Roots Corporation (OTC:RROTF) Q1 2022 Results Conference Call June 14, 2022 8:00 AM ET
Company Participants
Meghan Roach – President and CEO
Mona Kennedy – CFO
Conference Call Participants
Brian Morrison – TD Securities
Patricia Baker – Scotiabank
Matthew Lee – Canaccord
Stephen MacLeod – BMO
Operator
Good morning. My name is Pam, and I will be your conference operator today. At this time, I would like to welcome everyone to Roots’ First Quarter Earnings Conference Call for Fiscal 2022. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
On the call today we have Meghan Roach, President and Chief Executive Officer; and Mona Kennedy, Chief Financial Officer of Roots.
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 our 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 assumption and beliefs in the 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 first quarter management’s discussion and analysis and/or its annual information form dated April 6, 2022 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 the ability to deliver on these statements.
Roots undertakes no obligation to update or revise any forward-looking statements made on this call. The first 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 Q1 2022 conference call is also available on Roots’ Investor Relations site. Finally, also note that all figures discussed on this conference call are in Canadian dollars, unless otherwise stated.
Thank you. You may now begin your conference.
Meghan Roach
Good morning. And welcome to our earnings call.
I’m very pleased to report that Roots’ delivered solid first quarter results. Most notably, sales increased 15.3% year-over-year to $43.1 million. Our strong performance can mainly be attributed to growth in customer traffic. This results from strong comparable sales year-over-year and in part, the temporary store closures due to lockdowns in several regions in Canada during part of Q1 2021.
Before we go any further, I want to pause to thank the team for all of their hard work. Everyone has done a phenomenal job, especially given the circumstances in which we have been operating. The market environment continues to be dynamic. Our performance reinforces the strength of our brand and further validates our omni-channel growth strategy. It also speaks to the desirability of our enhanced product portfolio, the traction that we are continuing to gain through our elevated brand positioning and the demand for the high-quality, comfortable and versatile clothing that Roots offers.
Now, in the prior quarter, I outlined four main growth pillars. The first is offering an elevated omni-channel experience to serve our customers wherever, however, and whenever they seek to shop. This includes corporate retail stores pop-up locations, e-commerce and international business partners. Roots currently ships to more than 55 countries and generates approximately $100 million in system-wide sales in Asia on an annual basis.
During the first quarter, we continued to progress our omni-channel infrastructure enhancements. We expect the majority of these to be completed in the second half of 2022. In the interim, we are continuing to offer a robust suite of options for our customers online and in stores to support their shopping preferences.
Our second growth pillar consists of reinforcing our brand position globally. With international partners and our e-commerce platforms, our brand’s reach is already broad. However we continue to further leverage the brand outside of Canada. This pillar also includes enhancing our product portfolio to better reflect our consumer target and continuing to drive engagement with the brand amongst existing and new customers. Our substantial brand equity and our premium offering resulted in strong demand for our products in the first quarter.
We are continuing to invest in our Journey Collection, our performance offering for consumers seeking the same great hand feel and quality that Roots has been associated with for decades. This collection offers more technical features such as antibacterial fabric, moisture-wicking, and UV protection. We’ve spent the last year testing a range of styles and continue to see excellent demand and upside potential with Journey.
Customer traction has been strong with sales growing over 40% year-over-year in fiscal 2021. This excellent momentum has continued into the first quarter of 2022. We also mentioned in the fourth quarter our success in offering more sizes in the One Collection. In Q1, we also extended the sizes available in our Salt & Pepper fleece. We will be using customer demand indicators to roll out more sizes across different parts of our collection during the remainder of 2022. You know as customer preferences evolve post-pandemic, perhaps most notable in our first quarter was a significant growth experienced in our core fleece program. While we continue to expand this offering with the use of different size logos, colors and updated fit, our core fleece remains a timeless style that has been a customers’ favorite for decades.
Our ability to consistently deliver a compelling product offering led direct-to-consumer gross margin to expand 180 basis points year-over-year to 63%. We have a robust product pipeline for the remainder of the year, and this includes the relaunch of Beaver Canoe in the summer to celebrate its 40th anniversary.
