Savers Value Village, Inc.

Good afternoon and welcome to Saver's Value Villages conference call to discuss financial results for the second quarter ending June 29th, 2024. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. Please note that this call is being recorded and a replay of this call and related materials will be available on the company's investor relations website. The comments made during this call and the Q&A that follows are copyrighted by the company and cannot be reproduced without written authorization from the company. Certain comments made during this call may constitute forward-looking statements which are subject to significant risks and uncertainties that could cause the company's actual results to differ materially from expectations or historical performance. Please review the disclosure on forward-looking statements included in the company's earnings release and filings with the SEC for discussion on these risks and uncertainties. Please be advised that the statements are current only as of the date of this call, and while the company may choose to update these statements in the future, it is under no obligation to do so unless required by applicable law or regulation. The company may also discuss certain non-GAAP financial measures. As a reconciliation of each of these non-GAAP measures to the most directly comparable GAAP financial measure can be found in today's earnings release and SEC filings. Joining from the management on today's call are Mark Walsh, Chief Executive Officer, Gibran Tanias, President and Chief Operating Officer, and Michael Marr, Chief Financial Officer. Mr. Walsh, you may go ahead, sir.

Thank you. Good afternoon, everyone. We appreciate you joining us today. Let me just start by laying out the highlights to the quarter and the way we are developing the business, and then I'll touch on each of these a little further. Our U.S. business performed well in the second quarter with results that were in line with our expectations. Our results in Canada were below our expectations, which we believe was driven primarily by macroeconomic factors. We feel very good about our pipeline of new stores and the performance of our recently opened stores. Our donation trends remain strong, and we continue to invest in a multifaceted supply and processing strategy that unlocks growth. Let me now touch on each of these in a little greater detail. African sales trends in our U.S. business remain solid throughout the quarter, with consistent low single-digit increases in both transactions and average baskets, while our business in Canada softened as the quarter progressed. Over the past few quarters, the Canadian economy has faced significant headwinds. GDP per capita has declined, and the unemployment rate has risen from 5.7 percent to 6.4% just in the first half of this year. Canadian household debt is over 100% of GDP, and household debt service costs have increased sharply to over 15% of household income. Both are near historic highs. Housing affordability is a core issue. Canadian home mortgages typically require an interest rate reset every few years, resulting in substantially higher mortgage payments at today's rates relative to a few years ago. Renters face similar cost pressures as Canadian rent inflation is up double digits over the last two years, and new housing and apartment supply remain severely constrained. Against this backdrop, Canadian consumers are cutting back on discretionary categories such as apparel and housewares. According to retail sales data published by Statistics Canada, total sales of apparel and footwear fell during the first four months of the year, with a decline accelerating as the year has progressed. While we also know from our consumer survey data that thrift shoppers, many of whom are at the low end of the income scale, are experiencing greater financial stress than the population at large. We see this playing out in our business in Canada where our customers skew younger and lower income than the general population. We are capturing some trade down from consumers who are reducing their spend at non-discount retailers, but unfortunately this is more than offset by weakness in our lower income customer cohorts. Macro conditions aside, we are focusing on managing what we can control and continuing to strengthen our offering and value proposition to the Canadian consumer. With an average unit retail of $5 US, we provide a tremendous value, and we have strong customer loyalty. Active member counts grew by double digit percentage in Canada over the last year, and we continue to see very low attrition from our loyalty program among our highest and best spenders. We're continuing to test approaches to drive foot traffic, increase conversion, and improve our overall value perception among consumers. While we are certainly not content with our results in Canada, we remain confident in our long-term outlook. We enjoy 95% brand awareness in Canada and estimate that one in three households shop with us. In addition, our Canadian business remains profitable With all but one of our comp stores, they are generating positive four-wall contribution despite current top-line headwinds. And our survey data indicate that our core Canadian consumers plan to increase their spending at thrift stores as their incomes grow. These strengths give us confidence in our ability to navigate the cyclical downturn and emerge well-positioned for continued success. Despite the macro headwinds in Canada, our long-term growth plans continue to gain momentum. This year, we are on track to open our targeted number of 22 stores plus an additional seven from the Two Peaches acquisition for a total of 29 new stores. We also feel good about the trajectory of our new stores for next year with an initial plan of 25 and a more balanced quarterly cadence to our opening schedule. We opened four new stores and acquired seven Two Peaches stores in the second quarter. Our new stores in total are exceeding our expectations with the U.S. stores performing especially strong. We have a tremendous growth opportunity in front of us, particularly in the United States, where thrift is still a highly fragmented and emerging sector. With just 165 stores in the U.S., we are underpenetrated in most major markets that we currently operate in, and we have virtually no presence in major regions of the country at the South and the Southeast. The U.S., which currently accounts for approximately half our stores, sales, and earnings, will increasingly drive our growth going forward. Roughly 60% of our new store openings in 2025 will be in the U.S., and