Good morning, ladies and gentlemen. My name is Michelle. I'll be your Conference Operator today. At this time, I would like to welcome everyone to the Roots First Quarter Earnings Conference Call for Fiscal 2023. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by two. On the call today, we have Meghan Roach, President and Chief Executive Officer, and Leon Wu, Chief Financial Officer.
Before the conference call begins, the company would like to remind listeners that the call, including the Q&A portion, may include forward-looking statements 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 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 dated June 7, 2023, and or its annual information form for a summary of the significant assumptions underlying forward-looking statements and certain risks and factors that could affect the company's future performance and ability to deliver on these statements. Roots undertakes no obligation to update or revise any forward-looking statements made on this call. The 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 investors.roots.com. A supplementary presentation for the Q1 2023 conference call is also available on the Roots investor relations site. Finally, please note that all figures discussed on this conference call are in Canadian dollars, unless otherwise stated. Thank you. Ms. Roach, you may begin your conference.
Thank you, operator. Good morning, everyone, and thank you for joining us today for our Q1 2023 Earnings Call. First quarter results were in line with our expectations and reflect the challenging economic environment. Given the inherent seasonality in our business, the first quarter represents a small proportion of sales, historically comprising only 15% of our total annual revenue. While Leon will speak to the financial details, I will touch on a few highlights in the first quarter. We were pleased with the strong year-over-year growth rates in most of our apparel categories. Our customers showed excitement for our expanded and more versatile dress and skirt offerings, which drove a more than fivefold increase in sales in those lines. We also experienced renewed momentum in our tops business, with both heritage logos and our more minimally branded wine collection performing well.
Activewear posted another strong quarter, growing over 50% year-over-year and reaching almost 10% of total sales in Q1 2023. We are pleased with the growing traction of this performance line, which meets the evolving needs of customers through unique features like antibacterial fabric, moisture-wicking capabilities, and UV protection. The performance of our active line speaks to the upside potential of the brand as we continue to innovate and expose consumers to a broader offering. We also encountered softness and demand from our traditional fleece bottoms, resulting in an overall decline in sales year-over-year, given the relative importance of the size of that category.
We attribute this performance to several factors: a trend shift towards dresses and skirts that improve that category while depressing bottom sales, a desire for more diversity in our bottom silhouettes, particularly in our women's business, and a return to fleece bottom sales levels more consistent with historical patterns. We are continuing to invest in building out this area of the business and have confidence that you'll see more diversity and excitement in this area going forward. In Q1, we achieved our highest average unit revenue in the company's history while maintaining gross margins above pre-pandemic levels, even with our shift to sustainable materials, driving product costs higher. These improvements point to the resilience and underlying strength of the Roots brand and our continued discipline around promotions.
In China, where we have only been operating in the market directly for approximately one and a half years, we are continuing to experience strong momentum with our customer base doubling year-over-year. Our performance to date reinforces our belief in the potential for Roots within that market. As we turn to our operational highlights, it is important to emphasize that our long-term growth strategy remains intact. While we are staying prudent and are taking steps to navigate the present circumstances, we are confident in the resilience and adaptability of our business and brand after the last three years. While the first quarter has a relatively small financial impact on the overall year, we use it as a time to invest in the key initiatives that will build a strong foundation for our seasonally strong third and fourth quarters and future years.
Enhancing our omni-channel capabilities remains an area of focus, as we want a seamless integration between our online and offline channels, providing customers with a consistent and convenient experience. We continue to prioritize investments in data analytics, customer insights, and digital strategies that support and reinforce our differentiated position in the market. Recognizing the significance of marketing and brand engagement to new customer acquisition, we've also been testing new marketing initiatives and enhancing our internal infrastructure to reach new audiences, to increase our brand visibility, and to enhance the brand's perception in the market. We recently launched the first campaign under our new Creative Director in residence, Joey Gollish, with Beaver Canoe for the spring/summer season. The campaign, which features video and still photography, has had strong engagement and pairs our enduring association with the outdoors and nature with modern styling and a contemporary feel.
