DAVIDsTEA, Inc. (NASDAQ:DTEA) Q2 2017 Earnings Conference Call August 7, 2017 4:30 PM ET
Joel Silver - President and CEO
Howard Tafler - Interim CFO
Nathalie Rolland - IR
Stephen Albert - Bank of America Merrill Lynch
Kelly Bania - BMO Capital Markets
Good afternoon ladies and gentlemen. This is DAVIDsTEA Second Quarter Earnings Conference Call. At the request of DAVIDsTEA, today's conference call is being recorded. All lines are currently in listen-only mode.
I would now like to turn the call over to Ms. Natalie Rolland of DAVIDsTEA.
Thank you. Good afternoon everyone. With me on the call is Joel Silver, President and Chief Executive Officer; and Howard Tafler, Interim Chief Financial Officer. Also present is Christine Bullen, Chief Operating Officer and President of DAVIDsTEA USA, who will participate in the Q&A session.
Before we get started, I would like to remind you of 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 statements. Additional information regarding these factors appear under the heading Risk Factors in our 10-Q, that will be filed with the Securities and Exchange Commission, subsequent to this call and will be 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 financial measure will be provided as supplemental financial information in our press release.
Now, I would like to turn the call over to Joel Silver, President and Chief Executive Officer of DAVIDsTEA.
Thank you, Natalie. Good afternoon everyone and thank you for joining us today. After almost six months in the job, I am excited about the DAVIDsTEA brand and our capacity to further extend its reach and build a solid business model for the future. We are addressing the missteps of the past, and we now have a better understanding of the distinct nature between the Canadian and U.S. consumer. In addition, I am encouraged that we are putting the right team in place, that many of the measures we are initiating will help us deliver improved performance.
While the second quarter remain challenging, the results were in line with our expectations. We continue to work through our excess inventory position, our planned seasonal promotional activity helped us return to a more normal level of inventory, including our seasonal carryover. We are pleased to enter the all important second half of the fiscal year, with a sound level of inventory.
Total sales increased, I am pleased to say, exceeded 11% and the rate of same store sales decline improved 4.8 percentage points to negative 0.9 from a negative 5.7% in the first quarter of fiscal 2017. However, our year-over-year gross margin as a percentage of sales declined, due to planned clearance of seasonal products and deleveraging of fixed costs. The impact was relatively similar on both sides of the border. We also made good progress this quarter, and in recent weeks, towards our short term goals of improving product assortment, in-store experience, e-commerce penetration and better understanding of our customers on both sides of the border.
The cornerstone to our new beginning was the performance of an extensive market study conducted on our behalf. Over 4,500 consumers were surveyed in Canada and in the U.S., including more than 2,700 of DAVIDsTEA's fans.
We had three primary goals for the research; first, to clearly identify our target market. Second, to identify the key differences between Canadian and U.S. consumers; and third, to measure brand awareness of DAVIDsTEA. We confirm the information that we already knew, and gleaned brand new facts to give us a thorough overview on customer preference in terms of the demographics, what they drink, their taste, how they drink and where they drink tea. We believe these insights will be key to further developing our strategy, to better tailor our DAVIDsTEA concept to consumers.
Another aspect of our study was to measure DAVIDsTEA brand awareness. In Canada, the study clearly indicates that DAVIDsTEA has strong brand awareness with further upside potential. In fact, as reported by the study, DAVIDsTEA is a top specialty tea brand, and the numbered tea among all the tea brands in Canada.
In the U.S., the brand remains in its infancy, but resonates among those who are aware of the brand. We will use this research to define our distinct customer targets in Canada and the U.S. and adjust our marketing and messaging to address these consumers.
As you know, Teavana announced they will be closing all its stores by next spring. From what we understand, a selection of Teavana products will continue to be sold in Starbucks stores. We perceive the store closures as positive for our business, and we are currently assessing the potential opportunity. At this time, we have 38 stores in Canada and 19 stores in the U.S. that are collocated in the same malls with Teavana stores, so this is where we could see the primary benefits, as DAVIDsTEA's locations will have greater prominence.
Last quarter, we discussed our plan to reduce SKUs to create a more streamlined and focused in-store experience, so our customers connect with our best products. We are continuing to rationalize up our assortment as we enter fall and the important holiday season. This, combined with our enhanced visual merchandising to improve product appeal and create an easier shopping experience, as well as the implementation of new marketing strategies, will provide a more cohesive brand message to restores DAVIDsTEA growth and strengthen our leadership in specialty teas.
As indicated before, our e-commerce platform is a key area of focus for us going forward. During Q1, we began work on a new robust, more stable web site to replace our existing site. The new site, slated for launch in early 2018 will have much improved capabilities to keep up with existing online demand, will provide easier shopping to greatly improve experience for customers and should allow us accelerate our e-commerce growth. The project represents a total investment of between C$3 million and C$4 million to complete.
