Stitch Fix, Inc.

Good day and thank you for standing by. Welcome to the second quarter fiscal year 2023 Stitch Fix earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Hayden Blair.

Good afternoon, and thank you for joining us today to discuss the results for Stitch Fix's second quarter of fiscal year 2023. Joining me on the call today are Katrina Lake, Interim CEO of Stitch Fix, and Dan Jetta, CFO. Also joining us on today's call is David Ockerhart. We have posted complete second quarter 2023 financial results in a press release on the quarterly results section of our website, investors.stitchfix.com. A link to the webcast of today's conference call can also be found on our site. We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please review our filings with the SEC for a discussion of the factors that could cause the results to differ. In particular, our press release issued and filed today, as well as the risk factors sections of our annual report on Form 10-K for our fiscal year 2022 previously filed with the SEC, and the quarterly report on Form 10-Q for our second quarter of fiscal year 2023, which we expect to be filed tomorrow. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements except as required by law. During this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the press release on our Investor Relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, This call in its entirety is being webcast on our investor relations website and a replay of this call will be available on the website shortly. With that, I will turn the call over to Katrina.

Thanks Hayden. 12 years ago, I was inspired by a very simple human problem to help people look and feel their best. Now, as I find myself back as interim CEO, this simple mission feels more resonant than ever. I'm proud of the ways that we've made our mission a reality but also motivated by the opportunity ahead. We're still in the early days of transforming the industry of apparel, and I feel optimistic that Stitch Fix can continue to lead the way in personalization and achieve greater impact in the years to come. While many companies may be starting to define an AI strategy, our company was built on data science from day one. We have built technology and systems that leverage the best elements of human stylists combined with machine learning And the billions of proprietary data points that we have around client and product interactions are rich, meaningful data sets that predict outcomes and help us to understand what clients need. At the same time, I realize we haven't met recent expectations. Driving towards an ambitious vision has resulted in a loss of focus. We must, now more than ever, deliver on the client experience, bring focus in our marketing efforts, and drive results for our shareholders. We have clarity on our path long-term and short-term. Long-term, I continue to have great conviction that the market opportunity for a more personalized way to buy apparel is large and growing, and that we have a significant advantage rooted in our decade of experience in leveraging data to deliver personalization at scale. Shorter term, we also have clarity. We need to get back to a position of execution and profitability. We have a history of achieving both in the past and I'm confident we will get there again. There were two major events in fiscal second quarter intended to help reposition and refocus the company to set ourselves up to optimize for liquidity and profitability in the short term and maximize our long-term growth potential. First, we restructured our operating model and made the difficult decisions to reduce our headcount by 20% of salaried positions and to shutter operations in our Salt Lake City warehouse. Late last year, we began analyzing the team and determined to restructure the organization in an effort to create a leaner operating model. This also allows us an opportunity to reorganize and refocus to more nimbly execute. These decisions are never easy, but we know it was the right decision to achieve our goals of liquidity and profitability and for the overall health of the business. And second, we are conducting a search for a permanent CEO. The Board and I realize that the macroeconomic environment, competitive landscape, and even our own business has changed meaningfully over the past few years, and we are excited to find the right leader for the present and future of Stitch Fix. I am encouraged by the process thus far and am confident that we can find an inspiring person to lead the Stitch Fix team and help reestablish the track record of results we were once known for. In addition, we shared in our press release this afternoon that Dan Jetta will be stepping down as CFO to pursue a new opportunity. The Board and I want to thank Dan for his service to Stitch Fix and wish him well for the future. David Ofterhaar, our SVP of Finance, will succeed him as CFO. David joined us four years ago with an eye towards CFO succession. In working together these many years, I have been impressed and inspired by his depth of partnership with the functional leaders at Stitch Fix, his deep commitment to and understanding of our business and our team. He is a thoughtful and trusted leader, and I'm excited for him to step into the CFO role. Now onto the financials in the quarter. Fiscal second quarter revenue came in at $412.1 million, which was at the lower end of the provided range. Despite this, we delivered adjusted EBITDA of $3.8 million, which was at the high end of our guidance range due to effective cost controls and our corporate restructuring. Dan will dive more into the financials later on, but before handing it over, I want to touch on topics in marketing and our product that demonstrate how the company is rallying around bringing focus and clarity to better deliver results for our clients and shareholders. Consistent with the broader company, our marketing strategy aims to preserve liquidity and achieve profitability while simultaneously attracting long-term customers to fuel a return to growth. This will be the case as we continue to refine our traditional paid channels as well as diversify into under-penetrated channels we have yet to scale. We are also continuing to lean into client retention and re-engagement strategies in an effort to continue to increase engagement and optimize our CPAs. It's worth highlighting that our CPAs were down over 40% from a year ago, which shows, despite a significant reduction in overall budget, we are gaining traction and more effectively deploying our marketing dollars. Overall, we know these are the right things to focus on, and when combined with our efforts to maximize the client experience, and improve retention should maximize ROI in the short term and set the stage for a return to growth. Moving on to the client experience. A complicated macroeconomic environment and tighter client wallets make it more critical than ever to re-examine and bring focus to our client experience. The ambitious vision we embraced for the past many months has resulted in a client experience that is less focused on our core areas of differentiation And we believe that there is opportunity to drive long-term value by being really deliberate and targeted about the role of features and functionalities in the Stitch Fix ecosystem. As an example, we've recently refined our point of view on Fixed Preview. Although at the highest level, Fixed Preview has demonstrated a positive impact on AOVs, digging into the data, we see a more nuanced story. There absolutely are clients who significantly benefit from fixed preview, but there are also clients for whom showing a preview actually increases cancellations. Acting on this data, we found an opportunity to drive better outcomes and LTV by experimenting with eliminating the preview for some clients, allowing those clients to enjoy the surprise and delight that we know those clients value, while allowing other clients to benefit from the agency of fixed preview. I share this example of letting data drive our decisions and providing more intention and focus in the client experience. I anticipate there are many similar opportunities as we dig into the data and the experience, and we believe these strategies will drive LTV, enabling us to optimize cash flow and profitability in the short term while positioning ourselves for an eventual return to growth. Before I turn it over to Dan, I want to thank the entire team at Stitch Fix. We talk internally about celebrating Stitch Fix Grit as one of our core operating tenants, and I've been inspired by the grit I've experienced day in and day out from the team these past few months. I continue to be inspired by the passion I see to deliver value for our clients and our business and to make our company a fantastic place to work. Our continued focus and data-driven decision-making are paving the way for a bright future for Stitch Fix. I believe we are on the right track to get there and I look forward to continuing the journey with you all. With that, I'll turn it over to Dan.

