DAVIDsTEA Inc.
Q2 2016 Earnings Call Transcript

Published: 8 Sep 2016

[Operator:]

Welcome to this DAVIDsTEA Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time I'd like to turn the conference over to Ms. Rachel Schacter of ICR. Please go ahead.

[Rachel Schacter:]

Thank you. Good afternoon, everyone. With me on the call is Sylvain Toutant, the President and Chief Executive Officer and Luis Borgen, Chief Financial Officer. Before we get started I'd like to remind you 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-Q that was filed with the Securities and Exchange Commission on September 7, 2016 and is 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 measure will be provided as supplemental financial information in our press release. Now I'd 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. As always, I will begin by discussing the highlights of our second quarter results and the progress we're making against our growth strategies. 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're pleased with our financial performance for the second quarter. Total sales of CAD41.1 million were above our expectation and increased 25% compared to the second quarter of the prior year. Strong new store performance and a healthy comparable sales increase of 5.1% on top of a 6.9% comp sales increase in the prior-year period fuel this 25% sales increase. Q2 2016 marks our 28th consecutive quarter of comp increase, as customers once again responded positively to our merchandising assortment. Innovation in units continue to be key drivers of our comp performance and the pipeline for continuous innovation is strong. We opened 10 net new stores during the second quarter, ending the quarter with 208 stores, or an increase of 26% versus the end of Q2 last year. This includes 164 stores or 80% of our store base in Canada and the remaining stores in the U.S. We remain on track to grow our store base by 21% or 40 new stores in FY '16, including 23 to 27 new stores in Canada and 13 to 17 stores in the U.S. Our Q2 openings were balanced across a variety of formats in malls, including lifestyle centers and outlet and street location. These openings include Robson Street in downtown Vancouver, a location we have been looking at for a while, as well as more regional markets like Val-d'Or in Canada or Culver City in California and our seventh store in Chicago, as we continue to densify in some key U.S. market. Looking more closely at our U.S. business, our U.S. sales performance was driven by strong e-commerce sales and offset by lower than expected store sales. We're constantly learning from our existing U.S. store base which allows us to continue to refine our expansion strategy going forward in this region and continue to build our brand awareness. Our strong U.S. online sales continued to illustrate that our brand is resonating with our U.S. customer. We continue to refine the U.S. model, learn from our customers and remain enthusiastic and focused on the expansion opportunity we see for our brand. Gross profit dollars in the second quarter of CAD19.9 million grew 24% over the prior-year period. Our gross profit as a percent of sales was 48.5%, a decrease of 50 basis points over the same quarter in 2015, driven mostly by FX impact. On a constant currency basis gross profit as a percent of sales was 49.1%, up 10 basis points year over year which Luis will discuss in more detail shortly. But it is noteworthy that our strong sales performance was accompanied by healthy underlying gross margin, a testament to our innovative merchandising strategies complemented by compelling marketing that drives customer acceptance. Adjusted EBITDA of CAD0.2 million was in line with our expectation and compared to prior-year levels of CAD0.2 million as higher SG&A offset the increase in gross profit. Results from operating activities was negative CAD2.9 million and earnings per share for the quarter was a loss of CAD0.09. All in all, it was a solid second quarter that builds on our strong first quarter performance. As we look towards the remainder of the year, we remain focused on delivering on our goals, both operational and financial. We have consistently discussed our strategic priorities and they remain unchanged. Our number one priority remains targeted retail expansion. As just discussed, we opened 10 net new stores in the second quarter and are planning 40 total stores opening this year, representing 21% store growth. The second pillar of our growth strategy is to drive comparable sales growth through a steady stream of new and innovative products and continued increase in brand awareness. Time and time again we have seen customer react positively to newness in our assortment which is the key reason why as an organization and management team we're so focused on innovation. In Q2 our teams again delivered on this front with Caribbean Crush, Coco Colada and Pom Diggety tea launches that were very well received by our customers. We continue to build awareness of DAVIDsTEA brand through community-based marketing events and digital campaigns. During the second quarter we participated in community events across both Canada and the U.S., including Wanderlust Whistler, Wrigleyville Summerfest and Palo Alto Festival of Art. Additionally our digital campaigns are evolving to become more targeted and personalized as we better utilize our growing CRM capabilities. Our e-commerce site remains an important part of our business and continues to be a compelling growth opportunity and one we invest against both in terms of technology and talent. In the second quarter we again saw increased e-commerce penetration as we continue to make progress towards our long term target