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Good morning, ladies and gentlemen. My name is Michelle, 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 2023. [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 of 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 7, 2023, 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 these 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 2023 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. Ms. Roach, you may begin your conference.
Thank you, operator. Good morning, everyone, and thank you for joining us today for our Q1 2023 earnings call. First quarter results were in line with our expectations and reflect a challenging economic environment. Given the inherent seasonality in our business, the first quarter represents a small proportion of sales, historically comprising only 15% of our total annual revenue.
While Leon will speak to the financial details, I will touch on a few highlights in the first quarter. We will please with the strong year-over-year growth rates in most of our apparel categories. Our customers showed excitement for our expanded and more versatile dress and skirt offerings, which drove a more than fivefold increase in sales in those lines. We also experienced renewed momentum in our Tops business with both heritage logos and our more minimally branded 1 collection performing well.
Activewear posted another strong quarter, growing over 50% year-over-year and reaching almost 10% of total sales in Q1 2023. We are pleased with the growing traction of this performance line, which meets the evolving needs of customers to unique features like anti-bacteria fabric, moisture wicking capabilities and UV protection. The performance of our active line speaks to the upside potential of the brand as we continue to intimate and expose consumers to our broader offering. We also encountered softness in demand from our traditional fleece bottom, resulting in an overall decline in sales year-over-year, given the relative importance of the size of that category.
We attribute performance to several factors: a trend shift towards dresses and skirts and improve that category while depressing bottom sales, a desire for more diversity in our bottom silhouettes, particularly in our women's business, and a return to fleece volume sales levels more consistent with historical patterns. We are continuing to invest in building out this area of the business and have confidence that you'll see more diversity and excitement in the [ theoretical report ].
In Q1, we achieved our highest average unit revenue in the company's history while maintaining gross margins above pre-pandemic levels, even with our shift to sustainable materials, driving product costs higher. These improvements points to the resilience and underlying strength of the Roots brand and our continued discipline around promotions. In China, where we have been only been operating in the market directly for approximately 1.5 years, we are continuing to experience strong momentum with our customer base doubling year-over-year. Our performance to date reinforces our belief in the potential for Roots within that market.
As we turn to our operational highlights, it is important to emphasize that our long-term growth strategy remains intact. While we are staying prudent and are taking steps to navigate the present circumstances, we are confident in the resilience and adaptability of our business and brand after the last 3 years.
While the first quarter has a relatively small financial impact on the overall year, we use it as a time to invest in the key initiatives that will build a strong foundation for our seasonally strong third and fourth quarters and future years. Enhancing our omnichannel capabilities remains an area of focus as we want a seamless integration between our online and offline channels, providing customers with a consistent and convenient experience.
We continue to prioritize investments in data analytics, customer insights and digital strategies that support and reinforce our differentiated position in the market. Recognizing the significance of marketing and brand engagement to new customer acquisitions, we have also been testing new marketing initiatives and enhancing our internal infrastructure to reach new audiences to increase our brand visibility and to enhance the brand's perception in the market.
We recently launched the first campaign under our new Creative Director of Residence, Joey Gollish with [ fever fine ] for the spring/summer season. That campaign, which features video and cell photography has had strong engagement and pairs are enduring association with the outdoors and nature with modern filing in a contemporary deal.
Last month, we also launched a capsule collection with Alder Apparel, a start-up Canadian brand that has shared values across inclusivity, diversity and sustainability as well as the passion for the outdoors. This collaboration features 9 apparel pieces and 3 other items. The early response to this collection has been positive.
Looking ahead, we are intensifying our preparations for a momental milestone, the celebration of our 50th anniversary in August. As we celebrate our rich history and legacy, we aim to surprise and delight our customers with special releases and experiences. We have an exciting lineup of launches planned for the upcoming year, including limited-edition pieces, heritage classics and new collaborations. We look forward to sharing these details during our second quarter conference call in September.
Before turning the call over to Leon, I would like to reflect on the progress and achievements Roots has made in pursuing its sustainability goal. Over the past few years, we have made significant strides in integrating sustainable materials into our clothing line, which we refer to as preferred fibers and materials.
With a sustainably first mindset, we have successfully reduced our reliance on conventional materials, and we were recently included in the textile changes, material change Index as 1 of the top 10 companies making the greatest year-over-year improvement. In 2023, we expect over 80% of our garments to contain preferred fibers and materials, an incredible accomplishment that required extensive internal transformation of the brand.
