Roots Corp

TSX:ROOT

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. My name is Pam, and I will be your conference operator today. At this time, I would like to welcome everyone to Roots' First Quarter Earnings Conference Call for fiscal 2022. [Operator Instructions] On the call today, we have Meghan Roach, President and Chief Executive Officer; and Mona Kennedy, Chief Financial Officer of Roots.

Before the conference call begins, the company would like to remind listeners that the call, including the Q&A portion, may include forward-looking statements of our current and future plans, expectations and intentions, results, level of activities, performance, goals or achievements or any other future events or developments.

This information is based on management's reasonable assumptions and beliefs in the light of information currently available to Roots, and listeners are cautioned not to place undue reliance on such information. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected. The company refers listeners to its first quarter management discussions and analysis and/or its annual information form dated April 6, 2022.

For a summary of the significant assumptions, underlying forward-looking statements and certain risks and factors that could affect the company's future performance and the ability to deliver on these statements, Roots undertakes no obligation to update or revise any forward-looking statements on this call.

The first quarter earnings release, the related financial statements and the management's discussion and analysis are available on SEDAR as well as on the Roots Investor Relations website at www.investors.roots.com. A supplementary presentation for the Q1 2022 conference call is also available on Roots Investor Relations site.

Finally, also note that all figures discussed on this conference call are in Canadian dollars, unless otherwise stated. Thank you. You may now begin your conference.

[Meghan Roach, executive]

Good morning, and welcome to our earnings call. I'm very pleased to report that Roots delivered solid first quarter results. Most notably, sales increased 15.3% year-over-year to $43.1 million. Our strong performance can mainly be attributed to growth in customer traffic. This results from strong comparable sales year-over-year and in part the temporary store closures due to lockdown in several regions in Canada during part of Q1 2021.

Before we go any further, I want to pause to thank the team for all of their hard work. Everyone has done a phenomenal job, especially given the circumstances in which we have been operating. The market environment continues to be dynamic. Our performance reinforces the strength of our brand and further validates our omnichannel growth strategy.

It also speaks to the desirability of our enhanced product portfolio, the traction that we are continuing to gain through our elevated brand positioning and the demand for the high quality, comfortable and versatile clothing that Roots offers.

Now in the prior quarter, I outlined 4 main growth pillars. The first is offering an elevated omnichannel experience to serve our customers wherever, however and whenever they seek to shop. This includes corporate retail stores, pop-up location, e-commerce and international business partners. Roots currently ships to more than 55 countries and generates approximately $100 million in system-wide sales in Asia on an annual basis.

During the first quarter, we continued to progress our omnichannel infrastructure enhancements. We expect the majority of these to be completed in the second half of 2022. In the interim, we are continuing to offer a robust [ lead of options ] for our customers online and in stores to support their shopping preferences.

Our second growth pillar consists of reinforcing our brand position globally. With international partners and our e-commerce platform, our brand's reach is already broad. However, we continue to further leverage the brand outside of Canada. This pillar also includes enhancing our product portfolio to better reflect our consumer targets and continuing to drive engagement with the brand amongst existing and new customers.

Our substantial brand equity and our premium offering resulted in strong demand for our product in the first quarter. We are continuing to invest in our Journey Collection. Our performance offering for consumers seeking the same great hand feel and quality that Roots has been associated with for decades.

This collection offers more technical features such as antibacterial fabric, moisture wicking and UV protection. We have spent the last year testing a range of styles and continue to see excellent demand and upside potential with Journey.

Customer traction has been strong, with sales growing over 40% year-over-year in fiscal 2021. This excellent momentum has continued into the fourth quarter of 2022. We also mentioned in the fourth quarter, our success in offering more sizes in the One Collection. In Q1, we also extended the sizes available in our Salt & Pepper fleece. We will be using customer demand indicators to roll out more sizes across different parts of our collection during the remainder of 2022.

As customer preferences evolve post pandemic, perhaps most notable in our first quarter was a significant growth experience in our core fleece program. While we continue to expand this offering with the use of different sized logos, colors and updated fits, our core fleece remains a timeless style that has been a customer favorite for decades.

Our ability to consistently deliver a compelling product offering led Direct-to-Consumer gross margin to expand 180 basis points year-over-year to 63%. We have a robust product pipeline for the remainder of the year. And this includes the relaunch of Beaver Canoe in the summer to celebrate its 40th anniversary.

