Roots Corporation

Good morning, ladies and gentlemen, and welcome to the Roots Corporation Q2 2024 Analyst Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Friday, September 13, 2024. I would now like to turn the conference over to Ms. Megan Roach, CEO. Please go ahead.

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 continued to strengthen our balance sheet reducing net debt by 20% compared to this time last year. As a reminder, the first half of the year remains seasonally small for Roots financially, K-50 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 were 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, 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 inherent relevance amongst new and existing consumers. Now turning to our second quarter highlights. In June, we introduced the summer version of our Cloud Sweat, an ultra-soft 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 a core offering for Roots and an area we will continue to depend 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 in the lead-up to the Olympics. As mentioned last quarter, we faced some inventory challenges in our Cooper Case 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 in the Q3. As indicated in a separate press release earlier today, Corinna Sheinfeld, 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 a 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. We are also seeking to continue reconnecting our product with our outdoor route Since joining us in 2020, Karina has been an exceptional partner, establishing a go-to-market process and products in line with our brand vision and direction. I have appreciated Karina's passion and commitment to the brand, and it is a testament to her leadership that she leads 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 exclusive event to launch our fall and holiday products. The first collection fully influenced by our creative director of residence, Joey Gawlish. attendees, including key influencers, industry leaders, and media, had the opportunity to explore the craftsmanship, creativity, and innovation behind the collection in a carefully curated presentation. However, it was not only about unveiling products. It was about sharing the story of how our vision for the season aligned with the evolving desires of our consumers. This launch set the tone for a pivotal moment in our seasonal strategy, and the collection bends time and style before our 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 values. 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 have focused on creating more resonant, 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 continue 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 Eden Center renovation earlier this year, blends Roop's deep heritage and 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 system. 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's 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.

Thanks, Megan, 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, That's 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 two locations heavily impacted by construction immediately outside of our store. As Megan mentioned, we are very pleased with the performance of our core product categories. Our active collection continues to drive double-digit year-over-year growth, Our minimal logo Quouse 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, 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 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 US 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 13 cents per share, improving from a net loss of $5.3 million, or 13 cents 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 fleets 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 seasons. 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 a trailing 12-month adjusted EBITDA, was 2.3 times at the end of Q2 2024. I will now pass it back to Megan for closing remarks.

Thank you, Leon. In closing, our second quarter results reflect notable improvement 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.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchstone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by the number two. If you're using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Our first question comes from the line of Brian Morrison from TD Cowen. Go ahead, please.

Good morning, Megan. Good morning, Leon. Good morning, Brian. First question. It's obviously an increasingly competitive environment this back-to-school and holiday season with the health of the Canadian consumer. So talking 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 of degree. Are we talking low single digits, mid-single digits?

Absolutely, Brian. So I think I'll highlight a couple of things. So from the back-to-school perspective, we did see growth. We're not going to specifically give you the range of that growth because it's early in the quarter. But I think when you look at the reason for the growth, it's really coming from a number of things. So I think first off, We do have a strong product portfolio. You know, we came into the second half of the second quarter and into the third quarter with, you know, healthy Cooper fleece inventory. We had strong collections, such as a cloud collection or active collection. And we're seeing that resonate with our consumers. That's very positive. In addition to that, you know, we really have had some really effective branding and marketing initiatives going on. So you can see that we've been louder in the marketplace. The types of content that we have out there across the board is much better. You know, we have our new brand ambassador programs, we've had more events. And so as a result of that, we're seeing more pickup with our brand, you know, 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 Center store, you know, 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 hitting 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, you know, we saw improvements in the second quarter versus the first quarter. And we also saw those continuations of those improvements into the third quarter with our back-to-school period.

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, you know, 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 and driving your product?

I think we have a couple of key things. So this is 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 wintertime period also related to active. I think the strength of our active category, from my perspective, comes in two things. I think, one, it still represents the same amazing softness, comfort, you know, fits that our, you know, course sweats do, but just in different materials. And so people really love that feeling against their skin. I think the second thing is that, you know, we actually have a fully sustainable activewear line, which is unique in the marketplace, you know, very differentiated, I think, relative to some of the people who are out there today. And I think the third thing is, you know, Roots has always been known for this cross-section between athletics and comfort, right? If you go back a number of years, we've obviously had the athletic sponsorship, the Olympics, a number of different things. And so, once cleats are coming to us, they are coming to us for things that they can wear both indoors and outdoors. And so, you know, our product really resonates with them because you can wear it through multiple different use cases and occasions. And so we've been seeing customers, you know, come back again and again for some of these core products in our active selection.

Okay. Inventory. It looks very healthy, but it also looks very lean as I look back over the years. You mentioned that you have your core fleece welded positioned, and I assume you have limited pack-aways. 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?

Yeah, Brian, that's a great question. I could take that one. So we split our inventory into really two 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 it 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 two quarters. However, it is an area that we are okay to sell out. 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 packet hold inventory that we've sold through. I wouldn't use last year as a benchmark in the first two quarters, just given the packet hold that was carried to Q3 and Q4. But as we get into, sorry, 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 had some global logistics ocean freight challenges that we're continuing to monitor, and we're also paying close attention to what's happening with the local markets as it relates to air freight, if needed. So we are being quite proactive there in managing that to ensure that the products come in in time for our peak period.

Okay, thank you, Leon. Maybe just to follow up on that, 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?

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 rates. 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 rates. 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 two main variables that we continue to monitor are the FX rates, specifically the US 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 air freight as needed, that cost could increase further. So those are two factors that we expect to partially offset some of the huge three and Q4 product margin tailwinds from a costing perspective. But ultimately, in the third and fourth quarters, we expect the costing and margins to be more prominent for the benefit.

Okay. So we just think they offset each other. Yep. Okay. And then, Megan, question on store optimization initiatives. You know, 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?

Well, I think, Brian, as we've talked about in previous quarters, we're in a lucky position because we have very few stores that lose money, right? So when we look across our store base, from our perspective, we really have a strong initiative focused on increasing sales per store foot. And so as we've looked at the stores we've closed so far, in a lot of cases, we've 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 a certain high traffic locations to generate better sales for 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 for square foot over the next couple of quarters. And I think when you look at our comps, I mean, it's nice to see the improvement of quarter over quarter in that, and we continue to be focused on those comp sales, but obviously, you know, in the near term, there's been some reductions to overall sales as a result of store closures. But you should see the positive impacts come through both gross margin and EBITDA as a result of some of these changes.

Thank you very much. I'm encouraged to see what happens in the second half.

Thank you, Brian.

Thank you. If 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.

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 in that order, you may now conclude the call.

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 on due 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 quarter management's discussion and analysis and or its annual information forum 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.