DAVIDsTEA Inc.
Q3 2016 Earnings Call Transcript

Published: 9 Dec 2016

[Operator:]

Good day and welcome to the DAVIDsTEA Third Quarter 2016 Earnings Conference Call. Today’s conference is being recorded. 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 Sylvain Toutant, President and Chief Executive Officer and Luis Borgen, Chief Financial Officer. Before we get started I would 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 December 8, 2016 and is available at www.sec.gov and on our Web site. 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. I will begin by discussing the highlights of our third quarter results followed by a discussion of 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 for your questions. Looking at our third quarter financial performance, sales came in at $44.1 million, and comparable sales increased by 0.8% while EPS was a loss of $0.10, weaker than expected, mainly driven by lower gross margin. We expected low single-digit comp given the issue with our email distribution in early August that negatively impacted the sale. However we experienced a more challenging macro backdrop in both Canada and the U.S., and the email issue persisted longer than expected resulting in softer than expected performance. Let me now provide more color around this performance. As mentioned previously, the email issue had a negative impact on our August sales, both in-store and online and while we worked to resolve this issue by changing migration strategy, it unfortunately had a longer impact than we initially expected, as our marketing emails were still not reaching our customers. The issue was not fully resolved until October when we brought on additional support from an outside service provider, and have since seen normal delivery and open rate which gives us increased confidence, the issue is now addressed. In Q3, the overall retail environment was difficult in Canada and we were faced with a more cautious consumer in the U.S. partially due to the election. This challenging macro backdrop in both markets had a negative impact on our overall business. While ecommerce sales in both region were strong during the third quarter, the rate of growth moderated and we saw softer trend in our comp performance mainly in Canada. Given this softer sales backdrop we were more promotional in Q3, to drive sales. On the new store front, we opened 17 new stores during the third quarter, ending the quarter with 225 stores or an increase of 23% versus the end of Q3 last year. This includes 178 stores or 80% of our store base in Canada and the remaining stores in the U.S. Our Q3 openings were balanced across a variety of formats in malls, including lifestyle centers and outlets, and street locations as well as a mix between urban location and more regional market. Our new store performance in Canada remains strong, however our U.S. new store performance is mixed. Given the productivity ramp in certain U.S. store, it's taking longer than we envisioned. We have taken a non-cash asset impairment charge related to underperforming stores mainly in the U.S. We have almost completed our planned 40 new stores openings for this year with seven stores remaining to be opened in Q4. However given the recent weakness in select U.S. stores we feel it is prudent to reevaluate our targeted U.S. retail expansion for fiscal 2017 and moderate the pace of our planned U.S. opening. We're in the process of 2017 budgeting and our current thinking is 10 to 12 new stores in the U.S. and approximately 15 to 18 new stores in Canada. On the U.S. front, we believe this moderation in store growth will provide us with the opportunity to reenergize our existing store base, be very selective with new opening focusing more on lower profile location that deliver higher returns and also free-up capital to reinvest in our thriving ecommerce business. We are working on the following initiatives to improve U.S. store productivity to levels that enable us to meet our return criteria. Since joining the company in May as Managing Director of U.S. market, Christine Bullen has identified some key learnings that we are incorporating. She has assessed our U.S. store leadership team and made some key hires at the district leadership level that bring more retail and merchandising experience to the group [ph] and from a merchandising perspective, Christine will be implementing more U.S. versus Canada localization as well as West Coast versus East Coast localization within the U.S. She’s also developing a separate marketing calendar that is most specific to the U.S. market given the unique shopping patterns of our U.S. customers. I want to take a moment to discuss some recent learnings around the U.S. customer’s in-stores experience and shopping preference. We have found that our U.S. customer refer to shop quickly and efficiently while also utilizing self-service to interact with our product. We are incorporating this learning to refine our U.S. in-store experience, which brings me to our next initiative. We