DAVIDsTEA Inc.
Q1 2016 Earnings Call Transcript

Published: 8 Jun 2016

[Operator:]

Good day and welcome to the DAVIDsTEA first quarter 2016 earnings call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Rachel Schacter of ICR. Please go ahead.

[Rachel Schacter:]

Thank you. Good afternoon, everyone. With me on the call is Sylvain Toutant, President and Chief Executive Officer and Luis Borgen, Chief Financial Officer. Before we get started, I would like to remind you of the company's Safe Harbor language, which I am sure you are all familiar with. This presentation includes forward-looking statements about our expectations for the performance of our business in the coming quarter and year. Each forward-looking statement contained in this presentation is subject to risk 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 SEC filings 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 would like to turn the call over to Sylvain Toutant, President and Chief Executive Officer of DAVIDsTEA.

[Sylvain Toutant:]

Thank you, Rachel. Good afternoon, everyone and thank you for joining us today. I will begin by reviewing the highlights of our first quarter performance and then discuss the progress we are making on our growth strategy. Luis will then go over our financial results in more detail and review our outlook, after which, we will open the call up to your questions. We are pleased with our first quarter results which came in above our top and bottom line guidance ranges and reflect a strong start to the year. Total sales of CAD44.5 million were up 24.3% coming in above our expectations despite a difficult overall retail environment and a continuation of pronounced economic headwind affecting the Canadian market. Our sales results were driven by strong new performance and a healthy comparable sales increase of 4.9% on top of the 6.3% comp sales increase in the prior year period. Q1 2016 marks our 27th consecutive quarter of comp increases, and this strong comp performance was again fueled by our innovative merchandise assortment, our engaging in-store experience, and our unique and compelling marketing efforts which we continued to resonate with our customers. We opened five new stores during the first quarter, including three stores in the last two weeks ending the quarter with 198 stores or an increase of 23% versus the end of Q1 last year. This includes 159 stores or 80% of our store base in Canada and the remaining stores in the U.S. We are on track to grow our store base by 21% or 40 new stores in fiscal 2016, including 23 to 27 new stores in Canada and 13 to 17 stores in the U.S. as we continue to expand our footprint to realize the full potential of over 550 stores that we believe exist for the DavidsTea brand in North America. As we said on our last call, our Canadian openings will mostly be in existing market with some openings in small markets, while our U.S. store openings will be mostly skewed toward mall, lifestyle, and outlet location. We remain disciplined as we continue to target high traffic locations that are a good fit for our concept. We are excited about our fiscal 2016 class of stores, and we will announce these locations around each store opening date. Now on to profitability. Gross profit dollars in the first quarter increased by 21.5% to CAD23.2 million. Our gross profit as a percent of sales was 52.1%, a decrease of 120 basis points over the same quarter in 2015 driven mostly by FX impacts. On a constant currency basis, gross profit as a percent of sales was 54.2%, up 90 basis points year-over-year, which Luis will discuss in more detail shortly. Driven by the sales outperformance, adjusted EBITDA of CAD4.6 million was above the high end of our guided range and increased 15% compared to the prior year period level of CAD4 million. Results from operating activities were CAD2 million. Earnings per share for the quarter, was CAD0.06, CAD0.01 above the high end of our guidance and a 50% increase compared to adjusted earnings per share of CAD0.04 in the prior year period. Our solid first quarter results continued to demonstrate the appeal of both our concept and our product offering, including the wide variety of tea products, our focus on innovation and design, and our distinct and flexible retail format, and successful e-commerce business. Our strong relationship with our customer is reinforced through our unique marketing strategy as well as our passionate and knowledgeable tea guides that create an in-store experience that truly focuses on the customer. We continue to believe we are well-positioned in an attractive industry that is benefiting from consumer trends with broad demographic