Roots Corp

TSX:ROOT

Earnings Call Analysis

Earnings Call Transcript 2025-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the Roots Corporation Q2 2024 Analyst Conference Call. [Operator Instructions] This call is being recorded on Friday, September 13, 2024.

I would now like to turn the conference over to Ms. Meghan Roach, CEO. Please go ahead.

[Meghan Roach, executive]

Good morning, everyone. Thank you for joining our Q2 2024 earnings call.

Second quarter sales came in at $47.7 million compared to $49.4 million last year, with direct-to-consumer sales of $36.4 million relative to $37.1 million in Q2 2023, and comparable sales were nearly flat. Direct-to-consumer gross margins declined 100 basis points, while product margins improved by 230 basis points. Adjusted EBITDA losses were stable compared to Q2 2023 at $3.1 million relative to $3.0 million in the prior year.

Notably, we also continue to strengthen our balance sheet, reducing net debt by 20% compared to this time last year. As a reminder, first half of the year remains [ seasonally small ] for Roots financially, [ typically ] representing approximately 30% of annual sales.

Before I review the highlights for this quarter, I will also briefly touch on our early back-to-school results. We are pleased to see growth during the back-to-school period, underscoring the strength of our product portfolio and the effectiveness of our ongoing initiatives in branding, marketing and enhancing the in-store experience. While it is early in the third quarter, these results speak to the strength of the brand and its important relevance amongst new and existing consumers.

Now turning to our second quarter highlights. In June, we introduced the summer version of our Cloud Sweats, an ultrasoft cotton fleece product with minimal logos and more fashion-forward silhouette that resonated extremely well with consumers.

Our Active collection also experienced another quarter of double-digit growth. Active now represents the core offering for Roots, and an area we will continue to expand upon as part of our go-forward strategy.

This summer, we also saw strong sell-through of our Northern Athletics collection, with the momentum around Canada and sports and [ lead up ] to the Olympics.

As mentioned last quarter, we faced some inventory challenges in our cooper fleece collection in Q1 and the start of Q2, which impacted sales. However, we ended the quarter in a healthy inventory position in this product offering, which benefited us in late July and into Q3.

As indicated in a separate press release earlier today, Karuna Scheinfeld, Chief Product Officer, will be stepping down at the end of 2024. We do not intend to replace the Chief Product Officer role. However, we have commenced the search for senior-level design talent with international experience in the outdoor and active sectors. As mentioned, Active has been a fast-growing area of the business, and we are also seeking to continue reconnecting our product with our outdoor roots.

Since joining us in 2020, Karuna has been an exceptional partner, establishing go-to-market process and products in line with our brand vision and direction. I appreciate Karuna's passion and commitment to the brand, and it is a testament to her leadership that she leaves us with a strong team that I'm confident can support the brand in its next phase of evolution.

In early September, we hosted an inclusive event to launch our fall and holiday products. The first collection fully influenced by our Creative Director in Residence, Joey Gollish. Attendees including key influencers, industry leaders and media had the opportunity to explore the craftsmanship, creativity and innovation behind the collection and a carefully curated presentation.

However, it is not only about unveiling products. It is about sharing the story of how our vision for the season align with the evolving desires of our consumers. This launch set the tone for a pivotal moment in our seasonal strategy, and the collection blends timeless style with forward-thinking trends.

From a marketing perspective, last quarter, we launched our brand ambassador program, with the goal of enhancing brand visibility through authentic, relatable representatives who embody our core value. This initiative aims at strengthening connections with our target audience through the personal engagement of our ambassadors, while driving greater consideration of Roots across key product categories. The initial results have exceeded our expectations, and we see this program as a pivotal driver for future growth, helping us reach both new and existing customers more effectively.

Our teams have been thoughtfully enhancing our marketing assets and refining our brand messaging as we prepare for the second half of 2024. These efforts are already reflected in our back-to-school and newly launched fall campaigns, which both highlight our enhanced creative direction. We are focused on creating more resident-compelling content that not only aligns with consumer trends, but also deepens our connection with our audience. These initiatives are setting the stage for a stronger, more impactful presence as we approach the critical holiday season.

During the quarter, we continued to roll out our improved store concept, with construction commencing on our new door on Robson Street. Our enhanced store experience, as illustrated by our Eaton Centre renovation earlier this year, blends Roots' deep heritage in nature with a brighter, more modern aesthetic. We will have numerous stores undergoing renovations in 2025 under this new concept.