have developed a new store concept that we are currently testing in our Natick mall store in Boston, which is specifically designed to address inefficiencies and customer sale point in our store located in high traffic model. This new format test store opened on November 4th. The store is designed as a self-serve format with pre-packaged loose-leaf tea and a small tea bar in the middle of the store with guys three guides available if the customer needs assistance while the traditional service counter has been removed. This allows the customer to still have the full DAVIDsTEA experience by interacting with our loose-leaf tea offering and smelling the tea, but without having to wait in line to be serviced in order to do so. If successful this is a format that we would expense to more stores. We have been very pleased with our ecommerce performance, which has been a bright spot for us and continues to illustrate the broad brand appeal of DAVIDsTEA. We have been seen increased ecommerce penetration all year and say that again in the third quarter albeit deceleration in absolute growth rate, given the issue with our email distribution that curtailed overall performance in the third quarter. And for us, this increased ecommerce penetration is financially beneficial given the higher tickets and the high profit margin on an ecommerce transaction. Going forward we will allocate more resources to our ecommerce platform as we see additional on-tap opportunities that we want to capitalize on. Specifically we are just at the early stage of harnessing the potential of the CRN data that we have collected and we’ll begin to utilize this data more going forward. This increased ecommerce focus will help fuel the capital life expansion of the brand and our customer reach. Lastly, we remain pleased with our hotel, restaurant and institution business as we continue to expand our distribution partnership in this sector, though it still remains a small segment of our business. We believe there are additional HRI opportunities for our brand as well as other channels that we are just beginning to explore that will increase our brand visibility. We will keep you updated as we make progress on this. And we remain focused on driving overall comparable sales growth to continue prioritization of innovation and brand building initiative. On the product front in Q3, we introduced new teas that our customers enjoyed including Blueberry Tea, Throat Rescue and Carrot Cupcake in addition to new format cups and mug. Our Halloween seasonal merchandise still continues to resonate with our customers. We also launched some holiday product in Q3 this year which is earlier than years back. This timing reflects a long planned holiday inventory investment that we decided to make this year in order to capitalize on the strong historical demand of certain best sellers and to avoid the early season out of stock that we've experienced in prior holiday season. On the marketing front in Q3, we have some exciting initiatives as it relates to our previously announced partnership with Me to We, an innovative social enterprise that supports the work of charity partner Free The Children. Our customers have been responsive to our collection of Me to We tea and tea-related accessory, and we also participated in five weekday events which are great way for us to engage with our millennial customers while raising our brand awareness. Turning to our near term outlook, the Canadian backdrop is challenging in Canada as you well know represents over 80% of our sales. That said, we can and we must do better. If we deliver sufficient innovation with product, marketing and in-store experience then external headwinds will not have the impact they're having our business. Given this backdrop, we're taking a cautious view of the fourth quarter and the plan moderation in 2017 store growth will allow us to focus our energy on reinvigorating the DAVIDsTEA experience. Finally, as you all saw, my departure from DAVIDsTEA at the end of this fiscal year was announced in October. It has been a privilege to lead DAVIDsTEA and I want to thank each and every one of the team members for their hard work and dedication. They have helped build this unique brand and the customer loyalty we enjoy and they will drive the future growth and success of the Company. In terms of transition of my responsibility, after my departure at the end of fiscal year in order to ensure a smooth transition, we have a Transition Committee of the Board in placed lead by Maurice Tousson, Chairman of the Board. We are pleased to have announced today that Christine Bullen, Managing Director of U.S. Markets, has been appointed as Interim President and CEO effective upon my departure at the end of the fiscal year. I will work closely with Christine and the Transition Committee to facilitate a seamless transfer of responsibility. And now for a more detailed review of our third quarter results as well as our outlook, I will turn the call over to Luis Borgen, Chief Financial Officer.