appeal. Looking ahead, we remain focused on driving brand awareness through our strategic growth priorities combined with our targeted retail expansion. Let me briefly discuss these priorities including progress made in the first quarter. Our number one priority remains focusing on our targeted retail expansion. As just discussed, we have opened five stores in the first quarter and are planning 40 total stores opening this year, representing 21% store growth. A few weeks ago, we announced the appointment of Christine Bullen as the Managing Director of U.S. Market. Christine joins us after 10 years with the Swiss-based global leader in the premium chocolate segment, Lindt, most recently leading the direct-to-consumer and specialty channels for the U.S. Prior to Lindt, Christine held retail leadership roles with Elizabeth Arden, Nine West Group, and Nordstrom, as well as with high growth brands such as Laila Rowe. Her background as a seasoned retail executive with substantial U.S. experience makes her a great fit for leading our U.S. market growth as we continue to expand our North American footprint. The second pillar of our growth strategy is to drive comparable sales growth through a constant flow of new and innovative products. During the first quarter, we launched new tea flavors, including raspberry cream pie, pistachio ice cream, and mango fruit punch, which our customers were very excited about. In terms of product innovation, we continued to be very pleased with the early success of our iced tea press that we launched at the beginning of the first quarter. This unique product has provided an inventive way for our customers to freshly brew quality iced tea on the go. We remain committed to designing unique and innovative products like this that our customer will love and that also differentiate DAVIDsTEA. We continued to build awareness of the DAVIDsTEA brand through community-based marketing supplemented by our digital campaign. During the first quarter, we participated in community events across both Canada and the U.S. including The JUNO Awards in Canada, WE Day in both Chicago and LA, and the Coffee & Tea Festival in New York City, just to name a few. Additionally, we began to utilize more targeted and personalized digital campaigns in the first quarter as a result of our enhanced CRM capability, which will be a focus for this year. We will keep you updated on our progress, which brings me to our e-commerce site. In the first quarter, we again saw increased e-commerce penetration as we continued to make progress towards our long-term target of 15%. Our e-commerce growth continues to grow faster than our store growth as our customer enjoy our optimized search engine capabilities and increased speed for assessing information content as a result of our enhanced site. Our improved e-commerce platform also has allowed us to collect personalized data on individual customer's preference from our frequent steeper loyalty program which has afforded us the opportunity to deepen the connection with our loyal customers. As mentioned on our fourth quarter earnings call, we now have the ability to tailor our marketing strategies by geography, and in turn be even more relevant to our customers, including a targeted marketing campaign in California around iced tea that we discussed previously. We have seen early success from this campaign and will continue to utilize segmented marketing efforts going forward, which will enable us to drive incremental sales over time. Lastly, we remain excited about the opportunity within the hotel, restaurant, and institutions sector as we expand our partnerships in this area. In the first quarter, we signed agreement with six original coffee and tea solution distributors in Canada representing another great opportunity to increase our brand visibility in North America. So in summary, we are pleased with our first quarter results that came in ahead of our guidance and reflect a strong start to the year despite a mixed overall retail backdrop. We are encouraged by the consistent performance of our stores and the progress we continue to make against all of our strategic growth priorities. Given the solid start to the year, we are reaffirming our previously provided outlook. In closing, I want to take a moment to thank all of our team members for the excitement and the passion that they bring to our company and our customers everyday. They are the reason our customer love the DAVIDsTEA experience and reward us with their loyalty. And now for a more detailed review of our first quarter results as well as outlook, I will turn the call over to Luis Borgen, our Chief Financial Officer.

