Roots Corp

TSX:ROOT

Earnings Call Transcript 2024-Q4

[Operator]

Good morning. My name is Judy, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Roots Fourth Quarter and Full Year 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 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 fourth quarter management's discussion and analysis and/or its annual information form dated April 9, 2024, 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 fourth quarter earnings release, the related financial statements and the management's discussion analysis are available on SEDAR as well as on the Roots Investor Relations website at www.investors.roots.com.

A supplementary presentation for the Q4 2023 conference call is also available on the Roots Investor Relations site.

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

[Meghan Roach, executive]

Good morning, everyone. Thank you for joining us today for our Q4 2023 earnings call. Despite the headwinds caused by the significant interest rate increases over the last 2 years, that have impacted consumer discretionary spending and our fourth quarter revenue, we delivered solid performance across several key metrics. As we continue to navigate the current economic landscape, we remain proud of the team's dedication and focus on our major strategic initiatives, which will position the company for long-term growth as the market normalizes.

During the fourth quarter, total revenue declined by 2.9%, while our direct-to-consumer sales were down slightly at negative 0.8%. Our gross margin increased by 210 basis points leading to an adjusted EBITDA decrease of 1.5% year-over-year. On an annual basis, we also significantly reduced our inventory by 34%, drove net debt down by roughly 32% and more than doubled our free cash flow.

Leon will take you through the financial results in more detail. But before we turn to Leon, let me highlight some of our key accomplishments from the fourth quarter in 2023 as well as our strategic outlook for 2024. In Q4, we saw positive traffic trends across our stores and our website. We also enhanced our brand presence and created production. The launch of the 50th anniversary campaign brought new customers to the brand and reminded existing customers of our rich heritage and quality product offering.

Our enhanced studio and our team as well as the addition of a Creative Director in Residence led to better content creation, highlighted in our robust holiday campaign and our summer campaign, which captures the minds of consumers. Our notable international collaboration during the fourth quarter in the year included Barbie and CLOT. Barbie plays to our strength with our predominantly female consumer base, it also enabled us to showcase our impressive offering across sweats and leather to a new audience.

With the only Canadian Barbie doll, the partnership also formed a solid part of our gifting strategy in the fourth quarter. CLOT, our first Asian focused partnership sold well across multiple international markets, and facilitated a more physical on-the-ground presence with its distribution in CLOT stores in Asia, and it also helps position us well for future market development.

Our core collections also continued to drive positive momentum. We continue to grow our active-wear board category, which increased by 45% year-over-year and grew as a percentage of total sales. Cooper Sweats sales also stabilized on an annual basis and grew in the fourth quarter. We successfully launched several new product initiatives. Most notably, more than 90% of our products are now made with sustainable materials such as organic cotton or recycled polyester. And we also saw growth in our Taiwanese business, which has been renovating stores, enhancing its online presence and engaging with a new younger audience.

In 2023, we also enabled Canadian stores to shift to our U.S. consumers, which significantly increased the availability of our assortment to the market. As a result, e-commerce sales to the U.S. increased double digits during the fourth quarter and the year.

In China, we also shifted to a new more established partner on Tmall, reflecting our positive growth to date and our belief in the long-term opportunities in the market. We made significant new hires across marketing, technical and product development and data analytics, and we also reorganized several major groups to optimize our organizational efficiency and effectiveness.

Looking ahead, we have identified several opportunities to enhance our performance further and position ourselves for long-term success, here are some of our key strategic priorities. We will continue to improve our product margin with product cost reductions already secured in 2024 and incremental targets in place for 2025. We have been able to do this without reducing our product quality, and in many places, improving it.

We're also making strategic investments in data lake and AI technology to improve both the online and store experience as well as conversion. In the near term, our focus is to enable more personalization and relevant content as well as recommendations to our customers online. In store we plan to use AI to enhance merchandising and replenishment, and our data lake will also strengthen our data-driven insights across the company.

With our new Chief Marketing Officer now in place, enhancing awareness and consideration of Roots and its product franchises is also a key priority. We are focused on improving marketing execution, such as launching a brand investor program, creating more engaging and diverse content and investing in targeted and efficient media channel. We're also expanding our year-round active work collection, which now incorporates more performance and sustainability features and building out our product offering, including an elevated Made-In-Canada line.