Now let's turn to our enduring brand strength. With a history spanning almost 5 decades, Roots retains many loyal followers and a highly attractive customer base that has shown a willingness to pay for the unique features and benefits we offer. Through collaborations with artists, celebrities and influencers, we continue to promote brand awareness to a broader global audience.

In February, we hosted the Weeknd’s 32nd birthday party in Las Vegas, where the Canadian artists wore a custom varsity jacket by Roots, handmade in our Toronto Leather Factory, the jacket commemorate the launch at his Dawn FM album. This represents our 10th year of collaborating with the Weeknd and the XO brand.

During the quarter, we also partnered with local artists Benny Bing & Morningstar in a series of limited-edition studio fleece in varsity jacket. Benny Bing's [indiscernible] based on his incredible painting [indiscernible] celebrate the [ BD ] of Black Women using vibrant colors and took over 5 hours to sell.

Morningstar, a mixed French-First Nation's Illustrator, painter and muralist, partnered with us for International Women's Day, and she created a piece that celebrated the diverse qualities of women. The artistry and passion that [ went ] in to making these pieces made them highly [indiscernible] and also very quickly sell out.

Within our third growth pillar, we are focused on taking a progressive approach to enhancing corporate social responsibility at Roots. During the first quarter, we joined Sustainable Apparel Coalition. This apparel, footwear and textile industry is leading alliance for measuring sustainability. The Coalition developed the Higg Index, a standardized value chain measurement tool for all industry participants. Our membership reflects our commitment to reducing our environmental footprint and promoting social justice throughout the global supply chain.

Aligned with this initiative, we anticipate having most of our apparel made with sustainable materials by the end of 2022. Our beloved Salt & Pepper and Cooper Beaver fleece products are already made with some recycled content, as we move these collections to organic cotton in the autumn. We will see a significant volume shift to sustainable materials.

Roots is not a fast fashion brand. Our move towards sustainable materials is only the latest initiative in our commitment to helping our customers build a timeless wardrobe of high-quality, comfortable clothing. Our final growth pillar remains operational excellence across the organization to drive long-term profitable growth.

Mona will discuss this during her overview of the financial results. But before passing on to Mona, I want to note that in the short term, we continue to manage through the industry-wide supply chain disruption, inflation and the lingering global effect of the COVID-19 pandemic.

Roots has weathered many similar periods of disruption throughout its almost 50 years of existence, and we continue to believe in its enduring brand affinity and exceptional product offering. I will now turn the call over to our CFO, Mona Kennedy.

[Mona Kennedy, executive]

Thanks, Meghan, and good morning, everyone. As mentioned, we've delivered solid Q1 2022 results, amid a fluid market environment. Total sales increased 15.3% to $43.1 million in the first quarter of 2022 from $37.3 million in the first quarter of 2021.

DTC sales reached $37.4 million, up 19% year-over-year. This solid performance reflects strong same-store sales growth as we saw significant traffic recovery in stores. Additionally, we were cycling over some temporary store closures from lockdowns last year.

P&O sales amounted to $5.7 million [indiscernible] quarter of 2022 compared to $5.9 million last year. The slight decline mainly stems from a reduction in our Taiwan business, partially offset by strong sales growth of custom Roots-branded products to business clients and by additional sales through TMall.com in China.

Gross margin improved significantly during the first quarter, rising 340 basis points to 60.9%. In DTC, gross margin improved 180 basis points, 63%, driven by higher merchandise margins that reflect our discipline on promotions with reduced markdowns.

We also benefited from a favorable impact of foreign exchange rates on U.S. dollar purchases. These factors were partially offset by lower government subsidies as well as higher transportation and air freight costs for certain products.

Additional air freight costs negatively impacted DTC margin by 100 basis points. Moving to SG&A. We reported expenses of $31.3 million, up 21% from last year. However, excluding the year-over-year impact of government subsidies and temporary rent abatements, SG&A expenses only rose 9.3%. So we gained leverage on our SG&A expense versus last year.

This increase was essentially due to higher store labor costs as stores were fully opened this year, and we also had some investments in talent in our head office. Adjusted EBITDA stood at a loss of $3.2 million in the first quarter of 2022 compared to a loss of $2.5 million last year.

It's important to note that last year's adjusted EBITDA included $2.9 million of incremental rent abatements and government subsidies. Excluding these items, our adjusted EBITDA improved by $2.2 million year-over-year. This last figure allows us to appreciate all the initiatives that our team put forward to stimulate sales and improve operating profitability.