Thank you, Katrina, and hello to everyone on the call. Before jumping in, I want to thank Katrina and the Stitch Fix Board for this opportunity and congratulate David on his new role. David and I have enjoyed a positive and productive working relationship during my tenure and I am confident he is the right person to lead the team. David and I will be working together over the next several weeks to ensure an orderly transition. On to our Q2 results. Q2 net revenue declined 20% year-over-year to $412.1 million due to lower net active clients and higher promotional activity in the quarter. Net active clients in the quarter declined 11% year-over-year to approximately 3.6 million. As Katrina mentioned earlier, we have continued to diversify our marketing channel while ensuring we realize positive near-term ROI on advertising spend. Total advertising spend in the quarter was 5% of net revenue and down 46% year-over-year. We like the trends we are seeing in overall CPAs. Even with the lower spend in advertising, we did see positive year-over-year in gross client ads in men in Q2. And while women's and kids' gross ads were down year-over-year, our rates are improving in both lines of business. We do continue to see elevated levels of inactive clients and continue to focus on improving this with the right client experience. We expect advertising to be 6% to 7% of net revenue for the rest of the year, though we'll continue to be opportunistic if we experience the right ROI and lean in where appropriate. Revenue per active client declined 6% year over year to $516. While our overall average order value is holding relatively steady year over year, similar to Q1, Our analysis continues to show that all client cohorts are spending less than in prior years. We expect this trend to continue through the rest of FY23. Q2 gross margin came in at 41%, down 400 basis points year-over-year, driven primarily by lower product margins due to increased promotional activity and higher product cost. Total transportation costs were also up year-over-year due to increased carrier rate. Consequently, gross margin was down approximately 100 basis points from Q1 due mostly to increased promotional activity. We expect gross margins to be around 42% for the remainder of the fiscal year and are actively focused on improving gross margins as we see opportunities to improve product margin, transportation efficiency, and inventory efficiency over time. Q2 adjusted EBITDA came in at 3.8 million reflecting our ongoing cost control efforts, including a reduction in force and the closure of our Salt Lake City warehouse. The adjusted EBITDA excludes $34.7 million of restructuring and one-time costs. Net inventory ended the quarter at $159 million, down 28% quarter over quarter and down 13% year over year. Free cash flow for the quarter was positive $15.4 million, our first quarter of positive free cash flow since Q1 of FY22. And we ended the quarter with $224 million in cash, cash equivalents, and highly rated securities. In summary on our cost structure, with the execution of our restructuring actions and our reduced advertising levels, We have now executed against all the actions needed to realize 135 million of cost reduction targets for FY23. Additionally, we shipped our last fix from the Salt Lake City Distribution Center at the end of January, and we have distributed the inventory across the remaining fulfillment centers in our network. We will begin to see cost savings from the closure in Q4. Our goal remains to achieve positive adjusted EBITDA and free cash flow in the short term while continuing to position ourselves for profitable growth in the future. And we believe we are well on our way to achieving these goals. Now onto our outlook. For the remainder of the fiscal year, we expect to continue to face a challenge in highly promotional operating environment. With that said, we are leaning into our areas of differentiation and focusing on managing the things within our control. We will continue to responsibly manage our cost structure with the goal of staying adjusted EBITDA and free cash flow positive for the remainder of the year. For our fiscal Q3, we anticipate revenue to be between 385 and 395 million. We expect adjusted EBITDA for the quarter to be between negative 5 million and positive 5 million largely reflecting increased seasonal advertising spend as we continue into the spring-summer season, where our CPAs are generally more efficient. For the full year FY23, we now expect revenue to be between $1.625 billion and $1.645 billion. We expect adjusted EBITDA for the year to be between break-even to positive $10 million. Going forward, we remain relentlessly focused on liquidity and profitability. The improvements we have made in our cost structure will allow us to invest in growth as we continue to focus on improving our client experience. And over time, we expect the improved client experience will enable us to grow our net active, revenue, and free cash flow. With that, I'll turn the call over to the operator for Q&A.

