Roots Corp

TSX:ROOT

Good morning. My name is Elliot, and I will be your conference operator today. At this time, I would like to welcome everyone to the Roots Third Quarter Earnings Conference Call for fiscal 2024. [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, 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 to listeners to its third quarter management's discussion and analysis dated December 10, 2024, 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 third quarter earnings release, the related financial statements and the management's discussion analysis are available on SEDAR as well as the Roots Investor Relations website at www.investors.roots.com.

Supplementary presentation for the Q3 2024 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 expected. Thank you. You may now begin your conference.

Thank you, operator. Good morning, everyone, and thank you for joining our Q3 2024 earnings call. On the call today, I will briefly review our third quarter financial results, which our CFO, Leon Wu, will cover in more detail and then discuss our operational highlights and early reads in our holiday results. Our strong back-to-school momentum continued throughout the third quarter with total sales finishing at $66.9 million compared to $63.5 million last year, a 5.3% increase year-over-year.

The growth was driven by both segments. DTC sales increased 3.8% to $54.2 million and Partners and Other sales grew 12% to $12.7 million. In addition, our comparable sales increased by 5.8% with growth coming from both e-commerce and stores. On top of our strong sales growth, we achieved gross margin expansion of 160 basis points through improved product costing, lower discounting and scaling of our operating costs. This resulted in adjusted EBITDA of $7.1 million or 10.6% of sales, growing 29% from $5.5 million or 8.7% of sales last year.

We also continue to see improvements in our balance sheet and our inventory composition heading into the fourth quarter.

Now turning to our third quarter operational highlights that drove growth year-over-year. We remain focused on enhancing our brand visibility and the corresponding marketing assets and brand messaging. This was executed through full funnel marketing initiatives that produce an authentic and relatable experience to our customers. Our brand ambassador program, which launched in the first quarter of this year, continues to generate organic connections with our target audience and resulted in strong engagement metrics across key social channels as well as product content in line with our key collections during the season.

In September, we launched a multiyear partnership with the Nature Conservancy, Canada. This partnership is a natural extension of our brand, caring for the very landscape that inspire us.

Our third quarter back-to-school fall campaign also provided consumers with a new modern perspective of Roots and contain compelling content that really resonates in our key commercial period. The success of these 2 campaigns was reflected in the strong sales of the collections featured. Our holiday campaign, Anything Roots, Everything Holiday, aims to connect with consumers through multiple touch points, underscoring why Roots continues to be a wardrobe favorite and makes the perfect thoughtful gift during the holiday season.

We also launched a first-of-its-kind experiential activation at The Well in Downtown Toronto. This pop-up transported visitors to nostalgic scenes featured in our campaign, reheading the magic of the season and reinforcing why Roots is phenomena to the Canadian holidays.

Designed to evoke the warmth and charm of classic holiday traditions, the experience also offered guests the chance to connect with loved ones through personalized greeting cards while discovering our new winter collection. In early December, we also announced our partnership with the WNBA and Canada's first WNBA team, the Toronto Tempo. This partnership reinforces our commitment to athletics and community. We look forward to sharing our new products associated with the WNBA and the Toronto Tempo in early 2025.

From a product perspective, we are pleased with the strong reception to both our seasonal newness and our core collections. Our fall Signature collection, the first collection fully influenced by our Creative Director, Joe Gollish, saw strong sell-throughs on its key pieces and offer consumers a modern logo and innovative styling options to complement our core collection.

Our Adult Active collection continues to be one of the fastest-growing product offerings at Roots, growing over 40% year-over-year. As this collection becomes a core year-end offering, we continue to see upside growth in this area. Our core fleece collections comprised of our iconic Cooper fleece, Genderfree One fleece and the ultrasoft minimal logo cloud fleece experienced strong year-over-year growth and accelerating momentum from the first half of the year. These collections were highlighted in our back-to-school campaign and also benefited from the improved inventory position that negatively impacted sales in the first half of the year.