[Luis Borgen:]

Thanks and good afternoon everyone. I will begin my remarks with a review of our third quarter FY '16 results and then discuss our outlook for the fourth quarter and full year 2016. As a reminder, we report our results in Canada dollars, so the dollar amounts I refer to when reviewing our results and guidance are Canadian dollars. Additionally, I will reference adjusted results in my comments today. We have provided these results as well as an explanation of each line item and a reconciliation to IFRS results 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. To [technical difficulty], I would like to point out some special items included in our third quarter 2016 IFRS results. Our third quarter results included a CEO separation charge of 0.6 million, which equates to 0.5 million after-tax or $0.02 per diluted share, in connection with the vesting of stock awards and certain other compensation related to the announcement of Sylvain’s departure at the end of fiscal 2016. We also recorded a non-cash asset impairment charge combined with the provision for onerous contracts of 2.6 million, which equates to 1.9 million after-tax or $0.07 per diluted share, for the impairment of underperforming stores. Lastly, we recorded a 0.3 million expense due to a loss on disposal of property and equipment associated with that the native new [ph] store concept in the third quarter which equates 0.2 million after-tax or $0.01 per diluted share. Turning to our results, our sales in the third quarter of 2016 were 44.1 million, up 21.5% from 36.3 million in the third quarter of 2015. We ended the quarter with 225 stores, an increase of 43 net new stores or 23% versus 183 stores at the end of third quarter of 2015. This includes 178 stores in Canada and 47 stores in the U.S. In Q3 we opened 17 net new stores with year-over-year increase in store opening weeks of 26%. Comparable sales increased 0.8% on top of 6.3% comp increase in the third quarter last year. Our comp and top-line were negatively impacted by tougher consumer backdrop, particularly in Canada, as well as the lingering effect of the email issue. Gross profit dollars increased 13.9% to 20.5 million from the 18 million in the third quarter of 2015. Gross profit as a percent of sales decreased 310 basis points to 46.5% from 49.6% in the prior-year period, primarily due to increased promotional activity, as well as a sales mix shift to lower margin kip and the adverse impact of the stronger U.S. dollar on U.S. dollar-denominated purchases. SG&A increased to 27.2 million from 18.9 million in the third quarter of fiscal 2015. As a percent of sales SG&A increased 61.6% from 52.0% in the third quarter of fiscal 2015. Excluding the one-time charges I mentioned earlier, in the third quarter of 2016 adjusted SG&A increased to 23.7 million from 18.9 million in the third quarter of fiscal 2015, due primarily to the hiring of additional staff to support company growth, including new stores, and higher store operating expenses to support the operations of 225 stores as of the end of the third quarter as compared to 183 stores at the end of the prior year period. As a percent of sales, adjusted SG&A increased to 53.7% compared to adjusted SG&A of 52.0% in the prior year period. My comments will now refer to adjusted results. Adjusted results from operating activities for the third quarter of 2016 were a loss of 3.2 million as compared to last year’s adjusted results from operating activities of a loss of 0.9 million. Our effective tax rate for the third quarter of 2016 was 24.1% compared to 7.3% in the third quarter of 2015. Adjusted net loss was 2.4 million or a loss of $0.10 per fully diluted share, as compared to adjusted net loss of 0.8 million or a loss of $0.03 per fully diluted share in the prior year period. Adjusted EBITDA for the third quarter of FY'16 was 0.1 million compared to 1.5 million in the prior year period. In terms of liquidity, we ended the quarter with 33.1 million in cash, no debt and availability of 20 million under our revolving credit facility. Now, turning to our outlook, as Sylvain mentioned we have an innovative holiday merchandize lined up, compelling marketing plans, and a strong ecommerce platform and what we believe is resolution of the Q3 email issue. Moreover the Canadian environment remains difficult, given that the high volume holiday week still lie ahead, with a softer backdrop we're revising down our Q4 and full year outlook. For the fourth quarter of fiscal 2016 we expect sales to be in the range of 84 million to 88 million, and 11% to 16% increase over the fourth quarter of fiscal 2015 based on opening seven new stores and assuming a comparable sales range of negative low single-digit to flat. Adjusted EBITDA is expected to be in the range of 20 million to 22 million. Net income is expected to be in the range of 12.1 million to 13.5 million, with earnings per share in a range of $0.47 to $0.52, on about 25.9 million weighted average shares outstanding. For fiscal 2016 we now expect sales to be in the range of 214 million to 218 million, an 18% to 21% increase over FY'15. This is based on opening 39 net new stores for the full year and assumes a comparable sales increase in the flat to low single-digit range. Adjusted EBITDA is expected to be in the range of 25 million to 27 million. Adjusted net income is expected to be in the range of 9 million to 10.5 million or $0.35 to $0.40 per share. This assumes adjusted fully diluted common shares outstanding of 26.0 million. With respect to CapEx, in 2016 we expect to spend a total of 21 million to 22 million with about 85% to 90% of our capital budget devoted to our 40 planned new stores and some store renovations, with the remainder of the capital budget to make continued investments in our infrastructure. As we look towards fiscal 2017, we're early in the planning process, however as we sit here today our preliminary thoughts around 2017 store openings are approximately 15 to 18 new stores in Canada and 10 to 12 new stores in the U.S. Overall we're prioritizing a higher return on our store investment, this means more lower profile store locations that carry higher returns. We're also focused on improving our productivity of our higher profile locations. This moderation of our store growth reflects our disciplined capital allocation. Stores must meet our return criteria or show they are on a path to doing so. We will also be redeploying some capital towards our thriving ecommerce business, to continue to expand the reach of our brand and our customer base. We'll provide more detail on our 2017 outlook on our Q4 call. For all other details related to our resulting guidance, please refer to our earnings press release. And with that, I would like to turn the call back to the operator to start the Q&A session.