Last month, we also launched a capsule collection with Alder Apparel , a startup Canadian brand, that has shared values across inclusivity, diversity, and sustainability, as well as a passion for the outdoors. This collaboration features nine apparel pieces and three leather items. The early response to this collection has been positive. Looking ahead, we are intensifying our preparations for a monumental milestone, the celebration of our 50th anniversary in August. As we celebrate our rich history and legacy, we aim to surprise and delight our customers with special releases and experiences. We have an exciting lineup of launches planned for the upcoming year, including limited edition pieces, Heritage classics, and new collaborations. We look forward to sharing these details during our second-quarter conference call in September.
Before turning the call over to Leon, I would like to reflect on the progress and achievements Roots has made in pursuing its sustainability goals. Over the past few years, we have made significant strides in integrating sustainable materials into our clothing line, which we refer to as preferred fibers and materials. With a sustainably first mindset, we have successfully reduced our reliance on conventional materials, and we were recently included in the Textile Exchange's Material Change Index as one of the top 10 companies making the greatest year-over-year improvements. In 2023, we expect over 80% of our garments to contain preferred fibers and materials, an incredible accomplishment that required extensive internal transformation of the brand.
We are one of the few heritage brands globally that has made this significance of a transformation over such a short period of time, and we are incredibly proud to be doing so in our 50th year. Outside of our investment in new materials, we recognize the importance of social labor, particularly in our supply chain. We mentioned in Q4 that Roots has admitted to the Fair Labor Association and is pursuing the Fair Labor Accreditation in the apparel and footwear market. During the first quarter, we commenced this rigorous process, and we look forward to providing you with updates on our progress towards this accreditation in future quarters. In closing, we are happy with the progress we've made across key initiatives this quarter, even though we expect sales and margins headwinds to continue into the second quarter due to the current economic climate.
Before we move to financial details on the earnings call, I would like to take a moment to express my gratitude to the members of our incredible team who are the driving forces behind our continuous improvement as a brand. I will now pass the call over to Leon.
Thanks, Meghan. Good morning, everyone. Despite the short-term macro headwinds, we remain confident in the long-term operating fundamentals of the business and continue to operate with a strong balance sheet, ample liquidity, and have improved our inventory position over last year. Turning to our Q1 2023 results, total sales decreased 3.7% to CAD 41.5 million. DTC sales reached CAD 35.4 million in the first quarter, down 5.3% year-over-year. This decline was driven by continued economic uncertainties and the ongoing promotional environment. As Meghan mentioned earlier, we are highly encouraged by the year-over-year sales growth across most of our apparel categories. However, this was not sufficient to offset the revenue decline in select fleece bottom styles, which represented a larger portion of our business.
Our Partners and Other segment sales grew 6.9% from CAD 5.7 million in Q1 2022 to CAD 6.1 million in Q1 of this year. This growth was mainly due to higher sales to our international operating partner in Taiwan, increased licensing royalties of the Roots brand to select manufacturing partners, and a favorable foreign exchange impact on US dollar sales. Total gross profit amounted to CAD 24.5 million in Q1 2023, compared to CAD 26.2 million in Q1 2022, representing a year-over-year decrease of 6.6%. Consolidated gross margin reached 59% in Q1 2023, compared to 60.9% in Q1 2022. DTC gross margin was 61.3%, 170 basis points lower than 63% in Q1 2022.
The reduction in DTC gross margin can be attributed to higher product costs from the transition to sustainable materials and from heightened promotional activity on targeted seasonal inventory. Despite the competitive environment, we remain disciplined around promotions, with discount rates remaining significantly below pre-pandemic levels. These factors were partially offset by lower freight premiums of 120 basis points in the first quarter, reflecting less air freight costs and improvements in the global freight market. In addition, our DTC gross margin was affected by an unfavorable foreign exchange impact on US dollar purchases, offset in Q1 by the release of a non-cash per inventory provision. We anticipate the decline in our gross margin will gradually moderate in the latter half of the year, as our transition to sustainable materials comes full circle on an annual basis.
