Good afternoon. Welcome to the Stitch Fix Second Quarter 2018 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to today’s speakers. Please go ahead..
Thank you for joining us on the call today to discuss the results for our second quarter of fiscal 2018. Joining me on today’s call are Katrina Lake, Founder and CEO of Stitch Fix; Paul Yee, our CFO; and Mike Smith, our COO.
We have posted complete Q2 financial results and our shareholder letter on the Investor Relations 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 also like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could materially differ 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 our results to differ. 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.
Also, during this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the shareholder letter 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 to our IR website and a replay of this call will be available on the website shortly. I would now like to turn the call over to Katrina..
Thanks, David and thank you all for joining us today. After the market closed today, we issued our quarterly shareholder letter with more details on our results, which I encourage you all to read. I will take a moment and highlight a few points from the letter. We are pleased with the results of our second quarter.
We grew our active client count to 2.5 million as of January 27, 2018, an increase of 588,000 and 31% year-over-year. We grew our net revenue to $295.9 million, representing 24% year-over-year growth.
We drove strong growth across both our women’s and men’s categories and are excited to tell you about two initiatives later on this call that create a more frictionless and personalized client experience, which should benefit our clients and our business.
Q2 2018 also marked the fourth consecutive quarter that we grew revenue at approximately 25% year-over-year. In Q2 2018, we delivered $3.6 million in GAAP net income and $18.2 million in adjusted EBITDA. These results demonstrate our focus on delivering disciplined growth while continuing to make measured investments in our business for our future.
Paul will discuss our second quarter financial results in more detail later on this call. I’d now like to take a few moments to provide color on a few initiatives from Q2. Firstly, we continue to apply data science and algorithms to drive improvements across our business.
In the past, we have discussed how we are using data science to optimize pick paths in our distribution centers to pair clients and stylists and even to design apparels. To highlight one newer area where we have been especially excited by the results, I will spend a moment on algorithmic repurchasing.
For core styles such as denim, cardigans and work wear, we tend to reorder styles that are working. Beginning in late Fiscal 2017, our women’s buyers began using algorithmic re-buying tools that we built to inform inventory repurchase decisions.
The algorithm helps buyers determine optimal re-buy styles and purchase quantities to meet the varying demands of specific client segments. For example, we algorithmically repurchase inventory based on seasonal demand fluctuations and style preferences of specific age demographics.
Through the use of this tool, we have driven increases in client satisfaction across style and fit and believe it also contributed to higher average order value. Implementing this technology allows us to improve the probability that our clients find and keep things they love and also to risk reduce our inventory.
Secondly, I am very excited to discuss Style Pass and Extras. These are two recently launched initiatives that represent significant steps in our strategy to continue innovating and improving our client experience.
These offerings are intended to drive a more frictionless and flexible client experience and grow both our mind share and wallet share with our clients. Most importantly, we believe that these new capabilities reflect a step change in enabling our clients to better personalize their experiences with us.
Style Pass offers unlimited styling for an annual membership fee. It allows our clients to get fixes more frequently without paying a styling fee every time they order a fix. One of our primary goals in launching Style Pass was to reduce the friction from the client experience, making it easy to be top-of-mind for all of our clients’ apparel needs.
Prior to its launch, we conducted a pilot that demonstrated that participation in the program increased client satisfaction, engagement and average revenue per client.
We started rolling out Style Pass in December of 2017 to select clients across categories and price points, offering a $49 annual membership fee for unlimited styling, with the fee acting as credit towards any items the client purchases.
While it’s still early, we are optimistic about the results of Style Pass since launched and about post-launch enrollment rates. We also recently launched an offering called Extras.
It serves our initial women’s offering plus size and maternity clients and added flexibility to our service by allowing clients to add essentials such as underwear, socks, bras and other items that did not require a styling experience in addition to the five items in their fix.
Extras products currently range in price from approximately $10 to $65 and includes third-party market brands, as well as exclusive brands. Clients are able to add as many of the incremental items of their choice to any fix they order.
This capability allows us to better serve our clients by being able to serve even more of their wardrobe needs while driving incremental revenue and margin per order.
While both of these initiatives are in their early days, we are very excited about the new technological and operational capabilities they offer for our business to further personalize the client experience. And now, I will turn it over to Mike, who will walk you through highlights within our women’s and men’s categories for the quarter..
