Roots Corporation ($ROOT)

Good morning. My name is Kara, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Roots First Quarter Earnings Conference Call for Fiscal 2026. [Operator Instructions] On the call today, we have Meghan Roach, President and Chief Executive Officer; and Leon Wu, Chief Financial Officer. Before the conference call begins, the company would like to remind listeners that the call, including the Q&A portion, may include forward-looking statements concerning its current and future plans, expectations and intentions, results, level of activities, performance, goals or achievements or any other future events or developments. This information is based on management's reasonable assumptions and beliefs in light of information currently available to Roots, and listeners are cautioned not to place undue reliance on such information. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected. The company refers listeners to its first quarter management's discussion and analysis dated June 11, 2026, and/or its annual information form for a summary of the significant assumptions underlying forward-looking statements and certain risks and factors that could affect the company's future performance and ability to deliver on those statements. Roots undertakes no obligation to update or revise any forward-looking statements made on this call. The first quarter earnings release, the related financial statements and the management's discussion analysis are available on SEDAR as well as on the Roots Investor Relations website at www.investors.roots.com. A supplementary presentation for the Q1 2026 conference call is also available on the Roots Investor Relations site. Finally, please note that all figures discussed on this conference call are in Canadian dollars unless otherwise stated. Thank you. You may begin your conference.