Now, let’s turn to our enduring brand strength. With the history spanning almost five decades, Roots retains many loyal followers, and a highly attractive customer base that has shown a willingness to pay for the unique features and benefits we offer. Through collaborations with artists, celebrities and influencers, we continue to promote brand awareness to a broader global audience. In February, we hosted The Weekend’s 32nd birthday party in Las Vegas, where the Canadian artists wore custom varsity jacket by Roots. Handmade in our Toronto leather factory, the jacket commemorated the launch at the Dawn FM album. This represents our 10th year of collaborating with the Weekend and the XO brand.
During the quarter we also partnered with local artists, Benny Bing and Morningstar in a series of limited edition studio fleece in varsity jacket. Benny Bing’s piece based on his incredible painting elite celebrated the beauty of black women using vibrant colors and took over five hours to sew. Morningstar and mixed French First Nations illustrator, painter and muralist, partnered with us for International Women’s Day. And she created a piece that celebrated the diverse qualities of women. The artistry and passion that went into making these pieces made them highly coveted and also very quick to sell out.
Within our third growth pillar, we are focused on taking a progressive approach to enhancing corporate social responsibility at Roots. During the first quarter, we joined Sustainable Apparel Coalition, this apparel, footwear and textile industry’s leading alliance for measuring sustainability. The coalition developed the Higg Index, a standardized value chain measurement tool for all industry participants. Our membership reflects our commitment to reducing our environmental footprint and promoting social justice throughout the global supply chain. Aligned with this initiative, we anticipate having most of our apparel made with sustainable materials by the end of 2022.
Our beloved Salt & Pepper and Cooper Beaver fleece products are ready made with some recycled contents. As we move these collections to organic cotton in the autumn, we will see a significant volume shift to sustainable materials. Roots is not a fast fashion brand. Our move towards sustainable materials is only the latest initiative in our commitment to helping our customers build a timeless wardrobe of high quality, comfortable clothing.
Our final growth pillar remains operational excellence, across the organization to drive long-term profitable growth. Mona will discuss this during her overview of the financial results. But before passing onto Mona, I want to note that in the short-term, we continue to manage through the industry-wide supply chain disruption, inflation and a lingering global effect of the COVID-19 pandemic. Roots has weathered many similar periods of disruption throughout its almost 50 years of existence, and we continue to believe in its enduring brand affinity and exceptional product offering.
I will now turn the call over to our CFO, Mona Kennedy.
Mona Kennedy
Thanks Meghan, and good morning, everyone.
As mentioned, Roots delivered solid Q1 2022 results amid a fluid market environment. Total sales increased 15.3% to $43.1 million in the first quarter of 2022 from $37.3 million in the first quarter of 2021. DTC sales reached $37.4 million, up 19% year-over-year. This solid performance reflects strong same store sales growth, as we saw significant traffic recovery in stores. Additionally, we’re recycling over some temporary store closures from lockdowns last year. P&O sales amounted to $5.7 million in first quarter of 2022 compared to $5.9 million last year. The slight decline mainly stems from a reduction in our Taiwan business, partially offset by strong sales growth of custom Roots-branded products to business clients and by additional sales through TMall.com in China.
Gross margin improved significantly during the first quarter, rising 340 basis points to 60.9%. In DTC, gross margin improved 180 basis points, 63% driven by a higher merchandise margin that reflects our discipline on promotions with reduced markdowns. We also benefited from a favorable impact of foreign exchange rates on U.S. dollar purchases. These factors were partially offset by lower government subsidies as well as higher transportation and air freight costs for certain products. Additional air freight costs negatively impacted DTC margin by 100 basis points.
Moving to SG&A. We reported expenses of $31.3 million, up 21% from last year. However, excluding the year-over-year impact of government subsidies and temporary rent abatements, SG&A expenses only rose 9.3%. So, we gained leverage on our SG&A expenses versus last year. This increase was essentially due to higher store labor costs as stores were fully open this year, and we also had some investments in talent in our head office.
Adjusted EBITDA stood at a loss of $3.2 million in the first quarter of 2022, compared to a loss of $2.5 million last year. It’s important to note that last year’s adjusted EBITDA included $2.9 million of incremental rent abatements and government subsidies. Excluding these items, our adjusted EBITDA improved by $2.2 million year-over-year.
This last figure, allows us to appreciate all the initiatives our team put forward to stimulate sales and improve operating profitability. We are very pleased with the progress accomplished to this day. The net loss in the first quarter of 2022 amounted $5.3 million or $0.13 per share, versus $4.9 million or $0.12 per share last year at this time.