[Operator:]

Thank you, ladies and gentlemen. [Operator Instructions] And our first question will come from Kelly Bania from BMO Capital.

[Kelly Bania:]

Hi, I guess a lots and lots of questions here. I guess first on the email issue, what exactly happened? Because if I recall the issue that was talked about in early September was isolated to August and has been resolved at that point. So I’m just wondering, what happened, who is responsible for that and what impact does it have on comps?

[Sylvain Toutant:]

Yeah let me -- Kelly, this is Sylvain. So, we did a migration starting in June actually from an email distribution provided to another one. And this is a process that usually takes a few months, especially with the size of our database. And so we started to see poor email open rates really late July and August and we were concerned and did some investigation at that time. But when we did the full launch of our August, the full launch of our fall season, which was an August 23th, we saw a much slow open rate, which raised further alarm and really prompted a more thorough investigation. We started to look at the situation really more importantly and we realized that the initial migration strategy was actually corrupting our IP address, which did impact our email delivery capabilities and so what we did at that time is we did right away change our strategy. And we thought this new approach would fix the issue, because immediately we saw very positive results between August 30 and September 15. Our actual open rate of our email went back to where it was before, but then after that it start to decline again. And we realized that we needed outside support essentially rectify the situation. We hired an outside service who provided better tools to manage our IP address and really get a certification. This new service took time to fully rectify the situation, because you have to do that by batch and I would say that by October 12, we really saw our open rates back to pre-migration levels and the open rates have been really staying at a same placement since then very, very healthy level. So we feel good now about where we are and we did [indiscernible] really middle of October.

[Kelly Bania:]

Okay. And I guess on store growth. So I think you’re cutting your plan. I think you said for next year for 25 to 30 down from 40? I mean you’ve had kind of some hiccups here on the email and a little weaker consumer. I mean is that a reason to slow store growth or I mean could we see store growth slow even more? I mean where are returns really coming in?

[Sylvain Toutant:]