We're very pleased with the progress accomplished to this day. The net loss in the first quarter of 2022 amounted to $5.3 million or $0.13 per share versus $4.9 million or $0.12 per share last year at this time.

Turning to our balance sheet highlights. Our inventory position is healthy, standing at $39.2 million at quarter end. This compares to $41.3 million at the beginning of the quarter and $42.5 million at the end of the first quarter a year ago. Although supply chain pressures remain, we're comfortable with our inventory composition entering Q2.

In addition, we believe that our inventory is generally low risk, as core products account for approximately 2/3 of inventory. We also ended the first quarter in a solid financial position. At the end of the quarter, net debt stood at $39.4 million, which was nearly 50% less than at the same time last fiscal year.

Our net leverage ratio was also very strong at 0.8x at the end of Q1. During the first quarter, we repurchased 377,000 shares for a consideration of $1.2 million under our NCIB program. Since initiating the program last December, we have repurchased 582,000 shares out of an authorized amount of nearly 2.2 million shares until December 15, 2022.

In summary, fiscal 2022 is off to a good start with a greater store traffic driving sales growth in the first quarter while maintaining our promotional discipline. Our results reflect the power and positioning of our brands in the marketplace. Q2 is also tracking nicely, and we're pleased to see customers coming back to our stores. This said, we will not benefit from any subsidy or abatements this year as opposed to the benefits totaling approximately $6.5 million last year in Q2.

In the meantime, the entire Roots team is working hard to alleviate supply chain pressures, and we're confident about the strategies we're putting forward. We're taking a proactive stance with respect to transportation and logistics, including finding the optimal balance between air freight, premium and regular ocean freight as well as strategically managing our pack-and-hold inventory.

Based on what we see in terms of shipping rates and production flow, we currently expect an impact on DTC gross margin of about 150 to 250 basis points in the second half of the fiscal year. This said, our objective is to have products and stores on time at the most efficient cost possible.

As Meghan mentioned, we're focusing on executing our long-term profitable growth strategy. Roots' history of nearly 50 years fosters passion, pride and resilience throughout the organization. These key attributes, along with our strong appealing brand laid a foundation for a sustainable growth platform.

Our sound financial position, meanwhile, provides us with the flexibility to confidently move ahead and create lasting value for our shareholders. I would like to thank our entire team for a solid quarter. We remain focused on operational excellence throughout all levels of the organization. Despite external challenges, our agility and resiliency will allow us to continue driving solid results. We look forward to updating you on our second quarter results in September.

With that, operator, please open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from Brian Morrison with TD Securities.

[Brian Morrison, analyst]

So Meghan, we've seen some major retailers in the U.S. see a shift away from the casualization movement during the pandemic. I'm wondering if you're seeing this trend. If so, how do you adapt to it when it takes hold? And maybe just comment on Mona's prepared remarks that said that Q2 is tracking nicely. Maybe some color on that.

[Meghan Roach, executive]

Yes, absolutely. So the short answer is no, actually. We haven't seen any negative impact from the casualization of the wardrobe. If anything, the fact that people are still living a hybrid lifestyle or they're spending 2 to 3 days in a week in the office and other days at home is continuing to positively impact our purchases of our core items. .

And I think actually, in my prepared remarks, I had mentioned that we actually saw a significant growth in our core offering in the first quarter. And so we haven't seen any negative impact on the brand at all of any shifts around and trends. And I think the big focus for us is we are a brand that's been around for 50 years, and a lot of our core offering has been something that we've offered for many, many years and we continue to see customers being very compelled to buy the products we offer because we really feel that we have a unique differentiated position in the marketplace.

[Brian Morrison, analyst]

Okay.

[Meghan Roach, executive]

And [ I take your ] second question, sorry, Brian, with Q2. Q2 momentum continues to be strong, and we're very happy with the way things are trending.

[Brian Morrison, analyst]

Excellent. And then, Mona, your comment about the 150 to 200 basis points of drag with respect to, I believe, it was freight costs in the second half of the year. Is that DTC? Is that consolidated? And do you have any ability to offset that or is that what you believe is going to happen?

[Mona Kennedy, executive]

That's DTC. So it's 150 to 250 basis points in the second half of the year. Ability to offset it, I mean we're generally working on margin as you see, and we'll continue to do that in terms of trying to sell products at full price and things of that nature. And as we've mentioned, kind of in Q4 and previously, we're also looking at strategic price increases to potentially offset that.