We are 1 of the few heritage brands globally that has made the significance of a transformation over such a short period of time, and we are incredibly proud to be doing so in our 50th year. Outside of our investment in new materials, we recognize the importance of social labor, particularly in our supply chain. We mentioned in Q4 that Roots was admitted to the Fair Labor Association and is pursuing the fair labor accreditation in the apparel and footwear market.
During the first quarter, we can manage this rigorous process, and we look forward to providing you with updates on our progress towards this accreditation in future quarters.
In closing, we are happy with the progress we've made across key initiatives this quarter, even though we expect sales and margin headwinds to continue into the second quarter due to the current economic climate. Before we move to the financial details on the earnings call, I would like to take a moment to express my gratitude to the members of our incredible team, who are the driving forces behind our continuous improvement as a brand.
I will now pass the call over to Leon.
Thanks, Meghan, and good morning, everyone. Despite the short-term macro headwinds, we remain confident in the long-term operating fundamentals of the business and continue to operate with a strong balance sheet, ample liquidity and have improved our inventory position over last year.
Turning to our Q1 2023 results. Total sales decreased 3.7% to $41.5 million. DTC sales reached $35.4 million in the first quarter, down 5.3% year-over-year. This decline was driven by continued economic uncertainties and the ongoing promotional environment.
As Meghan mentioned earlier, we are highly encouraged by the year-over-year sales growth across most of our apparel categories. However, this was not sufficient to offset the revenue decline in select fleece bottom styles which represented a larger portion of our business.
Our Partners and Others segment sales grew 6.9% from $5.7 million in Q1 2022 to $6.1 million in Q1 of this year. This growth was mainly due to higher sales to our international operating partner in Taiwan, increased licensing royalties of the Roots brand to select manufacturing partners and a favorable foreign exchange impact on U.S. dollar sales.
Total gross profit amounted to $24.5 million in Q1 2023 compared to $26.2 million in Q1 2022, representing a year-over-year decrease of 6.6%. Consolidated gross margin reached 59% in Q1 2023 compared to 60.9% in Q1 2022. DTC gross margin was 61.3%, a 170 basis points lower than 63% in Q1 2022. The reduction in DTC gross margin can be attributed to higher product costs from the transition to sustainable materials, and from high-end promotional activity on targeted seasonal inventory.
Despite the competitive environment, we remain disciplined around promotions, with discount rates remaining significantly below pre-pandemic levels. These factors were partially offset by lower freight premiums of 120 basis points in the first quarter, reflecting less airfreight costs and improvements in the global freight market.
In addition, our DTC gross margin was affected by an unfavorable foreign exchange impact on U.S. dollar purchases, offset in Q1 by the release of a noncash inventory provision. We anticipate the decline in our gross margin will gradually moderate in the latter half of the year as our transition to sustainable materials comes full circle on an annual basis.
SG&A expenses were $33 million in Q1 2023 compared to $31.3 million in Q1 2022. The 5.4% increase in SG&A expenses was mainly caused by higher store labor costs associated with longer store operating hours, contractual increases in store rent costs and higher corporate compensation expenses as we invest in targeted areas of the business that will support long-term profitable growth.
Net loss totaled $8 million or $0.19 per share in Q1 2023 compared to a net loss of $5.3 million or $0.13 per share in Q1 2022. Adjusted EBITDA amounted to a loss of $5.8 million in Q1 2023 compared to a loss of $3.2 million in Q1 2022.
Moving to our balance sheet. Our inventory position was $50.4 million, 28.6% above Q1 2022 and improved relative to the end of last year. The year-over-year increase in inventory was primarily driven by $4.7 million of higher core inventory to be released for sale in the second half of 2023 under our pack-and-hold strategy, $2.9 million of higher product costs related to our transition to sustainable materials, and a $3.6 million increase from more on-hand units, which was partially caused by the earlier timing of summer inventory receipts.
We have made good progress towards lowering our inventory levels in the first quarter, and we are on track to rightsize this balance in the second half of 2023. At the end of the first quarter, our financial position remained stable with net debt of $41 million, up slightly from $39.4 million a year ago as a result of bringing in summer season inventory earlier. We had total liquidity of $74 million, including $14 million in cash and $60 million available borrowing capacity under our revolving credit facility.