[Luis Borgen:]

Thanks Sylvain and good afternoon, everyone. I will begin my remarks with a review of our first quarter FY16 results and then discuss our outlook for the second quarter and full year 2016. Before I begin, let me remind you that we report our results in Canadian dollars. So please keep in mind that the dollar amounts I refer to when reviewing our results and guidance in Canadian dollars. Additionally, my comments today will focus on adjusted results. We have provided these results as well as an explanation of each line item and a reconciliation to IFRS net income and earnings per share in our earnings press release which was issued earlier today. Please see the IFRS to non-IFRS reconciliation tables in our press release for further detail. Our sales in the first quarter of 2016 were CAD44.5 million, up 24.3% from CAD35.8 million reported in the first quarter of 2015. We ended the quarter with 198 stores, an increase of 37 net new stores or 23% versus the 161 stores at the end of the first quarter of 2015. This includes 159 stores in Canada and 39 stores in the U.S. In Q1, we opened five stores including three in the last two weeks of the quarter for a year-over-year increase in store operating weeks of 23%. Comparable sales increased by 4.9% on top of a 6.3% comp increase in the first quarter of last year. And as Sylvain mentioned, Q1 2016 marks our 27th consecutive quarter of positive comp sales. Gross profit dollars increased 21.5% to CAD23.2 million from the CAD19.1 million reported in the first quarter of 2015. Gross profit as a percent of sales decreased by 120 basis points to 52.1% from 53.3% in the prior year period, primarily due to the adverse impact of the stronger U.S. dollar on U.S. dollar denominated purchases partially offset by supply chain efficiencies. Excluding the FX impact, on a constant currency basis, gross profit dollars in the first quarter were CAD23.6 million, up 23.6% year-over-year with a corresponding gross profit as a percentage of sales of 52.2%, up 90 basis points from last year, driven by improved product cost and supply chain efficiencies. SG&A increase of CAD21.1 million from CAD17 million in the first quarter of 2015. As a percentage of sales, SG&A was 47.5% compared with the prior year period at 47.4%. Results from operating activities for the first quarter of 2016 were CAD2 million as compared to last year's adjusted results from operating activities of CAD2.1 million. Our effective tax rate for the first quarter of 2016 was 29.3% compared to 0.5% in the first quarter of 2015. Net income was CAD1.5 million or CAD0.06 per fully diluted share, CAD0.01 above our first quarter guidance range as compared to adjusted net income of CAD1.1 million or CAD0.04 per fully diluted share in the prior year period. Adjusted EBITDA for the first quarter of FY16 was CAD4.6 million compared to adjusted EBITDA of CAD4 million in the prior year period. In terms of liquidity, we ended the quarter with CAD69.1 million in cash and availability of CAD20 million under our revolving credit facility. Now I would like to turn to our guidance. For the second quarter of fiscal 2016, sales are expected to be in the range of CAD39 million to CAD40 million based on opening 11 new stores and assuming a comparable sales increase in the mid single-digit range. Adjusted EBITDA is expected to be in the range of CAD0.2 million to CAD0.5 million. Net loss is expected to be in the range of minus CAD2.1 to CAD2.4 million, with adjusted loss per common share in the range of CAD0.08 to CAD0.09 on about 24.2 million weighted average shares outstanding. As a reminder, in a quarter where we report a net loss, we use basic shares outstanding to calculate the net loss per share due to the anti-dilutive impact of using of fully diluted share count in a loss-making quarter. For fiscal 2016, we are reiterating our previously issued guidance. We continue to expect sales to be in the range of CAD215 million to CAD219 million, a 19% to 21% increase over FY2015. This is based on opening 40 new stores for the full year and assumes a comparable sales increase in the mid single-digit range. As I said on our Q4 call, we have hedged all of our U.S. dollar purchases for FY2016 and this is reflected in our outlook. Our full year 2016 guidance still assumes FX driven gross profit as a percentage of sales declines to be offset by anticipated leverage of fixed cost and SG&A and adjusted EBITDA is expected to be in the range of CAD31 million to CAD33 million. Adjusted net income is expected to be in the range of CAD13 million to CAD14 million or CAD0.50 to CAD0.54 per share, which represents EPS growth of 25% to 35% on about 26.1 million adjusted fully diluted common shares outstanding. As a reminder, while we expect adjusted EPS for full year to increase in the 25% to 35% range from FY2015, we expect Q3 loss per share to be slightly higher than the prior year period due to FX headwinds as well as higher wages and higher stock-based compensation expense. Also, we anniversary FX headwinds, higher wages and compensation expense in Q4 and benefit from higher sales volume associated with the holiday season. We expect our fourth quarter 2016 EPS increase to be above the increase we are projecting for the full year. With respect to CapEx, in 2016 we continue to spend a total of about CAD21 million to CAD23 million. We still plan to devote about 85% to 90% of our capital budget to our 40 planned new stores and some store renovations with the remainder of the capital budget to make continued investments in our infrastructure. For all other details related to our resulting guidance, please refer to our press release. I would just like to make one additional statement. On a constant currency basis, our gross margin should be 54.2%, not 52.2%. And with that, I would like to turn the call over back to the operator to start the Q&A session.

[Operator:]

[Operator Instructions]. We will take a question from Matthew Boss from JPMorgan.

[Esteban Gomez:]

Hi guys. This is Esteban, on for Matt. Thanks for taking my question. Can you speak a little bit about your expectations for free cash this year? And then more specifically, your priorities for capital deployment? You ended the quarter with almost 20% of your market cap in cash and it doesn't seem like you need any of this to run the business or grow stores at your planned pace. So just wondering how you would rank some of the options you have?

[Luis Borgen:]

Yes. In terms of free cash flow, we expect our free cash flow to be slightly positive, flat to slightly positive. We operate the business with no debt and our operating cash flow at this point is going to be equal to or slightly greater than our total CapEx, Esteban. In terms of cash uses for the business, our main priority is to grow the business and to invest in stores, e-commerce, and other infrastructure investments. That's our main priority for our cash.

[Esteban Gomez:]

Got it. So would you potentially consider accelerating your store growth, just given the amount of cash you have on your balance sheet?