We will also be capitalizing on our momentum in Asia by making more targeted investments in China, which is emphasized by our recent switch in Tmall partners and partnerships with CLOT and from [indiscernible]. We are proud of what our team has achieved this quarter and throughout the year. We continue to innovate and adapt to the changing consumer preferences and behaviors, while staying true to our core values of quality, comfort and sustainability.

We've also made significant progress on our chief initiatives, such as expanding our product portfolio, improving our product margins, enhancing our e-commerce capabilities and growing our international presence. We are confident that we have a solid foundation to build on as we enter 2024 and beyond. However, I want to emphasize that we continue to expect economic headwinds in the first half of the year.

Over the medium to long term, we believe we have a unique opportunity to leverage our brand equity and our loyal customer base to capture more market share and drive long-term growth and profitability. I will now turn the call over to Leon Wu, our Chief Financial Officer.

[Leon Wu, executive]

Thanks, Meghan, and good morning, everyone. I'll start by covering our fourth quarter results followed by a quick summary of our fiscal 2023 performance. As a reminder, our fourth quarter and fiscal year 2023 contains an extra week such that Q4 2023 results comprises of 14 weeks and fiscal year 2023 results comprises of 53 weeks.

Unless otherwise noted, comparisons referenced the respective 13-week and 52-week fiscal periods in 2022. Where meaningful, I will highlight the financial impact of the extra week. Q4 sales were $108.2 million, a decrease of 2.9%. DTC sales were $97.8 million, down 0.8% compared to $98.5 million last year. The extra week in fiscal 2023 represented $2.2 million of DTC sales.

As Meghan mentioned, DTC sales were driven by strong demand in our core products as we saw positive performance during market-wide Black Friday and Cyber Monday periods. We saw positive year-over-year traffic patterns across both channels throughout Q4, reflecting the ongoing strength of the Root's brand as a destination during our strongest quarter. However, this was offset by declines in conversion reflecting the tighter consumer discretionary spending in the current macroeconomic environment within Canada.

Our average basket size has remained consistent year-over-year, indicating that when customers are ready to transact they are spending the same amount with Roots. Partners and Other sales were $10.5 million, down 19% compared to $12.9 million last year. The decline in sales was primarily driven by a wholesale order to select retail partners that Root chose to not repeat last year.

On a full year basis, our partners and other sales were $40.2 million, compared to $40.9 million last year, which excluding the Q4 wholesale order that did not repeat, reflected positive growth in the Asia market. Total gross profit was $63.4 million in Q4 2023, up 0.7% compared to $63 million last year. Total gross profit margin was 58.6%, up 210 basis points compared to total gross profit margin of 56.5% last year.

The increase in the total gross profit margin was driven by a higher mix of higher-margin DTC sales this year, and improvements in gross margins within both operating segments. DTC gross margin was 59.9% in the quarter, 120 basis points higher than 58.7% in Q4 2022. The increase in DTC gross margin was as a result of a lower inventory provision in Q4 2023 due to the healthier inventory position ending the year.

Our DTC gross margin also increased from improved product costing and lower freight costs, including 60 basis points from lower air freight but was offset by a higher mix of sales during discounted periods such as Black Friday and an unfavorable foreign exchange impact on U.S. dollar purchases.

As of Q4 2023, we have largely caught the product margin impacts from the transition to sustainable materials that began in Q3 2022. Furthermore, we anticipate further year-over-year product margin upside in 2024, resulting from the investments made to advance our sourcing function, partially offset from the ongoing foreign exchange headwinds on U.S. dollar purchases versus last year.

SG&A expenses were $41.2 million in Q4 2023 down 3.9% from $42.9 million last year. The decline in SG&A expenses was driven by gains arising from lease modification under the IFRS 16 leasing standard, and lower variable selling costs. This was partially offset from higher store and corporate personnel costs, including from the increased minimum wage in Ontario that began in October, and impact from this extra fiscal week in Q4 2023.