Thank you, operator. Good morning, everyone, and thank you for joining our Q1 2026 earnings call. On the call today, I will briefly review our financial results for the first quarter, which our CFO, Leon Wu, will cover in more detail and then discuss our operational highlights. We entered fiscal 2026 with strong momentum. Total Q1 sales reached $42.6 million, up 6.5% year-over-year, driven by growth in both segments. Direct-to-consumer sales increased 3.3% with comparable sales growth of 3.2% or 16.6% on a 2-year stack basis. Partners and other revenue grew 26.6%, supported by strength across our wholesale, business-to-business and licensing channel. Gross profit was $25.5 million, representing a gross margin of 59.9% compared to 61.5% in Q1 2025. Direct-to-consumer gross margin was strong at 61.3%. The change in gross margin reflects 2 factors, both of which we expect to be temporary. First, prior to transitioning to our new third-party logistics partner, we have been proactively reducing aged inventory by shifting additional products to final sale, which will limit the volume carried into the new facility. Second, as we sold inventory purchased at a higher U.S. dollar exchange rate last year, this impacted gross margin. This headwind will reverse over the balance of fiscal 2026. The adjusted EBITDA loss in the first quarter was $7.4 million compared to a loss of $7.1 million last year. The most material difference versus prior year relates to a noncash expense from the mark-to-market revaluation of our DSUs, which increased as our share price appreciated during the quarter. Net debt of $23.4 million represented a 20.7% reduction year-over-year. During the quarter, our trailing 12-month active customer base also grew in the high single digits year-over-year. Overall, Q1 reflects a solid start to fiscal 2026 and demonstrates the continued resilience of the Roots brand. I will now turn to the operational initiatives that drove our first quarter performance. Our merchandising performance in the first quarter reflects the continued strength of our core franchises and the success of our investment in newer higher-growth categories. Our Cloud collection delivered another standout quarter with demand outpacing our planned supply in parts of the collection. Our Activewear category continued to grow as a meaningful component of our product mix and now exceeds 10% of direct-to-consumer sales. Midweight outerwear and our counter seasonal spring lifestyle collection both performed ahead of our expectations. These results validate our strategy to extend the Roots brand into year-round complementary categories. Our newer collaborations and partnerships also continue to gain traction with the successful launch of the Roots Toronto Blue Jays 50th anniversary collection and the second drop of our official WNBA collection in March. In April, we also launched a limited edition spring/summer collaboration with LOOPY, a popular Korean character Buddy the Beaver, the iconic Roots Mascot. The launch coincides with International Beaver Day and reflects our strategy to extend the Roots brand to new audiences internationally. Our marketing approach in the first quarter continued to evolve towards a more disciplined, data-driven model with a clear focus on return on advertising spend and incremental contribution. Our paid search and paid social channels both delivered strong growth, and our investment in conversion-focused campaigns generated meaningful incremental revenue. In the quarter, we also completed an external assessment of our customer base that confirms the underlying strength of our customer economics. Our base is sticky, our retention is consistent across cohorts and our omnichannel customers continue to generate a higher lifetime value than those who shop any one channel exclusively. These findings will help guide our marketing investment in the remainder of the year. Creative marketing remains an efficient tool in our marketing mix. Now and looking ahead, we continue to evolve our roster, ensuring we show up authentically across the channels and communities that matter most to our customers. In March, we announced the continuation of our partnership with Toby Fournier, a Canadian standout for Duke University's women's basketball team, her second year as the Roots ambassador. The partnership reflects our deepening commitment to women in sports and our growing activewear category. In April, we extended our partnership with the Nature Conservancy of Canada into its third year and launched a limited edition Made in Canada T-shirt series crafted from circular materials. This program reflects the continued investment we are making in sustainable design and in supporting the natural landscapes that have always been central to Root's brand. As we look to the summer, we are focused on maximizing engagement with our customers and new consumers, particularly given the major sporting events happening in key cities. From cross-country activations to product customization, we are focused on connecting with our communities at a point when Canadian pride and togetherness are trending higher. Now turning to our direct-to-consumer performance. Comparable store sales improved year-over-year, reflecting the continued benefit of our investments in selling training, digital merchandising and store operations. We also completed renovations at several of our key locations during the quarter, including Sherway Gardens in Toronto. Furthermore, as we continue to expand our retail footprint, we've opened our first mono-brand Roots store in the Vancouver International Airport in partnership with Avolta. As a brand associated with Canada, Travel and Comfort, we see meaningful growth opportunities in travel retail locations across the country. In e-commerce, online traffic and revenue both grew year-over-year. Our paid media generated meaningful incremental revenue, and we expect to continue building on that progress throughout the balance of the year. During the quarter, we also made meaningful progress on the operational initiatives outlined in our previous calls. Our distribution center transition to metro supply chain remains one of our top priorities and is on track for completion this summer. We also continue to integrate artificial intelligence into our workflow where relevant as we advance our technology road map. Thus far, we've experienced benefits across several areas of the business, including inventory management, analytics, omnichannel experience and customer service. We continue to look for ways to drive efficiency and growth by leveraging these powerful tools that have been enabling us to operate the business with greater agility. As we move into the second quarter, our priorities remain consistent. Our management team remains focused on operations and long-term growth. We continue to invest in our highest growth product franchises and category expansions. We are completing the transition of our distribution operations. We are reallocating more of our customer acquisition investment towards our highest return digital channels, and we are taking a disciplined evidence-based approach to brand and marketing investment to support both near-term performance and long-term brand equity. We are mindful of the broader macroeconomic and trade environment, and we will continue to monitor these dynamics closely while operating the business with discipline and focus. Before I turn the call over to Leon, I would like to thank our employees for their continued dedication and our customers for their continued loyalty to the brand. Roots is a brand with deep heritage, a commitment to quality and a genuine connection to community and nature that continues to set us apart. With that, I will turn the call over to our CFO, Leon Wu, for a deeper review of our financial results.

