DAVIDsTEA Inc.
Q1 2017 Earnings Call Transcript

Published: 8 Jun 2017

[Operator:]

Good day and welcome to the DAVIDsTEA First Quarter 2017 Conference Call. [Operator Instructions]. At this time, I’d like to turn the conference over to Rachel Schacter of ICR. Please go ahead, ma’am.

[Rachel Schacter:]

Thank you. Good afternoon, everyone. With me on the call is Joel Silver, President and Chief Executive Officer and Luis Borgen, Chief Financial Officer, also in the room is Christine Bullen, Chief Operating Officer and President of DAVIDsTEA who will join us for the Q&A session. Before we get started, I would like to remind you of the Company’s Safe Harbor language which I’m sure you’re all familiar with. This presentation includes forward-looking statements about our expectations for the performance of our business in the coming quarter and years. Each forward-looking statement contained in this presentation is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statement. Additional information regarding these factors appears under the heading Risk Factors in our 10-K which was filed with the Securities and Exchange Commission subsequent to this call and will be available at www.sec.gov and on our website. The forward-looking statements in this discussion speak only as of today’s date and we undertake no obligation to update or revise any of these statements. If any non-IFRS financial measure is used on this call, a presentation of the most directly comparable IFRS financial measure to this non-IFRS financial measure will be provided as supplemental financial information in our press release. Now I’d like to turn the call over to Joel Silver, President and Chief Executive Officer of DAVIDsTEA.

[Joel Silver:]

Thank you, Rachel. Good afternoon everyone and thank you for joining us today. Just over two months ago I was given what I sincerely believe is an exceptional opportunity to lead a talented team in getting things back on track for a truly great brand. Since taking over as CEO in late March I've confirmed my belief that DAVIDsTEA is highly recognized, is known for quality and innovation and has a very solid retail concept but clearly there is considerable work to be done to reinvigorate the overall business. The first quarter remain challenging as we continue to work through our excess inventory position. Total sales I'm pleased to say were up close to 10% as well our year-over-year margin decline was less than had been anticipated. Luis will review our financial results in detail after which we will open the call up to your question. Our overriding objective is to make tea and the DAVIDsTEA experience which is our core resonate with our customers as it did from the very beginning. We are in two distinct markets, Canada and the U.S. and it's clear we're at different stages of maturity in each. We have a very strong Canadian business underlined by the fact that we do 80% of our sales in Canada. We are extremely confident in Canada, DAVIDsTEA's has an excellent platform and one we will continue to build upon. There has been significant effort trying to penetrate the U.S. market while there has been some success it has been limited, we will not abandon the U.S. market but we do intend to emulate the Canadian success in the U.S. with the necessary adjustment to perfect our business model. We want to address all markets proportionally to unlock all potential value while the growth of our U.S. store base will be limited in the short term we must improve the performance of our existing store base particularly where we have density such as the New England and the Midwest. The American consumer is different and we must adapt our marketing approach accordingly. This requires a highly disciplined approach. We owe you our shareholders nothing less. Tea is a world movement and is the most widely consumed beverage in the world next to water, it's the only beverage commonly served hot or iced any time anywhere for any occasion. We believe we can grow our share in the tea world to become an international tea brand. To achieve this we have to return to the basic principles of vertically integrated product development. We will work to ensure we are the best and are perceived that way by consumers wherever we decide to conduct business. We have learned over the past couple of years the global expansion is only possible when a strong brand makes a necessary adjustments to local culture. We know how we have to get things back on track. We have the makings of a solid plan to improve our product assortment, the in-store experience and raise the bar on our e-commerce platform among other things. We also know that with the dynamic DAVIDsTEA's brand we have a great company and a great future. We intend to fully maximize these assets. While premature to lay out the plan at this time the process has begun. However it will take a few quarters to fully implement the strategic initiatives and for them to gain traction and positively impact our results. Let me detail some of these initiatives, our first area of focus is renewing and streamlining our focus on tea by refining and reducing our SKUs by approximately 25% to create a more streamlined and focused in-store experience. We expect this modified assortment to be applied to all the products, accessories food and drink. We are enhancing visual merchandising to improve product appeal and create an easier shopping experience. In addition we are implementing a new merchandising strategy to provide a more cohesive product message around tea, all this should lead to better sales results. A second area of focus is investing in our digital footprint including our website, CRM capability and digital marketing to increase our digital presence given the consumer shift to online and the growth of our e-commerce business as we move towards our medium term target of approximately 15% penetration. During Q1 we began work on our new robust and more stable website to replace our existing site and which will have improved capabilities to keep up with existing online demand and allow us to accelerate our e-commerce growth. The website is planned to launch later this year. The enhanced technology and functionality, the ease of shopping will be greatly improved experience to our customers. Once fully operational we anticipate healthy gains in our online business. Our investments in CRM and digital marketing will allow us to reconnect with our existing customers, and personalize our communication based on our customer's previous shopping patterns and preferences. We will significantly increase the frequency of our customer communication and utilize more relevant communication. We have begun to see early positive results from personalized and targeted emails. We'll continue to believe the digital opportunity is significant one for us both as a more effective marketing vehicle as well as a more meaningful revenue channel and our focus in this area will help fuel capital efficient expansion of the brand and customer reach. On the marketing front we're continuing to conduct consumer research to help hone-in on what is important and relevant to our customers. We plan to have the data from our initial consumer research study collected by summer at which point we'll analyze the feedback and utilize this information in our go forward brand strategy and messaging. We are also continuing to analyze our various selling seasons and sub-campaigns across stores in all lines to create a more consumer focused approach to our campaign. Investing in our people is another priority. We're pleased with the early success of employee training programs are focused on retail excellence. As a part of this program we are training our employees to increase the average transaction and seeing success. We're making progress in our store testing and we will also utilize these learnings to drive sales, improve the customer experience and achieve operational efficiency. We also see potential in growing alternate sales channels such as wholesale distribution and online marketplaces where we will monetize the DAVIDsTEA brand and increase its visibility as well while currently a small segment of our business we're looking to expand it's reach and partnerships in hotel, restaurant and institutional businesses. Some of the first quarter's operational highlights include, and we've seen some early success from the new store format in our native mall store in Boston, given these encouraging results we opened up a store in this format in our Toronto market which has done quite well thus far. We're also pleased with the results of our refresh test that we have rolled out to an additional 100 stores this year for a total of a 170 stores. The refreshed test includes re-fixturing and improved customer flow and visual merchandising. In-store traffic counters will be in over 130 stores by fiscal year-end. We believe traffic counters will be helpful in deploying labor more effectively while also providing helpful insights into the key metric such as conversion. Overall our first quarter generally played out as expected with some trend improvement in the back half of the quarter and now for more detailed review of our first quarter financial results I will turn the call over to Luis Borgen, our Chief Financial Officer.