[Brian Morrison, analyst]

Okay, last question...

[Meghan Roach, executive]

Sorry, Brian, just to add on to that. I think the other thing that we're doing is we're giving you a range of estimates. So we're obviously continuing to work on our side to determine where we can obviously speed up the flow of goods or minimize air freight. So I think we wanted to be transparent with the marketplace to give a rough estimate of what we anticipate in the second half of the year, but we're obviously trying to minimize it as much as we possibly can.

[Brian Morrison, analyst]

Okay. Last question, Meghan. You had a very active NCIB when you reported your Q4 results right through mid-April and then all of a sudden, it stopped. There was about 377,000 shares. I'm wondering why that happened and what your plan is with respect to the NCIB going forward?

[Mona Kennedy, executive]

Yes. No, we've been...

[Meghan Roach, executive]

[indiscernible] Mona?

[Mona Kennedy, executive]

Yes. Thanks, Meghan. So we've been active on our NCIB. Brian, as you mentioned, we repurchased 377,000 shares in Q1 and since its [ inception ], 582,000 out of the approximately 2 million that we announced. Our intention is to continue to buy shares opportunistically from time to time. But as you know, there's a lot of uncertainty ahead of us and head of all retailers and all companies in general in the market, and we're remaining cautious on providing any guidance on that.

[Brian Morrison, analyst]

So do you plan to complete your 2 million share repurchase plan?

[Mona Kennedy, executive]

All right. As I said, we're being cautious on providing any guidance on that, so I won't specifically provide that.

[Operator]

Your next question comes from Patricia Baker with Scotiabank.

[Patricia Baker, analyst]

Well, Brian asked a number of my questions, but I just want to follow up on the impact of the expedited air freight on DTC margins in the back half. So you're saying that it's 150, 250 basis points in the second half of the year, would that be equally felt in Q3 and Q4?

[Mona Kennedy, executive]

Patricia, so in terms of equally, yes, I would say so. There is a bit more pressure in Q3 than there was last year, given some closures in China, we've had to airfreight a bit more product for Q3 of this year than we did last year.

So if you're comparing to last year, you'll see more pressure in Q3. But you'll see equal pressures in Q4 as well. And as Meghan mentioned, it's a dynamic situation, and we continue to monitor it. So there might be -- this is a rough estimate that we're providing, but there should be pressure in Q4 as well.

[Meghan Roach, executive]

And I think it's important to know -- sorry, Patricia just jumping in. I think it's important to know that the way the air freight works is obviously capitalized into our inventory, and so it hits the P&L as we sell the inventory down. And so what we're trying to do is obviously bring in inventory as early as we can to make sure we capitalize on the demand for the second half of the year.

And I think I would just note also that our strategy really isn't any different than it was in 2021. So we're really looking at the quantities of air freight and comparing them to levels that we spent last year. So from that perspective, we're continuing to take the same strategy in terms of our approach to air freight and be very tactical in terms of where we use it and continue to be obviously mindful of the fact that these are temporary increases in costs that we're obviously incurring on a long-term basis, we anticipate rates to continue to decline.

[Operator]

Your next question comes from Matthew Lee with Canaccord.

[Matthew Lee, analyst]

Congrats on the strong quarter. I know that things are relatively fluid right now, but given your promotional discipline and supply chain strength, what sort of gross margin profile can we expect you to achieve long term? Is it fair to say that kind of steady-state consolidated gross margins are probably closer to the mid-60s once supply chain issues [indiscernible]?

[Mona Kennedy, executive]

We're not providing that guidance, particularly in the current environment, Matthew, where we've been working very hard over the past 8 quarters on margins. And as you've seen, there's been continuous margin improvement. It's something that's a focus for us continuously. But as you know, in the short term, there are pressures on margins. So it's really hard to provide that guidance and not really that smart for us to do that at this point.

So we will remain disciplined with our promotional activities. As you know, our average unit revenue has gone up significantly since 2019. So we'll continue to do that. Our focus is on full price selling. We're bringing in some new categories with new features with higher prices. So we're working on margins, but not providing that guidance. And as we've now mentioned a number of times, there are short-term pressures from an airfreight perspective in Q3 and Q4 that we're experiencing.

[Matthew Lee, analyst]

Right. Okay. And then I know that you were talking a lot about transportation, but have you seen any inflation in terms of material costs?

