Earnings call: Roots Corporation Q2 2024 sales dip, debt reduction on track

Roots Corporation (ROOT), a prominent lifestyle brand, reported a slight decrease in sales for the second quarter of 2024 during its Analyst Conference Call on September 13, 2024. Despite the sales dip, the company successfully reduced its net debt and maintained stable adjusted EBITDA losses. CEO Meghan Roach highlighted the early success of back-to-school sales and the company’s strategic initiatives, including the introduction of a summer Cloud sweat and the active collection’s continued growth.

Key Takeaways

• Q2 sales at Roots Corporation fell 3.4% to $47.7 million from $49.4 million in the previous year.
• Direct-to-consumer sales saw a 1.8% decline, standing at $36.4 million.
• Adjusted EBITDA losses remained constant at $3.1 million.
• Net debt was reduced by 20% year-over-year to $40.8 million.
• The company reported strong early back-to-school sales and a robust product portfolio.
• Roots launched a summer Cloud sweat and experienced double-digit growth in its active collection.
• CFO Leon Wu announced a gross profit of $26.9 million with a gross profit margin of 56.4%.
• SG&A expenses were reduced to $31.8 million.
• The company is focusing on store optimization and AI-driven inventory systems.

Company Outlook

• Roots Corporation is concentrating on maintaining brand relevance and strengthening market position for the upcoming holiday season.
• Store optimization efforts are aimed at enhancing sales per square foot.
• The company is preparing for new initiatives in the latter half of the year.

Bearish Highlights

• The company faces challenges with gross margins due to unfavorable foreign exchange rates and increased freight costs.

Bullish Highlights

• Roots Corporation saw improvements in inventory and sales performance in its Cooper Fleece collection by the end of Q2.
• Activewear collection continues to show double-digit growth.
• The company is managing inventory to prevent shortages and focusing on core collections.

Misses

• Despite the overall reduction in net debt, the company experienced cash outflow due to seasonal inventory purchases.

Q&A Highlights

• Increased airfreight costs may reduce some benefits from product margins in the upcoming quarters.
• Most stores remain profitable, with a nominal reduction in store count.
• Store closures have temporarily impacted sales, but gross margin and EBITDA improvements are expected from optimization efforts.
• CEO Meghan Roach underscored the importance of upcoming developments in the second half of the year.

Roots Corporation’s commitment to reducing debt and refining operational efficiency, particularly through AI-driven inventory systems and store concept enhancements, suggests a strategic approach to navigating the competitive retail landscape. As the company anticipates challenges from increased freight costs and foreign exchange rates, it also expects to see benefits from its focus on core collections and seasonal demands. With the back-to-school season showing positive signs and the holiday season on the horizon, Roots Corporation is gearing up for potential growth and market strengthening initiatives.

Full transcript – None (RROTF) Q2 2024:

Operator: 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. [Operator Instructions] This call is being recorded on Friday, September 13, 2024. I would now like to turn the conference over to Meghan Roach, CEO. Please go ahead.

Meghan Roach: 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 continue 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, typically representing approximately 30% of annual portfolio. Before I review the highlights for this quarter, I will also briefly touch on our early back-to-school results. We are 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, marketing, 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 sleeve product with minimal logos and more fashionable silhouettes that resonated extremely well with consumers. Our active collection also experienced another quarter of double-digit growth. Active male wear presents a core offering for Roots in an area we will continue to expand 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 and slowly up to the Olympics. As mentioned last quarter, we faced some inventory challenges in our Cooper Fleece 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 and into Q3. As indicated in a separate press release earlier today, Karuna Scheinfeld, Chief Product Officer, will be stepping down at the end of 2024. We do not intend to replace the Chief Product Officer rule. However, we have continued to 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 all seeking to continue reconnecting our product with our outdoor Roots. Since joining us in 2020, Karuna has been an exceptional partner, establishing a go-to-market process and products in line with our brand vision and direction. I have appreciate Karuna passion and commitment to the brand. And it is a testament to her leadership that she leads us in a strong team that I’m confident can support the brand in its next stage of evolution. In early September, we hosted an exclusive event to launch our fall and holiday products. The first collection fully influenced by a Creative Director of Residence, Joey Gollish. 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. How 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 selection bends time and style before it’s making trends. From a marketing perspective, last quarter we launched our brand ambassador program with the goal of enhancing brand visibility through authentic, relatable representatives to 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, and 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 Root’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 systems. 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 a strong quarter of double-digits growth in the U.S. and China 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.