Turning to our balance sheet highlights. Our inventory position is healthy, standing at $39.2 million at quarter-end. This compares to $41.3 million at the beginning of the quarter, and $42.5 million at the end of the first quarter a year ago. Although supply chain pressures remained, we’re comfortable with our inventory composition entering Q2.
In addition, we believe that our inventory is generally low risk, as core products account for approximately two-thirds of inventory. We also ended the first quarter in a solid financial position. At the end of the quarter net debt stood at $39.4 million, which was nearly 50% less than at the same time last fiscal year. Our net leverage ratio was also very strong at 0.8 times at the end of Q1. During the first quarter, we repurchased 377,000 shares for a consideration of 1.2 million under NCIB program. Since initiating the program last December, we have repurchased 582,000 shares out of an authorized amount of nearly 2.2 million shares until December 15, 2022.
In summary, fiscal 2022 is off to a good start with a greater store traffic driving sales growth in the first quarter, while maintaining our promotional discipline. Our results reflect the power and positioning of our brand in the marketplace.
Q2 is also tracking nicely, and we’re pleased to see customers coming back to our stores. That said we will not benefit from any subsidy or abatement this year, as opposed to the benefits totaling approximately $6.5 million last year in Q2. In the meantime, the entire Roots team is working hard to alleviate supply chain pressures. And we’re confident about the strategies we’re putting forward. We’re taking a proactive stance with respect to transportation and logistics, including finding the optimal balance between air freight, premium and regular ocean freight as well as strategically managing our pack and hold inventory.
Based on what we see in terms of shipping rates and production flow, we currently expect an impact on DTC gross margin of about 150 to 250 basis points in the second half of the fiscal year. This said, our objective is to have products and stores on time at the most efficient cost possible. As Meghan mentioned, we’re focusing on executing our long-term profitable growth strategy. Roots’ history of nearly 50 years fosters passion, pride and resilience throughout the organization. These key attributes along with our strong appealing brands lay the foundation for a sustainable growth platform. Our sound financial position, meanwhile, provides us with the flexibility to confidently move ahead and create lasting value for our shareholders.
I would like to thank our entire team for a solid quarter. We remain focused on operational excellence throughout all levels of the organization. Despite external challenges, our agility and resiliency will allow us to continue driving solid results. We look forward to updating you on our second quarter results in September.
With that, operator, please open the line for questions.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Brian Morrison with TD Securities. Please go ahead.
Brian Morrison
So, Meghan, we’ve seen some major retailers in the U.S. see a shift away from the casualization movement during the pandemic. I’m wondering if you’re seeing this trend. If so, how do you adapt to it when it takes hold? And maybe just comment on Mona’s prepared remarks that said that Q2 is tracking nicely, maybe some color on that.
Meghan Roach
Yes, absolutely. So, the short answer is no, actually. We haven’t seen any negative impacts from the casualization of the wardrobe. If anything, the fact that people are still living a hybrid lifestyle where they’re spending two to three days in a week in the office and other days at home, is continuing to positively impact our purchases of our core items. And I think actually, in my prepared remarks, I have mentioned that we actually saw significant growth in our core offering in the first quarter. So, we haven’t seen any negative impact on the brand at all of any shifts around in trends.
And I think the big focus for us is, we are a brand that’s been around for 50 years, and a lot of our core offering has been something that we’ve offered for many, many years, and we continue to see customers being very compelled to buy the products we offer, because we really feel that we have a unique differentiated position in the marketplace.
Brian Morrison
Okay. Thank you for that…
Mona Kennedy
And then second question, sorry, Brian, was Q2. Q2 movements continues to be strong, and we’re very happy with the way things are trending.
Brian Morrison
Excellent. And then, Mona, your comment about the 150 to 200 basis points of drag with respect to I believe it was freight costs in the second half of the year, is that DTC, is that consolidated? And do you have any ability to offset that or is that what you believe is going to happen?
Mona Kennedy
That’s DTC. So, it’s 150 to 250 basis points in the second half of the year. Ability to offset it, I mean, we’re generally working on margin as you see. And we’ll continue to do that in terms of trying to sell products at full price and things of that nature. And as we’ve mentioned, kind of in Q4 and previously, we’re also looking at strategic price increases to potentially offset that.