To execute our strategy, it requires us to add some key people. In August, we began solidifying the team with the additions of Sarah Segal and Natalie [indiscernible]. Sarah is heading up the group, focusing on tea, product development and innovation, while Natalie is spearheading the direct merchandising function, which includes assortment planning and inventory management. We are confident these additions and others will enhance our strength as leaders in the tea industry.
As you know, we have been testing a new store format called UPSHINE, which was originally our native location. While it is too early to make a complete assessment, I am pleased to report that we are seeing early success and are encouraged by key learnings. At this time, we have opened three new stores in this format in Toronto, Boston, and Columbus, Ohio.
Overall, DAVIDsTEA results for the second quarter fiscal 2017 were disappointing, but were in line with our expectations, given that we are still in the early days of our improvement plan. We expect the all important second half of the fiscal year will translate into improved full year results.
As we announced a few weeks ago, I am happy to a appoint Howard Tafler took on interim CFO. Howard has been with DAVIDsTEA to close to 18 years and has successfully built and overseen accounting and finance department. He has a thorough knowledge of our industry and business and provide solid leadership and continuity.
I will now turn the call over to Howard for a more detailed review of our second quarter financial results and then return with some final comments.
Thank you, Joel. Good afternoon everyone. I would first like to thank the management and Board of directors at DAVIDsTEA for the opportunity to support Joel and the team and my new role. I will begin my remarks with a review of our fiscal 2017 second quarter results. As a reminder, the dollar amounts referred to in reviewing our results are in Canadian dollars.
Sales in the second quarter increased 11.2% to C$45.7 million from C$41.1 million a year ago. We ended the quarter with 236 stores, an increase of 28 net new stores and 13% versus 208 stores last year. In Q2, we opened four new stores in Canada, one new store in the U.S. and we closed one store in Canada for a year-over-year increase in the store operating weeks up 16%. Comparable sales decreased by 0.9% versus a 5.1% comp increase in the second quarter last year, as we continue to face more challenging overall consumer retail backdrop. Gross profit increased by 1.5% to C$20.2 million from C$19.9 million last year. Gross profit as a percentage of sales decreased to 44.2% from 48.5% in the prior year period, primarily due to the planned clearance of seasonal products and deleveraging of fixed costs due to the negative 0.9% comp this year.
Adjusted SG&A in the second quarter increased to C$25.9 million from C$22.8 million a year ago, due primarily to the hiring of additional staff to support the growth of the company, including new stores, and higher store operating expenses considering 28 additional stores. As a percentage of sales, adjusted SG&A increased to 56.6% from 55.5% last year.
Adjusted results from operating activities for the second quarter of fiscal 2017 decreased to a loss of C$5.7 million compared to a loss of C$2.9 million last year. Adjusted net loss was C$4.2 million or C$0.16 per fully diluted share as compared to a net loss of C$2.3 million or C$0.09 per fully diluted share in the prior year period. Adjusted EBITDA was a negative C$2.2 million compared to C$0.2 million in the prior year. In the second quarter, we incurred a C$2.3 million impairment charge, due to underperforming U.S. stores, and a C$1 million executive separation charge related to the departure of our former Chief Financial Officer.
As of quarter end, ending inventory was C$28.6 million as compared to C$25.1 million for the same period last year. On a per store basis, inventory increased by 0.5%, as our planned seasonal promotional activity enabled us to return to a more normal level of inventory, including carryover, as compared to year end.
In terms of liquidity, we ended the quarter with C$56.4 million in cash, or a net cash position of C$2.19 on a per share basis, with no debt and availability of C$20 million under our revolving credit facility.
Regarding our outlook, as in Q1, we won't be providing quarterly and annual guidance at this time. However, we are slightly modifying the 2017 limited outlook commentary that was provided in Q1. To that effect, we are planning to open between 10 and 12 stores in Canada and up to five stores in the U.S. this year. We also expect CapEx for the year to be between C$15 million and C$18 million and to be free cash flow positive for the full year.
With that, I will turn the call back over to Joel for some final remarks, before we open the call to your questions.
Thank you, Howard. As we previously indicated, we see 2017 as a reset year for DAVIDsTEA. Armed with our extensive survey results, we are actively working to solidify and implement key strategic initiatives to positively impact our results. We are focused on improving the profitability of our Canadian store network, which represents approximately 80% of our total sales. We have a sound plan that encompasses e-commerce and various marketing initiatives.
The U.S. business remains a work in progress. We will consider closing non-performing stores, as well as consider selective store growth opportunities. We have recently solidified our management team in key aspects of the organization, and we are encouraged with the initial progress we are making to improve DAVIDsTEA performance.