of 15%. Our e-commerce growth continues to outpace our store growth, as our customers enjoy our optimized search engine capabilities and increased speed for accessing information content as a result of our enhanced site. As a reminder, this increased penetration is financially beneficial for DAVIDsTEA, given the higher ticket and higher profit margin of an e-commerce transaction. Our improved e-commerce platform has enabled us to better collect and analyze customer preference that in turn enables us to improve engagement and deepen the connection with our Frequent Steepers. Lastly we remain excited about the opportunity within the hotel, restaurant and institution sector as we expand our partnership in this area. So in summary, we're pleased with our overall second quarter financial performance. Looking ahead to the second half of the year and all-important Q4, we have been in preparation mode for the key holiday selling season. And our teams are focused on execution during the big weeks and months that lie ahead. Our second quarter performance in combination with our product and marketing lineup for the back half of the year gives us confidence to reaffirm our previously provided outlook. Before I end, want to thank all of our team members for their hard work and commitment to our brand that has driven our success to date and will enable our success going forward. And now for a more detailed review of our second 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 second quarter FY '16 results and then discuss our outlook for the third 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 are 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 second quarter of FY '16 were CAD41.1 million, up 25.3% from CAD32.8 million in the second quarter of 2015. We ended the quarter with 208 stores, an increase of 43 net new stores or 26%, versus 165 stores at the end of second quarter of 2015. This includes 164 stores in Canada and 44 stores in the U.S. In Q2 we opened 10 net new stores for a year-over-year increase in store opening weeks of 25%. Comparable sales increased by 5.1% on top of a 6.9% comp increase in the second quarter last year and as Sylvain mentioned, Q2 2016 marks our 28th consecutive quarter of positive comp sales growth. Gross profit dollars increased 23.6% to CAD19.9 million from the CAD16.1 million in the second quarter of 2015. Gross profit as a percent of sales decreased by 50 basis points to 48.5% from 49% 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. On a constant currency basis gross profit dollars in the second quarter were CAD20 million, up 24.2% year over year with a corresponding gross profit as a percent of sales of 49.1%, up 10 basis points from Q2 of last year. SG&A increased to CAD22.8 million from an adjusted SG&A of CAD17.9 million in the second quarter of FY '15, due primarily to the hiring of additional staff to support Company growth, higher store operating expenses to support the operation of 208 stores as of the end of the second quarter as compared to 165 stores at the end of the prior-year period, as well as newly incurred public company costs. As a percentage of sales SG&A increased to 55.5% compared to adjusted SG&A of 54.6% in the prior-year period. Results from operating activities for the second quarter of 2016 were negative CAD2.9 million as compared to last year's adjusted results from operating activities of negative CAD1.9 million. Our effective tax rate for the second quarter of 2016 was 18.2% compared to 0.6% in the second quarter of 2015. The net loss was CAD2.3 million or a loss of CAD0.09 per fully diluted share, as compared to adjusted net loss of CAD1.6 million or a loss of CAD0.07 per fully diluted share in the prior-year period. Adjusted EBITDA for the second quarter of FY '16 was CAD0.2 million, flat with the prior-year period. In terms of liquidity, we ended the quarter with CAD60.6 million in cash, no debt and availability of CAD20 million under our revolving credit facility. Before reviewing our guidance, during August we experienced a technical issue with our email distribution during which a significant portion of our marketing emails were not being delivered to our customers. This technical issue had a negative impact on our August sales. The issue has since been resolved and we have reflected this in our Q3 guidance. Now turning to our guidance, for the third quarter of FY '16 we expect sales to be in the range of CAD43 million to CAD44 million based on opening 15 new stores and assuming a comparable sales increase in the low single digit range. Adjusted EBITDA is expected to be in the range of CAD0.6 million to CAD0.9 million. The net loss is expected to be in the range of negative CAD2 million to CAD2.3 million, with a loss per common share in the range of negative CAD0.08 to negative CAD0.09 on about 24.8 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 a fully diluted share count in a loss-making quarter. For FY '16 we're 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 FY '15. This is based on opening 40 new stores for the full year and assumes a comparable sales increase in the mid-single-digit range. Our full-year 2016 guidance still assumes FX driven gross profit as a percent of sales decline to be offset by anticipated leverage of SG&A expense. 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 in the 25% to 35% over FY '15. This assumes adjusted fully diluted common shares outstanding of 26.1 million. With respect to CapEx, in 2016 we continue to expect to spend a total of 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 earnings press release. With that, I would like to turn the call back over to the operator to start the Q&A session.