SG&A expenses were CAD 33 million in Q1 2023, compared to CAD 31.3 million in Q1 2022. The 5.4% increase in SG&A expenses was mainly caused by higher store labor costs associated with longer store operating hours, contractual increases in store rent costs, and higher corporate compensation expenses, as we invest in targeted areas of the business that will support long-term profitable growth. Net loss totaled CAD 8 million, or CAD 0.19 per share in Q1 2023, compared to a net loss of CAD 5.3 million or CAD 0.13 per share in Q1 2022. Adjusted EBITDA amounted to a loss of CAD 5.8 million in Q1 2023, compared to a loss of CAD 3.2 million in Q1 2022. Moving to our balance sheet.
Our inventory position was CAD 50.4 million, 28.6% above Q1 2022, and improved relative to the end of last year. The year-over-year increase in inventory was primarily driven by CAD 4.7 million of higher core inventory, to be released for sale in the second half of 2023 under our pack and hold strategy. CAD 2.9 million of higher product costs related to our transition to sustainable material, and a CAD 3.6 million increase from more on-hand units, which was partially caused by the earlier timing of summer inventory receipts. We have made good progress towards lowering our inventory levels in the first quarter, and we are on track to right size this balance in the second half of 2023.
At the end of the first quarter, our financial position remained stable, with net debt of CAD 41 million, up slightly from CAD 39.4 million a year ago. As a result of bringing in summer season inventory earlier, we had total liquidity of CAD 74 million, including CAD 14 million in cash and CAD 60 million available borrowing capacity under our revolving credit facility. As we shared during the Q4 2022 call, we amended our credit facility during the quarter, extending the maturity by 2 years to September 2026, under the previous terms. In terms of our NCIB, we remain active, repurchasing nearly 462,000 shares in the first quarter for a total consideration of CAD 1.4 million. As a reminder, the NCIB allows us to repurchase for cancellation up to 2.1 million shares during the 12-month period ending December 15, 2023.
As of Q1 2023, we had repurchased more than 695,000 shares under the current NCIB program. In closing, we remain excited about and firmly stand behind the long-term growth potential of Roots. By maintaining a robust balance sheet and ample liquidity, we are well equipped to navigate through the short-term macroeconomic conditions. The strong financial position also allows us to plan beyond the short-term challenges, to strategically invest in a disciplined manner toward the execution of our growth strategies and generate sustainable shareholder value. This concludes our prepared remarks for Q1 2023. With that, operator, please open the line for questions.
Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment please, for your first question. Your first question will come from Brian Morrison at TD Cowen. Please go ahead, sir.
Oh, good morning, Meghan. Good morning, Leon.
Morning.
Good morning.
Hey, Meghan, I'm interested in your commentary upon data analytics, what you currently have with respect to data, what additional metrics you would like to have, and maybe the magnitude of the investment it's going to take to get you there?
Well, I think, Brian, the good news is we actually have it's pretty well invested today in terms of the data and systems that we have. We have put in place a new person specifically to focus on data analytics. From an infrastructure perspective, you know, we do actually have your CRM system. We do collect information from our consumers, both in stores and online. Really it's about kind of improving the usage of that data, and also kind of enhancing our collection of our consumer data from a store perspective to match it back to our retail, the e-commerce environment. Fundamentally, we have a good infrastructure already in place.
It's more about the usage of that data and the application of it broadly, as opposed to actually having to invest heavily in the infrastructure across the technology stack.
It's more just deciphering, putting effort into what you have rather than accumulating more information.