Thank you.

As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again.

Our first question comes from Yusuf Squali with Truist. You may proceed.

Great. Thank you very much. Hi, guys. A couple of questions. Good to hear from you, Katrina, again. The first question maybe for Katrina, can you just speak at a high level about how you see, I mean, you talked earlier about you, on the one hand, you've had a lot of focus, on the other, you have clarity on the path forward. One, maybe can you just expand a little more about what, pinpoint the two or three areas where you felt the Citrix had lost its focus And then maybe kind of what gives you the confidence that you are back on the path that should ultimately get you to growth. And then maybe can you double click a little bit on your EBITDA margin guide of negative five to positive five and just help us about how you get there. Obviously, I think you said gross margin should be around 42%. which really only leaves advertising and sales and marketing and G&A as the other components. So maybe just provide a little more color on where you see those for the second half of the year. That would be very helpful. Thank you both.

Great. Thanks, Yousef. It's good to be back. I'll answer your first question, and then I will have Dan weigh in on the second around EBITDA margin. On kind of the focus and clarity, I think there's innumerable examples that I could bring. you know just at a very high level as we thought about expanding the business in a very ambitious way we took a marketing approach that that probably tried to bring people in through a variety of different customer segments and you know very notably we spent marketing dollars trying to bring people into a freestyle first experience as an example so that's a place where You know, not only did we find that that marketing of freestyle first wasn't as effective as what we had done historically in fixes, but it also actually made it harder for us to be able to be acquiring people into the fixed channel. And so that's, I think, one example of how that comes to life. Another one is around inventory. You know, we definitely built up an inventory in anticipation of a freestyle customer that, you know, was a different set of inventory than fixes and also more unknown. It was a customer we hadn't served before. It was a channel we hadn't served before. And so, you know, there was more risk in the inventory. And going forward, we can use our 10 plus years of historical data to really be able to buy with confidence on the inventory side. And that's another good example of focus. And the customer experience as well, I mentioned us looking at Preview as an example, and I think there are still other places where we can really kind of clean up the customer experience so that we're really maximizing value for the client and value for the shareholder at the same time. In terms of confidence back to growth, I think there's a lot of places where, I think all of those places are areas where on the inventory front, I think we can feel confident looking at what we're doing going ahead from now. And on the marketing front, I think we have near-term results that show that things are working. When Dan referenced that we saw customer acquisition costs down by 40% compared to last year, and to me, that's a great example of how focused is is kind of creating value in the business today. And I think we feel really confident that it's creating value in the business long-term. Dan, you want to talk about EBITDA?