[Operator:]

[Operator Instructions]. And we first go to Matthew Boss with JPMorgan.

[Matthew Boss:]

So if we broke down your same store sales this quarter, what was your U.S. versus Canada comp? And can you speak, just provide a little bit of detail on the drivers of the lower than expected brick-and-mortar trends that you spoke about in the U.S. that you are seeing?

[Luis Borgen:]

So Matt, our total comp was 5% and our U.S. comps are slightly better than the total comps. On the U.S. side, I will let Sylvain speak to that. But let me address the lower than expected Q3. We lowered it from mid-single digit to low single digit related to an August email issue which has since been resolved in Q3.

[Sylvain Toutant:]

And just to go back to Q2 sales, we called it out because we saw a change in trend in Q2 for our U.S. retail. And we believe that the choppy environment impacted everybody, but in our case we believe we were impacted by specific Company factors, mainly management change that happened. Have I lost everybody?

[Matthew Boss:]

I'm still here. I think you are live.

[Sylvain Toutant:]

Okay. So that was essentially that. We had some management change in our U.S. business at the leadership level.

[Matthew Boss:]

So you're saying your U.S. and your Canadian comps were fairly similar?

[Sylvain Toutant:]

Slightly better in the U.S.

[Matthew Boss:]

Okay. And what was the brick-and-mortar versus the e-commerce in the U.S. in terms of the trend in the quarter?

[Sylvain Toutant:]

We don't break that. We never break it out.

[Matthew Boss:]

Okay. And then just to follow up, as we think about your store profile, is 40 stores a year the best way to think about door growth in 2017 and beyond? And just how should we think about the mix of U.S. versus Canadian new stores as we think about moving beyond this year?

[Luis Borgen:]

Matt, we typically provide annual guidance in the April earnings release. But as we sit here today, at this point we're around the 40 store range for this year, as we said. And for next year, that's our current thinking. But obviously we won't give official guidance until we do the April earnings call in terms of future store growth plans and the relative mix between Canada and the U.S.

[Matthew Boss:]

And then just one last clarification, beyond the email issue that you had in August, do you see same-store sales in September/October moving back to the mid-single digits? Was it more of a one-time thing?

[Sylvain Toutant:]

Yes. Right now we're saying that we're back on trend, where we want it to be.

[Operator:]

We will take our next question from Sharon Zackfia with William Blair.

[Sharon Zackfia:]

I guess a couple of questions. I think, Sylvain, you mentioned that you continue to learn in the U.S. But then you said it was kind of a maybe a management change issue. So can you help us understand maybe what you kind of continued to learn in the July quarter as the bricks-and-mortar slowed in the U.S.?

[Sylvain Toutant:]

First of all, just to go back to that. We have lost our U.S. Head of Operation and followed that, two District Manager left. And so obviously what we saw is a very discernible difference in performance between stores with DM supervision and stores without DM supervision. We're back on track, we've got Christine Bullen that we've announced as Managing Director for our U.S. business and all of our DMs in place as we speak right now. So obviously this hiccup was kind of happening and people are important. It's retail and it's how you lead people and it's very, very important. We obviously in terms of learning, I think - we see our model, we see our consumers reacting very, very solidly to our brand. Q2, just a look at our performance on our e-com business really tells us that the brands resonate very well. But like every other retailer, we need to execute perfectly at the store level. And for that we need the strong leadership in place.

[Sharon Zackfia:]

And then a follow-up question on the implied fourth quarter guidance. Luis, I think that kind of relates to pretty significant margin expansion that quarter. Can you help us think about where you're expecting that? Is that more gross margin led in the fourth quarter or will it be more SG&A?