Meghan Roach
I think the other thing that we’re doing is, we’re giving you a range of estimates. So, we’re obviously continuing to work on our side to determine where we can obviously speed up the flow of goods or minimize air freight. So I think we wanted to be transparent with the marketplace to give rough estimate of what we anticipate in the second half of the year, but we’re obviously trying to minimize it as much as we possibly can.
Brian Morrison
Okay. Thank you. Last question, Meghan, you had a very active NCIB when you reported your Q4 results rates through mid-April, and then all of a sudden it stopped. So, it’s about 377,000 shares. I’m wondering why that happened and what your plan is with respect to the NCIB going forward?
Meghan Roach
Do you want to handle that Mona?
Mona Kennedy
Yes. Thanks Meghan. So, we’ve been active on our NCIB, Brian, as you mentioned. We purchased 377,000 shares in Q1, and since its inception, 582,000 out of the approximately 2 million that we announced. Our intention was to continue to buy shares opportunistically from time to time. But as you know there’s a lot of uncertainty ahead of us and ahead of all retailers and all companies in general in the market, and we’re remaining cautious and not providing any guidance on that.
Brian Morrison
So, do you plan to complete your 2 million share repurchase plan?
Mona Kennedy
As I said, we’re being cautious on providing any guidance on that. So, I won’t specifically provide that.
Brian Morrison
Okay. I’ll follow-up later. Thank you.
Operator
Your next question comes from Patricia Baker with Scotiabank.
Patricia Baker
Brian asked a number of my questions. But, I just want to follow-up on the impact of the expedited air freights on DTC margins in the back half. So, you’re saying that 150 to 250 basis points in the second half of the year, would that be equally pressures in Q3 and Q4?
Mona Kennedy
Good morning, Patricia. So, in terms of equally, yes, I would say so. There is a bit more pressure in Q3 than there was last year. Given some closures in China, we have had to air freight a bit more products for Q3 of this year than we did last year. So, if you are comparing to last year, you will see more pressure in Q3. But, you will see equal pressures in Q4 as well. And as Meghan mentioned, it’s a dynamic situation and we continue to monitor it. So, there might be — this is a rough estimate that we’re providing, but there should be pressure in Q4 as well.
Meghan Roach
I think it’s important to know that the way the air freight works is obviously it’s capitalized into our inventory. And so, it hits the P&L as we sell the inventory down. And so, what we’re trying to do is obviously bring in inventory, as early as we can to make sure we capitalize into the demand for the second half of the year. And I think I would just note also that our strategy really isn’t any different than it was in 2021. So, we’re really looking at the quantities of air freight and comparing them to levels that we spent last year. So, from that perspective, we are continuing to take the same strategy in terms of our approach to air freight. And these very tactical in terms of where we use it and continue to be obviously mindful of the fact that these are temporary increases in costs that we are obviously incurring. In our long-term basis, we anticipate rates to continue to decline.
Patricia Baker
Okay. Thank you to both of you for that. Thank you.
Operator
Your next question comes from Matthew Lee with Canaccord. Please go ahead.
Matthew Lee
Hi, team. Congrats on the strong quarter. I know that things are relatively fluid right now, but given your promotional discipline and supply chain strength, what type of gross margin profiles can we expect you to achieve long-term? Is it fair to say that kind of steady state consolidated gross margins are probably closer to mid-60s, once supply chain issues are finished?
Mona Kennedy
We are not providing that guidance, particularly in the current environment, Matthew. We have been working very hard over the past eight quarters on margins. And as you’ve seen, there has been continuous margin improvement. It’s something that’s a focus for us continuously. But as you know, in the short-term, there are pressures on margins. So, it’s really hard to provide that guidance and not really that smart for us to do that at this point. So, we will remain disciplined with our promotional activities. As you know, our average unit revenue has gone up significantly since 2019. So, we’ll continue to do that. Our focus is on full price selling. We are bringing in some new categories with new features with higher prices. So, we are working on margins, but not providing that guidance. And we have now mentioned a number of times, there are short-term pressures from an air freight perspective in Q3 and Q4 that we are experiencing.
Matthew Lee
Right. Okay. And then, I know that you are talking a lot about transportation, but have you seen any inflation in terms of material cost?