Yeah. Hi, Yusuf. On the EBITDA guide, the negative five to positive five, again, I think we've provided obviously revenue and gross margin. And we also provided that 6% to 7% advertising number. For Q3, we're going to be on the higher end of that 6% to 7% simply because as we enter our spring, summer season, it's a very efficient quarter for us. We talked, Katrina talked about it, and we're very focused on the efficiencies within our marketing channel. And we just feel as we exited Q2 and go into Q3, we're like what we're seeing. And so think of Q3 as the higher end of that 6% to 7%. That leaves us, of course, with SG&A excluding advertising on a run rate basis. After our restructuring, that gets you to that negative 5 to positive 5 million. Of course, if we're not seeing the efficiencies, we won't spend the advertising dollars. So we feel pretty good about the guidance and, of course, the level of spend that we're now targeting for advertising.

And just to be clear, that $34 million that I think you mentioned in one time, restructuring costs and other, that hit the SG&A and expense line of $187 in Q2?

It did.

Okay. All right. That makes sense now. Thank you very much.

Thank you. Our next question comes from Simeon Siegel with BMO Capital Markets. You may proceed.

Hi, this is Garrett Klingstern on for Simeon. Thanks for taking our question today. Just noticing in the press release, you guys noticed going back to more of a stylist-focused approach. Is that kind of a de-emphasis maybe a little bit for kind of freestyle? Katrina, you just mentioned getting inventories right from within the freestyle versus the fixed business, understanding how those are different. I'm just curious how you guys are thinking about that business going forward and how you're planning kind of how to work around some of the challenges maybe you've had there.

Yeah, thanks, Derek. It's a good question. I think there's no question that freestyle adds value in ways that fixes didn't. I think the most clear way that we think about that is looking at the assortment data. We've shared in calls historically that we're seeing a different assortment being bought in freestyle than fixes. We're seeing more outerwear, shoes, accessories. That says to us that this is helping to fill a different need for our clients. That being said, as I mentioned in the last question, I think using freestyle as a customer acquisition vehicle as an example, that was less effective. what we're really trying to do is to say, where are areas of differentiation? And personalization, styling are really at the core of that, especially if you think about our kind of competitive positioning relative to others. Those are spaces that we really uniquely own. And so as we think about what is the customer experience that best delivers against personalization, against styling, I think freestyle can be a component of that, but we're probably thinking of it more as one ecosystem that has a more clear customer journey rather than thinking of them as kind of separate business units.

Great. Appreciate that. And just as a quick follow-up, I'm just, you know, looking at the 42% guidance for gross margins the remainder of the year. And Dan, your comments on how, you know, the difference from 1Q to 2Q is about 100 bps of markdown pressure. Are you guys seeing kind of a return to markdown levels where you were, you know, going back a few quarters? I'm just curious how you're planning about markdown pressure for kind of the back half of the year and kind of what you're seeing more broadly within your customers and their ability and their willingness to shop on kind of more of a full price level compared to kind of a discounted one.

Yeah, you know, the way we approach, we've talked about this in the past and thanks for the question. The way we've approached markdown is really focused on where we think we have excess or the wrong inventory and using our freestyle channel to move that inventory. And we've seen success in that as opposed to the option of selling it out to a third party liquidator. And so we've seen success in that and we will continue to utilize that. Although, as you can see from our inventory levels now, we've come down considerably and we feel we've right-sized our inventory. We feel very good about the inventory position that we're in now in terms of total dollars. We still have some buckets to work through. And so we are using the Freestyle channel for that. And the Fixed channel, we are not discounting a lot. We simply aren't doing that. Clients love the styling service that we give them, and we have not seen the need to discount in the Fixed business, and we don't anticipate doing that going forward.

Great.

Thank you, Pastor.

Thank you. Our next question comes from Mark Altrager with Baird. You may proceed.

Hi, this is Amy Teske on for Mark. Thanks for taking our question. On the inventory point, you know, as you've worked down inventory and pulled back on your receipts, what is your level of comfort that you now have the right type of inventory? So how do you think about the composition of your inventory between casual and dress styles and product categories? Thank you.