[Luis Borgen:]

We're not providing guidance for the fourth quarter. What we can say, Sharon, is that for the full year we're still comfortable with our CAD215 million to CAD219 million top line and the EBITDA we laid out along with the EPS guidance. We do think the factors that are driving the higher levels of earnings per share growth in the 25% to 35% range relate to really three things. Number one, it is our highest volume quarter and with the higher volumes we're able to leverage a lot of our fixed expenses much more efficiently, both in the operating and selling side, i.e., within G&A. And second, our corporate overhead, our G&A specifically, we're able to leverage those salaries meaningfully. Number two, we're anniversarying our higher salaries and compensation expenses that we had been incurring through Q1, Q2 and Q3. So come Q4 be able to gain leverage on that. And the last point is, our current view is that some of the FX headwinds that we had been experiencing will start to abate by Q4 this year. So those really are the drivers between gross profit and SG&A that are driving our higher expectations for earnings for the year.

[Operator:]

Next question comes from Lorraine Hutchinson with Bank of America Merrill Lynch.

[Stephen Albert:]

This is Stephen Albert on for Lorraine. Questions around gross margin. So it's nice to see the FX headwinds abating for you guys, but we have seen for a few quarters now kind of constant currency gross margin expansion decelerate. Is this attributable to kind of lower margin product mix with new stores? Help us kind of think about the constant currency gross margins?

[Luis Borgen:]

Each quarter is different, Stephen. So we obviously have different seasonality, different customers. We try and provide as much guidance as we can, given our known cost, our known mix. But in any given quarter we have different sales and merchandising activities that we do, different testing things that we do. We do expect that over time we're going to go flat to slightly positive on a constant currency basis and so break in sales and gross margin is something we try and give fairly good guidance to. I can tell you our teams are buying better. Number two, we're improving our sales mix over time to emphasize loose leaf tea and beverages which are higher margin than the house. And we're being much smarter about our promotional cadence and segmented email marketing. So when you put all that in the mix, we try and provide guidance. But what I can tell you that is, we're trying to improve that on a constant currency basis which we have been doing. I wouldn't take the 10 bps in Q2 as a trend. As we know more each quarter about our hedging and our mix and so forth, we will provide more clarity on that.

[Stephen Albert:]

That was kind of ties into my follow up. Color on hedges. I know in the past you have kind of given some qualitative color on where you have locked in hedges for future quarters and what we should expect from the FX impact. Anything heading into 2Q, 3Q next year?

[Luis Borgen:]

So we haven't gotten any additional hedges since we were last on our earnings call several months ago. So nothing new to report on that front. To the extent that we do any between now and our December earnings call, we'll obviously update you on what we did and the potential impact on that, holding everything else constant. But right now we don't have any new information on hedges because we haven't done any since last quarter.

[Operator:]

We will go ahead and take our next question from Kelly Bania with BMO Capital Markets.

[Kelly Bania:]

First I just wanted to ask on new store productivity, do you have any color on where that came out for the quarter? I think comps were generally in line, I think, with your expectation. But I think you said total sales were a little bit ahead of your plan for Q2. So I'm assuming that's new store productivity?

[Luis Borgen:]

Yes. That would be accurate, Kelly. Our upside came from the store productivity and that really was Canadian driven on new store productivity. Very similar to previous quarters. We have very strong performance in Canadian stores. That continued through in the last quarter.

[Kelly Bania:]

So do you have any specific numbers on what that was on a weighted average basis for the quarter?

[Luis Borgen:]

We can follow up with you on that. I don't have any specific numbers in front of me. But I can tell you the trend line was very similar to what we had in the previous quarters in terms of overall Q1 and it was driven by Canada, just to be clear on that.

[Kelly Bania:]

So for the guidance for the full year, it sounds like the email issue was isolated to August. Maybe there's some lost sales there, but you are maintaining your full-year guidance. So was that just because the first quarters have been a little bit stronger on the top line so you're able to maintain that? Or is there any earnings impact from this or how do we think about that?

[Luis Borgen:]

Sure. So in August we had a very specific email issue where we couldn't email. That was reflected in the guidance we gave for Q3 which is why it is low single digit on the comp sales perspective. That has now been resolved. And when we looked at our annual guidance, given the range we gave both on revenue as well as earnings per share and we look at our forecast for Q4, we still feel comfortable that we're within that guidance range both for top line and bottom line, given our expectations for the balance of the year between now and full year. So there was a revenue impact and a profit impact, but that's been Incorporated into our Q3 and full-year guidance. And we still feel comfortable reiterating our FY '16 figures.

