Aritzia Inc. (OTC:ATZAF) Q2 2021 Results Earnings Conference Call October 14, 2020 4:30 PM ET

Company Participants

Helen Kelly – Vice President, Investor Relations

Brian Hill – Founder, Chairman and CEO

Jennifer Wong – President and COO

Todd Ingledew – Chief Financial Officer

Conference Call Participants

Mark Altschwager – Baird

Mark Petrie – CIBC

Irene Nattel – RBC Capital Markets

Derek Dley – Canaccord

Stephen MacLeod – BMO Capital Markets

Meaghen Annett – TD Securities

Lorraine Hutchinson – Bank of America

Operator

Thank you for standing by. This is the conference operator. Welcome to Aritzia Second Quarter 2021 Earnings Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

I will now turn the conference over to Helen Kelly, Vice President of Investor Relations. Please go ahead.

Helen Kelly

Thank you, Anastasia. And thank you all for joining Aritzia’s second quarter 2021 earnings conference call. Apologies for the brief delay. On the call today, I am joined by Brian Hill, our Founder, Chief Executive Officer and Chairman; Jennifer Wong, President and Chief Operating Officer; and Todd Ingledew, our Chief Financial Officer. Following management discussion we will host a question-and-answer period open to analysts and investors.

Please note that remarks on this conference call may include our expectation, future plans and intentions that may constitute forward-looking statements. The uncertain and dynamic nature of COVID-19 and its ongoing impact could continue to materially alter our performance.

We would refer you to our most recently filed Management Discussion and Analysis and Annual Information Form, which include a summary of the material assumptions, as well as certain material risks and factors that could affect our future performance and our ability to deliver on these forward-looking statements. Our earnings release, the related financial statements and MD&A are available on SEDAR, as well as the Investor Relations section of our website at aritzia.com.

I will now turn the call over to Brian

Brian Hill

Thank you, Helen, and thank you everyone for joining us this afternoon. I am pleased to report alongside Jennifer and Todd our Q2 results, which reflect the encouraging recovery of our business. Notwithstanding the ongoing impact of COVID-19 and the evolving social, economic and political climate, we are pleased with our performance and excited about the outlook for the future and I could not be more grateful for our incredible team with whom I have had the privilege of working alongside every day.

All of our boutiques are now open and have been performing better than our expectations. Our eCommerce business has maintained its exceptional growth, albeit not at the same rate as when our boutiques were closed, at far higher projections than previous to COVID.

Our world-class talent and infrastructure in which we continue to invest remain strong, and we have capitalized and will continue to capitalize on the many opportunities made available in this unprecedented time.

Net revenue was $200 million in Q2, down 17% from $241 million last year. As you will recall, our net revenue was down 43% in Q1. The significant improvement on our quarter-over-quarter results is an encouraging sign of our businesses ongoing recovery.

Despite shuttering our retail operations in March, we were thrilled by the response of our people and our clients. As we reopen and began the recovery of our retail operations early May, this enthusiasm carried forward into Q2.

Our multichannel client relationship continued, upholding the momentum of our eCommerce business, which delivered 82% growth compared to last year, despite the reopening of our boutiques throughout the quarter. Importantly, our increasing revenue combined with highly effective inventory and cost management allowed us to maintain our strong cash position.

As a result of keeping all our people employed during the shutdown and starting to plan our reopening the moment we closed our doors, we were able to reopen our boutiques quickly, efficiently, and above all, remain vigilant with our health and safety precautions for our people, our clients and our communities. At the start of the quarter, 31% of our boutiques were reopened and by the end of it, 96% were. As of September 9th, all our boutiques were reopened.

Notwithstanding lower traffic and social distancing limiting our in-store capacity, as we reopened our boutiques in the second quarter, our clients enthusiastically returned. While it is too early to tell what our new normal boutique performance will be, we were encouraged by the persistent improvement in our boutique productivity during the quarter, which reopened boutiques performing on average at 70% of last year’s productivity.

With geographical variation and performance depending on the past and present impacts of COVID-19, this is clearly a regional recovery for us. Suburban boutiques outperformed downtown boutiques and Canada unsurprisingly recovered in Q2 at a quicker pace than the United States.

During the quarter, we began a number of initiatives and launched new enhancements to our eCommerce website, enriching our client’s shopping experience, which Jennifer will share with you shortly.

In addition, our site navigation and content on the breadth of offerings were optimized, allowing our clients to more easily shop various attributes such as fabric, rise, length and color. This meaningful extension of our site navigation supports our expanding product offering and will continue to scale with the growth of our assortment.

And while we have typically largely foregone paid advertising, the online environment offers compelling opportunities to test. As such, we recently launched a paid media pilot to evaluate the potential return on a formal paid media program. We will share more details if this becomes a meaningful ongoing initiative.

As noted, we see unlimited potential in our online growth, complementing the strategic advantage of a strong boutique network. Our clients continue to demonstrate their desire for an omni experience and this multichannel relationship presents boundless opportunities.

Since the beginning of COVID-19, as we have discussed, our product team pivoted flawlessly. Immediately upon closing our boutiques in the first quarter, we focused on moving our spring/summer inventory. This put us in great inventory position to start the second quarter and allowed us to maintain markdown levels consistent with the same time last year.

This meant that at the beginning of August, we are in a remarkably clean inventory position, which allowed us to launch fall with new exciting product that has been incredibly well received and notably has facilitated full price selling.

Second, we effectively pivoted our inventory to reflect our client’s lifestyles and activities with less professional and event product to more of a casual and lifestyle product. As we recently saw in our client’s response to the launch of our fall 2020 product lines, we are still chasing the overwhelming demand that we have experienced since the start of COVID.