[Luis Borgen:]

Thank you and good afternoon everyone. I'll begin my remarks with a review of our first quarter. As a reminder the dollar amount referred to when reviewing our results are in Canadian dollars. Sales in the first quarter of fiscal 2017 increased 9.4% to 48.7 million from 44.5 million in the first quarter of fiscal 2016. We ended the quarter with 232 stores, an increase of 34 net new stores or 17% versus 198 stores at the end of the first quarter of 2016. In Q1 we opened three new stores in Canada, one new store in the U.S. and we closed one store in Canada and two stores in the U.S. for a year over year increase in store operating weeks of 20%. Comparable sales decreased by 5.7% versus a 4.9% comp increase in the first quarter last year. Gross profit dollars increased 4.3% to 24.2 million from the 23.2 million in the first quarter of fiscal 2016. Gross profit as a percent of sales decreased 240 basis points to 49.7% from 52.1% in the prior year period primarily due to increased discounting compared to the prior year to clear through post-holiday inventories. The year over year margin decline was less than we had expected due to leveraging of fixed cost given the improved sales trends in the second half of the quarter combined with less promotional activity than we expected. Adjusted SG&A increased to 25.6 million from 21.1 million in the first quarter of fiscal 2016. As a percent of sales adjusted SG&A increased to 52.6% from 47.5% in the first quarter of fiscal 2016 due to deleveraging of fixed cost attributed to the negative comparable sales growth. Adjusted results from operating activity for the first quarter of fiscal 2017 were a loss of 1.4 million as compared to last year's adjusted results from operating activities of 2.0 million. Adjusted net loss was 1.1 million or $0.04 per fully diluted share as compared to net income of 1.5 million or earnings per fully diluted share of $0.06 in the prior year period. Adjusted EBITDA for the first quarter of fiscal 2017 was 1.5 million compared to 4.6 million in the prior year period. As of April 29, 2017 ending inventory was 28.6 million as compared to 17.6 million as of the end of the prior year period. On a per store basis inventory increased by 39%, going forward we continue to plan to reduce our buys and have fewer selling seasons as we continue to work through excess inventory and expect this will take us several quarters to work through. In terms of liquidity, we ended the quarter with 56.3 million in cash or a net cash position of $2.20 on a per share basis. No debt and availability of 20 million under our revolving credit facility. Regarding our outlook, we are continuing to not provide quarterly and annual guidance at this time given 2017 is a recent year. As we develop go forward strategic plan to drive improved results. However looking at our quarter to-date trends our comparable sales are in the negative low single digit range, during the second quarter we will have our semi-annual clearance sale to continue to clear it through excess inventory which we expect will result in increased pressure on our gross profit margin compared to the first quarter. We expect to see SG&A deleverage in the second quarter as compared to the prior year period taking these factors into account we anticipate in operating loss for the second quarter of fiscal 2017. We plan to open five stores during the second quarter including four in Canada and one in the U.S. with one store closure in Canada. With respect to CapEx in 2017 we expect to spend a total of about 16 million to 20 million. Included in our CapEx guidance is approximately 3 million to 4 million for the launch of our new website later this year which is reflected in our CapEx guidance. We continue to expect to be free cash flow positive for the year. With that I'll turn the call back over to Joel for some final remarks before we open the call to your questions.