Well, just want on the slow store growth. As far as the Canadian market goes for 2017, we had planned about 20 stores, so we are pretty much in line with our range right now of our 15 to 18 stores for Canada, so it's -- in Canada, we keep going, we keep opening stores. In the U.S., we're slowing down. We want to give ourselves the time to really digest all the learnings. I've talked in my prepared notes about the Natick mall test. We think it's a very important test for us and we want to make sure we capture all the learning around that store before we accelerate growth again. And so that gives obviously the time for Christine, as she started the work in U.S. to really make a good assessment and make the right investment at the right place, to really capture the learnings, make the improvement and also be able to roll out the stores of the future for us which is essentially what we've done in Natick. One more thing on the Canadian front, Kelly, we expect to end the Canadian store base at 181 stores this year, targeted 225 overtime, so that leaves about 45 stores, and we want to maintain good capital discipline on every store that open including Canada. So the pace that we've outlined, 15 to 18, obviously if we can find more stores with adequate returns, we'll continue to do that, we’re not capital constrained. That's just our preliminary thinking around growth. We're also looking at redeploying some of the capital against ecommerce opportunities across North America. So it was a just an indication of what our perspective plans may be and obviously those could change as we think about it further over the next couple of months with the Board and with Christine.

[Kelly Bania:]

I think, should you really be opening any U.S. stores at this point?

[Luis Borgen:]

Yes, I think we’ll wait, it's very important to be selective and so we're going to keep opening stores in what we call lower rents, lower repetition costs. We’ve had some very successful run with these stores at this point in time. So we -- from the learnings as we move forward, from the learnings that we've got, we know the type of stores that does work for us and brings the best returns, and these are the stores we want to open going forward until we figure out the result that we can get from native stores.

[Kelly Bania:]

Sylvain, can you just give a little more color on your decision to leave here. It seems a little bit ill-timed and I guess not much noticed, but any color you can provide on the decision there?

[Sylvain Toutant:]

Kelly, I wish I could, it's very personal and it's not something you plan for. So it was a personal decision. I went to inform the Board as soon as I had to make that decision and I did so, and honestly when we look at the timing, everything was set up for Q4, everything was in the inventory -- in the stores really to be shipped. We were more in execution mode, so from a business perspective at this point in time, we're actually planning Q2 of next year and Q3. So -- but as soon as I had to make that decision, which is really personal I informed the Board.

[Operator:]

Our next question will come from Lorraine Hutchinson from Bank of America Merrill.

[Lorraine Hutchinson:]

Once the email issues were fixed in October, can you comment a little bit about your trends over the past five or six weeks?

[Luis Borgen:]

We don’t comment on intra-quarter trends Lorraine, but I can tell you that the guidance we've given for the current quarter incorporates what we've seen through last week. And so we've seen some acquisitions [ph] in Canada and it's hard to discern in the U.S. how much is the election hiccup versus other issues either with just general macro condition in the consumers and we're seeing a lot more promotional activity in both countries. But our best thinking is what we’ve shared in terms of our sales, our comp guidance, as well as our bottom line performance. Obviously we’re now please with it, and we’re working really hard to identify what things we need to change and improve result going forward.

[Lorraine Hutchinson:]

Okay. And then you mentioned that you had brought some of the holiday product in earlier in an effort to bring more inventory around key products. Are those -- do you have some liable inventory given the decline in demand quarter-to-date. And how should we expect gross margin to trend in the coming quarters?

[Luis Borgen:]

Lorraine, the inventory side grew faster than sales. Somewhere of that is foreign exchange, some of our planned investments in businesses such as some of our teas, we are making some best -- our best sellers. And some of this is frankly inventory that was bought ahead of our current sales trends. In terms of the gross profit going forward, once again that we have little less than we’ve had in past in Q4. Hence the wider sales range and with that comes wider variability in the gross profit margin, we expect to realize. We believe the probability [ph] outcomes related to the inventory and the sales level are captured in our EPS guidance and that’s probably as much details we can give you today, it’s just been a challenging quarter Q3. So we’re a little more cautious as we look out into Q4.

[Operator:]

[Operator Instructions]. Next go to Chris Krueger with Lake Street Capital Markets.

[Chris Krueger:]

Just a couple quick ones as it relates to your store rollout for next year. I know you indicated 10 to 12 units in the U.S., 15 to 18 in Canada. How many of these units are you committed to, like with lease signings and things like that, like if you did see a reason to go even lower?

[Sylvain Toutant:]

I would say at this point in time, the numbers we’re putting on the table is actually pretty secure, it’s more than just a pipeline. Both Canada and the U.S. we’re either committed to it or in the process of finalizing signing.