In October, Roots is also recognized at the Canadian Arts and Fashion Awards for outstanding achievement, celebrating the brand's rich heritage and commitment to quality, authenticity and innovation. In early November, we launched our [indiscernible] collaboration with Wicked, inspired by the Land of Oz. Products included an enchanting collection of [indiscernible], Graffiti and Custom Varsity jackets and bags made in our Toronto Weather factory.

This collaboration brought both new and existing customers to the brand. Earlier this month, we also welcomed our new Head of Design, Bea Nam. A graduate of Parsons School of Design, Bea brings 20 years of fashion design, product development and brand strategy to the role, including the experience of prominent global casual and athleisure brands. We're excited to have her join the team and look forward to sharing her impact in the quarters to come.

The execution of our operational initiatives and our focus on executional excellence continue to serve as cornerstones for improving the customer experience and enabling profitable growth. During the third quarter, we completed the first phase of our new flagship store on Robson Street in downtown Vancouver. Upon completion of the final phase by the middle of 2025, the new 4,000 square foot location situated next to the current store will feature our new contemporary design concept that incorporates the forest and other nature-inspired [indiscernible], modern visual features, a brighter color palette and fixture elements focused on improving the customer shopping experience.

The project marks one of several upcoming renovations in our most prominent locations starting in 2025 to support the enhancement of our brand initiatives.

We also marked the first anniversary of the launch of our endless aisle platform. This tool has improved the ability of customers to access our entire collection when in store, and we have seen double-digit increases in the in-store order placements, ensuring more customers leave our stores with the products they desire. We are also starting to realize the early benefits of the adoption of our AI initiative.

Q3 reflects the second quarter since launching our AI-driven replenishment systems, and we have seen notable improvements in our inventory efficiency metrics of stores and improving customer experience through inventory availability. We are excited about the potential in this area as the systems gather more data and improve algorithms. We see this tool as a key component to supporting accelerated growth at stores.

We also launched the first phase of our AI-driven online solutions that provide curated messaging through own communication channels intended to improve response rates and the relevance of content sent to customers. In addition, we enable customer communication through SMS messaging. The second phase of this solution is expected to go live in early 2025, which will further curate the experience of our e-commerce website based on the past shopping preferences of each visitor.

Before turning the call to Leon, I would like to briefly provide our early reads on the holiday period following into Q4. We are pleased that the third quarter momentum continued throughout the first 5 weeks of the fourth quarter, which includes the Black Friday and Cyber Monday period. While it is still early, the preliminary results underscore the long-term growth opportunities of Roots and its enduring brand affinity with new and existing customers, especially during the holiday period. As a reminder, the fourth quarter has historically accounted for nearly half of our annual revenue.

With that, I will pass the call to Leon, who will review our third quarter financial results in more detail.

Thanks, Meghan, and good morning, everyone. Total sales were $66.9 million in Q3 2024, up 5.3% as compared to $63.5 million in Q3 2023. PTC sales were $54.2 million, up 3.8% relative to $52.2 million a year ago. Notably, our DTC comparable sales grew 5.8% during the quarter and were positive across both channels. The increase in DTC sales was driven by strong performance in our core product collections by Cooper fleece, Cloud fleece and Active, which was further amplified through our back-to-school and fall marketing campaigns and improved in-stock position.

Our investments in AI-driven store replenishment and store scheduling, enhancements to our store experience at key flagship locations and the omnichannel endless aisle capabilities launched last year together also led to improved conversion.

The growth in DTC sales was partially offset by closures of select stores since Q3 2023 as part of our ongoing initiative to optimize our store fleet by consolidating less profitable stores and driving comparable sales growth. We are pleased with the sales momentum built since the tail end of Q2 2024, achieved by building the brand through captivating brand campaigns, improved customer experience and curated product assortments, all while remaining disciplined on our discounting.