And thirdly, we began our exciting new initiative to significantly expand our product assortment. The expansion of breadth including new style development, depth including sizes, length and colors, and new categories such as swim, intimates, bags, shoes and beauty, many of which are targeting our eCommerce channel began with our Fall 2020 Collection and we will have an even larger impact on spring 2021 and thereafter.

As Jennifer will elaborate in a minute, we are exceedingly pleased with the launch of our Product Lifestyle Management System this week, which will support the ongoing expansion of our product strategy.

As we move forward with our expansion, attracting taught creative talent remains an utmost importance. In the second quarter, we expanded our design team with talent acquired from world renowned fashion brands who are already making a significant contribution to our product expansion strategy, and to complement our design team, we further invested on manufacturing talent, securing senior leaders whose global experience is invaluable.

In marketing, we presented our clients with captivating campaigns have both reflected their stay-at-home reality and resonated with their adjusted lifestyles. Our product catalog continues to successfully featured models shooting from home and our compelling product campaigns continued with a fall launch of each of our major brands.

During the quarter, we wrapped up our Aritzia Community Care Program, which we launched to show our heartfelt gratitude and support from those fighting on the virus frontlines. Through the program, we gifted 100,000 frontline healthcare workers in Canada and United States with custom clothing packages, a total retail value of $10 million. It was our honor to do our part to support the selfless healthcare heroes.

Last but not least, sustainability has always been a priority for us. We are proud to have completed our first CDP climate assessment in August and officially became a company with carbon neutral operations within our offices, stores and managed DCs as of the second quarter, covering our 2019 Scope 1 and 2 emissions. We achieved all this through all of our efforts to minimize our footprint complemented by purchasing renewable energy credits and VCS certified carbon offsets.

While this is an important first step, we know there is more we can do as an industry leader to make a difference. We are committed to this important work and we will continue on our journey to do the right thing for our people and the planet.

As we progressed into our new normal, we are encouraged by our results and in embracing our opportunities. We are proud of how much we have accomplished as a team in the second quarter. Our results are testament to the everyday lifestyle — Everyday Luxury experience that continues to resonate with our loyal clients, our engaging service, beautiful product, aspirational environments and the unwavering commitment of our people.

Looking at Q3 to-date, we are pleased with the positive client response to our fall/winter product launch. This has manifested itself into sustained momentum of our eCommerce business and continued improvement in boutique productivity in the first six weeks of the third quarter.

As we now prepare for the holiday season, which represents our busiest time of year, we are cautiously optimistic about our potential. Given our clients enthusiastic response to our fall launch, we are prepared as always to respond to the demand with flexibility.

As we move forward through the fall season and enter winter, we are already experiencing sellouts and are quickly chasing reorders on these highly productive styles. And while occupancy restrictions, recent increases in COVID-19 positive case rates and new corresponding government restrictions in some markets will continue to impact our retail performance. Our eCommerce business is well-positioned to continue to offset these measures.

I will now turn the call over to Jennifer to give you an update on some of the key areas of our operations. Jen?

Jennifer Wong

Thanks, Brian, and good afternoon, everyone. The past six months has stretched us in new and in many cases previously unimaginable ways. As a team, we have come up with creative and agile measures to pivot our business as we faced unprecedented challenges head on and we have achieved this while continuing to delight our clients with the Everyday Luxury experience they have come to love and expect from us.

Although, the pandemic is not yet behind us, from an operations perspective, the second quarter was about resuming our long-term strategy and building for future growth. I’d like to give you a progress update in four key areas.

First, continually improving our distribution and logistics, second, supporting our product expansion strategy, third, driving topline growth by empowering our clients to shop seamlessly between our physical and digital channels, and finally, fulfilling our commitment to cultivate and celebrate diversity and inclusion at Aritzia.

With the sustained momentum in our eCommerce channel carrying through the second quarter, we continue to refine all processes and activities across our distribution and logistics operations to accommodate the doubling of our eCommerce units. I am pleased we have been able to keep our people safe, while maintaining delivery times that meet or exceed our client’s expectations.

Starting with our Layer It On Sale this past weekend, we have recently ramped up hiring and training of additional DC associates in preparation for our upcoming holiday season. While the retail environment in the near-term remains certain, our infrastructure is well-positioned to continue to meet growing demand.

As you may recall, one of the infrastructure projects we have been working on for the past few years is our product lifecycle management system or PLM. We reached an important milestone just yesterday with the official launch of the platform.

This is the culmination of years of hard work and dedication of our team, who along the way mapped over 129 processes, gathered over 600 business requirements, executed over 20,000 steps in the system, developed training materials for over 245 processes and consolidated thousands of data records. Completing this launch was a marathon and while we have additional phases to come, I am proud of our team for this major accomplishment.

PLM enhances our efficiency in bringing a product to market and provides the scalability to support the expansion of our product offering well into the future. The adoption of PLM will follow the normal cadence of our product lifecycle, with multiple seasons cycling through at their respective checkpoints. Fall 2021 will be the first collection to see its product cycle through PLM from initial concept right through to delivery.

Next, with personalized experiences and enduring relationships as an ongoing priority, we continue to invest in an exceptional omnichannel experience. Earlier this year, we launched and have gradually expanded the use of digital selling tools.

Our results so far show a meaningful increase in both conversion rate and average order values. We are excited about the potential of digital selling tools and we will continue to expand usage across our boutiques in the coming months.