Yeah, I'll take that one. That's a great question, Amy, and thanks for asking it. First of all, we had talked about inventory in our Q4, again, in our Q1 results, and how we had a lot of inventory and we simply needed to work it down. And we've done that. And a lot of that, of course, was getting rid of excess inventory and or the wrong styles or brands of inventory. We're in a much better position now. As I mentioned, we still have a little bit of work to do on the inventory that is going to be short-term, and that's included in our guidance going forward. But we feel really good about the brands that we're targeting and with a big focus on our exclusive brands, which are trending very well for us. And in fact, I'll just share that we did notice in January where we were soft on some of our exclusive brands on, you know, our customers told us they wanted that. And we quickly pivoted and where we were short on inventory, we chased back into it. And that's a great sign for us that our customers love our exclusive and our Stitch Fix only brands that we're selling. And so we're going to continue to focus on that in the very near term as we get into spring, summer, and then as we get back into fall, winter a year from now.

Thank you.

Our next question comes from Ed Urimo with Piper Sandler. You may proceed.

Hey, thanks very much for taking my question and welcome back, Pat. I guess just a bigger picture question. You guys are really known for personalization. You've talked about this a lot today. Do you think that your competitors have gotten better since the inception of your business? And maybe, Kat, if you have any observations of things that have changed adversely since you left and have come back and you're looking to rectify quickly, we'd appreciate that. Thank you.

Thank you, Ed. I think I got your question here. So in terms of just more of the competitive gap, you know, honestly, I feel really strong about our capabilities. And, you know, we've been able to be in this business for 10 plus years of a history of profitability with history of being able to deliver cash flows and and you know there's not a lot in the competitive set that are able to claim the same thing and so you know this focus that we've had around data science the focus that we've had around personalization I strongly believe that we continue to lead on that front and and I feel you know just as good if not better about that coming back into the role of In terms of things that I think your question was more of just like what has adversely changed, I think I spoke to it on the call, but I really do think it's focused. You know, I do think hindsight is 20-20, and I think we had some really ambitious visions that we were chasing after. And with kind of chasing an ambitious big vision came a kind of reduction of focus on what I would consider our core differentiators, which are really around personalization and the styling. And so, you know, I think a lot of what we've been talking about internally is just How can we make sure that everything that we are doing with our valuable resources and time are really focusing against delivering that for our clients and ultimately our shareholders, is being able to deliver an experience that feels personalized for all of our clients and making sure that everything that we invest in achieves that goal.

Thank you.

Thanks, Ed.

Thank you. Our next question comes from Trevor Young with Barclays .

Great. Thanks. First one, Katrina, just on the testing of discontinuing the fixed preview. Are you getting any sort of signal that keep rates are eroding in those circumstances? And then more broadly, big picture, do you feel like the call space is in a good place now to set the stage for recovery in some future quarter after we go through kind of the reset on core fixes here? Or is there some work to be done and maybe even some reinvestment to be done on the tech side to get that into a better place? Just any thoughts on that would be appreciated.

Great, thanks for the questions, Trevor. I'll take the first one and have Dan talk more about the cost basis. On fixed preview, I mean, one way to really think about it is to try to maximize the ROI and LTV of a given cohort. And so as we do some segmentation, we can see at a high level that overall we saw AOVs go up with the ability to have access to fixed preview. But once you dig in, there's going to be some cohorts where we see people more likely to cancel when they see a fixed preview. And so what we're really trying to optimize for are those LTVs. And so I think what we're able to do is to fine-tune, I guess, a little bit more at a more personalized level of where we're going to be deploying fixed preview to be able to maintain that benefit that you mentioned, to keep rate and AOV for the population for whom we know that that will occur, while at the same time reducing cancellations and making sure that we are retaining and engaging clients best in all of our cohorts by eliminating fixed preview from those who we don't think will benefit from it. And I would say also, you know, from a customer survey perspective, like one of the things that we hear is that one of the real benefits of FishFix is surprise and delight. And so to be able to, you know, for some clients, you know, you can think of it as a lack of agency, but you can also think of it as actually allowing people to have that surprise and delight. You know, somebody said to me, which I love this quote of like, as an adult, you just don't get a whole lot of good surprises in your life. and Sitch Fix can be one of those and so we know there are clients who really really value that and actually being able to continue and maintain that for those clients is valuable and LTV positive for those clients. Dan, you want to answer the question on the cost basis?