Partners and Other sales were $12.7 million, up 12% from $11.3 million last year. The sales increase was driven by higher sales to our international operating partner in Taiwan as a result of earlier timing of last year's Q3 orders shipping earlier in Q2 and by higher royalties from the licensing of the Roots brand to select manufacturing partners.

As a reminder, there was an extra week in the fourth quarter of fiscal 2023, which represented $2.2 million of sales last year. Total gross profit was $40.2 million in Q3 2024, up 8.2% compared to $37.1 million last year. The growth in gross profit dollars was driven by an increase in sales across both business segments and the increase in the gross profit margin across both segments. Total gross profit margin was 60% in Q3 2024, up 160 basis points compared to Q3 2023. DTC gross margin was 64% in the quarter, up 160 basis points from 62.4% last year.

As a reminder, 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 250 basis points, driven by the continued improvements to costing as part of our ongoing sourcing strategy and remaining discipline surrounding our discounting. This was partially offset by an unfavorable foreign exchange impact on U.S. dollar purchases. We expect further upside to our product margins through costing opportunities into the next year, partially offset by the stronger U.S. dollar relative to the Canadian dollar.

SG&A expenses were $34.5 million in Q3 2024, up 2.1% from $33.8 million last year. The increase in SG&A expenses was primarily driven by increases to store personnel costs as a result of legislative minimum wage increases throughout 2023 and recently in October 2024 and higher variable selling costs. As a percentage of sales, SG&A expenses scaled from 53.2% of sales last year, down to 51.6% of sales this year. In Q3 2024, net income was $2.4 million or $0.06 per share, improving from $0.5 million or $0.01 per share last year. Adjusted EBITDA was $7.1 million, increasing 28.8% compared to $5.5 million in Q3 2023.

Now turning to our balance sheet and cash flow metrics. At the end of Q3, our inventory was $60.4 million, down 2% as compared to $61.4 million at the end of Q3 2023. The year-over-year decrease in inventory was primarily driven by the strong sell-through of our pack and hold inventory over last year and lower off-price inventory. This was largely offset by increases to both on-hand seasonal styles and in-transit core replenishment and upcoming styles, reflecting a cleaner inventory composition and improved inventory health.

We have also been focused on improving the productivity of our inventory at stores through our automated replenishment system launched earlier in the year. Early benefits include the capability to enable daily replenishment, improved store inventory turns and reduced dormant stock.

Our free cash flow was a $6 million outflow in Q3 2024 as compared to an outflow of $1.7 million in Q3 2023. The increased year-over-year cash outflow was due to a return to our seasonal inventory purchase cadence for our fall and winter season, which was reduced last year due to the higher pack and hold inventory levels. Net debt was $46.9 million at the end of Q3 2024, down 11.3% as compared to $52.9 million at the end of Q3 2023. Our net leverage ratio, measured as net debt over trailing 12-month adjusted EBITDA, was 2.4x as at Q3 2024, improving from 2.6x a at the same time last year.

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

Thanks, Leon. In closing, the strong third quarter results and the positive early fourth quarter momentum reflects the immense long-term growth potential of the brand. We are entering 2025 with a stronger inventory composition and a healthy balance sheet and with marketing, products and operations working in unison. We are optimistic about maintaining positive momentum as we navigate the evolving consumer landscape.

Operator, we will now open the line for questions.

[Operator Instructions] First question comes from Andrew Lopez with TD Cowen.

Congrats on the strong quarter. I just want to start with the state of the consumer. Yes, I just want to start with the state of the consumer. What are you seeing to start in Q4 in general and from competitors, inclusive of any impact of the shortened holiday selling period? And relative to this, what is driving your outperformance both in terms of product and as a result of your digital marketing initiatives in place?

Andrew, maybe I'll take that and Leon can add some additional comments. So I would say from a how we're trending perspective. So from a Q3 perspective, we obviously saw very strong results, and we continue to see this momentum into Q4. So we're very happy with that. What we think is happening from a consumer perspective with us specifically is it really a combination between strong marketing efforts we've had, great quality products, and you're seeing that across a number of product categories, so active core fleece which includes Cloud, One and many of our seasonal product items also. And then in addition to that, you're seeing us just have really great operational excellence.

