Roots Corp

TSX:ROOT

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. My name is Lara, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Roots Second Quarter Earnings Conference Call for Fiscal 2023. [Operator Instructions]. On the call today, we have Meghan Roach, President and Chief Executive Officer; and Leon Wu, Chief Financial Officer.

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 concerning its current and future plans, expectations and intentions, results, levels 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 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 second quarter management's discussion and analysis dated September 11, 2023 and/or its annual information form 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 ability to deliver on these statements. Roots undertakes no obligation to update or revise any forward-looking statements made on this call.

The second 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 Q2 2023 conference call is also available on the Roots Investor Relations site. Finally, please note that all figures discussed in this conference call are in Canadian dollars unless otherwise stated. Thank you. you may begin your conference.

[Meghan Roach, executive]

Thank you, operator. Good morning, everyone, and thank you for joining us today for our Q2 2023 earnings call. As a reminder, Q2 has historically only represented approximately 15% of our total annual sales. We are pleased with our overall sales growth of 3.4% in the second quarter despite challenging economic conditions. We benefit from the earlier shipment of orders to our Taiwanese operating partner in the quarter, which helped to increase our Partners and Other sales year-over-year. We do anticipate solid growth in this region on a full year basis. And in addition, our investments in China are continuing to pay off a strong growth in that market as well.

On the Direct-To-Consumer side, revenues were down 3.5% compared to Q2 2022, due to the ongoing softness in demand for fleece bottom. However, we enjoyed strong customer traction or active, [ one end ] Beaver Canoe collections as well as with dresses.

As we look to the second half of the year, we have several bottom silhouettes gaining traction with consumers. For example, our men's woven park [ khaki ] pant is made with a sustainable performance fabric and blends tailoring with comfort for seamless look that can take you from the office to the golf course.

For the second consecutive quarter, our emerging [ asset ] collection, which accounts for approximately 10% of DTC sales delivered a year-over-year increase of more than 50%. We saw sustained growth in active on the strength of new customer acquisitions and expanded styles from last year including the addition of more golf and tennis offering. Our new always-on approach to paid media in this area has also helped to drive increased market awareness. Our gender free [indiscernible] of fleece collection 1 and our heritage Beaver canoe line also contributed double-digit growth in the second quarter, reflecting the diversity and the reach of our brand.

Turning to our 50th anniversary. On August 15, Roots officially turned 50. Celebrations began in mid-August with the first product drop at the Roots Sporting Goods and the Golden Beaver collection. Our launch events held in Canada and Taiwan were well attended by long-time Root fans, celebrity influencers and media, and we have been very pleased with the global media focus and attention generated thus far.

Throughout the next 12 months, we anticipate the curated assortment of limited edition products, collaborations and events to generate excitement amongst long-time Roots customers and new fans. In the near term, we will be launching a 50th anniversary commitment of print magazine. Roots stories, which brings the stories of our customers and their relationship with Roots and Roots products to the forefront and relaunching the renowned negative-heel shoe, which we're calling the sport route that Roots first introduced to the market in August 15, 1973. The negative-heel shoe will be the first item and a broader relaunch of our new footwear collection, which hit stores this fall.

Our planned festivities tapped into the emotional connection between our customers and the Roots brand while creating new iconic products for tomorrow's consumer. As we look at the Roots brand against the backdrop of our 50th anniversary, we are not reinventing it, but reimagining the brand in a more modern way and seeking to expand our customer base with new core favor.

In closing, it has been great to see the early customer response to our 50th anniversary collection, and we look forward to exciting new and existing customers with what is still to come this year. We also have a strong balance sheet with a healthy inventory position and ample liquidity, which continues to enable us to support our growth strategy. However, we continue to expect the higher interest rates and the current economic environment to weigh in consumers, particularly in Canada, which remains a headwind for us. I will now pass the call over to Leon.