I think we always want to continue to get more information from our consumers, absolutely. I think also the usage of the data from a consumer base is continuously changing, so there will be some investments. I don't want you to think that we have to invest in a massive new CDP or something like that, because we do have a customer data platform today. It's more about the usage of that data and then improving the collection of it, as well as improving the usage of it.
I guess the other thing I want to ask about from a high level is your consumer response to the higher price for sustainable materials? You did mention in your prepared remarks, it sounds like it's well received. Maybe just some further detail on that.
I mean, I think, listen, we haven't really seen any specific consumer pushback from the shift to sustainable materials as it relates to price. I think as I alluded to on the call, you know, where we saw some challenges in the first quarter, it's really in our traditional fleece bottoms business. You know, across the board in our other categories, you know, we are actually seeing very positive response from a consumer base perspective. From our perspective, we don't believe that the consumers are negatively responding to the shift to sustainable materials or the price changes. I think, you know, currently we are obviously in a challenging economic environment, I think that's impacting consumer purchasing behavior. More broadly, we feel very good about our shift.
As I mentioned on the prerecorded part of the call today, you know, about 80% of our goods are now transferred to preferred fibers and materials, which is a really substantial shift for a company like ours over such a very short period of time.
Last question, maybe for Leon. I'm just looking at the bridge on inventory. It looks to me like you've cleared out your non-core, so promotional activity to the same extent, we should see a degree of relief as you move into Q2, back half. Are you able to call out the non-seasonal margin impact of the CAD 290 that you highlighted?
Brian, of the 290, I would first back out the 120 basis points, air freight and ocean freight impact. That's the tailwind that we received in Q1. That basically implies that we had a 290 basis points margin decline, which was largely driven by a mix of IMU and markdowns. I would say that our outlook and our expectations for margins have not changed since last quarter, where we do expect markdowns and IMU pressures to continue into Q2. More specifically, as we start comping off of more organic and PFM materials in the second half of the year, we will see some lesser headwinds on a cost perspective. Our markdowns will continue into the second quarter.
We have tried to manage our markdowns in a way that is more in line with the market. If you think about when a lot of the market comes into more of a promotional and clearance period, it would be in the summer timeframe, and that's when we would expect to participate as well.
Okay, I guess one last question. I appreciate that comment. Approach to N CIB, obviously, have been very active lately. There must be some metrics associated with the capital return. Hoping you can share that with us.
W e will continue to be really opportunistic in terms of our NCIB. Obviously, we've shared that we continue to be very active in Q1, and you likely see that in Q2, we are continuing as well. Obviously, we're also mindful of the current economic challenges that we're facing. We want to be really prudent with the cash we have on hand. I am very happy with our liquidity and our net debt position, where it does give us some flexibility to continue to invest in the business as we look beyond the other side. We are balancing the NCIB needs as well as the business operational needs, especially as we head into a more seasonally heavy period of our year in terms of preparing for peak.
Any target metrics you can share, Leon, or no?
We are not sharing any target metrics for the NCIB at this point.
Okay. Good luck going forward. Thank you.
Thank you.
Your next question comes from Stephen MacLeod at BMO Capital Markets. Please go ahead, sir.
Thank you. Good morning. Morning, Meghan. Morning, Leon.
Morning!
Morning. Just a couple of questions. Just wanted to remind us, if you're able to, the % sort of your merchandise breakdown, like apparel versus fleece bottoms. I mean, fleece bottoms obviously was off, more than offset the growth you were seeing in apparel. Just wondering if you can share or remind us what the merchandise breakdown is?
You know, we don't share the details of the merchandise breakdown at that level. What I can say is that fleece is obviously a big portion of our sales overall, and that fleece bottoms, you know, is a larger portion of our business just in general. I would say that, you know, when you look at the fleece bottoms business, you know, we are comparable actually from a dollar perspective to 2019. What's interesting is that, you know, we're seeing it very comparable to pre-pandemic levels now, so we feel good about, you know, the current positioning of it.