that percentage will continue to grow. Overall, we expect new stores to be the primary driver of high single-digit total annual sales growth over the long term. Turning now to supply, donations were very strong in the second quarter, and this has been a trend for some time. On-site and green drop donations grew 6% over last year, and we're 78% of total pounds processed. As our efforts to provide our nonprofit partners, donors a convenient, efficient, and friendly experience continue to gain traction, we expect donation volumes to remain strong. We are focused on expanding our network of donation locations to take advantage of these trends and continue improving the quality and control of our supply. With strong on-site donations, a growing network of mobile donation locations and long-established relationships with our nonprofit partners, we project supply to be more than sufficient to support our existing stores and new store expansion for the foreseeable future. Equally important to our strategic positioning and scaling of our business is off-site processing. Over the last several years, we have made a number of investments to enhance our processing capabilities, especially in off-site facilities, including central processing centers and warehouse processing facilities. These offsite processing capabilities enable us to open stores and locations that for various reasons can't support onsite processing. This is a critical unlock for our new store growth plans, and it has already enabled us to significantly expand the field of play as we scout potential new store sites. More than half of our new stores going forward will leverage some form of offsite processing. While offsite processing has been a big win for us, we are in the early stages of building these capabilities. As we continue to gain experience, we are driving greater operational efficiency through increased throughput and process improvements. At our Edmonton Central Processing Center, the first one we opened in 2021, cost per unit has continued to decline and is now approaching the cost of traditional on-site processing in a store. This is a significant development for our expansion initiative. Achieving near parity in cost between the different processing approaches will enable a more profitable long-term growth and make offsite processing an even more important competitor differentiator for us. In closing, we recently marked the one-year anniversary of our debut as a public company. Since that time, we've achieved a number of important milestones. We've accelerated the pace of our new store openings. Offsite production is now a proven unlock new store growth we've entered new markets including the southeastern us and sydney australia and our loyalty membership is growing double digits i couldn't be prouder of the highly dedicated team members who have made all of this possible even as we navigate a difficult canadian economic environment i am more confident than ever in our long-term growth prospects and in our mission to make secondhand second nature now i'll hand the call over to michael to discuss our financial performance and the outlook for the remainder of the year.

Thank you, Mark, and good afternoon, everyone. It's a pleasure to be here at Savers Value Village and participating on my first earnings call with the company. As most of you are aware, I joined Savers in May and have spent the first few months in the field and familiarizing myself with the business and the team. I find many reasons to be excited about this company, including its unique business model, significant long-term growth potential, highly engaged customers and talented team. My priorities are increasing shareholder value, strengthening our finance capabilities, and evolving our approach to planning and forecasting the business across both near-term and longer-term time horizons. There is a strong foundation to build on, and I'm looking forward to working with the finance team and our business partners to help the company achieve its full potential. Our second quarter was highlighted by the acceleration of our new store growth plans. better than expected performance in our new stores, especially in the U.S., and continued progress in off-site processing. Our U.S. business was consistent with our expectations and first quarter trends, but sales and earnings in Canada were lower than we expected due to the challenging Canadian economic environment. Despite softness in Canada, our adjusted EBITDA margin was over 20% for the quarter, and we continued to generate strong cash flows, highlighting the resilience of our financial model. Turning now to the income statement, total net sales increased 2% to $387 million in the second quarter. On a constant currency basis, net sales increased 2.8% and comparable store sales decreased 0.1%. In the U.S., net sales increased 5.4% to $207 million and comparable store sales increased 2.1%, driven by growth in both transactions and average baskets. In Canada, net sales declined 2.4% to $150 million, and comparable store sales declined 3.1%, driven by declines in both transactions and average basket. A timing shift in the Canada Day holiday benefited Canadian comparable store sales by approximately 100 basis points in the second quarter, and is expected to negatively impact the third quarter by roughly the same amount. Cost of merchandise sold as a percentage of net sales increased 120 basis points to 42.1%, with the increase reflecting the impact of new stores and the two new central processing centers that were opened in the second half of last year, as well as deleverage on lower sales in Canada. As a reminder, our new stores typically open at roughly half of their mature sales levels, resulting in lower profit margins in their first few years. As we accelerate growth, New stores will be a headwind to profit margins in the short term. However, this headwind will subside as we continue to open stores at a sustained pace and our new store classes begin to mature. Investments in new stores generate strong returns on our capital, and the performance of our recently opened stores gives us added confidence in our growth plans. Investments in offsite processing are also impacting our cost of merchandise sold. Offsite processing entails additional activities and costs, including freight and overhead, resulting in pressure on our profit margins when we open a central processing center or other off-site facility and work through the initial ramp-up. However, as we increase throughput and improve productivity in these facilities, the cost per unit declines, providing a tailwind to profit