Thank you, Meghan, and good morning, everyone. Our first quarter results reflect the continued sales momentum and balance sheet deleveraging we have built over the past several quarters, while we also balance day-to-day operations with the progression of 2 of the important initiatives, our distribution center transition with Metro supply chain and the ongoing strategic review process. These initiatives resulted in $2.4 million of incremental costs incurred in the quarter, which had a more pronounced impact on our P&L given the seasonally smaller nature of our first quarter. I will now share some more details on the key elements of our results. Sales in Q1 2026 were $42.6 million, increasing 6.5% as compared to $40 million in Q1 2025. Our DTC segment sales were $35.8 million in the quarter, growing 3.3% relative to $34.6 million last year. Our comparable same-store sales grew 3.2% in the quarter, delivering a 2-year stack comparable sales growth of 16.6%. The DTC sales growth was driven by positive traffic across both channels, supported by a thoughtfully curated product assortment, which resulted in double-digit growth in certain franchises like Cloud and Activewear. Our partner and other sales were $6.8 million in Q1 2026, up 26.6% compared to $5.4 million last year. The growth in this segment was driven by significant growth across our domestic wholesale, custom products and licensing channels, reflecting both the continued expansion of our customer base in these channels and stronger volumes with existing customers. Total gross profit was $25.5 million in Q1 2026, up 3.8% as compared to $24.6 million last year. Total gross margin was 59.9% as compared to 61.5% in Q1 2025. Q1 2026 DTC gross margin was 61.3% as compared to 62.9% last year. The change in the DTC gross margin was driven by a temporary initiative to offer select products at final sale price points. The intentional strategy minimizes the prior season inventory that would need to be transferred and ingested into our third-party distribution center during the move in the second quarter and to reduce the potential processing of sales returns during this transition. Additionally, the DTC gross margin was also impacted by year-over-year foreign exchange impact on U.S. dollar purchases, partially offset by continued momentum and improvements to our product costing. SG&A expenses were $37.3 million in Q1 2026 as compared to $33.3 million last year, an increase of 12%. As previously noted, the progression of our DC transition and strategic review initiatives had a more notable impact on SG&A expenses during an otherwise smaller quarter. Within SG&A expenses, there was $1.8 million of incremental costs related to the distribution center transition, $1.7 million of which was comprised of accelerated noncash depreciation on existing assets and $0.6 million of incremental consulting and legal costs related to the strategic review. Excluding these nonrecurring costs, SG&A expenses would have increased by 4.9%, primarily reflecting higher variable selling costs from our sales growth, along with higher store-related occupancy costs and personnel-related salaries. Noncash stock option expenses and severance costs, along with an incremental $0.2 million of expenses recorded through the revaluation of cash settled DSUs that are linked to the increase in our share price. Our Q1 2026 net loss was $10.1 million as compared to a net loss of $7.9 million last year, and our net loss per share was $0.26 as compared to $0.20 last year. Since the first quarter historically represents approximately 14% of our full year sales, the impact of the nonrecurring project costs had a more pronounced impact on our net earnings in this quarter. Excluding the impact of the distribution center transition and strategic review initiatives, along with other nonrecurring or unusual costs outside the normal course of operations, our Q1 2026 adjusted net loss was $7.6 million as compared to $7.4 million last year. This represents an adjusted loss of $0.19 per share as compared to an adjusted loss of $0.18 per share last year. Our Q1 2026 adjusted EBITDA was a loss of $7.4 million as compared to a loss of $7.1 million in Q1 2025. As a reminder, due to the seasonality of our business, we typically generate small operating losses during the first half of the year, offset by larger earnings in the second half of the year. Now turning to our balance sheet and cash flow metrics. Our Q1 ending inventory was $45 million, increasing 11.1% as compared to $40.5 million last year. Of the increase, $0.5 million was attributed to the unfavorable foreign exchange impacts on our purchases. The remaining $4 million increase was primarily driven by higher in-transit inventory to support upcoming selling seasons and higher inventory in our Partners and Other segment to support the incredible momentum we are seeing in the custom product wholesale business. Our Q1 free cash outflow was $19.1 million, improving from an outflow of $21.8 million last year. The year-over-year improvement in free cash flow was driven by sales growth and ongoing management of working capital. Due to the seasonality of the business, we typically see cash outflows as we build up our working capital ahead of our peak season before generating larger cash inflows through the higher volume fall and holiday seasons. Our prior NCIB program terminated on April 10, 2026. Under that program, we did not repurchase any shares during Q1 2026. And over the full life of the program, we repurchased just under 1.3 million common shares for a total consideration of approximately $4 million. Net debt was $23.4 million at the end of Q1 2026, down 20.7% as compared to $29.6 million at the same time last year. Our net leverage ratio measured as net debt over trailing 12-month adjusted EBITDA was healthy at 1x. At the end of Q1 2026, we had $32.6 million outstanding under our credit facilities and total liquidity of $53.7 million, including net cash and available borrowings under our revolving credit facility. Operator, you may now open the line for questions.