We are also making significant strides in our AI initiatives this year, focusing on areas where AI can drive the most impact across our business. While some of our AI tools are still in their early phases, we are seeing promising progress, and expect these technologies to further enhance operational efficiency and customer engagement.

For example, we are now engaging in daily inventory replenishment to stores, enabled by our AI-driven allocation systems. With additional AI solutions set to go live next quarter, we are confident that these investments will continue to create long-term value and competitive differentiation in the marketplace.

From an international perspective, we generated another strong quarter of double-digit growth in the U.S. and China digital channels, and we continue to see medium-term growth opportunities in both markets.

On that, I will turn the call over to Leon Wu, our Chief Financial Officer.

[Leon Wu, executive]

Thanks, Meghan, and good morning, everyone. Total sales were $47.7 million in Q2 2024, down 3.4% as compared to $49.4 million in Q2 2023. DTC sales were $36.4 million, down 1.8% relative to $37.1 million a year ago. The decline in sales was driven by closures of select stores since Q2 of last year, as part of our ongoing store fleet optimization initiatives to consolidate less profitable stores and drive same-store sales growth.

Our DTC comparable sales were nearly flat, reflecting our upward trajectory in comparable sales relative to last quarter. Comparable e-commerce sales grew, offset by declines in comparable store sales from primarily off-price focused store locations due to cleaner year-over-year inventory, which resulted in less markdown sales and 2 locations heavily impacted by construction immediately outside of our store.

As Meghan mentioned, we are very pleased with the performance of our core product categories. Our Active collection continued to drive double-digit year-over-year growth, our minimal logo [ Cloud fleece ] collection saw tremendous customer response and surpassed our expectations. And our cooper fleece collection, which drove year-over-year sales headwinds in the first half of the year due to inventory shortages, saw sales strengthen in the back half of Q2 as replenishment was received.

Partners and Other sales were $11.3 million, down 7.9% as compared to $12.3 million last year. This was largely driven by the earlier timing of certain sales to our Taiwan operating partner in Q2 of last year, partially offset by increased royalties from the licensing of the Roots brand to select manufacturing partners.

Total gross profit was $26.9 million in Q2 2024, down 1.9% compared to $27.4 million last year. Total gross profit margin was 56.4% in Q2 2024, up 90 basis points compared to Q2 2023. The decline in gross profit dollars was driven by lower sales, partially offset by higher gross margins due to an increased mix of higher-margin licensing royalties.

DTC gross margin was 61.7% in the quarter, down 100 basis points from 62.7% last year. Our DTC gross margin is comprised of the margins earned on product sales and other impacts such as foreign exchange, freight and accounting adjustments.

During the quarter, our product margin increased by 230 basis points, driven by improvements to costing as part of our ongoing sourcing strategy and lower discounting due to our improved inventory position. This was offset by the combined impact of an unfavorable foreign exchange impact on U.S. dollar purchases, the timing of certain import duty recoveries received and a lower year-over-year accounting inventory provision taken at the prior year end, which would have benefited Q2 2023.

We are pleased with the progress we made on improving our product margins through improved sourcing strategies, and expect year-over-year product margin expansion to continue through the rest of the fiscal 2024. However, we expect that the current volatility in the supply chain, driven by both global ocean freight capacity limitations and recent domestic transportation labor disruptions, along with the ongoing higher U.S. dollar relative to the Canadian dollar, to offset a portion of the product margin gains.

SG&A expenses were $31.8 million in Q2 2024, down 1.5% from $32.3 million last year. The reduction in SG&A expenses was driven by savings from ongoing cost management initiatives, including lower store occupancy costs and lower variable selling costs. This was partially offset by higher store personnel costs as a result of legislative minimum wage increases since 2023.

In Q2 2024, net loss was $5.2 million or $0.13 per share, improving from a net loss of $5.3 million or $0.13 per share a year prior. Adjusted EBITDA was a loss of $3.1 million compared to a loss of $3 million in Q2 2023.

Now turning to our balance sheet and cash flow metrics. At the end of Q2, our inventory was $44 million, down 21% as compared to $55.9 million at the end of Q2 2023. The year-over-year decrease in inventory was primarily driven by the strong sell-through of our pack-and-hold inventory since last year and lower off-price seasonal inventory, reflecting our improved inventory health. By the end of Q2, we have received the necessary replenishment for our core fleet collections heading into the fall season.

Our free cash flow was a $9 million outflow in Q2 2024 as compared to an outflow of $7.2 million in Q2 2023. The increased year-over-year cash outflow was due to a return to our seasonal inventory purchase cadence ahead of the fall and winter season, which was reduced last year due to the higher pack-and-hold inventory levels that we had.