With our eCommerce business steadily growing, we also continue to invest in our digital capabilities. As Brian noted, during the quarter, we implemented a number of initiatives on aritzia.com to enhance our client’s shopping experience.

As a larger portion of our business shift to eCommerce, it is increasingly important to accurately convey size and fit information with our clients online. We are excited to be rolling out an AI tool later this month for size and fit optimization.

This technology allows us to provide highly personalized size recommendations to our clients at aritzia.com based on the measurement data and preferences of our — that our client provides, this tool leverages machine learning algorithms to generate precise fit guidance based on past purchases and its exceptional knowledge of our products. Given the strong client engagement and positive feedback on our fit enhancements to-date, we expect these added features will increase client satisfaction and boost conversion.

In the coming weeks, we are also launching a Buy Now, Pay Later payment option that allows for seamless checkout while decreasing the barrier to purchase. We expect this deferred payment method to be an effective tool to augment our omni initiative by increasing brand awareness, attracting new clientele and driving traffic. It also has the potential to meaningfully contribute to our topline growth by enhancing our conversion rate and average order value.

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Turning now to people. As Brian has noted, we continue to add world-class talents to support our growth. As we do, we are intent on ensuring for both our current and future employees that we are an inclusive culture that inspires high levels of engagement and performance.

Since our last call, we have made encouraging progress towards our commitment to cultivate and celebrate diversity and inclusion at all levels of our organization. We took our first ever company-wide D&I survey in August, we shared the topline results with all of our employees in September along with an action plan.

We learned that we have a strong foundation to build on. We also learned that there is room to improve our diversity in certain markets and in positions of leadership. We are already using this data to inform our D&I strategy.

Going forward, our top three actions are, number one, laying the foundation by embedding D&I into everything we do company-wide. This includes more diversity in key areas, such as hiring, career growth and leadership. Two, increasing learning and development through D&I training in our workplaces which is already underway. And last but not least, we are evolving our brand by more clearly defining and expressing our diversity and inclusiveness.

To that end, we launched our first D&I campaign titled With Love, Aritzia at the end of September. This campaign shines the spotlight on six inspiring individuals from around the globe who articulate and embody our diverse Aritzia community. Through a series of letters, featured and captivating videos, images and editorials broadly shared across our various platforms, we are highlighting diversity that inspires us.

We have recently received highly positive feedback on the campaign’s authenticity and it’s a powerful and timely way to connect with our clients on a unique new level. We will continue to seek out further opportunities to share our values and our commitment to authenticity, diversity and inclusion with our loyal clientele.

In conclusion, I share Brian’s cautious optimism. We are not immune from the impacts of the COVID virus literally, quite literally and figuratively. However, our powerful business model combined with our adaptability to the evolving retail landscape continues to serve us well in these extraordinary times.

I will now turn the call over to Todd to discuss our financial results.

Todd Ingledew

Thank you, Jennifer, and good afternoon, everyone. We are pleased with the momentum we saw in the second quarter that drove meaningful improvement in both our top and bottomline results, as strength in our eCommerce business continued and we reopened our boutiques. The ongoing recovery in our performance demonstrates the resilience of our business, as we adapt and navigate the uncertain environment.

Net revenue for the second quarter was $200 million, a decline of 17%. This compares to a decline of 43% in the first quarter. At the beginning of June, the start of our second quarter, 30 of our boutiques were reopened. At the time of our last call on July 9th, 89 boutiques had reopened and we are trending on average at 55% to 65% of last year’s sales productivity.

The sales momentum increased through the remainder of the quarter, driving overall boutique sales productivity of 70% for the full second quarter. By the end of the quarter, we had 93 of our 97 boutiques reopened.

As sales ramped in our boutiques the strength in our eCommerce business continued, delivering 82% growth in the quarter. The exceptional growth in eCommerce revenue year-over-year was driven by the positive response to our product, which manifested the meaningful increases to both traffic and conversion, with similarly strong performance in both Canada and United States.

Gross profit in the second quarter was $700 — $78 million or 35.2% of revenue, compared to 39.6% last year. The decrease in gross profit margins was largely driven by occupancy, warehousing and distribution center across deleverage from the reduced retail revenue. This was partially offset by improved merchandise margin from the cancellation of the warehouse sale this year, as well as mostly lower markdowns in the quarter compared to last year.

Gross margin also benefit from rent abatements and government payroll subsidies recognized during the second quarter. While the overall landlord response has been mixed, we appreciate the support in the formal abatements that we have received to-date from many of our landlords. We are continuing to work with each of them for further relief as we evaluate ongoing boutique performance and future traffic impacts in this uncertain environment.

SG&A expenses in the second quarter were $60 million, effectively flat compared to last year. SG&A expenses during the second quarter included additional costs related to the implementation of health and safety measures and other COVID-related costs, as well as investments in talent year-over-year. These were both offset by government payroll subsidies and savings and operating expenses.

Adjusted EBITDA returned deposit in the second quarter at $12 million, compared to $36 million last year.

We maintained our solid liquidity position through the end of the second quarter with cash balance of $207 million. Excluding the cash drawn down from our revolving credit facility cash increased $77 million from the same period last year. Despite the significant revenue decline associated with boutique closures we have maintained our liquidity since the start of the pandemic through strong eCommerce revenue, as well as prudent inventory and expense management. Given our strong cash position, subsequent to the end of the second quarter, we made the decision to repay in full the $100 million drawn on our revolving credit facility.

Inventory at the end of the second quarter was $141 million, a 3% increase compared to last year. Our swift action to calibrate inventory and immediately drive eCommerce revenue enabled us to enter the fall season in a clean inventory position with an on point product assortment and a return to full price selling.