[Sylvain Toutant:]

That is a possibility. We stated that our long-term goal is to grow our unit growth in the high teens. Our plan for this year is to do around 40 stores. To the extent we have new store opportunities either in Canada or the United States, we would certainly consider opening more good stores as long they meet our store payback and they strategically fit the markets that we want to target.

[Esteban Gomez:]

Okay. And if I could just sneak in one more on same-store sales. Can you just break out traffic versus ticket in the quarter? And any details you can give us on the performance of your U.S. versus Canadian store base?

[Sylvain Toutant:]

Yes. Well, so if you look at our comp first of all, we said most of our -- and the ticket was really the thing that drove -- our average transaction was up and our comp were good, because of our ticket. And that reflects really the performance of our our goods and merchandising strategy that really does resonate well with our customer. If you look at the biggest driver in terms of traffic decrease, it's really beverage-only transaction which is mainly a result of our ability to process more customer in our store and really do it in a proper way. So we are working on this to make sure that we can create a formidable process, much faster for customer to keep on using beverage to drive traffic but also allow our tea guys to have free time to really service the customer on the tea, looseleaf tea that they are buying at home and giving them advice and everything and not being only doing beverage. So beverage is very important for us. It's always been a gateway to the brand. But we want to make sure we do it in a much more efficient way going forward. The other impact, I would say, on our traffic would be cannibalization mainly in Canada which as you know, our new stores are performing much better than our pro forma and that does have an impact, a little bit more cannibalization, but it's similar to what it was the last quarter. But on the other hand we need that cannibalization to really improve again throughput for our customer in existing stores. So I think it's very healthy for the business. And I would say, the third thing is our e-commerce penetration that keeps growing and as you know, our average transaction is much higher on e-comm and more the brand is known, people can be more comfortable using the e-comm to buy and that does have an impact. But overall, it creates just more EBITDA for us because it is incremental to our EBITDA, it accretive to our EBITDA level. So that's mainly what's happening. And from a Canadian to U.S., even though we don't comment on, we don't break it out by country, it's pretty similar to what it was in the last quarter where the U.S. business is comping higher than the average.

[Esteban Gomez:]

Great. Thanks guys.

[Sylvain Toutant:]

Thank you.

[Luis Borgen:]

Thank you.

[Operator:]

Now we will go to Kelly Bania with BMO Capital.

[Kelly Bania:]

Good evening. Thanks for taking my question. Just on the traffic topic, if I am hearing you correctly, is the beverage-only transaction, if you were to look at transactions outside of that, would your traffic be positive or much better? Is that the right way to think about it?

[Sylvain Toutant:]

Yes, we don't break that out, Kelly. But I would say what I would reiterate is that our traffic is driven primarily by ticket. Beverage is, as we disclosed, down and that's by design and we are addressing that through our -- [indiscernible] that’s the main driver.

[Kelly Bania:]

Got it. And now that you have the frequent steeper program integrated online for a little while now, I guess any thoughts on the impact of that in terms of cannibalization to the stores, now that you have a little better data to do that analysis?

[Sylvain Toutant:]

What we have seen so far is that the combined effect is accretive, meaning people tend to buy more aggregate. Still early days. We need to view that data over longer periods of time. But what we have seen so far in the data we have been able to analyze is, a customer who shops both channels, buys more in aggregate than he did in single channel. They are heavier users.

[Kelly Bania:]

Got it. And then just a question on gross margin. I think on a currency neutral basis, it slowed a little bit from last quarter, still up, but you also didn't cite any of the mix shift pressures that I think we talked about last quarter. So I was just curious if we could get some more puts and takes on gross margins?

[Sylvain Toutant:]

Sure. It was up 90 basis points. The mix was unfavorable, like it was the last quarter but we were able to offset a good chunk of that through better buying. So a very similar dynamic to what we saw in the previous quarter, Kelly. But we are still very pleased on overall on a constant currency basis being up 90 points in this retail environment with a 4.9% comp with the high quality gross profit dollars coming through the P&L.

[Kelly Bania:]

And with the hedge in place, I don't know if you have given this, but can you remind us what you expect the impact from FX to be on your gross margin for the full year in terms of basis points?

[Luis Borgen:]

Yes. We haven't disclosed it. It should moderate as we get to the back half of the year. For fiscal 2016, since we did purchase the hedges for that for the full year. So for 2016, it will still be a headwind. And what I can tell you that for fiscal 2017, we hedged both Q1 2017 and Q2 of 2017. So for Q1 of 2017, we expect that to be relatively flat to our Q1 2015 rate and we expect, holding everything else on constant currency basis, the hedges we put in place, we are going to be favorable to our Q2 2017 relative to Q2 2016.