[Joel Silver:]

Thank you, Luis. We also announced today that Luis will be moving on. I do want to take this opportunity to thank him for his leadership and many contributions over the years, he played an integral role in DAVIDsTEA public over two years ago and has been instrumental in instilling financial and cost discipline. He has been especially helpful to me in my first two months here. We wish him well in his future endeavours. As concerns our outlook we expect continued gross profit margin in the second quarter with some delayed promotions, coinciding with our planned annual and summer clearance event. As we continue to work through excess inventory position. Looking ahead the rest the year we anticipate opening 10 to 15 new stores in Canada as we approach our total goal of approximately 230 stores. We will moderate our growth in the U.S. and be extremely selective in any new openings, possibly a maximum of five. To ensure those that we do open deliver higher returns. We will concentrate more on reenergizing the existing store base. As we said previously fiscal 2017 will be a reset year and as such we won't be issuing guidance through 2017. We'll reevaluate this at the appropriate time. We remain focused on the mid-term vision and realignment of DAVIDsTEA as we implement the needed strategic alternatives. I will now ask the operator to open the lines for question.

[Operator:]

[Operator Instructions]. We will take our first question from Lorraine Hutchinson of Bank of America Merrill Lynch.

[Stephen Albert:]

This is Stephen Albert on for Lorraine, my first question is on just the gross margin and the inventory a little bit if you were to think about it beyond just this coming quarter. Inventory per foot still up high-30s versus up high-40s last quarter. Is that elevated from where you had thought coming into the quarter and should we expect similar gross margin pressure as you're talking to in the first half in the back half of the year given it's a several quarter initiative to kind of get inventories right-sized.

[Joel Silver:]

On the first point with regard to the inventory level it's in-line with what we expected for Q2, we're sort of in a glide path to the back at our inventory levels by let's say Q4, the pressure we expect to experience in Q2 will moderate somewhat in Q3 and Q4 but we're still going to take a couple of quarters to work through our excess inventory position, we're working hard with our clearings and our buys to mitigate the impact of some of the inventory levels as well as our gross profit margin pressure but it is in-line with where we thought will be in Q2.

[Stephen Albert:]

Okay, and then SG&A should we continue to expect it to grow roughly at parity with square footage, are there any offsets or efficiencies to try to moderate that growth, how much are incremental investments in online impacting that line as well?

[Joel Silver:]

The SG&A deleverages partly due to the fact that seasonally Q2 and Q3 are generally lower quarters versus Q4, we are annualizing some of the investments we made last year in new hires into this year. We're making some investments in our online business both on the people side as well as the technology side which will flow through depreciation so we do expect some continued pressure on SG&A for the next several quarters, Q4 given the higher volume quarter we should moderate some of that SG&A deleverage but for the next two quarters I assume that will continue to be pressured.

[Operator:]

We will take the next question from Kelly Bania with BMO Capital.

[Kelly Bania:]

Joel, I think you mentioned the refocusing on tea SKU rationalization, I think you said up to 25%, I was just curious timing on when we should expect the progress on that initiative?

[Joel Silver:]

Yes, that was affected in the -- for the holiday buy, so we'll really start to see that impact for our holiday quarter which is our Q4.

[Kelly Bania:]

Okay. And Joel as you think about the DAVIDsTEA brand, spoke very highly of the brand but I'm just curious how you view the positioning of DAVIDsTEA, do you still see it as positioning as the healthy beverage alternative for -- you mentioned some maybe some differences in what the American consumer, how the brand is resonating there. So is there maybe a different brand positioning for the U.S. versus Canada or just any big picture thought from that front.