Turning to our third quarter. We are pleased with the enthusiastic client response to the launch of our fall product, which manifested itself into sustained momentum in our eCommerce business and ongoing improvement in our boutique productivity in the first six weeks of the third quarter.

While we were pleased with the trajectory of our business and believe we are well-positioned for holiday, we are only halfway through our third quarter. We have recently seen a return to tighter government imposed COVID-19 restrictions in two of our Canadian markets and saw an immediate impact to sales in our boutiques.

In addition, occupancy restrictions and reduced hours remain in place across our boutique network. Therefore, we are tempering our enthusiasm for the short-term and anticipate our retail performance to moderate in the back half of the third quarter. We expect the momentum in our eCommerce business will remain strong and continue to partially offset the potential impact of reduced boutique traffic.

To ensure the health and safety of our people and clients, we are maintaining stringent protocols for our boutiques, distribution center and support offices. These incremental measures are expected to add additional labor and operating expenses of approximately $4 million per quarter for the foreseeable future. Based on the level of our current performance, we expect government subsidies will be immaterial going forward.

We continue to expect capital expenditures for fiscal 2021 in the range of $30 million to $35 million. Including the three new boutiques already opened in this fiscal year, we plan to open an additional two to three new boutiques and two exclusive pop-up locations. We have also repositioned three of our existing locations already this year.

In conclusion, we are pleased with the momentum in our business, the ongoing recovery in our financial performance and our healthy liquidity position, and we remain confident in our ability to successfully navigate the crisis. As we look ahead, we will continue to strategically invest in our business to drive long-term growth and enhance shareholder value.

With that, I will now turn it back to Brian.

Brian Hill

Thanks, Todd. As I look forward, while the near-term remains somewhat uncertain, I could not be more excited about our long-term opportunities fueled by our four strategic growth drivers, geographical footprint expansion, product expansion, brand awareness and customer loyalty, and channel capabilities — omnichannel capabilities and digital enablement. We have been building our digital capabilities for several years and we are well-positioned to capitalize on our accelerating eCommerce business.

Over and above the digital enhancement of our website and our expanding footprint of profitable retail boutiques, our most effective marketing tool, fiscal 2022 will see our full attention directed to our omnichannel capabilities, which will seamlessly connect our eCommerce and retail sales channels.

Through a handful of services such as store inventory visibility, ship from store and buy online pickup in store, we will elevate our client’s experience, fueling sales in both our boutiques and our website.

Speaking to our geographical footprint, already in the third quarter, we have expanded to boutiques and open two new boutiques, one in the new market for us, Philadelphia. For the remainder of the fiscal year, we plan to open three more boutiques, one in the new market, Honolulu, which I am confident we will have no problem finding teams to support the opening of.

In addition, we are looking forward to the expansion of our signature Super Puff brand and vastly expanded product line this season. With the opening of two exclusive Super Puff pop-ups in iconic locations at the former Dean & DeLuca locate — Dean & DeLuca in Soho, New York City and the former Fred Siegel location in Los Angeles.

With many shuttering their doors, premiere real estate locations across North America are plenty, with corresponding financial terms that are unheard of. While our boutiques have always been highly productive, with opportunities coming available, we are in exciting position to strategically expand our boutique network in world-class highly profitable locations.

As mentioned earlier in the call, we have begun to implement our product expansion. This initiative and its potential to grow eCommerce business is compelling. Our product calendar has us expanding our breadth and depth each season, doubling our product selection by fiscal 2025.

We are confident in the tremendous growth potential of our business as we continue to enhance our eCommerce capabilities and omnichannel experience, expand our exclusive product offering and capitalize on unprecedented real estate opportunities, increasing our geographical footprint, all supported by investing in world-class talent and infrastructure.

Our results over the past several months have proven the viability of our powerful business model. Our people’s commitment to excellence and teamwork, and our client’s enduring loyalty during this time of crisis. Although, the retail landscape is shifting for many, our long-term future is rich with potential and we are well-positioned to capitalize on the boundless opportunities that lie ahead. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Mark Altschwager with Baird. Please go ahead.

Mark Altschwager

Good afternoon. Thank you for the detail and congrats on the progress and the recovery so far. I am wondering if you could share any more perspective on what the store productivity recovery looked like in August, sounds like maybe it was in the 80% range based on the quarterly average that you shared. Also digital, sounds like that has remained pretty steady relative to when you gave the update in July. So, I guess, this is a fair take away here that digital has not materially change quarter-to-date relative to the Q1 average even as the boutiques have ramped back up?

Brian Hill

I will take part of this and I will pass it to Todd here. Thanks for the questions and welcome. We have found our boutiques getting increasingly better every month or every period. P6 is better than P5 and P7 has been better than P6.

We have of late with some of the shutdowns in key markets like Ontario and Québec, and uptick in COVID numbers throughout the North America, but we have seen sort of flattening and some pressure on retail sales just of late. We will see what manifest themselves. It’s too early and too recent to be able to figure that out.

But I do — I am really optimistic, but I am a little cautious of what’s going to happen during peak periods running into November and specifically Black Friday in those weeks. Those are big important weeks for us and I am a little concern with store capacity issues and things around that.

I mean, typically it doesn’t really affect us much on a Tuesday afternoon with capacity issues because we probably weren’t at capacity anyway, but when we get to these peak periods and we start getting lineups at our boutiques and things like that and particularly with spikes up in COVID we are getting a lean on a little bit concerned what’s going to happen. We haven’t seen it manifest itself too much, but I am a little bit concerned. Todd, do you take the eCommerce question then?

Todd Ingledew

Yeah. I mean, we have continued to see strength in our eCommerce business, so as we said, and are expecting that that strength will almost offset or potentially offset the shortfall that we are expecting to continue in the boutiques.

But the answer to your question is no, we are not running at 150% like we were when the stores are closed in eCommerce. So that is a − has subsided a little bit, but it’s still our eCommerce business is far, far better than it was pre-COVID, the growth is far, far better than it was in pre-COVID. So we are super excited with the eCommerce.

And I think a little bit or a lot of it might have to do with COVID. I think we have done a great job on our product and anticipating trends and things. I think the fact that that we have — we got our inventory and we have had these great new collections that I don’t think all other competitors have had into the marketplace this fall and enhancements to eCommerce sites and things have all contributed to that and certainly people shifting to more digital is having effect.

But I wouldn’t suggest it’s accounted for all of it. I’d like to get shadow to my teams here and our teams here who have done an exceptional job product teams, eCommerce teams, marketing teams and the fluency of our distribution centers and our share retails teams reacting well and making customers feel really super comfortable in our stores.

So everybody’s banded together and done a great job and I know I am missing some teams here, but we are just super excited about the business and what’s been going on and are really happy with our performance throughout this period.

Mark Altschwager

That’s really helpful. Maybe just a quick follow-up there, I guess, it makes sense that store productivity may get more difficult to sustain as we approach the higher volume periods in the coming weeks here. We have seen efforts from some other brands and retailers to pull forward events to smooth out demand, now I know you haven’t historically been a promotional retailer, so tougher to do that. But just curious if you are making any changes on this front for this holiday, any different approach to the Black Friday period for instance, given the capacity constraints you mentioned in the stores?

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Brian Hill

Yeah. I mean, there’s probably mixed reasons why people are pulling forward then or maybe they have too much inventory, which we don’t have a problem, maybe they have cash flow challenges. I mean, we are super excited to see that we were in the midst of this pandemic, Q2 we made money and a lot of people didn’t, they are still losing money.

So, we don’t have a presently touchwood cash flow issues, business remains strong and we think that we have our promotional calendar and everything sort of aligned to where we want to be, and we are kind of going about this as normalcy as much as we can and it seems our customers are responding.

There is some concerns during these peak periods around store capacities and things. So we have been looking at maybe stretching some of these opportunities out, both from a sales perspective but also health and safety for our clients and our people.

So, we are just — we are making adjustments in everything that we are doing, but we are not abandoning what’s made us successful in the past and what our customers have appreciated in the past and then we are still committed to that Everyday Luxury experience and so it’s not really promotional calendars and things like that. That’s not how we operate.

We have never operated by having promotions in sales to generate sales. We have always used it to clear out inventory when the inventory that is a little bit more — and a little bit slower selling, but we haven’t ever used it to smooth things out in sales. So we are not going to lose sight of that. We are going to stay true to who we are and it seems to be working right now. So we are super thrilled.

Mark Altschwager

Great. Thanks again and best of luck over holiday.

Brian Hill

Thank you.

Operator

The next question comes from Mark Petrie with CIBC. Please go ahead.

Mark Petrie

Hi. Good afternoon. Brian, just given the unprecedented real estate opportunities that you mentioned and the compelling store economics that you are seeing, does this open a window to accelerate the store opening pace specifically in the U.S.?

Brian Hill

We have discussed that, I think, one — somebody might be suggesting you should be accelerating and opening a ton of new stores and more so than we have in the past. Others are suggesting that it could get — things could get — the opportunities could get even better, and in some cases, some of the landlords not recognized or either this sort of new reality.

So, but realistically, we do have logistics challenges with building them right now. We can’t cross the border and a lot of our teams up here in Canada and that hasn’t really impeded us, but it certainly hasn’t made it easier, and then, obviously, all the COVID restrictions on site, things like that and we haven’t really been able to go look at sites although we do have a senior real estate executive down in the U.S.

But — so and then — and so we kind of approached it as, look, it’s the same as anything. We have our pipeline. We wait for the right deals both from a location and shape and store perspective, as well as financial terms and we are going to continue to do that. So we are not really in a position that we are thinking let’s push the pedal down but we are also not letting it out there. The opportunities are too good to pass.

I would say, we are probably going to start getting more aggressive. We don’t think these opportunities are going to go away in the next week or month or anything else. And but at the same time, we are driving a lot more of our business through eCommerce.

So we think we can grow our business at a very, very good clip with continuing to promote and invest in eCommerce and continuing to open stores and continue to invest in our product and we are pretty comfortable with the mix that we have right now and have had in the past, and as the opportunities come up though, we are not hesitating doing deals, I can tell you that.

But are we doing more and going to push the pedal down more, not necessarily, we have our pipeline and if those opportunities come up, we are going to hit them. But the pipeline is the pipeline and the opportunities are the opportunities and we can’t really force them if they are not there.

Operator

The next question comes from Irene Nattel with RBC Capital Markets. Please go ahead.

Irene Nattel

Thanks and good afternoon. If I may just a shorter term question, can you talk a little bit about sort of the cadence of demands in terms of the mix of products that you are selling versus what you would normally sell? And then as we move through the balance of the year, what you are kind of thinking in terms of holiday, and I guess, sort of more formal wear and what have you, I guess, how you ordered it in given the new reality?

Brian Hill

Yeah. Thanks, Irene and welcome. We have shifted, people are spending more time at home, they are buying more comfortable clothing, they are buying more casual clothing. I sat with our Barberton designer here last night, so I think it was 10 o’clock something, chatting with her about the demand that she’s had and we have seen some of the demand for some professional wear and event where it go down.

But it’s going to come back. I mean people — a lot of people are changing their lifestyles or working from home and everything else. But I can’t find a single person who likes being shut in every day. I mean everybody wants to get out just climb in and get out, and quite frankly, I think, we are all going a little stir crazy. And once people start going out again, they are going to want different types of clothes and when they are hanging out at home.

So what’s so beautiful about our brand is that in our product mix is we have brand — we have products and we have as you know, as well as anybody Irene, we have our lines that cater to professional and event, but also have casual and lifestyle and active lines and practical lines, and we have a balance between coats and sweaters and pants and shorts and dresses and everything. And I think that’s one of the things we have always been the most proud of is our product mix and everything else.

So we just pivoted quite fluently to our new product mix and it’s certainly different than it was a year ago for sure. But I am pretty confident that it’s going to go back and look at a lot more. Hopefully if we get this behind us a year or two from now, this — it’s going to look a lot more like it did a year ago than it looked in the last six months and we are going to be ready for that too.

And so, we are ready for everything. I mean, as I just mentioned, we are ere profitable for the quarter. We had a great start to our Q3 and so we are super excited. And whatever the situation is we are ready for it and we will adapt accordingly.

Irene Nattel

That’s great. Thank you. I really appreciate that and yes please God I’d love to get all that. I am just thinking a little bit further ahead, how should we expect to see the evolution of the extended offering happen over time, you said, and how are we as consumers and as analysts going to really see it as it happens?

Brian Hill

I think part of the whole impetus of this is the fact and I have mentioned on the last call the fact that we are not constrained by the four walls of our retail stores anymore. And although retail drives still a majority of our sales, eCommerce has hit a critical mass now that we can explore and develop product that could come out as eCommerce-only product.

So we are going to continue to do that. I mean, we have a list of 18 initiatives and we have them all jammed into the next year and a half, two years and we had a board meeting the other day and they all looked at me and said, come on Brian, get a little bit more realistic.

So my big takeaways from the Board was, at our Board meeting was, prioritize these initiatives and obviously hit the ones that are the easiest to do and certainly are going to generate the most profit and maybe put some of the other ones secondary and tertiary.

But there’s some super easy ones, just adding colors that we couldn’t do before because the stores have limitations in size − and sizes and lengths and things like that, so these are no brainers. We are already executing on most of these right now as we started this fall season, we have had most of these, we have had extended sizing since last spring, we have added colors, more colors this fall, we are going to see a lot more next spring and summer.

So we are going to see a lot of that more online. There might be a bit more variability in the stores, but the as soon as they have their limited capacities. We are going to start seeing our warm weather collections, be a little bit more robust particularly since we are opening in Texas. We have three stores open in Texas now. We are in San Diego. We are just in a store we just mentioned in Ala Moana in Hawaii and places.

So we are going to continue to pursue that warm weather initiative and then we are going to start looking in other categories and we actually already started building the teams to explore other categories, expand on our denim and just really facilitate the breadth of offering.

As I mentioned, I think of the last call, if you look at a lot of the pure-play eCommerce people out there who have no limitation that their merchandise breadth is multiples of ours. And so for us to compete and to execute well and continue to capture our customer’s imaginations and give her luxury, Everyday Luxury, we need to strengthen and broaden the appeal of all our products and so we are going to continue to explore that. We are really excited about our whole product teams energized.

And it’s going to cost money. It’s going to cost capital. We need more space and more people and more heads and more expertise and some of these people don’t come inexpensively because we are bringing, some are Canadians and some of the sport people are Canadians, but we are bringing some of these experts in from all over the world. But, we are pretty excited about what we have assembled so far and what we are going to assemble.

So we are looking forward to it and we are going to see — you are going to start seeing things hopefully already with the sizing and things, but you are going to start seeing a lot more colors and start seeing a lot more breadth of styles and some of these categories as soon as next year.

Irene Nattel

That’s great. Thank you. Looking forward to it.

Operator

The next question comes from Derek Dley with Canaccord. Please go ahead.

Derek Dley

Yeah. Hi there and congrats on a strong quarter and outlook. Just wondering in terms of gross margin came in quite strong this quarter and I get you are not expecting the $2.5 million in subsidies going forward, but likely some of the rent abatement may continue. So when we think about gross margin, do you feel you are getting closer to that sort of normalized range called 38%, 39% over the over the balance of the year and especially given your healthy inventory position?

Todd Ingledew

Yeah. Well, there’s obviously a number of factors impacting gross margin. One that Brian discussed is that, we have returned to full price selling. So from an emerge margin perspective, we expect to be flat with the prior year.

But we still continue to expect deleverage from occupancy and warehousing costs, because we do have all the boutiques open now. So the pressure from deleverage is lessened, but we are still expecting to have lower boutique sales and so that will drive some deleverage.

And we did receive significant rent abatements that we negotiated in the second quarter. We do expect abatements savings similar to that in the third quarter. However, we currently aren’t planning for any of that or that material for the fourth quarter.

So there is a difference between the two quarters. And to maybe put a finer point on it, we expect the gross margin will be below last here in Q3, but potentially that the gap will be smaller than the 440 basis points that we saw in Q2.

Brian Hill

And if I could add to that as you may or may not recall, nine months ago, 12 months ago, I was discussing increased raw material prices, wool, silks, all those things have gone up. So we are actually buying all the products we have received in this season with those higher inventory costs, so raw material costs. So our starting margin isn’t quite as high as it was.

That said, going forward, Derek, we are seeing far and we are seeing a lot of actually downward pressure on these prices due to the demand, the worldwide demand. And so we are working to start seeing some better margins due to raw material costs, probably not spring so much, we are going to see a little bit in the spring, but next fall, we are booking in wools and downs and things like at far less prices than we are now.

So we are going to pass some of those on our consumers who we think are going to have some financial challenges due to the economy. But some of them will help us retain or regain some of the margin that we lost this year from — get back up to previous years.

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Derek Dley

Okay. That’s really, really helpful. Appreciate the color. And maybe just one more quick one, just regionally, I think, last quarter, I know you commented that Vancouver, the Pacific Northwest was performing a little bit better than some of the other regions, were there any big sort of disparities this quarter on a regional basis?

Brian Hill

Yeah. I think, Todd, try to give answer.

Todd Ingledew

Yeah. I mean we are seeing — we saw some of the same trends we saw. As I mentioned in my discussion earlier that it’s not just present COVID situations. We have — well, we have seen previous COVID, so regions that were affected dramatically by COVID. They just — they were hit hard and they haven’t recovered quite, as well as regions that weren’t.

But now with this sort of so called second wave, we are seeing a whole another new pattern develop and with Ontario shutting down, I was in Ontario and in market in our stores on Saturday and I notice a definitive decrease in traffic once the premier shutdown the province on Friday night. So we will see that and I believe it’s a 28-day shutdown, but we have already seen effects at retail.

Now whether those get made up from an eCommerce perspective, I don’t know. But once again when things like that happen it rocks the consumer, it rocks people, they don’t go out as much, they don’t go out not just shopping in the stores, but they don’t have events and things are going out too. So whether just be controlled dinner parties or whatever I think it rocks everybody.

So we are seeing these patterns − we have seen these patterns evolve, but now we are seeing new patterns take place as falls as reopen and we have seen different regions get affected a little bit heavier. I mean, we are getting affected probably at the worst case we have had out here in British Columbia, Ontario re-shutting down again. All of a sudden these — there are numbers from the U.S. which is harder hit before are almost flat with numbers in Canada are now as far as percentage soft.

So it’s ever evolving. It’s really organic and it’s unfortunate that we are all going through this, but we are just going to roll with the punches and do the best we can and so far the team’s done a remarkable job.

Derek Dley

Terrific. Appreciate the color. Thank you.

Operator

The next question comes from Stephen MacLeod with BMO Capital Markets. Please go ahead.

Stephen MacLeod

Thank you. Good evening. Good afternoon. I just wanted to follow up specifically on your comments around the online category expansion. You gave some good color in the Q&A. But I think in your prepared remarks you sort of suggested that you have actually have introduced some new products or new category expansions online. Just wondering if you could give a little bit of color around what we have seen so far and what the customer reaction has been to that?

Brian Hill

Yeah. I know, I hope I didn’t mislead in that. I think, I — what I am trying to communicate is, we are grouping sort of three different groupings of product expansion. We are grouping colors, lengths, sizes, that sort of an existing styles. We are grouping — then the second group is with new styles and existing product lines and the third is new categories.

I didn’t mean to mislead and I apologize if I did. What we are already seeing is the first category. We have new sizes. We have new lengths now hitting the stores. And we have new colors and just more selection of colors hitting the stores and we have just seen a positive response to it, right?

I mean it’s hard to predict exactly because you can’t really tell what new items whether you would have sold, what the rate of sale would have been nor what the percentage of black would have been versus yellow versus green versus have now you have black, yellow, green, purple and blue, are those sales in the purple and blue incremental or some of them incremental and then taking away from. So it’s hard to figure that out.

We do know though, that by just offering different lengths and things like that, we are going to appeal to a broader range of customers. So my daughter is always complaining and she’s 5’9 and she’s always complaining that her pants are too short to wear at Aritzia and now she’s thrilled because she can buy pants to fit her now. So — and buy is the operative word here for her. So, yeah, she’s out buying those sorts of things now and she can buy and fit in her pants quite well.

So there’s just an opportunity for us to be a lot more things to a lot more people here from a color in that perspective. Even sort of more body conscious items that have skin tone, looks different on different skin tones and enable to offer a wider variety of that looks better on different people in their different skin tones.

So we are excited about that and that’s what we have seen so far. We haven’t really introduced a broader range, and quite frankly, last spring when COVID hit, one of the first things we did was have a really good hard look at our breadth of our existing lines and we kind of called some of the items that we didn’t think we needed.

So we quickly have pivoted though on that as our business picked up and our — we got cleaned out our inventory quickly pivoted and been adding new styles and our customers have responded very much. So, but we have added new styles and existing programs and things like that. We have seen it perform extremely well, which is probably something I just left out.

But there really isn’t — the quantity of new styles, we are just focusing on our core strengths and our business is good. We are super pleased with it so at this point in time. But we are not going to see any of these things that I mentioned to Irene for a little bit here. So I apologize if I misled you there.

Stephen MacLeod

No. No. That’s great. Well, that’s good. Incremental colors and thank you. And then I just wanted to just maybe along those lines, Jennifer, you talked about Product Lifestyle Management, which was officially launched. Can you just give us a little bit of color around kind of what benefits you are expected to realize from this new product? I think you said that fall of 2021 would be the first collection with product cycle into this new tool. So I just want to get a little color there?

Jennifer Wong

Sure. The strategic benefit ultimately is to enable the product expansion strategy that Brian has just spoken about. So in my group, we build infrastructure to enable growth and essentially everything we do generally ties to a growth initiative or a growth driver or optimizing our current business in some way.

So, ultimately, if we are going to scale our product assortment and create more skews essentially as what it translates to right down to the lowest level. We need a system to help manage the data and manage the processes to make sure we do it efficiently and can manage it essentially cost effectively.

So, some of the side benefits apart from strategically enabling us to expand our product mix is, more than a greater efficiency, greater control and management over design quality, construction quality, possibly fit quality.

So all of the aspects that go into the development of a product will now be managed through a system rather through manual processes and spreadsheets and basically documents. So it’s kind of critical in order for us to expand our product.

Stephen MacLeod

Right. Okay. That’s helpful. That’s all. Thank you. That’s it for me.

Operator

The next question comes from Meaghen Annett with TD Securities. Please go ahead.

Meaghen Annett

Thank you. Good afternoon. Just to have more of a follow-up question on the Buy Now, Pay Later pay later option that you discussed. So about more of a regional initiative and how meaningfully do you see that impacting conversions and basket size? And do you think that there’s any maybe potential offset to those benefits?

Jennifer Wong

The product? Hi, Meaghen, welcome back, it’s Jen. We chose a product that has great promise, I guess I would say, in Canada and the U.S. And so for us we will be starting with the product online. I think they have it, I think they do have a presence with U.S. in actual bricks and mortar. But we are going to use it for our online business first and foremost in the U.S. and in Canada.

And essentially, I am not sure if you know how this payment solutions work. But it’s — at the end of the day, it’s a deferred payment solution and so what it allows is it allows greater accessibility for purchasing power to our clients.

There’s also tremendous marketing synergies between the company that we chose and ourselves and that can drive client acquisition. But essentially, at the end of the day, when I say a drive conversion and possibly average order value, that’s because it allows our client to make their purchases, they essentially have credit and that allows them to make their purchases now rather — now and defer the payment over a period of time.

Meaghen Annett

Okay. So does that impact returns at all or?

Jennifer Wong

I don’t think it will impact it one way or the other. I don’t like that — it’s just — it’s actually just making our products more accessible. What I would say is, as it relates to return, that’s where the size and fit optimization product that I spoke about actually will impact positively and that we would hope to see that if a client is purchasing items more accurately, there will be fewer returns. So that’s what we have done to address return metric.

Meaghen Annett

Okay. That’s it for me. Thank you.

Jennifer Wong

Did that make sense? Great.

Operator

The next question comes from Lorraine Hutchinson with Bank of America. Please go ahead.

Lorraine Hutchinson

Thanks. Good afternoon. Your comment about evaluating paid media is really leading to my question about the long-term implications of higher online penetration to your margin structure. Can you just talk a little bit about the puts and takes there, please?

Brian Hill

Yeah. It really is a test and we don’t really have — we are not going to — that’s the whole purpose of it and we are not going to have any numbers until we actually come up with that. Our team is a lot more versed team that’s — that we have presently is a lot more versed in this area than previous teams who had in the past.

And I think our — their perspective is pretty balanced. There is some people would tell you that paid digital is something that at the end of the day, you don’t eventually make money on and others would tell you it’s a windfall in a client acquisition and everything else.

So we are going to explore and see what that means for Aritzia. Our biggest client acquisition, and I have always said this and to this call and our teams is our retail stores, which retail footprint and we have seen that in the past when we have had these stores open and our sales and eCommerce sales in those regions go up.

But at the end of the day, this is — there has been this major shift. There already was a shift. But as you know, there’s more of an exponential shift to digital and we need to become more famous in the United States and with our sales and our eCommerce sales accelerating and everything else, we still have a huge opportunity in the U.S.

And really at the end of the day, hopefully five years from now, we will be doing more business in the U.S. market in eCommerce than we will in Canada and that’s just the nature of the people and the size of the market and presently we are not.

So, we are exploring everything here and they are going to get back to see if it’s profitable, if it makes sense, are we driving incremental sales? Are we trading to always or whatever it is that we are doing here?

From a marketing perspective, I historically thought that we are better off treating our people and our existing customers and spending the money on them rather than acquiring new customers. But the digital landscape is different and unlike real estate everybody’s website is treated equally as far as searches and everything else goes to some degree.

But — so we are going to, well, actually not treated equally based on that, so we are going to have to explore that. It was simple before, you go by get a good location and retail and a better location retail and now you need to have that equivalent. You need to do to spend money on digital and everything else and pay digital.

So that’s what the exploration is. It’s not — we are not going to see a meaningful increase of our business in the short-term because we are quite frankly we are out testing all sorts of different digital pay digital vehicles and then report back, we are doing some AB testing around that and things like that.

So we see this as something that is going to be evolving, and as I mentioned in the call, and we will hope, if it becomes something more meaningful we are going to do a change in strategy we will — everybody here on the call will be the first to know. But right now we are still in the test phases.

And quite frankly, I just don’t know the answers on all the puts and takes, obviously, it’s investment and less expenses and as here — revenues less expenses and return, but I just don’t know what that equation is going to look like and what buttons within the digital landscape are going to work for us and proved to be incremental versus ones that are not.

Lorraine Hutchinson

Thank you.

Operator

This concludes the question-and-answer session. I would like to turn the conference back over to Helen Kelly for any closing remarks.

Helen Kelly

Thank you, Anastasia. And thanks again to everyone for joining us this afternoon. We will be available after the call to any — answer any questions you may have. Take care and we look forward to speaking with you again soon. Thank you.

Operator

This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.



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