Like Meghan mentioned, we have invested to make substantial improvements to our business operations in 2023. As we look ahead to 2024 we expect total SG&A to grow at similar rates as current inflationary levels. Net income totaled $14.6 million or $0.36 per share in Q4 2023 as compared to Q4 2022 net income of $13 million or $0.31 per share. This equates to an increase of 12.6% on a total basis or an increase of 16.1% on a per share basis.

Adjusted EBITDA was $23.2 million in Q4 2023 compared to $23.5 million for the same period last year. Now turning over to our balance sheet and cash flow. Our inventory position ended the year at $36.2 million, down $18.8 million or 34.2% as compared to $55 million at the end of 2022. The year-over-year decrease in inventory was driven by both a $12 million reduction in on-hand inventory as we strategically managed our purchases during the year and sold through our pack and hold collections, and $6.8 million of lower in-transit goods, partially due to the later timing of shipments from our vendors during the year.

We entered fiscal 2023 with approximately $8 million of pack and hold core inventory. At the end of the year, we have sold through over 80% of this inventory at comparable discount rates as the rest of our assortment, validating the merits of this strategy to both manage inventory levels and preserve margins.

While we are pleased with the overall reduced inventory levels, the strong fourth quarter demand of certain core product categories like Cooper Sweats exceeded our expectations. As a result, we anticipate there may be missed sales opportunities during the first half of the year as we work to replenish our stock in those specific areas.

The improved inventory position and continued discipline surrounding our capital investments were key drivers to the improvement of our free cash flow, which was $12.4 million on a full year basis up 187% compared to $4.3 million in the last year. As a result, we have continued to deleverage our balance sheet, ending the year with net debt of $17 million down 31.6% as compared to $24.8 million last year.

Our net leverage ratio measured as net debt to adjusted EBITDA was less than 0.9x and we will look to further deleverage by the end of next year.

In closing, I am proud of our team's progress in improving our inventory health and driving cash flow growth to reduce our net debt, while navigating through the challenging operating environment. We expect sales headwinds will persist in the first half of 2024, driven by the macroeconomic challenges and missed inventory opportunities in certain core collections, but we are optimistic that the progress made in 2023 will set us up for long-term profitable growth and the consistent delivery of strong annual free cash flows.

This concludes our prepared remarks for Q4 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]

Can you please talk about consumer behavior, what you've seen through the start of fiscal 2024 just in terms of are you continuing to see strong traffic and conversion being impacted by the macroeconomic environment? And maybe just elaborate on your comments, you expect to see headwinds through the first half of the year. Does that imply you should see strength in the second half?

[Meghan Roach, executive]

Yes. So I think what I would say is a few things. I mean, obviously, we're all waiting with bated breath this morning to see what the Bank of Canada says about interest rates. I do think that interest rates are playing a big impact on consumer discretionary spending broadly. We saw that in the fourth quarter, and we expect to continue to see that in the first half of the year. And so our citation I think consistent with the market's expectation is that there should be some easing of that into the second half of the year, which should have a positive impact on consumer discretionary in general. So I think that's kind of the overall macro perspective that we have.

I would say more broadly, what we're really focused on our business is what we're seeing from a traction perspective, with our key collections. So continue to see some great demand as it relates to core and after-wear, as Leon alluded to in his comments, and obviously, excited to see some of the new stuff that we have coming out now to see the reaction from a consumer perspective, but we're obviously taking into consideration the overall macro headwinds that continue to be present and that we expect to be present at least until the second half of the year.

[Brian Morrison, analyst]

Okay, are you able to share -- I mean, the active-wear growth is quite impressive. Are you able to share what percentage of sales that makes up at this point in time? Or is that too detailed?

[Meghan Roach, executive]

Just many people say selling on it, but what I can tell you is that it has been increasing as a percentage of sales over the last year. So we are seeing an increased penetration, but we haven't disclosed specifically the percentage this quarter.

[Brian Morrison, analyst]

Okay. And then in terms of inventory, obviously, I understand the sell-through has been very good. You have to replenish to a certain extent in certain brands. Can we expect with supply chain normalization that you're going to be running a pretty lean inventory despite the replenishment that has taken place from -- on a going-forward basis?