Thanks, Katrina and hello to everyone, joining us on today’s call. I will begin with a discussion of our women’s category, which had another solid quarter of growth. In Q2, we expanded assortments from our newest brand partners and applied learnings from our initial women’s offering to our plus size business.
In the first quarter of 2018, we added several recognized brand partners to our portfolio of women’s brands and in the second quarter, began rolling out an expanded assortment of these brands to meet client demand. These recently added brand partners include Calvin Klein, Levis, Tahari and Tommy Hilfiger.
Client feedback on these additions has already been very positive and we believe it reinforces our role as matchmaker between great brands and the clients who love them. Our focus on establishing innovative brand partnerships also extended to performance wear brands in recent quarters.
We have partnered with several brands, including Beyond Yoga and Sweaty Betty, in addition to announcing our pilot partnership with Nike, which commences in spring 2018. We believe these partnerships will enable us to address more clients’ apparel needs over time.
Turning to our men’s offering, we delivered another strong quarter of growth as we learn more about our male clients and leverage the data they share with us to serve them better. For example, we estimate the size of our men’s TAM is roughly two-thirds of that of women’s.
However, our initial men’s clients have already demonstrated that they are willing to spend approximately 80% of what our women’s clients spend. We believe this is a testament to the strength of our men’s offering. As we shared in our first shareholder letter, over 85% of clients share feedback at fix checkout.
This information allows us to be very targeted in the way we improve the client experience. As a recent example of how we use this data to enhance the client experience from the product side, in Q2 we identified a significant opportunity to better serve XXL clients and in particular, XXL clients who self-identified as husky.
We collected and analyzed size and fit feedback relating to how apparel fit through the shoulders, chest, sleeves and body and incorporated that fit feedback into our fit specifications. These customized fits drove a success rate improvement among our husky clients of nearly 40%.
As our women’s and men’s offerings and client bases continue to grow, we are excited about our opportunity to leverage our growing dataset to enhance our personalization capabilities, client experiences and overall performance. I will now turn the call over to Paul who will talk you through our financial performance and outlook..
higher revenue, the timing shift of marketing and other operating expenses from Q2 to Q3, and finally, a $2.6 million reduction to our sales and use tax liability. By comparison, adjusted EBITDA on Q2 fiscal 2017 was $24.1 million, or 10.1% of net revenue.
Moving on to our outlook, for the third fiscal quarter, we expect net revenue in the range of $300 million to $310 million, representing growth of 22% to 26% year-over-year. This range includes our expected impact of Style Pass and Extras.
We expect adjusted EBITDA in the range of $5 million to $10 million, for an adjusted EBITDA margin of 1.7% to 3.2%. Our adjusted EBITDA range reflects several dynamics at play. First, as noted before, we had timing shifts of advertising and other operating expenses from Q2 to Q3.
Second, we decided to make several important opportunistic investments we feel are the right thing for our business longer term. These include incremental advertising spend based on favorable efficiencies we are seeing and also based on our plans to test different ways to better integrate data science into our marketing efforts.
In addition to retain and recruit the best talent in the industry, we will be making strategic incremental investments in stock-based compensation for non-executive key members. For the full fiscal year, we are raising the lower end of our net revenue range.
We now expect net revenue of $1.19 billion to $1.22 billion, representing growth of 22% to 25% year-over-year. In terms of adjusted EBITDA, we are narrowing our range to $45 million to $55 million for an adjusted EBITDA margin of 3.8% to 4.5%. With that, we are now ready for your questions. Operator, I will turn it over to you..
Thank you. [Operator Instructions] Your first question will come from Douglas Anmuth with JPMorgan..
Great. Thanks for taking the question. I had two that I wanted to ask. First, just on Style Pass, I was hoping Kathy could give a little bit more color there in terms of what you are seeing.
I know it’s extremely early, but we are curious, first of all, is it available to everyone at this point or is it still specifically being targeted to only certain members or people that you want to reengage with? And then secondly on marketing, I realized 2Q is not the biggest quarter, but can you talk a little bit more about what you are seeing in terms of the efficiencies that are making you want to spend more in 3Q as well? Thanks..
