occupations that need high-performance and protective footwear as a critical tool for the job. BOOT benefits from the work market’s year-round demand to partially offset the seasonality of its outdoor footwear sales (which are strongest during the second half of each year). The Company’s outdoor customers include people active in hunting, fishing, camping and other outdoor activities. If you’re a deer hunter (I am not), you will most certainly be familiar with the Company’s products as LaCrosse footwear sponsors Buckmasters, the largest whitetail deer hunting association in the U.S.

Though one might instinctively perceive footwear as an unattractive industry because of fashion-related risks, the segments in which the Company competes are not significantly challenged by fashion-related trends (in fact, one of the Company’s shoe molds hasn’t changed since the 1960s). LaCrosse is not a fashion-oriented/hit-driven footwear company like Skechers or Deckers. In LaCrosse’s niche segment, durability, comfort, and performance is far more important than style. The work segment is obviously correlated to employment trends but the Company’s work-related focus is police/security/firefighters, an industry segment that is more stable than general employment trends. During 2004, the Company offered approximately 500 styles of footwear primarily targeted to men. LaCrosse recently announced its plan to develop and market occupational and outdoor footwear targeted to women (this includes DANNER footwear designed specifically for female soldiers of the U.S. Marine Corps).

In the late 1990s, BOOT’s brands were associated with time-honored quality and performance but the Company was operating at a growing loss and straddled by increasing debt. In 1999, the Company produced a majority of its products in the U.S. and gross margins lingered in the low 20s. In recent years, BOOT has managed a strategic transition to a product development, marketing and sourcing company, driven by a major consolidation of operations and cost reductions. The Company has evolved from a fixed-to-variable business model and expects to outsource more of its manufacturing in the next few years. In 2004, LaCrosse outsourced 65% of the product it sold; management intends to outsource up to ~80% (retaining some U.S. manufacturing exposure to be eligible for Military orders and also to manufacture product sold in Japan where “Made in the USA” receives a premium that also justifies some U.S. exposure).

Included among the several reasons I like BOOT is the significant brand equity and product appeal of both LACROSSE and DANNER (two brands that have prospered for over 180 collective years). Both brands have a legacy following. Primary research with police officers, Military personnel, and hunting enthusiasts confirms that a market exists for premium footwear; more importantly, both LACROSSE and DANNER are viewed to be among the “best of breed” for quality footwear in selected work and outdoor segments. Discussions with over fifty retailers also reinforces that both LACROSSE and DANNER have strong competitive positions in their niche segments and that both brands have significant “pull” appeal at the premium tier of the market (note that the ASP of LaCrosse’s footwear is more than 50% greater than overall peer group’s ASP).

The LACROSSE brand is positioned for “high performance in the field and on the job”. LACROSSE is particularly strong in PAC boots and in 2002 the magazine Sporting Goods Business recognized LACROSSE as one of the top fifty well-known sporting brands in the U.S. This accolade is especially impressive since the Company only spends ~$2m per annum on advertising and promotion. The DANNER brand is known as the “expert’s choice” in premium outdoor footwear. DANNER is particularly strong in hunting boots and the DANNER Pronghorn boot was selected “Best of the Best” by the largest outdoor magazine (Field & Stream) in 2004.

There are of course numerous challenges to developing a sustainable brand in any industry and the footwear industry is no exception. Competition includes Berkshire Hathaway’s H.H. Brown--Browning, Carolina, Chippewa, Roper, Double-H; Rocky Boots—Georgia Boot, Dickies, Lehigh; Wolverine—Merrell, Bates, Hy-Test, Sebago; Red Wing Shoes (Irish Setter), Timberland, New Balance (Dunham), and Columbia. Less than ten industry brands have been around as long as LACROSSE and less than 25 industry brands have been around as long as DANNER.