As we shared during the Q4 2022 call, we amended our credit facility during the quarter, extending the maturity by 2 years to September 2026 under the previous terms. In terms of our NCIB, we remained active repurchasing nearly 462,000 shares in the first quarter for a total consideration of 1.4 million. As a reminder, the NCIB allows us to repurchase for cancellation up to 2.1 million shares during the 12-month period ending December 15, 2023. As of Q1 2023, we had repurchased more than 695,000 shares under the current NCIB program.
In closing, we remain excited about and firmly stand behind the long-term growth potential of Roots. By maintaining a robust balance sheet and ample liquidity, we are well equipped to navigate through the short-term macroeconomic conditions. The strong financial position also allows us to plan beyond the short-term challenges to strategically invest in a disciplined manner towards the execution of our growth strategies and generate sustainable shareholder value.
This concludes our prepared remarks for Q1 2023. With that, operator, please open the line for questions.
[Operator Instructions] Your first question will come from Brian Morrison at TD Securities.
Meghan, I'm interested in your commentary upon data analytics, what you currently have with respect to data, what additional metrics you would like to have and maybe the magnitude of the investment is going to take to get you there?
I think, Brian, the good news is we actually have -- it's a pretty well investment day in terms of the data and systems that we have. We have put in place a new person specifically to focus on data analytics. But from an infrastructure perspective, we do actually have a CRM system. We do collect information from our consumers, both in stores and online.
And so really, it's about kind of improving the usage of that data and also kind of enhancing your collection of our consumer data from a store perspective to match it back to our retail e-commerce environment. But fundamentally, we have a good infrastructure already in place. It's more about the usage of that data and the application of it broadly as opposed to actually having to invest heavily in the infrastructure across the technology stack.
Okay. So it's more just a cycling putting effort into what you have rather than accumulating more information?
Yes. I think we always want to continue to get more information from our consumers, absolutely. I think also the usage of the data from a consumer base will continue be changing. So there will be some investments, but I don't want you to think that we have to invest in a massive new CDP or something like that because we do have a customer data platform today. It's more about the usage of the data and then improving the collection of it as well as improving the usage of it.
Okay. Okay. And then I guess the other thing I want to ask about from a high level is your consumer response to the higher priced sustainable materials. You did mention in your prepared remarks, it sounds like it's well received. Maybe just some further detail on that.
Yes. I mean, I think, listen, we haven't really seen any specific consumer pushback from the shift to sustainable materials as it relates to price. I think as I alluded to on the call, where we saw some challenges in the first quarter, it's really in our traditional fleece bottoms business. And so across the board in our other categories, we are actually seeing very positive response from a consumer base perspective.
So from our perspective, we don't believe that the consumers are negatively responding to the shift to sustainable materials where the price changes. I think currently, we obviously are in a challenging economic environment.
And so I think that's impacting consumer purchasing behavior. But more broadly, we feel very good about our shift. And as I mentioned on the prerecorded call today, but 80% of our goods are not transferred to preferred fibers and materials, which is a really substantial shift for a company like ours or for such a very short period of time.
Okay. And then last question maybe for Leon. I'm just looking at the bridge on inventory, it looks to me like you've cleared out your noncore. So promotional activity to the same extent we should see a degree of relief as you move into Q2 back half. But are you able to call out the nonseasonal margin impact of the 290 that you highlighted?
Yes. So Brian, of the 290, I would first back out the 120 basis points air freight and ocean freight impact. That's the tailwind that we received in Q1, so that basically implies that we had a 290 basis points margin decline, which was largely driven by a mix of IMO and markdowns.
I would say that our outlook and our expectations for margins have not changed since last quarter, where we do expect markdowns and IMO pressures to continue into Q2 and more specifically, as we start comping off of more organic and PFM materials in the second half of the year, we will see some lesser headwinds on a cost perspective.
And our margins -- sorry, our markdowns will continue into the second quarter. We have tried to manage our markdowns in a way that is more in line with the market. So if you think about when a lot of the market comes into more of a promotional and clearance period, it would be in the summer time frame, and that's when we would expect to participate as well.
Okay. I guess 1 last question. I appreciate that comment. And approach to NCIB, obviously, have been very active lately. There must be some metrics associated with the capital return hoping you can share that with us.
Yes. I mean we will continue to be really opportunistic in terms of our NCIB. Obviously, we've shared that we continue to be very active in Q1 and likely we see that in Q2, we are continuing as well. Obviously, we're also mindful of the current economic challenges that we're facing. We want to be really prudent with the cash we have on hand.