[Kelly Bania:]

And any color you can give on traffic or ticket trends and how you feel about price increases going forward?

[Luis Borgen:]

So Q2 was very similar to the previous quarter where the comp was entirely driven by average increase in the average ticket. And in terms of price increases, that's something that we look at by category over time. So obviously we have higher rents and we do and we do annual pay increases. So we have to cover those costs, either through productivity improvements or some sort of nominal price increases. We have and will continue to make adjustments to our pricing, both up and down, to reflect both consumer preferences and where we can optimize pricing. But I can tell you that overall it's basically low single-digit price increases on a net basis that we have executed.

[Kelly Bania:]

And then just another one I guess with the email hiccup in August. Did you learn anything about your customers' habits there? Or do you know how much of your online sales are generated through your marketing and your emails? And I believe you are working on developing an app for next year. Just wondering how that is tracking.

[Luis Borgen:]

On the first part of your question, we did learn a lot about the impact that our email has both not only on our e-commerce business, but also on our retail base. We're actually going through that data and having a little more detail to figure out the elasticity, so to speak, of the emails versus overall sales. So we have nothing to share with you at this point in time. Part B was--

[Sylvain Toutant:]

The mobile app.

[Luis Borgen:]

Mobile app. That's something we intend to roll out in 2017. As we get closer to that date we will be able to provide you with a little more information on the timing and the features we intend to have on that. But it's something that's in our pipeline and we have people working on for delivery in 2017, hopefully sooner rather than later. With all IT projects, we want to make sure we're far enough down the project. But I can tell you we're very committed to doing a mobile application for DAVIDsTEA.

[Kelly Bania:]

And then if I could just add one more. I think you mentioned a lot of volatility in parts of U.S. retail. I guess, what do you feel like you're seeing from the consumer generally in Canada and the U.S.?

[Sylvain Toutant:]

I would say I would qualified the consumer as being cautious. And they're honestly a little bit more cautious than what we would like. But overall I think when we look at our results in Q2, consumers will react to great innovation. They will react to a nice value proposition. So that really pushed us and pushed the team to keep on innovating and bringing really value-driven items to them or an amazing new taste profiles so we can get the consumers to react. But we see that. We see a little bit obviously around Alberta, a little bit more soft. And I would say the U.S. is probably the same read. I mean, I read the same news like everybody else and we're seeing the consumers being a little bit more cautious.

[Operator:]

[Operator Instructions]. We next move to Chris Krueger with Lake Street Capital Markets.

[Chris Krueger:]

I am pretty new to the story. But when you talk about this email glitch, are these like a customer list where you use it for marketing to drive traffic to the stores, to the website? Did this go for a couple of weeks or was it a few days? Can you put a number on how many emails didn't get to where they are going? Just want to make sure I understand it.

[Sylvain Toutant:]

We're not going to put a number, but it was significant. Obviously it is a very important part of our marketing program. And we want to make sure when we have an email going to our customer base, you probably know that, but we have a Frequent Steeper program, we have a loyalty program which is really important and our customer stay very engaged with the brand. So once we have a miss like this and they don't actually receive the email we're sending, that obviously, it creates a technical problem for us and it has an impact on our business. And that's why we've baked that into our Q3 guidance.

[Chris Krueger:]

Okay. And as you kind of roll out in a bigger way, especially in the U.S., are you noticing anything on the competitive front, whether it's competing for consumers or competing for real estate?

[Sylvain Toutant:]

I think there's a lot of white space available. It's a big market. Tea is a growing category. And the health and wellness trend is actually really helping the category. So we benefit from that. For us it's all about how we execute, how we developed our brand message and how we build awareness in the U.S. as we move forward more than looking at the competition.

[Operator:]

With no further questions in queue, I'd like to turn the conference back over to management for closing remarks.

[Sylvain Toutant:]

Thank you everyone for joining us today. We look forward to speaking with you when we report our third quarter results. Thank you.

[Operator:]

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation. You may now disconnect. Have a great rest of your day.