Leon Wu: Thanks, Meghan 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 as 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 Meghan mentioned we are very pleased with the performance of our core product categories. Our active collection continued to drive double-digit year-over-year growth. Our minimal logo core 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, up 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 impacts 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 U.S. 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 $0.13 per share, improving from a net loss of $5.3 million or $0.13 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 fleece 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 season, 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 or retraining 12-month adjusted EBITDA was 2.3 times at the end of Q2 2024. I will now pass it back to Meghan for closing remarks.

Meghan Roach: 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.

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Brian Morrison from TD Cowen. Go ahead, please.

Brian Morrison: Hey good morning, Meghan. Good morning, Leon.

Meghan Roach: Good morning.

Leon Wu: Hi, Brain.

Brian Morrison: 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. So I didn’t catch it all, but 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?

Meghan Roach: Absolutely, Brian. So I’m thinking to 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 such 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. We came into the second-half of the second quarter and into the third quarter with 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, we really have had some really effective branding and marketing initiatives going on. So you can see that we’ve been laddering 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 pick up 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 (NYSE:ETN) Center store you know a couple 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 allocations is improving as we’ve been using the 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 the continuations of those improvements into the third quarter of their back-to-school period.

Brian Morrison: Okay and that’s helpful and I guess 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?

Meghan Roach: 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 especially coming out in the winter time 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, fit that our, you know, core 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 active wear line, which is unique in the marketplace, very differentiated relative to some of the people who are out there today. And I think the third thing is 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 when customers are coming to us, they’re coming to us for things that they can wear both indoors and outdoors. And so, I mean, 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 here come back again and again for some of these core products in our active collection.

Brian Morrison: Okay. Inventory looks very healthy, but it also looks very leading as I look back over the years. You mentioned that you have your core fleece well positioned, and I assume you have limited pack away. 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?

Leon Wu: Yes, 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 that 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 up. And it is one that we often see where products are well received. It could sell out towards the end of the season. In terms of just managing today inventory, one of the things I would call out is that the large decrease relative to last year is largely from the pack-and-hold inventory that we’ve sold through. I wouldn’t use last year as a benchmark in the first two quarters, just given the pack-and-hold that was carried to Q3 and Q4. But as we get into — sorry, as 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 have some global logistics, ocean freight challenges we’re continuing to monitor. And we’re also paying close attention to what’s happening with the local market as it relates to air freight, if needed. So we are being quite proactive there and managing that to ensure that the product is coming in time for our period.

Brian Morrison: Okay. Thank you, Leon. Maybe just a follow-up on that, just 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.

Leon Wu: 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 rate. This quarter, we were very happy with the improvement 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 rate. 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 U.S. 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 airfreight as needed, that cost could increase further. So those are two factors that we expect to partially offset some of the Q3 and Q4 product margin tailwind from a costing perspective. But ultimately, in the third and fourth quarter, we expect the costing and margins to be more prominent for the benefit.

Brian Morrison: Okay. So we just think they offset each other?

Leon Wu: Yes.

Brian Morrison: Okay. And then Meghan, question on store optimization initiatives. 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?

Meghan Roach: Well, I think, Brian, as we talked about in previous quarters, we’re in a lucky position because we have very few stores that lose money, right? So when you look across your store base, from our perspective, we really have a strong initiative focused on increasing sales per square foot. And so as we look at the stores we closed so far, in a lot of cases, they either consolidated those into other stores, we’re focusing on sometimes increasing our footprint to account for the fact that we think we have a better opportunity in certain high-traffic locations to generate our sales per square foot. So we also have 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 per 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 quarter-over-quarter on that, and we continue to be focused on those comp sales. But obviously, 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.

Brian Morrison: Okay. Thank you very much. I’m encouraged to see what happens in the second-half.

Meghan Roach: Thank you, Brian.

Operator: Thank you. 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.

Meghan Roach: 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 operator, you may now conclude the call.

Operator: 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, levels of activities, performance, goals or achievements or any other future events or developments. This information is based on management’s reasonable assumptions and beliefs in light of information currently available to Roots, and listeners are cautioned not to place undue reliance on such information. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected. The company refers listeners to its third quarter management’s discussion and analysis 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. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and you can now disconnect your lines.

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