I would say that, you know, when you think about our merchandising mix overall, what's been nice to see is, again, the increased penetration of dresses and then the increased penetration of activewear, which is now almost 10% of our business. I think when you think about the broader diversification of Roots overall, I think what we're leaning towards is continuing to diversify the base. We think fleece is going to be continually important, but we do believe things like activewear and some of these other categories will continue to play an important role in the brand going forward.
Great. Thank you. Just as you, as you think about the gross margin Leon, I think you were saying that, d id I understand correctly that you were saying you sort of would need to back out the 120 basis points of lower freight premiums, so margins were sort of really down 290 basis points in the quarter? Is that right?
The 290 basis points is what I would think about in terms of product margins. That's a mix of the IMU and the markdown rates. In terms of the freight, we just call that out just for the readers to really understand where our margin composition is coming from. We did have last year in Q1, we talked about 100 basis points air freight impact, and in Q2, we talked about a 50 basis point air freight impact. It's just something we wanted to call out to make sure that everyone's aware of the margin tailwinds that we're benefiting from going into Q1 and Q2, but also be mindful of the cost and IMU impact. Sorry, cost and markdown.
No, that's helpful. Just as you turn to Q2, you talk about just some of those pressures continuing, both from a macro perspective as well as markdowns. Would you expect Q2 margins to be down, but not quite as much, I'm talking about DTC gross margin here, but not quite as much as it was in Q1?
L ast quarter, we talked about expecting that the second half, sorry, the first half margin is roughly going to be down around 350 basis points on a product margin/markdowns perspective. We do expect that, currently, we haven't changed that expectation. Again, we are looking at taking a little bit more of a promotional frame outlook in terms of when we're going to have our clearance products in line with the market. Where the market is a lot more promotional in the summer period, that's the time we want to participate.
Okay, that's helpful. Then you talked about, which I thought was interesting, just your highest level of average unit revenue in the company's history. Can you talk about how that compares against traffic levels? A re you seeing traffic pressures materially because of the economic backdrop?
Sorry. I don't think that we have a necessarily a strong correlation between traffic and AUR. On AUR, a lot of that is just driven by a combination of the customers really receiving our PFM products well, but also, again, with our managed markdowns, as we really try to be more promotional when the market is promotional. Traffic, again, we are seeing good traffic trends in most of our stores. Again, I wouldn't necessarily link AUR and traffic trends.
Okay, that's helpful. Okay, that's great. That's all I have. Thank you so much.
Ladies and gentlemen, once again, if you would like to ask a question, please press star one now. Your next question will come from Matthew Lee at Canaccord Genuity. Please go ahead, sir.
Good morning, thanks for taking my question. A lot of mine were answered already, maybe you can talk about Creative Director, Joey Gollish. H e's been working for the company now for around three months. Maybe just discuss some of the insights we've gleaned from his time so far, in terms of updates of his collaboration line and maybe what that means ballistically for some of your classic products. Thanks.
A bsolutely. We've been really happy with Joey, having Joey on board so far. H e's been a great addition to the team, and he brings definitely a modern, contemporary perspective to what is a fantastic heritage brand. I think you see that with the Beaver Canoe campaign, which hopefully you've all seen online and through various channels, which is the first campaign that he oversaw. I think it's definitely on point with what Roots stands for from a brand perspective, but also more modern, more contemporary feel, and also from a stylistic perspective as well, just from the creative assets. I feel really good about the direction that he's been taking things. He has just really started to work on impacting the product collection, as he's only been in for three months.
As you know, we work , obviously a couple of seasons in advance, so you will see more impact with his product collection coming into next year. There are certain small collections that he's been impacting already, but we feel very good about the direction he's taking things, and we feel just good about the reaction we've seen to both his collaboration with us as well as the reaction to, you know, his creative input into some of these campaigns so far.
Okay, thanks. This is very helpful.
Your next question comes from Sabahat Khan at RBC Capital Markets. Please go ahead.