Yes, thank you very much, Doug. So, firstly on Style Pass, it’s a little bit too early to tell in terms of what we expect.
What we were really excited about when we piloted the program was we saw improvements in client satisfaction and engagement of how often they were engaging with the service and overall we saw higher revenue, average revenue per client in that test group. And those are some attributes of the program that we really love and are really excited about.
It is not rolled out to everybody. We won’t hear the specifics around kind of who becomes eligible for the program, but we are able to identify those that would benefit most and target the program accordingly, but we are very excited about kind of what we are seeing so far.
On the marketing side, marketing is not a big area of spend for us in the second quarter. However, there are some pretty meaningful differences between this quarter and last quarter.
This quarter was we had all of our channels or all of our important channels in-house and that actually helped us to be able to keep marketing channels on in a way that was productive and very efficient for this quarter that kind of allows us to continue to generate momentum as we go into quarters where we spend more.
And we also did a lot of learning in that last quarter.
And so a couple of the – I think two of the more important things I would highlight are we are able to use data science to be able to do some incrementality testing and that has helped us to really better identify sometimes, for example, if we are running ads on Facebook, that demand might materialize on another channel, but it was influenced by Facebook for example and so it helps us to have a more granular sense of the efficacy across channels.
And I guess to pick on Facebook a little bit, I think that’s an area where we saw a lot of great improvements and efficiencies in men’s for example.
And so historically, Facebook was more challenging on our men’s business than our women’s business and really in the last quarter, we really unlocked some great learnings and some great efficiency there and so we are able to deploy more dollars there in a way that we wouldn’t have been able to deploy as efficiently, like 6 or 12 months ago.
And so while it was a lower spend quarter, it was a very important quarter in terms of learning and definitely getting us a lot of momentum as we look into the rest of the year..
Great. Thank you for the color. Appreciate it..
From RBC Capital Markets, we will hear from Mark Mahaney..
Okay, thanks. Maybe two questions or three questions, please. Paul, could you talk a little bit more about the shuffling of costs from Q2 to Q3? I am sorry if you covered it on the call, but just go through that again, please.
And then in terms of the higher average order value that you have seen, so could you pare that back a little bit? I think you talked about that in the algorithmic repurchasing part of the shareholder letter.
And is that higher price points, is that just more frequency or is that more items purchased per fix? And then the last one just a little bit more on the Extras and I think that’s very early stage for you, but any learning so far about how material that could be kind of 2 or 3 years down the road? Thank you..
I will take the first question and maybe I will turn it over to Kat to talk about the rebuy algorithm and then the questions on the other initiatives. So, in terms of the Q2 results, we did see some upside due to timing of costs. Cost sometimes shifts between quarters as we manage the business, we see the opportunity to spend at the right time.
And so what we found is we didn’t spend as much as we had planned earlier on advertising and to a lesser extent, on some operating expenses like consulting fees. And I would say roughly 40% of our upside in Q2 is just simply shifting into Q3 and that’s reflected in the guidance we gave for the quarter..
And so to answer and I will take care of your other two questions. The first one I think was the higher AOB that we mentioned in the algorithmic repurchasing section of our shareholder letter if that’s correct. And then your second question was on Extras.
In terms of the algorithmic repurchasing, I think I want to caution you against kind of extrapolating that data into being overall higher revenue quarter-over-quarter. What we are referring to here is a test basically that we would do if we say we can use our algorithmic repurchasing tools in this cell, but not in the other cell.
And what we see is that using these repurchasing tools improves the probability that we are going to have things in inventory available for clients that we know that they are going to love. And so that using this tool results in better outcomes than not using this tool.
And so it’s a little bit specific to this specific initiative and to caution you against kind of using it overall on the business, but it’s definitely – it’s one of these things that is a test that we can do and then we roll it out and it definitely benefits us all, but again, I think it’s really specific to that test.
On the question around Extras, it’s really too early to tell. We just launched that 2 weeks ago. And I think what I would say is in the short-term, what we have there today is a set of socks, tights, undergarments and so it’s a more curated selection of items that are available.
And these aren’t necessarily huge market opportunity items, but what it does is there is a couple of things it does, I think one it covers categories that clients would like the convenience of having it in their fixes.
It also prevents clients from having to look elsewhere for those item types, which they would have had to do 6 or 12 months ago and so those two are certainly benefits to the business. And I think the bigger thing that we are excited about is more around the capability.