[Chris Krueger:]

Okay. So it should be in that range than. Got it, and then this year your U.S. holiday trend just in the last couple of months, can you indicate a little bit of what you’re seeing out there?

[Sylvain Toutant:]

Well as Luis said, we’re trying to not to comment in truck [ph] waters, but there is certainly a before and after the election, there is a consumer confidence and we like other retailers saw that the consumer were distracted before. It will be interesting to see as you know this year we’re almost -- we’re adding a couple of days in the quarter before Christmas. And it will be interesting because for consumers it creates a full additional week of shopping potentially, because the holiday season is planned differently. So there is a lot of time, a lot of days of shopping and there are big days ahead of us, and we’ve tried to bake all this in our guidance we were planning.

[Chris Krueger:]

Okay. My next question was actually commentary on the election, I think you just answer that. It’s all I got it. Thanks.

[Operator:]

Our next question will come from Sharon Zackfia with William Blair.

[Sharon Zackfia:]

A couple of questions on the impairments you took in the U.S. Is there any commonality in terms of where those stores are or whether they're in neighborhood or urban or what have you.

[Luis Borgen:]

I think about half of the stores were from the '11, '12 and '13 vintage, kind of the experimental years. And then there were a handful of stores that were from the '14 vintage and they were primarily malls where we have high rent. So it going to make economic work. So we reviewed that, but there is no common theme in terms of those. There were very specific reasons why each of those stores was impaired. And so part of that learnings were incorporating into some of the testing we're doing and then we had it redesigned to address some of those pain points. And obviously Christine and the team will mark [ph] data into that and we're coming up with a plan to tweak, hence the moderation in store growth and the reinvestment in the e-com until we can have a better handle on what's going to work in the U.S.

[Sharon Zackfia:]

And so just so I understand that the strategy in the U.S. going forward, are you incorporating any of the Natick elements into the 10 to 12 U.S. stores planned for next year?

[Sylvain Toutant:]

Yes, we'd like to certainly do -- roll one out, I mean we're looking at -- the Natick test is really for big mall, with high traffic mall which are usually more expensive in terms of rent. And so that's the test we're doing there and we want to make sure in those stores, we're much productive with our labor and if you visit the store it's much more easy for consumers to shop by themselves and everything. So, this would be certainly the type of store we would do in another kind of flagship location if we have to announce one. The rest of the stores, if you look at our lifestyle and outlet stores, a lot of our lifestyle centers have been very good for us and the rest of the stores next year will be essentially these types of stores.

[Sharon Zackfia:]

And I think you said that the majority of the leases are already signed for next year for both Canada and the U.S., should we assume that there're going to first half weighted then or will it be kind of a normal opening schedule next year?

[Sylvain Toutant:]

I think we're going to have a normal scheduling schedule honestly in terms of balance because sometimes you do sign a lease and there's already somebody in there and they don't free up the space before February or March. So when we look at our portfolio we're trying to take that into account and balance it as much as we can. I think so far Luis, am I right? That's what we've seen a very balanced portfolio.

[Sharon Zackfia:]

And then lastly Luis do you still expect currency to be as favorable at some point next year? I know that's been pretty volatile.

[Luis Borgen:]

So, just to recap what we have done, Q1 of '17 was hedged at effectively flat rate to Q1 of '16, Q2 was hedged favorable to this year's Q2. We haven't done anything for Q3 or Q4 so that’s still an open item, it’s been a lot of volatility in the currency with the election and obviously the moves surrounding that. So, we haven't hedged the back half of the year, we're obviously working hard on cost improvement, mix, but we haven't hedged that, so that's still a variable out there.

[Operator:]

And that does conclude our question-and-answer session for today. And at this time, I'd like to turn it back to management for any additional or closing remarks.

[Sylvain Toutant:]

Thank you everyone, and the team is looking forward to talk to you in the next call. Thank you.

[Operator:]

That does conclude our conference for today. Thank you for your participation.