Net debt was $40.8 million at the end of Q2 2024, down 20% as compared to $50.9 million at the end of Q2 2023. Our net leverage ratio, measured as net debt over trailing 12-month adjusted EBITDA, was 2.3x at the end of Q2 2024.

I will now pass it back to Meghan for closing remarks.

[Meghan Roach, executive]

Thank you, Leon. In closing, our second quarter results reflect notable improvements over the first quarter, and we had solid back-to-school performance at the start of Q3.

As we enter the second half of the year, we are in a healthy inventory position, and remain focused on what we can control in this evolving consumer landscape. Our priority is keeping our brand at the forefront of our consumers' minds throughout the holiday season.

On that, operator, you may now open the call to questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Brian Morrison from TD Cowen.

[Brian Morrison, analyst]

First question, it's obviously an increasingly competitive environment this back-to-school and holiday season with the health of the Canadian consumer. So talk about the retail demand trends. I missed some of your opening remarks. So what actions have you taken to maintain or gain share in terms of product and brand and marketing? And maybe just elaborate on what you said during your remarks. I didn't catch all of it.

And also, can you comment on your back-to-school growth? Maybe just cadence, ballpark or degree? Are we talking low single digits, mid-single digits?

[Meghan Roach, executive]

So I think I'd highlight a couple of things. So in the back-to-school perspective, we did see growth. We're not going to specifically give you the range of that growth because it sits early in the quarter. But I think when you look at the reasons for the growth, it's really coming from a number of things.

So I think first off, we do have a strong product portfolio. We came into the second half of the second quarter and into the third quarter with healthy cooper fleece inventory. We had strong collections such as our Cloud collection, our Active collection, and we're seeing that resonate with our consumers. That's very positive.

In addition to that, we really have had some really effective branding and marketing initiatives going on. So you can see that we've been laddering the marketplace. The types of content that we have out there across the board is much better. We have our new brand ambassador program, we've had more events. And so as a result of that, we're seeing more pickup with our brand in consumers' minds. And amongst new and existing consumers, we're seeing more traction, which is positive.

And the third thing I said is we're enhancing store experience, right? So I think you can see that not only in the renovations we did at the Eaton Centre store a couple of quarters ago, but you're seeing that filter into our in-store merchandising. And as Leon alluded to and we've talked about before, some of our inventory allocation is improving as we've been using these AI systems. So we're having the right product in the right place for the customers now.

So it's really getting across kind of, I think, all cylinders from a company perspective, that's been helping us. And so as a result of that, at the end of the second quarter, we saw improvements in the second quarter versus the first quarter, and we also saw the continuation of those improvements into the third quarter with the back-to-school period.

[Brian Morrison, analyst]

Okay. And that's helpful. And I guess the one thing that really stood out in your commentary when you started going through your product lines is what's the strength in your Activewear segment? I think you said it's up double digit. I mean this really looks like a category that many retailers are gravitating towards these days. So what's really differentiating in driving your product?

[Meghan Roach, executive]

I think we have a couple of key things. So this is -- we've been continuously, over the last couple of quarters, seeing double-digit growth in Activewear, and it really is becoming now a core part of the Roots offering. So it's again an area you will see us continue to expand upon in the go-forward strategy, and you'll see some more different products actually coming out in the winter time period also related to Active.

I think the strength of our Active categories, from my perspective, comes to 2 things. I think one, it still represents the same amazing softness, comfort, fit that our core sweats do, but just in different materials. And so people really love that feeling against their skin.

I'd say the second thing is that we actually have a sustained -- fully sustainable activewear line, which is unique in the marketplace, very differentiated, I think, relative to some of the people who are out there today.

And I think the third thing is Roots has always been known for this cross-section between athletics and comfort, right? If you go back a number of years, we've always had the athletic sponsorship, the Olympics, a number of different things.

And so when consumers are coming to us. They're coming to us for things that they can wear both indoors and outdoors. And so our product really resonates with them because you can work through multiple different use cases and occasions. And so we're seeing customers come back again and again for some of these core products in our Active collection.

[Brian Morrison, analyst]

Okay. Inventory looks very healthy, but it also looks very lean as I look back over the years. You mentioned that you have your core fleece well positioned, and I assume you have limited pack away. What have you done to ensure that you don't run into the same product shortages that we ran into at the end of last year?

[Leon Wu, executive]

Yes, Brian, that's a great question. I can take that one. So we split our inventory into really 2 groups. We have the core inventory like our core cooper fleece collections, and then we have our seasonal inventory.