[Leon Wu, executive]

Thanks, Meghan, and good morning, everyone. I will discuss our financial performance for the quarter and then provide an update on our balance sheet and liquidity. Starting with our Q2 2023 results. Total sales increased 3.4% to $49.4 million, driven by our Partners and Others segments. PTC sales were $37.1 million, down 3.5% year-over-year. This decline was driven by the challenging economic conditions and the competitive environment. As Meghan indicated earlier, sales in our emerging apparel collections delivered strong year-over-year growth including a 50% sales increase in our active collection for the second consecutive quarter. However, these increases were not sufficient to offset softness in our fleece bottoms. Partners and Other segment sales grew 31.7% to $12.3 million in Q2 from $9.3 million last year. The growth was mainly due to higher sales to our international operating partner in Taiwan, including earlier year-over-year delivery on approximately $2.6 million of orders, in addition to organic volume increases.

Total gross profit amounted to $27.4 million in Q2 2023 compared to $28.3 million in Q2 2022, representing a decrease of 3.2%. Consolidated gross margin reached 55.5% in Q2 2023 compared to 59.3% in the same period last year. The 380 basis point reduction in gross margin is primarily due to a higher mix of lower-margin Partners and Other sales in the quarter.

DTC gross margin was 52.7% in the quarter, 130 basis points lower than 64% in Q2 2022. The reduction in DTC gross margin can be attributed to higher product costs from the transition to sustainable materials and increased sales mix of discounted products, which together drove a 270 basis point decline. These factors were partially offset by lower freight costs, including 40 basis points of air freight tailwinds. DTC gross margin was also affected by an unfavorable foreign exchange impact on U.S. dollar purchases.

As previously communicated, we anticipate that the decline in our gross margin will gradually moderate in the second half of the year as our transition to sustainable materials comes full circle on an annual basis. As a reminder, we expect to also benefit from approximately 130 basis points of DTC gross margin tailwind in the second half of 2023 as we comp off air freight costs incurred last year.

We are pleased with the trajectory of our DTC gross margin and our discipline on discounting as we executed on our inventory management strategy. Even as we work through our higher inventory levels, DTC gross margin remained well above pre-pandemic levels.

SG&A expenses were $32.3 million in Q2 2023, and compared to $30.6 million in Q2 2022. The 5.6% increase in SG&A expenses is mainly related to higher personnel costs at both our stores and corporate offices, and contractual increases in store rep charges. It should be noted that with the minimum wage increase scheduled for October 1 in the province of Ontario, which represents our largest concentration of labor, we expect our SG&A cost base will increase by approximately $300,000 in the second half of 2023 and $700,000 on a full year basis.

Net loss totaled $5.3 million or $0.13 per share in Q2 2023 compared to a net loss of $3.2 million or $0.08 per share in Q2 2022. Adjusted EBITDA amounted to a loss of $3 million in Q2 2023 compared to a loss of $0.6 million for the same period last year.

Moving to our balance sheet. As noted earlier, we have made substantial progress towards improving our inventory position, which rose 2% or $1.1 million year-over-year compared to 28.6% at the end of Q1 2023. The inventory increase in Q2 2023 was primarily driven by $3.9 million of higher core inventory to be released for sale in the second half of the year under our pack and hold strategy. $1.2 million of higher product costs related to our transition to sustainable materials and a $2.6 million increase for more on-hand units, which was partially caused by the earlier timing of inventory receipts. These factors were largely offset by $6.6 million decrease of lower in-transit inventory as we strategically manage our inventory buys for the second half of the year. By leveraging our pack and hold collections and tightening orders, we remain on track to rightsize inventory by the end of the year.

At the end of the second quarter, our financial position remained solid with net debt of $50.9 million, essentially flat from $50.2 million a year ago. We also had total liquidity of $61.1 million at quarter end, including $57.8 million available borrowing capacity under our revolving credit facility.

In closing, we continue to believe in the long-term fundamentals of the business and the value of our brand's distinctive positioning. We have maintained a robust balance sheet and ample liquidity to support our ongoing operations future growth initiatives and capital management strategies. Accordingly, we completed our largest share repurchases since implementing our NCIB program nearly 2 years ago. Buying back over 874,000 shares for a total consideration of $2.7 million in Q2 2023. As a reminder, the NCIB allows us to repurchase for cancellation up to 2.1 million shares during the 12-month period ending December 15, 2023. At the end of Q2 2023, we had repurchased 1.6 million shares under the current NCIB program.