Great, thanks, and good morning. J ust on the commentary around the consumer and the macro environment, I guess if the situation with the consumer and just the sales trends moderate, w hat are some levers you're thinking on the cost side that you might be able to tweak? W ould it be more focused on the stores, overheads? Just want to get an idea of how you're planning for a potential slowdown that might be more severe than what we might expect right now.
Well, I think a few things. I'll let Leon answer part of this. I think so from a high-level perspective, I think, just from the consumer, we're definitely seeing a difference between Canada and other markets. Y ou can see that in the results that have been reported by ourselves as well as other brands in terms of, you know, how Canada has definitely experienced a consumer, challenges in a different way. I would say from a high level perspective, you know, what's interesting is that our China business is, performing very well. While we've only been in the market for about a year and a half, where, you know, we're doubling our customer base there, and we're seeing very good trends from a revenue perspective.
I would say overall, we feel good about the broader direction of the company and the traction we're getting with our new product categories. Obviously, we have a cautious outlook as it relates to the consumers, particularly in the second quarter, and given the most recent rise in interest rates yesterday. From a cost perspective, Leon can speak to that, but I think one thing to emphasize from a high level perspective is that we are investing now for the future. We are obviously mentioning, you know, things like our customer, our analytics, you know, our improvements in our overall IMU into next year. These are places we're putting resources in now that we believe will impact us positively in the second half of the year and into 2024.
We want to be cautious on making too much of a short-term perspective and reducing costs at the expense of the long-term profitability of the business. Leon, maybe you can add a few additional thoughts.
Yeah, Saba, to make this point, we are in an investment period in the sense that we do want to look beyond 2023 into what Roots can be going forward. Some of the areas that we're seeing benefits there include things that we called out in Q4. Like our sourcing group and our head of sourcing there, we're seeing some great, exciting, wins there that we hope to share in early 2024. In terms of where we are finding cost improvements, we continue to partner with a lot of our close operating partners and looking at our existing contracts to try to refine some of our operations. Again, we have long-standing real estate partnerships with a lot of our landlords, so many of our rents are areas that we have ongoing discussions with.
Overall, we do want to make sure that we balance management costs with also having a good outlook on preparing for future growth.
Okay, great. Then I guess just more on the, maybe the product and sales side. Are you thinking maybe of adding some more lower price point offerings or maybe emphasizing more of a price point that might be attractive to the consumer in this environment? Do you think you can maybe just address that through promotional activity to get to the right price points? I want to understand how you're thinking about mix and pricing in this environment.
Yeah, I mean, I think, we are very much, I think, we are a premium product that I think deserves the value and price that it's been set on. I mean, if you think about the Roots product, I mean, many people have these products for a series of years, right? Sure, you know, I don't know if you have it in your household or, but I know a lot of people who do have it, who have had it for many, many years. As we get into our 50th anniversary, you know, one of the things we're talking about from a stories perspective is people who have products that are 20, 30, 40 years old from us, right? I think that Roots has an association with value, that is important to recognize.
From a price perspective, we don't anticipate reducing prices to take advantage of the current economic environment. From a promotional perspective, as Leon mentioned, you know, we do anticipate having the seasonal promotions that every brand has during the summertime period, and we'll probably be, you know, making sure that our promotions during that time period are attractive for consumers. We don't anticipate taking an increasingly promotional approach to our product overall. You know, since 2019, our basis points in Q1 have gone up 660 basis points, right, from a gross margin perspective. We are thinking about the longer term evolution of this brand and the importance of making sure that people see the value and the premium position of it. We don't want to devalue that by taking a short term perspective on discounting or price.
Great. Thanks very much for the call.
There are no further questions from the phone line, so I will turn the conference back to Meghan Roach for any closing remarks.
Thank you, everyone, for joining our first quarter results. We look forward to speaking to you in September, when we'll speak with you about our Q2 2023 results. Enjoy the summer.
Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.