[Leon Wu, executive]

Brian, sure, I could take that one. We do see that the supply chain timing and the lead times have normalized quite a bit over the last few months. That being said, I would say that at the current levels, there are certain pockets of inventory like our core, especially in Cooper Sweats, where we would prefer to be in a higher inventory position than we currently are, and that's what we shared, we may be missing some sales on the table contributing to Q1 and Q2 headwinds.

But in the long run, I would say that the current inventory levels were just slightly above it is where we would like to be in the short term, and in the long run, we do want to improve the productivity of the inventory.

[Brian Morrison, analyst]

And Leon, while I've got you, the comment with respect to lease modifications to change, is that a permanent change? I understand SG&A is going to grow in line with inflation, I think your comment was. But should we expect the change that has occurred in the fourth quarter, is that a permanent impact upon your financial performance?

[Leon Wu, executive]

I'm not quite sure in terms of what you were referring to in terms of permanent. So this is related to a few stores that we decided to either close or change the lease terms in the next year, and that was what's driving some of the savings. So yes, we'll continue to look at our real estate fleet and as we find opportunities to optimize that and drive savings there, we will.

[Brian Morrison, analyst]

Okay. And Meghan, can you comment maybe on the size of the footprint right now? I see that we've had some store reductions over the past 12 months? Or are we content with where we are or will we be evaluating maybe a smaller footprint going forward?

[Meghan Roach, executive]

Maybe I'll jump in Leon and then you can go, so I think what we are trying to do right now is really focus on not necessarily looking at the number of stores we have, but also the productivity of the stores as well as the footprint in terms of where our consumers are and where we think we're going to have the benefit of those consumers going forward. And so we've been doing a lot of research from an analytics perspective, really be focusing on what our cross-shopping is amongst consumers and then also what that means to our store footprint, so Leon, if you want to go into that in more detail, maybe I'll pass it on to you.

[Leon Wu, executive]

Yes. I would say that the strategy we've been looking at in terms of using pop-ups as a testing the market continues to be very robust and a way for us to enter into new markets as well. A lot of the stores we're actually closing are also just stores that we either are consolidating and moving to larger location or even stories where we have strong performance of vicinity stores often through these test and learn out models.

So I would say that the current fleet is a good size, but we'll always continue to look at where there's opportunities to either move around stores or improve the efficiencies, that's where we would really be focusing attention on.

[Brian Morrison, analyst]

Okay. And international sales, are we able to say the percentage that comes from the U.S. at this time or if it's disclosed?

[Meghan Roach, executive]

It's a small percentage, but we're seeing good growth. And I think -- as we talked about in previous quarters, our focus in the U.S. has really been around this multi-phase strategy, right? So the first phase of that was really getting our digital platform coming and then focusing on digital, then kind of pop up in more physical locations. And we were excited about the fact that in Q4 this year, we were able to enable our Canadian partnership to U.S. destinations, and so as a result of that, we really have increased the overall inventory pool, and that's what's been driving some really positive momentum in sales.

So we don't disclose specifically that percentage right now, although you can see a lot of details in our financial statements in regards to international and other. But broadly, we are very happy with the momentum that we're seeing there and continue to believe there's some good opportunity for us in the U.S.

[Brian Morrison, analyst]

Very good. Last question. I will say in a challenging year, I still think that what might be overlooked here is just how impressive and strong your free cash flow performance was. Can you maybe just comment upon -- did you renew your NCIB or with leverage down under 1 turn pre-IFRS 16? Do you have any intention of being active within NCIB or is your preference to repay debt at this point in time?

[Leon Wu, executive]

Brian, we'll continue to assess the market to see where it's going. A lot of the free cash flow this year is coming from the reduction of inventory. Obviously, that is great and in a position we want to be from net debt. But as we look into next year, as we anticipate headwinds in the first half of the year, we just want to be prudent and make sure that we are still maintaining a strong balance sheet and where the opportunities arise we'll look at alternative options as well.

[Operator]

We currently have no questions at this time. I would like to turn it back to Meghan Roach for closing comments.

[Meghan Roach, executive]

Thank you for joining our Q4 2012 earnings call. With that, operator you can conclude the call.

[Operator]

Thank you, Meghan, and thank you, Leon. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.