[Joel Silver:]

No, I think as a starting point we think it's an amazing positioning, but we are fielding some significant market research to both evaluate the current positioning and making sure it still resonates with our customers. We will have that research by the end of the summer time. So that's going to be some huge insights for us. You know as far as the U.S. marketplace as I think we've spoken before about 80% of the total tea consumption happens is iced in the U.S. obviously given heritage and weather and everything else. So just starting there it's such a dramatic difference. So I think we're learning a ton, we see a lot of similarities but we also see also in the key U.S. urban markets we see spike in some of our healthier flavors including some of the Matchas. So I think we're starting to really understand - better understand the dynamics of the assortment and we'll continue to push on those opportunities to maximize whichever regions we operate in.

[Kelly Bania:]

And then just last one for me, I think last quarter you meant you characterized some of the issues is kind of self-inflicted and I guess after the past couple of months of being there has anything changed on that front, do you think there's anything external either on the competitive environment that's changed or do you still feel confident these are I guess some self-inflicted issues that are under your control that you know in a couple quarters maybe you guys can make some real progress on?

[Joel Silver:]

No, it's definitely the latter. We believe that the reduction of the assortment even started before I walked in, the team has done a great job of looking at it, understanding the flow of goods relative to the flow of our customers. So I think we're going to see impact from that within the year and I think that will alleviate a lot of pressures that the business was facing over Q4 in Q1 of the last year.

[Operator:]

We will take a question from Sharon Zackfia with William Blair.

[Sharon Zackfia:]

Question on the discounting in the quarter, can you quantify how much that was and kind of how much you're expecting that to impact gross margin in the second quarter as well?

[Luis Borgen:]

The pressure of the 240 bps down, a good chunk of it was discounting. We do have some foreign exchange headwinds which should moderate heading into the back half. We also had some deleverage related to rent and supply chain costs, I think those factors will be essentially the same heading into Q3 magnified a bit by the fact that our volumes are going to be as high as we had expected when we built up the plan. So we expect at least the same amount of deleverage in Q3 as we had in Q2, we're trying to obviously mitigate those, I don’t think we could see real improvement until probably Q4 where we have a lot more volume and some of the initiatives that Joe and Christine are working on will take effect in terms of getting the inventory down, getting our buys down and improving our line of business.

[Sharon Zackfia:]

And then a second question on the improved trend in the second half of the quarter and so far in the second quarter, is there anything you kind of attribute that to and then did you see the improvement both in Canada and in the U.S.?

[Joel Silver:]

It was pretty similar across both geographies. It's been fairly choppy the first four to five months this year, it has been tough to predict which is one of the reasons we're not giving guidance but there's nothing specific that we saw that we could point to and say it’s a specific factor. We have seen a general trend improved versus the aggregate Q1 results, as we sit here we are in negative low single digits so it is an improvement in the trend but it's just been so choppy it's hard to predict much beyond that at this point.

[Operator:]

We will go next to Chris Krueger with Lake Street Capital Markets.

[Chris Krueger:]

Can you repeat the quarter to date same store sales trend? I didn't quite catch that.

[Joel Silver:]

It was negative low single digit is where we stand.

[Chris Krueger:]

Okay, all right. And I know you explained you expect five new stores in the second quarter and one closure how many closures do you expect for the full year?

[Joel Silver:]

Two Canada and about four U.S. at this point.

[Chris Krueger:]

OK. And last question, you've a lot of cash on the balance sheet and it was slowing easing back on your store growth, has there been any [indiscernible] of a share buyback?

[Joel Silver:]

We've discussed various ways to deploy the cash and we have made a determination on that, roughly something aboard, [indiscernible] part of our overall capital deployment discussions, at this point we haven't come to anything definitive with respect to our balance sheet of cash.

[Operator:]

That concludes today's question and answer session. I'd like to turn the conference back to management for any additional or closing remarks.

[Joel Silver:]

Thank you for joining us this afternoon. As we have laid out there is work to be done but we're confident that DAVIDsTEA brand will prevail and we believe we can maintain our lead in the tea world to become an international team brand. We really appreciate the patience of our shareholders and I will look to the council of our board through the year. I invite you to join us tomorrow at 2 PM for our Annual Meeting to be held at the office of DAVIDsTEA [indiscernible]. I look forward to updating you on our progress and any new developments in the second quarter earnings call. Thank you and have a good evening.

[Operator:]

That concludes today's conference and thank you for your participation.