Our overriding objective is to make the tea core experience better for customers, and ensure that DAVIDsTEA continues to set the bar as leaders in the tea industry. DAVIDsTEA has an exceptionally talented team of devoted people. I thank each of them for their commitment and contribution. It is reassuring to have this excellent support, and I know that together, we will continue to work very hard to enhance shareholder value.
I will now ask the operator to open the lines for questions.
[Operator Instructions]. Your first question is from Lorraine Hutchinson from Bank of America Merrill Lynch.
Hi, this is Stephen Albert on for Lorraine. My first question was on Starbucks and their decision to close all their Teavana locations. I think you talked about it being an opportunity. Any concern about what it says about the viability of the on-mall tea business?
This is Joel. I think it gives us more room to operate for sure. We think they had other focus areas, and we also know that it wasn't their focus area over the last several years. So we think it opens up a direct business opportunity for us. But again, for the 38 stores we have in Canada, we have another 19 in the U.S., they are collocated. We expect to see a direct benefit from those stores.
We are still unsure of some of the short term liquidation and impact what that may present. But we think overall, this is a definite positive for the business.
Okay. And the website relaunch; I think if my notes are correct, you are expecting to maybe roll that out back half of the year this year, maybe prior quarter? Why the pushout into early 2018?
Yeah. No I think we -- basically we were concerned about the stability of our existing site. I think many changes have been made to make us feel much better, and so we push the risk of -- ideally, you don't want to launch a new site in Q4. So we pushed the risk out to the beginning of next year, just to kind of mitigate that, and we are feeling great about the new site.
Does it mean anything for holiday, that you are going to still have the legacy web site for the big volume period?
No. The team has been putting a lot of risk mitigation in place to manage through the current site for holiday. But we feel much more comfortable about that plan, than try to rush an execution of a brand new site.
Okay. Thank you very much.
[Operator Instructions]. Your next question is from the line of Kelly Bania from BMO Capital Markets.
Hi, good evening. Thanks for taking my question. Just wanted to ask about promotions and discounts? I mean, just coming out of a quarter, where it sounds like you got the inventory into a place where you'd like it -- through some heavy discounting, possibly entering several months here, where Teavana maybe could be liquidating and discounting. You know, I guess, how do you think about your promotional strategy over the next several quarters here and getting those customers not used to those heavy discounts?
No, it's a good question. Overall, listen -- we are in an inventory position we are uncomfortable with, and so, we took the necessary steps to get it in control. And so I think, we have been happy with our execution. I think overall, the promotional strategy now relates to the brand, it's an open question that we keep having a good conversation about. And so, we will continue to ultimately do what we have to, to build the brand.
We think in terms of Teavana, that ultimately, the Canadian locations will be closed before the holiday. So we won't be facing that necessarily during our critical holiday time, because we think most of the locations in Canada will be closed already. In the U.S., we think those locations will be closed in the spring of next year. And so, we will continue to see what the impact is in the U.S., if they are more aggressive with liquidation.
But I think overall, the promotional strategy has been aggressive for us. I think the goal now is for us to kind of really revisit the brand and make sure what the right long term promotional strategy is for DAVIDsTEA.
Great. And I may be mistaken here, but I think you may have increased the number of U.S. stores opening this year; albeit small, I think you still characterized it as a work in progress. So did I miss something there, or is there something going on, the reason that --
No. We said last time up to five stores, and we are sticking with that. We already have three opened and plan up to two more.
Okay. And I guess, another just question on the study that you did; I guess, can you talk about any of the key differences that you did learn between the U.S. and the Canadian customer and what they are looking for? And then, do you have any -- I don't know if you are able to share this or not, but any data on the percentage of your sales that come from repeat customers?
Okay, so this is Joel. So overall, I think our -- we had a great study to really understand. Number one, obviously is the awareness level in Canada is much higher in the U.S. But we see the same overall conversion; which basically means that, once you are aware of us in the U.S., their ability to jump into the brand and try us and be part of our brand experience is high, relative to our low awareness. So we think that's an amazing opportunity for us.
We did see all kinds of differences obviously in their patterns. Everything obviously -- from some of the obvious, in terms of iced tea. But as you dig deeper into those segments, there is some real, sort of more detailed segmentation learning that we took. We obviously have some of the U.S. consumers just did -- some of the things we didn't know about, in terms of -- they are more open to exploring a wider flavor selection, for example.
So I think we now have these segments identified between Canada and the U.S., and it gives us the ability to market differently, to merchandize differently against these segments.
There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.
Thank you for joining us this afternoon. I look forward to update you on our progress of DAVIDsTEA.
This concludes today's conference call. You may now disconnect.