And so historically, Stitch Fix has really been 100% recommendation-based, where every single dollar of revenue is attributed towards a recommendation that we are generating and that’s still going to be the workhorse of this business, but the capability of allowing client choice in the experience is a very new one for us.
And so as we think about kind of the operational capability from a warehouse perspective and also from a technology perspective, 3 years from now, I don’t think the opportunity won’t just be how many pairs of socks can we sell? I think there are over a longer period of time a lot of ways that we can take advantage of this capability.
And so short-term, all of what we expect is wrapped up in our guidance and it’s all kind of within our expectations. But I think longer term it’s a really exciting capability that will allow us to personalize the experience of Stitch Fix in more ways than we can today..
Thank you, Katrina. Thank you, Paul..
Next, we will hear from Ross Sandler with Barclays..
Hey, guys. Just two questions on the gross margin.
Can you just give us an update on gross margin difference like an absolute level between the core women’s category and the newer categories like plus or men’s? Where is that today and where do you expect that to be a year from now? And then you called out clearance last quarter, it looks like some of that pushed into this quarter as you had talked about.
So I guess just steady state, how do we think about the clearance rate going forward after we get past this Q1 to Q2 dynamic? Thank you..
Thanks, Ross. As we have shared in prior quarters, the newer business, mainly men’s and plus size, do have a dilutive impact on gross margins driven by lower initial markups, higher shipping costs due to a lower footprint and inventory investments we are making to ensure that we are launching these businesses off the right foot.
And so that gap still remains today. We are not going to breakup the margins between the businesses. I did note in my remarks that we are starting to see some benefits of the scale. So, there is one example, the men’s initial markup, which is a measure of the scale and the size of the buys is up year-over-year by 190 basis points.
So, we are absolutely working towards continuing to get the scale from that benefit. I think probably in the next year we will add a third warehouse for the men’s distribution out of the five. So, I think over time you will see that gap close and certainly, we will benefit from the businesses scaling to a bigger size.
In terms of clearance, we did talk about last quarter is the fact that we shifted some clearance activity from Q1 to Q2. That did materialize. So when you do look at the overall gross margins from Q1 to Q2, it decreased 70 basis points. And that was driven entirely by clearance.
And so that was in line with our expectations and something that we had expected when we sort of entered the quarter.
In terms of steady state, I think probably on a bigger strategic level, we are going to continue investing in new categories as well as inventory overall and that will transpire into higher clearance year-over-year holding everything else constant.
What’s going to help us mitigate some of that investment, however, is the continual use of data science in terms of our styling tools and some of the repurchasing tools that Katrina mentioned earlier. That all will help us reduce our clearance upstream by buying the right amount of product and getting into the clients rather more effectively.
So, overall, I think steady state will be that will reduce clients longer term, but in the shorter term, we think the investments in inventory will allow us to ensure we give the great client experience earlier on with Stitch Fix..
And from Goldman Sachs, we will hear from Chris Marin..
Thank you. Just a couple questions from me. The first is on expanding price points, I think in the shareholder letter you talked a little bit about broadening out price points in the men’s category and that leading to some higher success rates.
Do you feel like you have all the price points you need in women’s, were there any kind of brands you could further bring in to expand that further? I am just curious how you are thinking about that.
And then secondly on marketing, can you remind us the mix between brand and performance and as you kind of continue to get better and better at attribution and data science as it relates to your marketing efforts? Should we expect that mix to change at all maybe more towards performance over time? Thank you..
Thank you, Chris. I will probably have Mike take the question on price points in the men’s and women’s businesses and then I will take it back for marketing..
Yes, hi, Chris. This is Mike. And yes, I think we still have room to grow expanding our assortment across price points in both men’s and women’s. I know you asked specifically about our opportunity in women’s.
And I think both from our brand perspective and a price point perspective, we can do a better job of matching where the clients are and what their expectations are. We have fortunately got a lot of data and they tell us where they want their price points to be and also what brands they like.
And we are vastly expanding what our offering is for clients. And I think what we talked about in the script was talking about brands that our people were asking for and we have this great opportunity to continue to expand along a lot of different brands..