I am very happy with our liquidity and our net debt position where it does give us the flexibility to continue to invest in the business as we look beyond the other side. So we are balancing the NCIB needs as well as the business operational needs, especially as we head into a more seasonally heavy period of our year in terms of preparing for peak.
Any target metrics you can share Leon or no?
We are not sharing any target metrics for the NCIB as of now.
Okay. Good luck going forward.
Your next question comes from Stephen MacLeod at BMO Capital Markets.
Just a couple of questions. Just wanted to -- could you just remind us if you're able to present sort of your merchandise breakdown like apparel versus fleece bottoms. I mean, fleece bottoms, obviously, was more than offset the growth you're seeing in apparel. So just wondering if you can share or remind us what the merchandise breakdown is.
We don't share the details of the merchandise breakdown at that level. What I can say is that fleece is obviously a big portion of our sales overall. And that fleece bottom is a larger portion of our business just in general.
I would say that when you look at the fleece bottoms business, we are comparable actually from a dollar perspective to 2019. So what's interesting is we're seeing it very comparable to pre-pandemic levels now. So we feel good about the current positioning of it.
I would say that when you think about our merchandising mix overall, what's been nice to see is, again, the increased penetration of dresses and then the increased penetration of activewear, which is now almost 10% of our business.
And so I think when you think about the broader diversification of Roots overall, I think what we're leading towards is the team is to diversify the base. We think fleece is going to be continued important, but we do believe things like activewear and some of these other categories will continue to play an important role in the brand going forward.
Great. Great. And then just as you think about the gross margin, Leon, I think you were saying that -- did I understand correctly that you were saying you sort of -- you would need to back out the 120 basis points of lower freight premiums. So margins were sort of really down 290 basis points in the quarter. Is that right?
The 290 basis points is what I would think about in terms of product margins. So that's the mix of the IMU and the markdown rates. In terms of the freight, we just called that out just for the readers to really understand where our margin composition is coming from. So we did have last year in Q1, we talked about 100 basis points air freight impact. And in Q2, we talked about a 50 basis point air freight impact.
So it's just something we wanted to call out to make sure that everyone is aware of the margin tailwinds that we're benefiting from going into Q1 and Q2, but also be mindful of the cost and IMU impact, sorry, cost and markdown...
Right. Okay. No, that's helpful. And then just as you turn to Q2, you talked about just some of those pressures continuing both from a macro perspective as well as markdowns. Can you just -- would you expect Q2 margins to be down but not quite as much -- I'm talking about DTC gross margin here, but not quite as much as it was in Q1?
Yes. So last quarter, we talked about expecting that the second half -- sorry, the first half margin is roughly going to be down around 350 basis points on a product margin/markdowns perspective. And we do expect that currently where we haven't changed that expectation. Again, we are looking at taking a little bit more of a promotional frame outlook in terms of when we're going to have our clearance products in line with the market. So where the market is a lot more promotional in the summer period, that's the time we want to participate.
Right. Okay. That's helpful. And then you talked about -- which I thought was interesting, just the highest -- your highest level of average unit revenue in the company's history. Can you talk about how that compares against traffic levels? Like are you seeing traffic pressures materially because of the economic backdrop?
Sorry, yes. So I don't think that we have a necessarily a strong correlation between traffic and AUR. So on AUR, a lot of that is just driven by a combination of the customers really receiving our PFM products well, but also, again, with our managed markdowns as we really try to be more promotional when the market is promotional. Traffic, again, we are seeing good traffic trends in most of our stores. But again, I wouldn't necessarily link AUR and traffic trends.
Okay. That's helpful. Okay. That's great. That's all I had.
[Operator Instructions] Your next question will come from Matthew Lee at Canaccord Genuity.
A lot of mine were answered already, but -- maybe you can talk about Mr. Saturday's Joey Gollish, and he's been working for the company now for 3 months. Maybe just discuss some of the insights we've gleaned from the time so far in terms of uptake of this collaboration lines and maybe what that means domestically for some new classic products like.
Yes, absolutely. We've been really happy with Joey having joined on board so far. I mean, he's been a great addition to the team and he brings definitely a modern contemporary perspective to what is a fantastic heritage brand. So I think you see that with the [indiscernible] campaign, which hopefully you've all seen online and through various channels, which is the first campaign that he oversaw.