With both the occupational and outdoor channels being very fragmented, there is less channel power that gets exerted against suppliers in contrast to the athletic footwear industry where the channel is more concentrated and has made it difficult for smaller vendors in the past (e.g., Converse before it was acquired by Nike). The three “big boxes” in outdoor (Bass Pro, Gander Mountain, Cabela’s) represent less than 10% of the market. According to industry estimates, the outdoor retail sector is likely to grow retail square footage by as much as 35% in each of the next couple of years. Greater retail space will require more inventory (especially of higher turning apparel and footwear merchandise which is expected to grow from 27% to 33% of all inventory at Gander Mountain).

The current fragmented retail channel dynamics are favorable but if the big boxes grow their collective share, it is not unreasonable to think that a balance of power shift to a more concentrated retail channel might develop and create some issues ( e.g., pricing pressure, private label competition, potential slotting and co-op advertising fees) to selected outdoor product vendors (note: this potential issue doesn’t exist for the work footwear segment which represents half of BOOT’s revenue mix; the channel for work/occupational product is even more fragmented than outdoor). If the outdoor retail channel were to become more concentrated, however, I believe BOOT’s position is likely to improve relative to the competition.

Brands are critical in the current fragmented retail channel and will become more important if the channel becomes more concentrated over time. My discussions with footwear department heads at a variety of Bass Pros plus research with the former head of merchandising at Gander Mountain provides anecdotal evidence to validate my hypothesis. Each “big box” is trying to drive private label across all outdoor categories but footwear is among the harder categories to achieve private label and especially so at the premium level. BOOT is starting to gain shelf space at the expense of other vendors as retailers try to optimize their SKU selection and in recognition of BOOT’s premium orientation and product appeal. Moreover, BOOT is considered to be among the best outdoor footwear vendors from a customer service perspective (as evidenced by winning an award from Gander Mountain in the last two years for “Best Vendor”). If vendors recognize a shift in the balance of power from vendor to channel, this is likely to serve as a catalyst driving consolidation among outdoor footwear vendors (this paradigm would be analogous to the consolidation that has materialized in the athletic footwear segment). The potential for an eventual takeout premium is described later.

Another reason I view BOOT as an attractive investment is management’s ownership alignment. In regards to the latter, the Schneider family owns ~45% of outstanding shares. The Company was purchased by the Schneider family from the heirs of the Company’s founding family in 1982. Chairman George Schneider died in March 2005 after serving as Chairman for 23 years. CEO Joseph Schneider (son of George) and the Schneider Family Trust bought 23,000 shares in May at $10.20-11.00. There has also been insider buying by other members of management as well as members of the Board (Director Sims purchased additional shares subsequent to the Company’s recent quarterly announcement).

Management is highly regarded and has successfully orchestrated a turnaround and is now executing a growth strategy based on increasing and leveraging the brand equity of its LACROSSE and DANNER footwear brands. For the latest nine months, management grew top-line by 8% (comps: Wolverine by 8%, Timberland by 5%, Rocky flat) and Q3’05 gross margin was 36.7% (an increase of more than 500bps from Q3’03). Though Q3 top-line results (up 3% yoy) were slightly disappointing, BOOT’s results were generally better than the competition. Though inventory grew substantially this quarter (primarily because of the new women’s product line being introduced), the Company’s success at improving gross margins and inventory turns during the last few years demonstrates management’s effectiveness at execution. As a result of improvements in systems, forecasting, and management processes, the Company’s inventory turns increased by 13% to 3.2 in 2004 (this is after adjusting for the non-recurring benefit of GSA delivery orders). BOOT’s inventory turn at 3.2 compares favorably with the Company’s nearest comp Rocky Boots, which generated an inventory turn of 2.6 in 2004. A comparison to much larger Wolverine World Wide, where inventory turns in 2004 were 3.8, suggests potential for additional inventory management upside. According to management and my discussion with other footwear and apparel vendors, a more important metric in managing the business is the “turn-and-earn” ratio (defined as Gross Margin times Inventory Turns). In 2004, BOOT achieved a ratio of 1.2 (in-line with the CFO’s objective to meet the minimum threshold for “best practices”); BOOT’s 1.2 compares to Rocky at 0.8. Management’s focus on working capital and the elimination of fixed assets is demonstrative of management’s effectiveness. This is further amplified by over $43m of CFFO, representing over 50% of current enterprise value, generated by the Company in the four years from 2001-2004; ~65% of this cash flow was from working capital improvements.