For our core cooper fleece collections, we did get a large replenishment coming in, in the late July, that we mentioned. And as we look ahead into Q3 and Q4, we have increased the purchases, such that we expect that will support our seasonal inventory needs.

From a seasonal perspective, this is an area that we continue to monitor very closely. We do expect this to drive great growth going to the next 2 quarters. However, it is an area that we are okay to sell up. And it is ones that we often see where products are well received. It could sell out towards the end of the season.

In terms of just managing the inventory, one of the things I would call out is that the large decrease relative to last year is largely from the pack-and-hold inventory that we've sold through. I wouldn't use last year as a benchmark in the first 2 quarters, just given the impact of how that was carried to Q3 and Q4. But as we get into -- sorry, as in Q1 and Q2. But as we get into Q3 and Q4, the inventory levels that we had in the prior years, we should be able to maintain.

And finally, the last thing I would mention is just obviously looking at the global logistics market and the developments there. So we had a rail strike. We have some global logistics, ocean freight challenges we're continuing to monitor. And we're also paying close attention to what's happening with the local market as it relates to air freight, if needed. So we are being quite proactive there and managing that to ensure that the product is coming in time for our peak period.

[Brian Morrison, analyst]

Okay. Maybe just a follow up on that, just -- inventory is in good shape now. How should we think about your gross margin profile in the second half as we have some offsetting factors such as FX and freight, and then on the other side, you have product gains?

[Leon Wu, executive]

Yes. So we are quite pleased with the product margin gains, which is the underpinning of our margin in the long run. So this is comprised of our IMOs as well as the markdown rate. This quarter, we were very happy with the improvements in the cost base of the inventory as well as the reduced markdowns just given the natural, healthier inventory levels.

We did call out the FX rate. There is some inventory accounting provision noise in there for the second quarter, which should dissipate towards the third and fourth quarter.

As we look ahead to the third and fourth quarter, the 2 main variables that we continue to monitor are the FX rates, specifically the U.S. dollar. And secondly, what is happening in the development as it relates to the transportation market.

So due to the global ocean challenges, we are seeing that the global market for ocean freight is going up roughly about 40% to 60% relative to what it was last year, but still well below what it was during peak COVID levels. As we leverage and explore airfreight as needed, that cost could increase further.

So those are 2 factors that we expect to partially offset some of the Q3 and Q4 product margin tailwind from a costing perspective. But ultimately, in the third and fourth quarter, we expect the costing and margins to be more prominent of a benefit.

[Brian Morrison, analyst]

Okay. So we just should think they offset each other?

[Leon Wu, executive]

Yes.

[Brian Morrison, analyst]

Okay. And then Meghan, question on store optimization initiatives. We have seen a little bit of a store count reduction, very nominal, but one and the same. How do you feel about the footprint at this time?

[Meghan Roach, executive]

Well, I think, Brian, as we talked about in previous quarters, we're in a lucky position because we have very few stores that lose money, right? So when you look across our store base, from our perspective, we really have a strong initiative focused on increasing sales per square foot. And so as we look at the stores we've closed so far, in a lot of cases, they either consolidated those into other stores or we're focusing on sometimes increasing our footprint to account for the fact that we think we have a better opportunity in certain high-traffic locations to generate better sales per square foot.

So when we look across the network, I mean I don't think we're looking at any like wide-scale closures for sure. We really are looking at where we can enhance the customer experience and the store experience and where we can put in initiatives to drive that incremental sales per square foot over the next couple of quarters.

And I think when you look at our comps, I mean, it's been nice to see the improvement quarter-over-quarter on that, and we continue to be focused on those comp sales. But obviously, in the near term, there's been some reductions to overall sales as a result of the store closures. But you should see the positive impacts come through both gross margin and EBITDA as a result of some of these changes.

[Brian Morrison, analyst]

I'm encouraged to see what happens in the second half.

[Operator]

There are no further questions at this time. I'd now like to turn the call back over to Ms. Roach for any final closing comments.

[Meghan Roach, executive]

Thank you, everyone, for joining our Q2 2024 earnings call. We hope you pay attention to the next couple of quarters as we have some exciting things coming down the pipeline.

And on that, operator, you may now conclude the call.

[Operator]

Thank you. The company would like to remind listeners that the call, including the Q&A portion, may include forward-looking statements of its 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 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 third (sic) [ second ] quarter management's discussion and analysis 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.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and you can now disconnect your lines.