[Operator Instructions] Your first question comes from the line of Brian Morrison with TD Cowen.

So maybe Leon or Meghan really. Just on the gross margin impact from merchandise clearance, does this reflect a different costing structure associated with the 3PL than an owned facility? And if so, will this impact your merchandising holdover strategy or working capital approach post the transition?

Yes, Brian, I can help address that. So the gross margin structure change has not occurred yet. That will occur when we fully transition to the DC starting really at the end of Q2 and early Q3. This is more of the discipline as it relates to as we transition the goods from the existing DC to the new DC, we will incur extra costs. So we're being diligent on looking at where we can really reduce those costs and where we have seasonal inventory that we could sell through. So really, it's more of a temporary initiative as we work to minimize the transition cost. Going forward, we will continue to take a very disciplined approach on managing our inventory and making sure that, that balance remains healthy. So I wouldn't say it changes drastically from the new DC to the existing DC from an overall long-term inventory management perspective.

I got it. And then I guess, the growing impact of inflation here, whether it be freight, sourcing, product inputs, how are you impacted by this? What's your ability to -- or your approach to mitigate?

Yes, it's a good question. So, so far in Q1, we haven't really seen any material impact from a fuel surcharge or freight perspective nor really from a supply chain raw materials perspective. Longer term, I would say the impact really depends on the duration of the war, right? So we do have longer partnerships with several of our partners, whether it's logistics or supply chain where we have capped fuel costs and ongoing discussions. So really, at this point, we have not seen a notable impact yet.

Okay. And then I guess, Meghan, you're obviously seeing very good reception to your product offering, especially your lifestyle and activewear. It looks good in the store, certainly. But I'm curious just in general, the consumer behavior that you're seeing? Is it still ongoing bifurcation, continued resiliency? Maybe just update what you're seeing as this inflation starts to creep in.

Yes. I think it continues to be a dynamic environment. Right now, we're operating in some of our smallest quarters. And so I think the impact on the consumer is really going to depend again on the duration of the war. And so in the interim, we're focused on some of the positive events in Canada, such as World Cup and really focusing on some of the strong units we've had within our product section and really focusing consumers on that. So as I mentioned in the overarching call, when you look at what we focused on in the first quarter, we really expanding that lifestyle collection, focusing on investing behind some of the strong things on Activewear, Outerwear and also our Cloud collection Sweats. Those all performed well for us, and we're continuing to see our newness resonate with consumers. So from the overall inflation environment, we really are looking over to longer term and really closely monitoring what happens with this war in the next couple of months as we lead up to our peak quarters of Q3 and Q4.

Okay. And I guess my last question, I apologize, I joined late. I assume you're going to say no comment process remains ongoing. But what is the public comment on the strategic process?

Yes. So as we said in previous releases, we do not intend to disclose any developments with respect to the strategic process. And really, this is unless and until the Board has approved a specific transaction or we otherwise have a determination from the Board that disclosure is required or appropriate by law. And so at this point there's no further update.

There are no further questions at this time. I would now like to pass it back to Meghan Roach, CEO, for closing remarks.

Thank you, everyone, for joining the call today. We look forward to updating you in the coming quarters. And I would like to say good luck to our Canadian team. Operator, we may now conclude the call.

This concludes today's call. Thank you for attending. You may now disconnect.