Mona Kennedy
We have seen some inflation in terms of material costs. As you know, cotton prices have been quite volatile and going high. And in terms of fuel cost, obviously there is an impact on that as well. We have taken some strategic price increases in the first half of the year and maybe so in the second half of the year to offset that. And we haven’t really seen significant resistance from customers. As you know since we’ve removed promotions, customers have been receptive of that and the strategic pricing increases also haven’t really faced much resistance. So, we are feeling good about that.
Matthew Lee
Right. And then maybe a different approach to an earlier question. Your current balance sheet is in really good shape, cash flows returning. Can you just give us an understanding of your capital priorities between dividend, buybacks and potentially M&A?
Mona Kennedy
Sure. As we indicated during our Q4 conference call, we are always looking at different alternatives and different ways of managing our business and we continue to look at our capital allocation with the Board. And at this time, we’re seeing of course on future capital allocation plans. And there’s a lot of uncertainty as I mentioned and you all know. So, in that context, we’re being cautious in providing any guidance. But yes, solid the financial position, debt levels are at the lowest level they’ve been for a really long time, and we were in a good cash position. So, we’re really proud of that.
Meghan Roach
And I think, Matthew, we’re always looking for ways to maximize shareholder value, right? So, I think, from our perspective, we feel good about our liquidity levels, we feel good about our debt levels. And so, we’re going to continue to monitor the macro environment and be considerate and mindful in terms of how we think about our capital allocation, as we continue to see how the rest of the year trades out in macro environment.
Operator
[Operator Instructions] Your next question comes from Stephen MacLeod with BMO. Please go ahead.
Stephen MacLeod
Lots of great color in the Q&A so far. So, lots of my questions have been answered, but just wanted to focus in on two things. I know you talked about the Q2 tracking nicely. I’m just curious, if you think about sort of where Q1 ended and where you are today. Have you seen any changes in consumer spending, just with respect to inflation and rising rates and some of the caution we’re seeing in the markets right now?
Meghan Roach
No. So, we took a small price increase, actually, in our core products at the start of Q1. And we really saw for an example, there are no impacts on consumer shopping behavior with us. Our customers are continuing to show a willingness to pay for all the unique features and benefits that we offer. And I think that customers are just seeing that we have really high quality products, so they know that they’re investing in something that will last.
So, from our perspective, we haven’t seen any negative impacts. And I think if you think about the macro environment in general, we are really happy with sales momentum going into Q2 and our inventory levels are lower. And so, when we think about the composition of inventory going into the second half of the year, we feel good about that. And we also feel good about this solid financial position that we’re in with the liquidity and the leverage ratios that we have. So that’s been all positive. And the final thing that I’d mention is that we have a pretty attractive customer demographic. And with our elevated brand positioning, we’re seeing that our customers so far have been less impacted by the cost inflation in terms of their purchasing habits. So, we’re continuing to see that willingness to pay for the unique features and benefits that we offer, as I mentioned. And that’s really our focus going forward.
Stephen MacLeod
And then, in your prepared remarks, Meghan, I think you were the one that were talking — you were talking about some of the omni-channel improvements that you expect to see in the back half of the year. Can you just give some color, maybe specifics around what improvements you are expecting to see?
Meghan Roach
Yes. So, I think we’ve talked about in last few quarters the fact that we’re continuing to make some investments in enhancing the infrastructure and our omni-channel environment. And so I think if we go into the second half of the year, a big focus for us is really on mobile enablement. And while the existing website is obviously mobile enabled, we want to continue to make sure that we have a robust back end, that’s going to support the continued functionality that we want to add.
So I think as you go into the latter half of the year, we’re continuing to make sure that we have things like endless aisle, buy online, pick up in store, all those key characteristics that customers are seeking. But a lot of our infrastructure investments are around continuing to make sure that we maintain that very symbiotic relationship between online and in stores. So, you should continue to see a more seamless ability to transact in stores, if you want to do an online transaction, and online, you should see the site to come faster. You should see kind of the usability improve overall.
So, I think our focus going forward is really on continuing to improve both, mobile enablement as well as the online conversion. So, we’re really making sure that we’re investing in places that will enable us to do that going forward.
Stephen MacLeod
Great. That’s great color. That’s all for me. Thank you.
Meghan Roach
Thank you.
Operator
There are no further questions at this time. Please proceed.
Meghan Roach
Thank you, operator. That concludes today’s call. And thank you again for joining us. We look forward to updating you on our progress when we report the second quarter in September of this year.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.
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