And I think it's definitely on point with what we stand or from a brand perspective, but also more modern, more contemporary of steel and also from a dialytic perspective as well as to term the creative assets. So we feel really good about the direction that he's been chasing things. He has just really started to work on impacting the product collection as he's only been in for 3 months. And as you know, we work obviously, a couple of seasons in advance. So you will see more impact from this product collection coming into next year. There are certain small collections that he's been impacting already. But I think we feel very good about the direction he is taking things and we feel just good about the reaction we've seen to book this collaboration with us as well as the reaction to his creative input into some of these campaigns so far.
Your next question comes from Sabahat Khan at RBC Capital Markets.
Great. I guess just on the commentary around the consumer and the macro environment, I guess, is the situation with the consumer and just the sales trends moderate, I guess, what are some levers you're thinking on the cost side that you might be able to tweak? Would it be more focused on the stores, overhead? Just want to get an idea of how you're planning for a potential slowdown that might be more severe than we might expect right now?
Yes. I think there's a few things. I'll let Leon answer part of this. But I think -- so from a high-level perspective, I think just for the consumer, we're definitely seeing a difference in Canada and other markets. And I think you can see that in the results that have been reported by ourselves as well as the brands in terms of how Canada has definitely experienced I think consumer challenges in a different way.
So say from a high level perspective, what's interesting is that our China business is performing very well while we leave it in the market for about 1.5 years, where we're doubling our customer base there, and we're seeing very good trends from a revenue perspective.
So I would say overall, we feel good about the broader direction of the company and the traction we're getting with our new product categories. But obviously, we have a cautious outlook as it relates to the consumers, particularly in the second quarter and given the most recent rise in interest rates yesterday.
From a cost perspective, Leon can speak to that, but I think 1 thing to emphasize from a high-level perspective is that we are investing now for the future. So we are obviously mentioning things like our customer, our analytics, our improvements in our overall IMU into next year. These are places that we're putting resources in now that we believe will impact us positively in the second half of the year and into 2024. So we want to be cautious on making too much of a short-term perspective in reducing cost at the expense of the long-term profitability of the business. But Leon, maybe you can add a few additional thoughts.
Yes. Sabahat, to make a point, we are in an investment period in the sense that we do want to look beyond 2023 into what Roots can be going forward. And some of the areas that we're seeing benefits there include things that we called out in Q4 so like our sourcing group and our Head of Sourcing there, we're seeing some great exciting wins there that we hope to share in early 2024.
In terms of where we are finding cost improvements, we continue to partner with a lot of our close operating partners and looking at our existing contracts to try to refine some of our operations. And again, we have long-standing real estate partnerships with a lot of our landlords. So many of our rents are areas that we have ongoing discussions with. But overall, we do want to make sure that we balance management costs with also having a good outlook on preparing for future growth.
Okay. Great. And then I guess just more on maybe the [ profit on ] sales side. Are you thinking maybe of adding some more lower-priced spin offerings or maybe emphasizing more of price point that might be attractive to a consumer in this environment? Or do you think you can maybe just address that through promotional activity to get to the right price points. I want to understand how you think about mix and pricing in this environment?
Yes. I mean I think we are very much -- I think we are a premium product that I think deserves the value and price that it's been set on. I mean if you think about the Roots product, I mean, many people have these products for a series of years, right? I'm sure maybe not -- I don't know if you have it in your household, but I know a lot of people who do have -- who have had it for many, many years.
And as we get into our 50th anniversary, 1 of the things we're talking about from a storage perspective is people who have products that are 20, 30, 40 years old from us, right? So I think that Roots is an association with value that is important to recognize. And so from a price perspective, we don't anticipate reducing prices to take advantage of the current economic environment.
From a commercial perspective, as Leon mentioned, we do anticipate having the seasonal promotions that every brand has during the summertime period. And we'll probably be making sure that our promotions during that time period are attractive for consumers, but we don't anticipate taking an increasingly promotional approach to our product overall.
Since 2019, our basis points in Q1 have gone up 660 basis points, right, from a gross margin perspective. And we are thinking about the longer-term evolution of this brand and the importance of making sure that people see the value and the premium position of it, and we don't want to devalue that by taking a short-term perspective on discounting or price.
Great. Thanks very much for the color.
There are no further questions from the phone line. So I will turn the conference back to Meghan Roach for any closing remarks.
Thank you, everyone, for joining our first quarter results. We look forward to speaking to you in September, and we will speak to you about our Q2 2023 results. Enjoy the summer.
Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.