Historically, the first half of the fiscal year represents less than 30% of our sales and as Meghan mentioned, we have most of the year still to come. We are excited to celebrate Roots 50th anniversary with our customers over the next 12 months, and we'll continue to strategically invest towards the execution of our long-term growth plan. This concludes our prepared remarks for Q2 2023. With that, operator, please open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Brian Morrison from TD Securities.

[Brian Morrison, analyst]

Maybe I can start out with the commodity pricing of the organic material. Is that falling back in line with expectations now should we see margin relief as we get into the second half of the year? Where is the pricing versus cost?

[Leon Wu, executive]

Yes, Brian. On the organic, so we will be comping the launch of the organics from Q3 of last year. So over time, as we start rolling out more and more of the organic and the penetration of our overall sales last year, we should start seeing the margin relief there. So it won't fully be in Q3, but as we fully roll it out in Q4 of last year, we should start seeing better -- [ higher MOS ].

[Brian Morrison, analyst]

Okay. And then in terms of your inventory, Leon, the $2.6 million of inventory at hand, how much of that is out of season that will require promotional activity? I understand some of it is just timing.

[Leon Wu, executive]

Yes. Actually, very little of it is the seasonal inventory. I think the team has done a great job of addressing the seasonal inventory concerns. Really, if we look at the breakdown of what's driving the inventory cost balance increase, it's largely just the higher cost per unit, the actual on hand from a pack and hold and just normal on-hand inventory is largely offset by the lower in-transit inventory, which is part of our overall strategy of reducing second [ half-pie ] to get our inventory back on track.

[Brian Morrison, analyst]

Okay. Meghan, just a few things I saw over the summer, specifically in a number of stores. I saw products within Mark's stores. I wonder if this is a trial phase and if you're seeking opportunity to expand other external DTC partnerships?

[Meghan Roach, executive]

Yes. That was the trial that we did with Mark last year. And I think we haven't opened this generally to expanding the business from a wholesale perspective. I think we have to make sure we have the right partners and the right products in those stores. And that specifically was just a trial of Mark's. But I think over time, we're going to see from a business perspective as we continue to think about ways to grow the presence of Roots. And what's going to be exciting is this -- you'll probably see a lot of Roots products in university. We have quite a few university partners in Canada this year. And so you're definitely going to start seeing Roots in a few more places. .

[Brian Morrison, analyst]

And how did the trial go with Mark's? Can you comment on that? .

[Meghan Roach, executive]

Not something to comment at this point in time, but I think that you'll be excited to see Roots again at the certain universities. And then over time, thinking about us going to different wholesale partners as we grow.

[Brian Morrison, analyst]

Okay. Last question. The opportunity in footwear. I know this is a growth driver back at the IPO, I think you backed off it to a certain extent. What's the driver behind the reinvestment at this point in time?

[Meghan Roach, executive]

We always have consumers who are coming into the brand and saying, listen, I love the Roots footwear I've had it for x number of years. And I think that what we want to do is be very planful and also very conservative in terms of how we're buying footwear but we think it's a great offering for consumers. So o what you're going to see is we just launched the negative-heel shoe or the sport Root we're calling it last week. As we get into later September, you're going to see some of our tough boots, and I think can have a couple of new heritage boots come into play, and they'll have more of the winter stuff coming out in October -- late October into November.

So I think when you look at our collection this year, it's going to be tight, it's going to be concise. It's going to feel really on brand from a Roots perspective. We're making the products in Portugal. The leathers are fantastic. It's a really good quality. And so we're looking to attract those consumers who over the years have been really loyal customers of it from footwear perspective, and we anticipate it being a small, but important part of the business, but it's not something where we're putting a massive growth pillar on it today. It's really more about completing the entire collection and giving people some excitement and playing back to the heritage that we've always had in the space.

[Operator]

[Operator Instructions] There are no further questions at this time. I'd now like to turn the call back over to Ms. Roach for any closing remarks.

[Meghan Roach, executive]

Thank you, everyone, for joining us today for our Q2 results. We look forward to speaking to you in December when we release our Q3 2023 results. Have a great day.

[Operator]

Thank you so much presenters. 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 lovely day.