The stock has good downside protection and upside potential. The stock is currently trading at 0.9x ‘05E Revenue and 7.4x ‘05E EBITDA (peer group trades at 1.1x and 7.8x). On 2006 estimates, BOOT is trading at 0.8x Revenue and 6.4x EBITDA (peer group trades at 1.0x and 7.2x). BOOT should grow more quickly than its peers (off lower base, improvement in margins, relative competitive position increasing in strength). It’s important to note that the latest quarter is BOOT’s peak in working capital and over $2 in debt per share ($12.6m of debt) will be significantly reduced by the end of Q4 through the seasonality of the business. The average CFFO generated in the last two fourth quarters was $11m (partially because of working capital improvements and non-recurring GSA sales but primarily because of the seasonality of the business). Since the Company transformed itself to be more of a design, marketer, distributor of its footwear by outsourcing a majority of manufacturing, the cap-x of the business is relatively insignificant at ~$1m per annum.

So, what’s BOOT worth? My conviction level for owning BOOT is based on the Company being well-managed by owner-oriented management, having highly regarded products and brands that are likely to outperform the growth of an industry with favorable tailwinds (retail square footage growth plus increasing appeal of outdoor/adventure activities that require quality outdoor footwear), and a valuation that is reasonable with significant upside potential. I ascribe a high probability to the latter; in fact, I believe BOOT will be acquired in the next 24 months. As noted, there is likely to be a consolidation theme that develops in the outdoor/work footwear market; BOOT would be among the most attractive targets to bolster the portfolio of a strategic buyer. I also know that BOOT has been contacted by private equity investors. BOOT is likely to be especially appealing to private equity investor Odyssey Partners which recently purchased Norcross Safety. Norcross competes with BOOT in the work footwear segment and has also recently purchased a small competitor in the outdoor footwear segment. The financing on Norcross is at ~6x Debt/EBITDA (this compares to BOOT at only 1x). Norcross was purchased by Odyssey for 1.12x Revenue in a “busted” auction. At that multiple, BOOT would trade at ~$17.40 (based on ‘06E Revenue) but given the high likelihood of significant interest among numerous strategic buyers and other private equity investors, BOOT would likely sell for more in a change-of-control transaction. Also, a DCF of BOOT, assuming 4% FCF perpetuity growth and 10% discount rate, yields a value of $17.60.

In light of Sarbanes-Oxley and its limited float (~$65,000 trades daily….yes, this idea doesn’t work for many VIC members), it doesn’t make much sense for BOOT to remain public. Management doesn’t disagree with this assertion but also isn’t overly concerned with it to go private in the near-term. The Company’s brands are extremely attractive to a variety of industry participants. This includes Wolverine World Wide, Rocky, Columbia Sportswear, Red Wing, and perhaps even Berkshire’s H.H. Brown or Justin Brands. The cost savings that an acquirer could achieve are substantial; two footwear industry “experts” estimated $7m (25% of SG&A) of “easy” savings. Such would increase EBITDA by over 50% in 2006 and this is before potential other savings (e.g., manufacturing savings; industry median gross margin was 500bps more than BOOT’s in 2004) and/or revenue synergies. Though a strategic acquirer would obviously pay only an amount necessary to out-bid other potential acquirers and would not pay for all potential cost savings/synergies, there is significant upside from $11.80 for what a strategic acquirer (or private equity investor) would pay. In one brief discussion between a private equity investor and the Company, management said there would be no sale without a two in front of the bid. Given a DCF at almost $18, management’s comment makes sense. BOOT is worth at least 50% more than the current stock quote in a change-of-control transaction and I think the pursuit of such is highly likely in the next two years. With the current valuation, I am happy to wait for such to materialize while management drives the business to achieve mid-to-high single digit top-line growth and expands margins to be consistent with the industry.

Catalyst

Expansion of outdoor retail square footage at estimated 30% rate
Margins expand to comparables
Continued execution that drives mid-teen EBITDA and FCF growth
Going-private or sale