So when you go into our stores, digital merchandising is great, the store staff are wonderful and online, we're seeing equal growth as we're seeing in stores. So it's a combination, I think, about executing across a number of different assets in the business that we're really seeing positive momentum. And so I can't comment on the broader consumer as it relates to our competitive set. But from our perspective, we are seeing a consumer out there and shopping with us during the holiday season.

Go ahead, Leon.

Yes, Andrew, I'll add on to additional things. So you mentioned the shorter holiday season. So we are acknowledging that there's 5 less shopping days between Black Friday, Cyber Monday and the Christmas season. That being said, it's -- we're still early in the quarter. So, so far, we're seeing the positive momentum, like Meghan mentioned, but it's something that we'll continue to monitor as we go into the holiday period.

The other thing that has been positive for us is just a strong inventory composition that we've had going into the holiday season. So last year, we were carrying a lot more pack and hold inventory. And as a result, it was a different amount of seasonal offerings to the consumer. This year, we had a much more relevant composition of inventory for the holidays. And as well, we're actually dropping new seasonal excitement for December and early into next year, which then should also continue to bring customers back.

Okay. Yes, that answers my question. I guess I just want to maybe follow up in terms of promotional activity that you're maybe seeing in the market just in terms of any kind of pull forwards?

Yes. Well, from our perspective, we continue to be disciplined around promotions. So we typically follow the consistent cadence with previous years. We started a little bit earlier this year, but nothing material, and we haven't seen any pull forward based on our financial results based on our cadence of promotions. We remain disciplined around the amount of promotions we've given, the quantity of promotions in terms of the depth. And then what we're actually seeing happening this season is really some strong sell-through of our products. And so less of a need to promote as you get closer to the end of the year.

No, I mean, that makes sense. And it sounds like your seasonal offerings are more aligned and reducing that need for any kind of promotional activity. So just on that, how do you feel your inventory and product assortment compared to last year in Q4? And exiting the year, where do you expect to be on seasonal inventory?

Yes. So we're in a much cleaner state this year than last year. So last year, we had a lot more carryforward. And if you remember, then as a result of that, when we carried for -- sorry, when we pulled inventory from Q1 to the holiday season to supplement that, that left us with a bit of a deficit in Q1 and Q2 of 2024. So we're in a much better spot this year, carrying relevant seasonal inventory into the holidays with planned units dropping for December and into the new year. So I would say that if we look ahead, inventory is in a great spot, not only from a balance perspective, but also from a competition perspective.

Okay. And then last one for me is just -- sorry, if you could just provide a little bit more color on the store closures in the quarter? I wasn't sure I was understanding that.

Yes. So as part of our ongoing strategy, we continue to look at our store portfolio and identify locations that may not be performing as well as others. The positive is that Roots generally makes profit in each of our locations, but we identify opportunities to really consolidate some of these stores and focus on some of our top stores.

So as we go into next year, you should expect us to really capitalize on some of our flagship locations, which we have been doing. We just recently announced a flagship in Vancouver that we're excited about. So overall, we're really looking to enhance the customer experience, and that's part of our ongoing real estate strategy to look at our fleet. But as a result, you still see that really positive comp sales, and that's the strategy we want to continue with.

Okay. I guess that would be excluded those store closures from the comps. Is that right or...

That's correct.

We have no further registered questions. I'll now hand back to Meghan Roach for any final remarks.

Thank you, operator. Thank you, everyone, for joining the call today. And thank you also to our entire team for their hard work, which enabled the positive results leading up to our busiest time of the year. We look forward to providing you with an update on our fourth quarter and fiscal 2024 results in April, and we wish everyone a safe and enjoyable holiday period.

Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines.