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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Thank you for standing by. This is the conference operator. Welcome to Aritzia's Third Quarter 2023 Earnings Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions]
I would now like to turn the conference over to Beth Reed, Vice President, Investor Relations. Please go ahead.
Thank you, [indiscernible], and thanks for joining Aritzia's third quarter fiscal 2023 earnings call. On the call today, I'm joined by Jennifer Wong, our Chief Executive Officer; Todd Ingledew, our Chief Financial Officer; and Brian Hill, our Founder and Executive Chair. Following prepared remarks from Jennifer and Todd there will be an opportunity to ask questions.
Please note that remarks on this call may include our expectations, future plans, and intentions that may constitute forward-looking information. Such forward-looking information is based on estimates and assumptions made by management regarding among other things general economic and geopolitical conditions, the competitive environment, and further COVID-19 resurgences. Actual results may differ materially from the conclusions, forecast, or projections expressed by the forward-looking information.
We will refer you to our most recently filed quarterly and annual management's discussion and analysis and our annual information form that is available on SEDAR, which include a summary of the material assumptions, as well as risks and factors that could affect our future performance and our ability to deliver on the forward-looking information. Our earnings release, the related financial statements, and the MD&A are available on SEDAR www.sedar.com, as well as the Investor Relations section of our website.
I'll now turn the call over to Jennifer.
Thanks, Beth. Good afternoon everyone, and thank you for joining us today. I hope you all enjoyed the holidays and Happy New Year from all of us at Aritzia. 2022 marked another exceptional year for our company as we welcomed new clients, grew our team of world-class talent, expanded our premier portfolio of boutique, and delivered a plan for our next phase of growth.
Our performance in the third quarter of fiscal 2023 showcases the ongoing sales momentum that we're seeing in our business as our much loved everyday luxury experience continues to resonate with both new and existing clients. Our record Q3 sales were higher than anticipated as all geographies and all channels outperformed our expectations. Net revenue of $625 million increased 38% from last year with comparable sales growth of 23%. This growth was fueled by our business in the U.S. where our outstanding pace continued growing by 58% from last year.
In Canada, we grew total sales by an impressive 22% and saw strong double-digit comparable sales growth. Our phenomenal sales results continue to be driven by new client acquisition as more people discover and become loyal to the Aritzia brand. During our Black Fiveday Event, we delivered record-breaking results with retail sales hitting an all-time high on Black Friday.
In e-commerce, on one of the very first days of the event, we had our highest day ever and then beat that record again on Black Friday itself. During sale period, e-commerce is becoming a larger and larger contributor to our growth. Throughout the Black Fiveday Event, our concierge team kept pace handling 150,000 client interactions.
I'm incredibly proud of all our team's dedication and hard work and our highly engaged people across North America along with our best-in-class processes and infrastructure allowed us to deliver another exceptional [Black Fiveday] [ph]. In Q3, our retail business surpassed our expectations increasing 39% from last year.
Our tremendous momentum in the quarter was fueled by outstanding comparable sales growth in our boutiques, as well as the progress we made on our real estate expansion strategy. We opened four newly expanded boutiques in the quarter, starting with a record breaking opening day at our Pollo Park location in Winnipeg, and then ending the quarter with another record breaking opening day at our Yorkdale flagship in Toronto.
Our boutique expansions are performing exceptionally well with the additional square footage allowing us to deliver an enhanced experience for our clients resulting in better than expected payback periods. In e-commerce, revenue grew an impressive 36% on top of 47% last year. We continue to experience strong traffic growth and demand. We also saw a meaningful lift in conversion as we benefited from site enhancements and our improved inventory position, compared to last year.
On November 29, we celebrated the tenth anniversary of our e-commerce business. We've come a long way in our journey to create a best-in-class shopping experience and we remain committed to improving and elevating our online platform as we make progress towards delivering e-commerce 2.0. In Q3, we enhanced product discovery by making it easier for clients to shop matching sets, understand size, length and color availability, and navigate the site with [less growing] [ph].
We also optimized the types of images we use across various parts of our website to better enable clients to find and evaluate products. For example, we change product listing page images for our sale items to off-model from on-model, which makes it easier for our clients to identify which items are on sale.
In Q3, key programs and client favorite continued to drive strong demand, which was balanced across the assortment. Selling in our professional, fashion, and tailored assortments continued to increase even as we maintained our momentum in lifestyle apparel. We also saw a strong start to the outerwear season. And we are pleased with the balanced demand we're seeing across our product offering as our multi-brand business model continues to enable us to cater to our clients' needs across all aspects of their lives.
Our beautiful product and boutique expansion strategy continue to propel our brand awareness and drive increased market share. The Aritzia brand is resonating incredibly well on social media with our clients who are doing the talking for us. And to our own social and influencer strategies, we are emphasizing what they're saying.
Our views on TikTok have surpassed 2 billion and are growing at a rate of nearly 100 million every month. In Q3, we continued to expand our influencer program, most notably with our Super on You campaign for the fall winter Super Puff collection featuring meaningfully more paid collaborations than last year. The campaign integrated seamlessly across all our marketing channels from social to aritzia.com and helps drive further progress on our path to getting famous in the U.S. where total client growth was 48%.
Turning to supply chain, we saw record order and sales volume both online and in our boutiques during our Black Fiveday Event. We topped our record for most e-commerce orders processed in a single day, while getting packages to our clients on-time and more quickly than last year. I'd like to give a big shout-out to our distribution team who enabled us to deliver exceptional results during the quarter, while also managing earlier than expected delivery of our spring product.
We ended the quarter with inventory up 187% over last year. The supply chain environment was dynamic and uncertain at the time we began placing orders for fall and winter product over 12 months ago. Given what we knew at the time, we made the strategic decision to order future season buys earlier in order to build back our inventory base due to unprecedented sales growth, mitigate supply chain risk, and ensure our ability to fuel the robust demand for our product.
On top of that, improved freight timeline resulted in inventory arriving even sooner than anticipated. We expect inventory growth to begin to moderate as we move through Q4 and to more closely align with sales trends by the end of Q2 of fiscal 2024. We expect markdowns in Q4 to be no greater than pre-pandemic levels. We are confident with the composition of our inventory, which is heavily concentrated in client favorite and has certainly enabled the strong sales growth we have delivered.
We believe we are positioned to capitalize on the continued robust demand for our products and the start of our spring selling season. While the competition for labor remains challenging, our growing recognition and industry leading wages have allowed us to continue to attract world-class talent. We are experiencing higher wages and salaries in our distribution centers and boutique network and adding headcount in our support office.
Our people are a key component of the existing infrastructure that is enabling us to deliver 38% revenue growth, as well as the future infrastructure that will allow us to capitalize on our growth strategy as we deliver everyday luxury to more and more clients across the world. Investing in talent is an investment in our future.
Turning to our ESG strategy, we have submitted a letter of intent to the science-based target initiatives confirming our commitment to set targets to reduce greenhouse gas emissions within the next 24 months. We're excited to join the more than 4,000 global organizations who are part of this initiative and our community remains a key priority for Aritzia and this year marked our third annual warm coat donation where we gifted 4,000 winter coats valued at over a million dollars to our Aritzia community partners across North America.
This quarter, I did visit many of our boutiques both in Canada and across the South Eastern and Midwestern United States. What particularly impressed me is how well our everyday luxury experience has translated across geographies from Vancouver to Dallas and Toronto to Miami, the Aritzia brand is showing up wonderfully and consistently with a geographically diverse client base discovering and loving our beautiful products, aspirational shopping environment, and the exceptional service they're receiving from our very passionate [indiscernible]. I could not be more confident in our ongoing geographic expansion strategy and our runway for growth in the United States.
Now, I will pass the call over to Todd.
Thanks, Jennifer, and good afternoon, everyone. We're extremely pleased with the ongoing momentum in our business as our everyday luxury experience continues to resonate with both new and existing clients across all geographies and channels. While our Black Fiveday Event broke a number of records, we are particularly pleased that the revenue growth rate during our 11 plus weeks of full price selling exceeded that of our sale period in the third quarter.
For the third quarter, we generated net revenue of $625 million, an increase of 38% from last year, and achieved comparable sales growth of 22.8%. We delivered these outstanding results against the normalized third quarter last year. This is the first time in almost three years all of our boutiques were open for the entire quarter in both the current and comparable quarter.
In the United States, we continue to see exceptional growth with net revenue of $314 million, an increase of 58% from last year. Our business in the United States accounted for 50% of net revenue in the third quarter, compared to 44% last year and 33% two years ago. This sustained momentum reflects the significant acceleration in our U.S. client base.
Net revenue in our retail channel was $423 million, an increase of 39%. This was led by growth in the United States where our comparable new and expanded boutiques all delivered exceptional results. In Canada, we also saw strong performance in all our boutiques with double-digit growth in the retail channel.
In e-commerce, our business continued to grow sequentially with net revenue of $201 million, an increase of 36% on top of a robust 47% increase in the third quarter last year and 79% in the third quarter two years ago during the pandemic. E-commerce trends were strong across all regions with growth predominantly driven by higher traffic and supported by increased conversion rates.
We delivered gross profit of $271 million, up 29% from last year. Gross profit margin was 43.3% declining 310 basis points from 46.4% last year. The decline was driven by inflationary pressures, additional warehousing costs related to inventory management, and the weakening of the Canadian dollar. The above pressures were partially offset by lower expedited freight costs and leverage on occupancy and depreciation costs.
SG&A expenses were $164 million or 26.2% of net revenue, compared to 24.3% last year. The 190 basis point increase reflects additional investments in retail talent to ensure we continue to deliver exceptional client service and ongoing investments in people, marketing, and technology to fuel our accelerated momentum and our future growth.
Overall, adjusted EBITDA in the third quarter was $120 million, an increase of 9% from last year. Adjusted EBITDA was 19.2% of net revenue, compared to 24.1% last year. Inventory at the end of the third quarter was $508 million, an increase of 187%, compared to $177 million at the end of the third quarter last year. As a reminder, we had extremely low inventory levels in the back half of last year, which negatively impacted sales.
We made the strategic decision to order future season buys earlier in order to build back our inventory base, mitigate supply chain risk, and ensure our ability to fuel the robust demand for our product. Due to the improved lead times, product has been arriving even earlier than anticipated, accentuating the comparison to the prior year.
To provide more context on timing, our reported inventory includes inventory on-hand and in-transit. When we include inventory on order still at the factory, our total committed inventory at the end of the third quarter was up 35.6% over last year, in-line with our sales growth.
To be clear, last year at the end of the third quarter, the vast majority of our committed inventory was still at the factory, due to the global supply chain challenges, where this year, the vast majority is either on-hand or in-transit. Overall, our inventory has enabled our outstanding sales growth and we are confident with the composition of our inventory, which is heavily concentrated in client favorites.
In the fourth quarter, we expect normalized markdowns to be no greater than pre-pandemic levels, and looking forward, we expect the year-over-year inventory growth to begin to moderate at the end of the fourth quarter, and to normalize on a reported basis by the end of the second quarter of fiscal 2024.
Since the implementation of our current NCIB on January 17, 2022, we have repurchased 1.8 million subordinate voting shares, returning $69.2 million to shareholders. Our liquidity position remains strong at the end of the third quarter with $132 million in cash and $0 drawn on our $175 million revolving credit facility.
Turning to our outlook, the positive momentum in our business has continued into the fourth quarter. As such, we now expect net revenue for the fourth quarter to be in the range of $580 million to $600 million, representing an increase of approximately 31% to 35%, compared to last year. This reflects continued outperformance in the United States and in our e-commerce channel, as well as ongoing strength in Canada.
For the full-year, we now expect net revenue to be in the range of $2.14 billion to $2.16 billion, up from our previous outlook of $2.00 billion to $2.05 billion. The new outlook now represents growth for the year of approximately 44% from fiscal 2022 on top of a 74% increase last year.
In addition to the six new boutiques and four expanded boutiques opened year to date through the end of the third quarter, we have opened an additional two new boutiques in the United States in the fourth quarter to date and plan to reposition one additional boutique in Canada later this quarter.
Turning to our gross profit margin. In the fourth quarter, we expect a decline of approximately 250 basis points, compared to the fourth quarter last year. Improvements from a reduction in the use of expedited freight will be offset by ongoing inflationary pressure, additional warehousing costs related to inventory management, and foreign currency headwinds, complying that we expect gross profit margin for the full-year to be approximately 200 basis points to 225 basis points below fiscal 2022.
While we expect inflation to persist, in the coming year, some of these headwinds may subside. In addition, we will review opportunistic pricing to contribute to margin improvements. We expect SG&A as a percent of net revenue in the fourth quarter to be approximately flat with the fourth quarter last year. Leverage on fixed costs are being offset by ongoing investments in our infrastructure, to fuel our momentum and enable our future growth.
While we continue to navigate an extraordinary operating environment, and accelerate our investments, over the long-term as our mix shift towards the United States and e-commerce, our leverage is expected to expand, driving the adjusted EBITDA margin target of approximately 19% by fiscal 2027 that we set forth in our long-term growth plan.
In summary, we are extremely pleased with the strength of our business, particularly with our growth in the United States and the momentum in our e-commerce channel. Our balance sheet is strong and we will continue investing in our strategic initiatives and infrastructure, which will allow us to deliver on our long-term growth targets. We remain confident in our ability to drive sustained profitable growth well into the future, while delivering meaningful shareholder value.
With that, I'll now turn the call back to Jennifer.
Thanks, Todd. And as Todd mentioned, the top line momentum from Q3 has continued through the back half of the holiday season and the start of our fall winter sale. And we're pleased with the success we're seeing across all product categories. Our markdown percentage remains no greater than pre-pandemic levels in-spite of a more normalized environment due to the improved inventory availability.
In December, we opened two new boutiques in the U.S. La Cantera in San Antonio, which is a new market for us and already competing for our best boutique in Texas, and fashion outlets of Chicago. Next month, we'll open our newly expanded Upper Canada boutique in Toronto, which will feature an A-OK cafe. We remain extremely pleased with the results we're seeing in our expanded boutique, as well as in our new boutiques and new markets.
And as we head into 2023, we remain laser focused on the development of beautiful, high quality products, as well as our engaging service, aspirational shopping environment, and captivating communication. We strive to delight our clients in each of these respects. And we believe our everyday luxury experience will continue to set us apart, propelling our brand and fueling our sales growth. And at the same time, we're intensely focused on driving growth that is both sustainable and profitable over the long-term.
We remain focused on the core fundamentals that have made us successful for 40 years executing well across our growth pillars and investing in the infrastructure that will allow us to deliver on our long-term growth plan that we laid out for you last October.
In closing, I would like to thank our entire team for their tremendous commitment and hard work and our clients for their enduring loyalty to Aritzia.
And with that, [indiscernible] we are ready for Q&A.
Thank you. [Operator Instructions] The first question comes from Stephen MacLeod with BMO Capital Markets. Please go ahead.
Thank you. Good evening. Just wanted to follow-up on the inventory. Just a couple of questions. The first one is, could you just remind us what percentage of the inventory is composed of client favorites? And then the second one is, you talked about inventory arriving sooner than expected, which I think is driving just the incremental gross margin decline from what your previous guidance was. And does that mean that you have more non-seasonal inventory, like did you get stuff sooner in the calendar than you would have previously?
Hi, Steve. First off, on the composition, the vast majority of the inventory is in our client favorites as we said to our proven sellers. And the inventory has arrived exceedingly early, as I stated. Last year, at this time, the vast majority of inventory was still at the factories and that was actually the backdrop with which we were making the buys for this season. And so, now that is completely flipped and the vast majority of our committed inventory is actually here on-hand or in-transit anyways.
And so yes, our distribution centers are being pressured and we are seeing additional costs related to handling all of the inventory, but we're more than pleased with the composition of that inventory. It peaked in Q3. As we said, markdowns are expected to be no greater than our pre-pandemic levels. And we expect the inventory on a reported basis to begin to moderate as we move through Q4 and to more closely align with sales trends as I said by the end of Q2.
Okay. That's good color, Todd. Thank you. Just along the lines of talking about the DC as sort of being pressured and that's causing – that's driving additional costs. Are those costs that you expect – obviously expect to continue to Q4, but would you expect as the inventory normalizes to a normalized level in Q1 and by the end of Q2? Will you still see those costs dragging in Q1 and Q2 of next year?
Yes, that's our expectation at this point. We'll put a finer point on that next quarter when we report our outlook for next year.
Okay. Okay. That's great. I'll go back in line. Thank you.
The next question comes from Derek Dley with Canaccord Genuity. Please go ahead.
Hi. Just following up on that question a little bit. I guess the inventory impacts that you mentioned that you're starting to use lower expedited freight, can you quantify what you have in the past, what that, I guess positive impact was this quarter from the reduced use of expedited freight and what you think that could be in Q4?
Yes. Well, in Q4, we provided the number last year. We had 400 basis points of pressure in Q4. We expect that we will have meaningfully less use of airfreight in this quarter in Q4. And the benefit in Q3 was approximately half of that 400 basis points, so roughly 200 basis points of benefit in Q3.
Yes, no, understood. That's helpful. And then just in terms of the overall consumer spending environment, you know obviously, we’re seeing a lot of inflation and talks around a potential challenging environment heading into 2023, have you seen any change in the composition of your, for example, your e-commerce consumers versus brick and mortar or any changes in that exposure just given some of these consumer spending dynamics?
We get asked that question a lot and we're watching it closely, but so far, what we're seeing is, a tremendous amount of consistency between who's shopping with us, what they're buying, their average basket size have not changed, the average selling price has not changed, the number of units has not changed. So, we're looking at all of these indicators and so far for us as consumer demand is not letting us and we're not seeing any notable changes in the behavior.
Yes. And if I can just add to that, I think one of the things that is on display in our results is the fact that our retail revenue grew by 39% and our e-com side of the business grew by [36%] [ph]. So, very consistent growth across both channels. And then also, as I mentioned in my prepared remarks, we actually saw higher growth during Q3 in our full priced portion of the quarter, compared to our sale period in the quarter. So, I think that's another clear indicator of the strength of our client demand.
Great. Thank you very much.
The next question comes from Martin Landry with Stifel GMP. Please go ahead.
Hi, good afternoon. Maybe to follow-up on that topic, it may be an obvious question, but I'd like to hear you develop on it. Why is it that you're not seeing any changes in your consumer patterns or given the inflation, given the rising interest rates? I'd love to hear a little bit as to why you think your customer base is less impacted or your sales were not impacted?
I'm going to answer that first and feel free to jump in, Todd. I think it first and foremost starts with our unique positioning in the marketplace of everyday luxury. And there's really no one that does what we do or comes close to what we do. We offer a superior quality product that's beautiful that fits well, has a quality of construction, and a detail of design that is second to none and our clients recognize that. And it's priced at a price point that is for everyone. You add-on to that, our multi-brand strategy and our broad assortment. You know, I was saying a minute ago to the group, we have [indiscernible] and it's high quality wool coats and it's high quality stock.
We have T-shirts to Super Puff. We have everything in between. And so, the broad assortment, multi-brand that cater to a specific segment of our market has a very, very broad appeal. And I think at the end of the day, the product stands for itself. Our shopping environment resonate well with our clients both physical and digital. We have a phenomenal group of style advisors in our boutiques that are so enthusiastic in providing exceptional customer experience and that extends to our concierge.
You know, you can go through all areas of our business. When someone receiving their online order. They're delighted to unpack their order that has been carefully packed by our folks in the DC. And I think it's not any one thing, it’s all of these things that we have honed over the last [40 years] [ph] that makes Aritzia who we are in its everyday luxury.
Okay, that's helpful. And my other question is on pricing. Todd, you mentioned that you expect inflationary pressure to persist and potentially looking at the price increases next year or in calendar 2023. Can you just discuss a little bit what you're thinking in terms of a number of percentages of SKUs, pricing, timing, just what are you factoring into your analysis right now?
Martin, we knew you would ask this question. So, we've been asked about pricing in the past, we did, Todd did mention we're reviewing our pricing opportunistically. I think would answer that question in terms of our overall pricing strategy. We're always looking at our pricing and we have kept our prices stable up until now. And what we are doing is, we're taking – we're continuing to take a close look and looking at opportunities where we can look at our pricing. And if you start first with our new items, we always – I don't and it is not a price change or price increase.
We launched with new items, priced appropriately based on cost structure, but also on what we believe the customer will bear. And so, we're pricing opportunistically and appropriately is when you look at our client favorite that our existing items, we are also looking at those and there will be select core items that we will opportunistically price as well. And then I would like to add the third point, which is as more of our business shift to the U.S. there is an effective increase in pricing just by nature of our business shifting to the U.S.
So, in total, there's no actual timing. We don't know – we’ll advise you on timing upon our review, and I want to emphasize it will be select items and opportunistic. We do not have a target of numbers of styles or SKUs in mind. We are always very balanced in how we approach these types of things because this is – this would be a meaningful change in how we're approaching things if we do.
Okay. Thank you and congrats on your results.
Thank you.
The next question comes from Mark Petrie with CIBC. Please go ahead.
Yes, thanks. Good afternoon. I wanted to follow-up on gross margin and Todd thanks for the detail and the quantification on the air freight costs, but hoping that you can quantify some of the other forces at play today like the normalization and the timing of sales and more being in sort of Jan, Feb, and lower margin periods, as well as the storage costs? And even if you don't sort of specifically quantify, just give us a sense of how much each of those forces weigh on the margin in Q4 and sort of drive that change in the outlook for the Q4 margin?
Sure. So, as we stated, we're expecting gross profit to decline 250 basis points. In the fourth quarter that compares to 310 in the third quarter. We're going to see the pressures that we saw in the third quarter persist. So, those are inflation on product costs, wage rates at the DC shipping costs, etcetera. So, all of those costs were previously expected.
However, the change is from the higher warehousing costs due to the early receipt of our spring inventory as I said. So, that's really the primary driver of the change. And if I looked at the pressure, we don't typically quantify the – each pressure, but inflationary is the majority. And then the others would be secondary to that.
So, the existing inflationary pressure, but again, we are confident in the composition of our inventory and we're not making any changes to our promotional strategy and we continue to expect our markdowns, as I said, to be no greater than pre-pandemic levels. And frankly we're already into our selling season right now and that's what we're seeing.
Yes. Understood. Okay. I appreciate all of that. Thank you. I wanted to ask about the, sort of labor market. And Jen, you highlighted some of the challenges there. Would just be helpful to hear a little bit more about that. Are the conditions tougher today than they were, say three months ago? And is that showing up just in higher labor costs or also, sort of increased vacancies or fewer scheduled hours than you might otherwise plan? Like do you think this is affecting the consumer experience at all?
Well, we're always – you know, we've always driven in every single year for top talent, world-class talent. So, we're always very competitive with our wages and our salaries across the board. This year is a little different because as you all know, the macro environment of lower unemployment rates and the great resignation and [quiet quitting] [ph] it is generally tougher.
That said, we've always been very good at attracting top talent and we've always been very good at being ahead of the curve in terms of our offering, it's like total rewards, remuneration wise for our people. And so, operationally, I don't think it translates anything in terms of the customer experience, but what it does mean and I try to emphasize this in my prepared remarks is that it's everything we do from creating beautiful product to creating exceptional client experience to start with people, starts and ends with people, and our current results of delivering a 38% sales increase this quarter is because of our people, and investing in the future in our long range plan and being successful in all of our growth levers, it is because of our people and investing in those people that we get in today and retaining them.
So, it's not just about attracting people, it's about retaining people. And offering them a rewarding career, which I think as an employer, we know and I'm supposed to [indiscernible] for a very long standing rewarding career that we can offer then. It's just a matter of making sure we stay on top of that and it is just more competitive, plain, and simple.
Okay. Thanks for that. I appreciate the color. And then just last – maybe just a quick follow-up with regards to, sort of the commentary around Q4 to date, just curious if there's any observable difference between Canada and the U.S.? I mean, you're saying, sort of trends are consistent, does that hold in, sort of both regions and all channels or both channels as well?
Yes. All geography, all channel, all categories.
Excellent. Thanks so much. All the best.
Thank you.
The next question comes from Alice Xiao with Bank of America. Please go ahead.
Hi. Thank you for taking our question. I wanted to follow-up on Mark's gross margin question. So, on your 4Q guidance, down 250 basis points, was any of it due to incremental kind of promotions or markdowns or noticing the customer, maybe gravitating towards the discounted product, despite you holding promotional offerings at a similar level to pre-COVID? And then out of the warehousing costs, FX, and cost inflation components, how are you thinking about these impacts into fiscal 2024?
Hi, Alice. No, none of the pressure on our gross profit in the fourth quarter is coming from markdowns that were unexpected. Our promotional strategy as we said is completely unchanged. And in fact, and I said it already twice now, but sorry to repeat again, but in Q3, our clients actually gravitated to the full price selling period and what we're seeing right now is in fact a balance between that as well where we are seeing a full price selling, as well as our promotional selling going exceedingly well obviously to be driving the results that we're projecting. And so, no, there's no pressure from markdowns.
And then on the other question, we do expect that those costs related to management at the distribution center to continue on until the inventory normalizes so through Q1 and Q2 of next year, obviously declining as we go through.
Got it. That's very helpful. And then when you say inflationary pressures, those are – you're referring to wage costs, right, not raw material inputs? Because will those become a cost benefit sometime in second half?
There are – so as of right now, we are seeing inflation pressure on our product costs, as well as wage rates and shipping costs as well. And by shipping, I'm referring to within North America, shipping to clients. There's a lot of fuel surcharges being added, but yes, we are seeing – continuing to see inflation impacts on our product costs and we expect that to continue into the first half of next year. And then again, we'll provide more detail around our outlook for next year on our next call.
Got it. Thank you.
The next question comes from Brian Morrison with TD Securities. Please go ahead.
Yes, good afternoon. Todd, I want to – I'm hoping you might be able to elaborate a little bit on the degradation in the [SG&A] [ph] margin profile as well. I know you attributed to people marketing and technology, but can you maybe just break down the increase to 50 basis point increase on an annual basis to SG&A?
The degradation you're referring to within Q3 on…
I'm talking about on an annual basis, your guidance there.
Oh, sorry. Yes, yes. So, the impact to our annual outlook for SG&A really comes from Q3 within the fourth quarter, where our expectations are effectively flat. So, we were a little higher than we anticipated in Q3 and that's the primary driver. And it's primarily from investments in our retail talent, compared to the year before where we were understaffed, frankly, in retail. And so, we're spending more. There is also inflationary pressure, as far as wages go within retail, but for the most part, it's additional hiring and ensuring that we have the right level of staff to provide our everyday luxury experience in the stores.
Does this have an impact on your fiscal 2024 outlook on this line item?
Maybe I – we will provide our outlook for next year on the next call, but I would expect that our level of expenditure will persist and especially as it relates to retail labor.
Okay. And I just want to clarify this point. I'm sorry to come back to you again, but when you look at your annual change on your gross margin guide, the majority, if not all of that pertains to supply chain and the increase in the warehousing cost that you're [indiscernible] as a result, is that correct?
Yes.
Thank you very much.
[Operator Instructions] The next question comes from Stephen MacLeod with BMO Capital Markets. Please go ahead.
Thank you. I just had a follow-up question. Lots of great color, so thank you. I'm not sure if you want to disclose it, but I was just curious if you could give a bit of, like intra-quarter color on where inventory levels are trending, considering you've seen strong traffic, good mix and full priced and selling through the quarter? Just curious if you can give any sort of more specific guidance or indication?
As we've already said, we expect the inventory levels to moderate by the end of the quarter. Obviously, we've had meaningful sales quarter to date, which is helping us lower that number as we work towards the end of the quarter, but we're also receiving spring product still that is continuing to again come earlier and earlier. So, again, we expect it to moderate by the end of the quarter at this point.
Okay. That's great. Okay. Thank you very much.
This concludes the question-and-answer session. I will now turn the call back to Beth Reed for closing remarks.
Thanks again everyone for joining us this afternoon. We're available after the call to answer your questions and have a great day.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.