[Mona Kennedy, executive]

We have seen some inflation in terms of material costs. As you know, cotton prices have been quite volatile and going high. And in terms of [ steel ] costs, obviously, there is an impact on that as well. We have taken some strategic price increases in the first half of the year and maybe so in the second half of the year to offset that.

And we haven't really seen significant resistance from customers since we've [ removed ] promotions, customers have been receptive of that. And the strategic pricing increases also haven't really faced much resistance. So we're feeling good about that.

[Matthew Lee, analyst]

Right. And then maybe a different approach to an earlier question. Your current balance sheet is in really good shape. Cash flow is returning. Can you just give us an understanding of your capital priorities between dividend, buybacks and potentially M&A?

[Mona Kennedy, executive]

Sure. As we indicated during our Q4 conference call, we're always looking at different alternatives and different ways of managing our business, and we continue to look at our capital allocation with the board. And at this time, we're seeing the course on future capital allocation plans. And there's a lot of uncertainty, as I mentioned, and you all know. So in that context, we're being cautious in providing any guidance. But yes, all the financial position, debt levels are at the lowest level they've been for a really long time, I think we're in a good cash position. So we're really proud of that.

[Meghan Roach, executive]

And I think, Matthew, we're always looking for ways -- sorry, Matthew, to maximize shareholder value, right? So I think from our perspective, we feel good about our liquidity levels, we feel good about our debt levels. And so we're going to continue to monitor the macro environment and be considerate and planful in terms of how we think about our cash allocation as we continue to see how the rest of the year trades out in macro environment.

[Operator]

[Operator Instructions] Your next question comes from Stephen MacLeod with BMO.

[Stephen MacLeod, analyst]

Lots of great color in the Q&A so far. So lots of my questions have been answered. But I just wanted to focus in on 2 things. I know you talked about Q2 tracking nicely. I'm just curious, if you think about sort of where Q1 ended and where you are today, have you seen any changes in consumer spending just with respect to inflation and rising rates and some of the caution we're seeing in the markets right now?

[Meghan Roach, executive]

No. So we took a small price increase actually in our core products at the start of Q1. And we really saw -- for an example, there are no impact on consumer shopping behavior with us. Our customers are continuing to show a willingness to pay for all the unique features and benefits that we offer. And I think that customers are seeing that we have [ pretty ] high-quality products, so they know that they're investing in something that will last.

So from our perspective, we haven't seen any negative impacts. And I think if you think about the macro environment in general, we are really happy with [indiscernible] going into Q2, and our inventory levels are lower. And so when we think about the composition of inventory going into the second half of the year, we feel good about that. And we also feel good about this solid financial position that we're in with the good liquidity and the leverage ratios that we have. So that's been all positive.

And the final thing that I'd mentioned is that we have a pretty attractive customer demographic. And with our elevated brand positioning, we're seeing that our customers so far have been less impacted by the cost inflation in terms of their purchasing habits. So we're continuing to see that willingness to pay for the unique features and benefits that we offer, as I mentioned. And that's really our focus going forward.

[Stephen MacLeod, analyst]

Great. And then in your prepared remarks, Meghan, I think you were the one that were talking -- you were talking about some of the omnichannel improvements that you expect to see in the back half of the year. Can you just give some color maybe specifics around what improvements you are expecting to see?

[Meghan Roach, executive]

Yes. So I think we've talked about in the last few quarters, the fact that we're continuing to make some investments in enhancing the infrastructure of our omnichannel environment. And so I think as we go into the second half of the year, a big focus for us is really on mobile enablement.

And while the existing website is obviously mobile enabled, we want to continue to make sure that we have a robust back end that's going to support the continued functionality that we want to add. So I think as you go into the latter half of the year, we're continuing to make sure that we have things like endless aisle, Buy Online Pick Up In Store, all those key characteristics that customers are seeking.

But a lot of our infrastructure investments are around continuing to make sure that we maintain that very symbiotic relationship between online and in stores. So you should continue to see a more seamless ability to transact in stores if you want to do an online transaction. And online, you should see the sites become faster, you should see kind of the usability to improve overall. So I think our focus going forward is really on continuing to improve both mobile enablement as well as the online conversion. So we're really making sure that we're investing in places that will enable us to do that going forward.

[Operator]

There are no further questions at this time. Please proceed.

[Meghan Roach, executive]

Thank you, operator. That concludes today's call, and thank you again for joining us. We look forward to updating you on our progress when we report the second quarter in September of this year.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.