[Kelly Bania:]

Got it. That's great. And then just a bigger picture question. Just curious if you could comment on announcement by Starbucks and Teavana and Anheuser-Busch to do this ready-to-drink tea in the U.S. next year. Do you expect any impact of that? Do you ever consider something similar? Just any thoughts on that.

[Sylvain Toutant:]

So I think it's exactly a good news. I think it proves the point that specialty tea beverage is really growing and really the cultural demand is there. And I think that as we build our brand and I have been saying that since day one, DAVIDsTEA is a beverage brand and we have been building the brand through our retail. I am a big believer in creating emotion around the brand and creating a full 3D experience through our stores. But the reality as we build that brand, that's really an open opportunity for us to either go in different channels or develop different formats. So as we speak now, we are very, very focused on delivering our plan for 2016 and opening our stores, but I think this is actually very a good news about the category of specialty tea, which is growing fast and which consumer has interest. And at the right time, we will capture opportunity that will arise for DAVIDsTEA.

[Kelly Bania:]

Great. Thank you.

[Sylvain Toutant:]

Thank you.

[Operator:]

[Operator Instructions]. At this time, we will move to Sharon Zackfia with William Blair.

[Sharon Zackfia:]

Hi. Good afternoon.

[Sylvain Toutant:]

Hi Sharon.

[Luis Borgen:]

Hi Sharon.

[Sharon Zackfia:]

Hi. Could you remind us what percent of your locations in the U.S. and Canada are in malls?

[Sylvain Toutant:]

So we will get to the right numbers. So we have, in the U.S. right now, 49% of our store base, about 50% is in street and the rest is mall. And in Canada, we have 74% in mall and 21% street. The rest is outside the mall.

[Sharon Zackfia:]

Thanks. There has been a lot of conversation obviously about mall traffic in the U.S. and the pressure there. And I guess I am curious first, I mean if that makes you rethink your strategy at all in the U.S. and how you develop? Or if you think that just creates more availability potentially in some locations? And then, I don't know if Canada is seeing the same kind of pressure on traffic. So maybe if you talk more broadly about the mal environment there?

[Sylvain Toutant:]

Okay. I think the two markets are very different. But if we talk about the U.S., that's why we have been putting the emphasis on our portfolio approach. And so when we talk about mall, we don't shy away from outlets. We don't shy away from lifestyle, which actually we love. And this year when we look at what we are going to do, it's going to be mainly, when we talk about mall, it's going to be composed of traditional mall that we are very selective with and we want to make sure we open in, what I call close to center court or high traffic locations within those malls. We are picky on our co-tenancy. That's very important for us. And lifestyles, then lifestyle and outlet been great, good number location for us and a great ability to move our concept. So as we said before, we have a mall store formats, but we have also an outlet format which is a little bit bigger with different rent profile. So we have been able to do that. On the street level, though in the U.S., we are also very, very selective and we want to make sure we open on amazing street and are really destination for shopping or have very high traffic. On the Canadian perspective, it is a little bit different. There is less of the lifestyle format. That might be a weather related thing because it's cold a little bit here. So outdoor shopping is less popular. There's a few big one. But the malls, we have been very successful in malls in Canada and even in small towns where we been able lately to open stores in smaller market and traditional mall, it still becomes a destination and we have been able to be successful in those areas.

[Sharon Zackfia:]

Okay. And can you give an update on e-commerce? I think we ended last year with around 9.5% of sales from e-comm. How is that trending? And what are your thoughts on where that might go in 2016?

[Sylvain Toutant:]

It continues to grow well ahead of the house. We expect it -- excuse me.

[Luis Borgen:]

Yes, we generally would expect to be maybe 1 to 1.5 points of increased penetration, Sharon, from where we ended fiscal 2015. I think that's the implied growth rate from that. But it's growing very nicely and it's becoming more accretive as we improve the supply chain, particularly in the United States.

[Sylvain Toutant:]

Yes. We are very confident about our 15% long-term goal on this one.

[Sharon Zackfia:]

Okay. Great. Thank you.

[Sylvain Toutant:]

Thank you.

[Operator:]

[Operator Instructions]. At this time, we have nothing in the queue. I will turn it back over to management for closing remarks.

[A -Sylvain Toutant:]

Well, thank you for joining us today and we look really forward to speaking with you again when we report our second quarter results. Thanks a lot.

[Operator:]

And this does conclude today's conference call. Thank you all for participating.