margins. That's exactly what we're seeing in our three more mature central processing centers. During the second quarter, unit cost reductions in these three CPCs partially offset the combined effects of new stores and new CPCs. The remaining increase in cost of merchandise sold as a percentage of net sales resulted from deleverage on lower sales in Canada. We have reduced processing levels in Canada in response to demand to mitigate the deleverage of our labor costs on lower sales. We continue to monitor this closely as we work to balance profit margins and the continued flow of fresh product to drive sales. Continuing down the income statement, salaries, wages, and benefits expense was $91 million. Excluding $20 million of IPO-related stock-based compensation, salaries, wages, and benefits as a percentage of net sales increased 60 basis points to 18.4%, reflecting the impact of new stores and higher wages and benefits. Selling general and administrative expenses as a percentage of net sales increased 230 basis points to 21.6%, primarily due to new stores and pre-opening expenses, along with information technology and general store expenses. Depreciation and amortization increased 18% to $17 million, reflecting our growth investments in new stores, central processing centers, and automated book processing systems. Interest expense decreased 43% to $16 million due to reduced debt and lower average interest rates. Gap net income for the quarter was $9.7 million or six cents per diluted share. Adjusted net income was $23.7 million or 14 cents per diluted share. Second quarter adjusted EBITDA was $80 million and adjusted EBITDA margin was 20.7%. Turning now to capital allocation, we remain committed to a disciplined approach that funds our growth and strengthens our balance sheet. As our business continues to generate strong cash flow, we will also be opportunistic in returning capital to shareholders. We remain on track for 29 new stores this year, and we expect operating cash flow to be more than sufficient to fund our capital expenditures. We've also taken a number of steps to strengthen our balance sheet this year. In January, we amended our senior secured credit agreement, which combined with a corresponding upgrade of our debt rating lowered our borrowing rate spread by 175 basis points. In March, we paid down $49.5 million of principal on our senior secured notes. In April, we terminated our interest rate and cross currency swaps and realized net proceeds of $38.4 million. And in June, we upsized our revolving line of credit by $50 million from $75 million to $125 million. and extended its maturity by one year in 2027. We finished the second quarter with $161 million of cash and cash equivalents and a net leverage ratio of 1.9 times. Also during the second quarter, we repurchased approximately 288,000 shares of our common stock at an average price of $11.51 per share. Additional repurchases since the end of the quarter have brought our total to 1.4 million shares repurchased to date at an average price of $10.51 per share. As of today, we have approximately $35 million remaining on our share of purchase authorization. Finally, let me discuss our updated outlook for 2024. Given the continuing macroeconomic headwinds in Canada, we believe a more cautious outlook is warranted. We are lowering our full year 2024 outlook for total net sales to a range of $1.53 billion to $1.56 billion. Comparable store sales to a range of down 1% to up 1%, with the U.S. up low single digits and Canada down low to mid single digits. Net income to a range of $42 million to $56 million. Adjusted net income to a range of $82 million to $96 million. And adjusted EBITDA to a range of $290 million to $310 million. Our full year 2024 outlook remains unchanged for new store openings and capital expenditures. We're still expecting a total of 29 new stores this year, which includes 22 organic openings and the seven acquired Two Peaches locations. The 18 stores planned for the second half of the year will open roughly evenly between the third and fourth quarters. We're also closing two stores with expiring leases during the third quarter, bringing net new store growth for the year to 27. Capital expenditures are still planned in the range of $105 million to $115 million. Our updated outlook primarily reflects different scenarios for how Canadian macroeconomic trends play out over the balance of the year. Elevated household debt levels and rising mortgage and rent costs are likely to continue to weigh on consumer spending in the immediate future. At the same time, inflation is falling, and the Bank of Canada has recently begun reducing its benchmark interest rate. both of which should eventually help ease pressure on consumers. At the midpoint of our range, we're assuming no material change in macroeconomic conditions in either Canada or the U.S. The low end of the range assumes additional deterioration in the Canadian economy and further reductions in consumer spending in our categories, as well as slightly softer U.S. sales trends. The high end of the range reflects modest improvements in the Canadian economy beginning in the fourth quarter, and slightly better U.S. sales trends. We expect comparable store sales trends to be slightly better in the fourth quarter than the third quarter for a couple of reasons. First, the previously mentioned Canada Day holiday shift will negatively impact Canadian comparable store sales by approximately 100 basis points in the third quarter, offsetting the corresponding benefit we saw in the second quarter. Second, our prior year comparisons get progressively easier as we move through the second half. Given these dynamics and the timing of new store openings, we expect total net sales dollars to be approximately the same in the third and fourth quarters. We also expect adjusted EBITDA margins will decline by a similar amount versus last year in both the third and fourth quarters, primarily reflecting gross profit margin compression related to investments in new store growth and offsite processing, as well as deleverage on lower sales in Canada. partially offset by continued efficiency gains in our central processing centers. And just a few final details. Our outlook for net income assumes an effective tax rate of approximately 34%. And based on our share purchase activity to date, we are now projecting weighted average diluted shares outstanding to be approximately 168 million for the full year. This does not contemplate any potential future share repurchases. This concludes our prepared remarks. We would now like to open the call for questions. Operator?