Great. And I will take the question on marketing, the mix between brand and performance today I mean, almost everything that we do would be categorized as performance. And so even on the TV front, for example, the TV spots that we are running are direct response.
We can attribute those within kind of a 5-second window directly to signups that we are seeing in response to that.
And so I think it’s definitely an opportunity as we think about the longer term of the company and kind of the longer term horizon of the types of marketing that we want to do in building a brand that people know and love and that really has this kind of hearts and minds type of place with consumers. And that’s an area that we are excited about.
And I think you will see over the course of, I don’t know a year or so that you will probably see us experiment with more types of marketing, but today, the vast majority of the marketing spend that you see would be more of what people would consider performance marketing.
Did I answer your question totally, Chris? Was there anything else on that?.
No, that was perfect. Thank you very much..
Okay..
[Operator Instructions] Next, we will hear from Erinn Murphy with Piper Jaffray..
Great. Thanks. Good afternoon. I guess my first question is for Kat, one of the observations we have had in the last month if you guys kind of launched promotion that really focused on lapsed customers, where they had a full month to complete a fix and you waived the styling fee.
I am just curious I guess how are you classifying a lapsed customer at this phase and any kind of frequency by which you are doing this and how is the I guess ROI when you actually do waive that fee? Do you see them come back to the platform? That’s my first question..
Yes. So, that’s a great question. The idea of clients who we share in our S-1, for example, that over 660,000 clients will not use Stitch Fix for a period of 4 months or longer and reengage. That is a big part of our business and that reengagement really is important. And so we see some of that reengagement happen naturally.
A lot of apparel spend is lumpy. You will see people buy things every 6 months or see things people buy a bunch of things at once and then not buy for a while. And so we want to be able to respect people’s spending patterns and respect people’s wallet size and also be available whenever people are on the market to buy clothes.
And so we do a lot of these programs through e-mail, through direct mail. We do all of them in an ROI positive way and we can test these very granularly. And so to be able to be top-of-mind for somebody when they are thinking, I have a trip coming up and maybe I should get a Stitch Fix to help me for that. That’s a very valuable marketing tool.
So, in terms of the question around the styling fee, these are programs that we don’t offer these to every single client. There are clients, for example, who might lapse who are looking for products that maybe more of a value price point, which is not a price point that we serve today.
And that would be a client that would be unprofitable to try to reengage. And so we are very granular at the client level of really having these reengagement efforts targeted against the clients that will benefit from it and where our business will benefit from it.
And so that’s a program that I think is a very personalized one, but one that’s very effective as we think about making sure that we are top-of-mind whenever our clients are looking to buy clothes..
Thank you. That’s super helpful.
And then I guess two more, one for Paul, can you just talk a little bit about sorry if I missed it how shrink progressed throughout the second quarter versus the first and you did talk about working on tackling that problem, so I am just curious what initiative do you kind of kick-started in the second quarter? And then just broadly maybe it’s for Mike or Kat, just on the Nike pilot, can you just talk a little bit more, is it apparel, is it footwear, men’s, women’s? And then does one have an option on the platform to opt-in that they want specific athletic or does it just kind of fill within a standard 5-item thing? Thank you..
Hi, Erinn. This is Paul. I will tackle the shrink question and turn it over to Mike to talk about Nike. So, like many parts of our operation, we treat shrink as an opportunity to optimize and we certainly have opportunities to continue to improve on that front. Q2 shrink increased 60 basis points year-over-year.
By comparison, we had increased 70 basis points year-over-year in Q1. So, the trend is generally in the same ballpark. We are taking actions on a lot of fronts. In Q2, we initiated some engineering work to support automatic credit card verifications and to more easily reverse failed charge attempts.
And then on a more strategic level, we are partnering with third-parties to develop systems just to build the capability to confirm that clients we are bringing on the platform are the right match for us in Stitch Fix.
So, we are looking at this like every other cost in the system and we will continue updating you in quarters to come as we make progress..
So, Erinn, this is Mike. Yes, the Nike partnership starts officially in April of 2018. So, we are just getting started with them. The conversations have been great. I mean, we are starting in women’s. We are starting in apparel.
I think we can expand to other, like broader into their assortment and across both genders, but initially, it’s starting in women’s apparel. The way people would ask for it is mostly through request notes, their stylist request notes and it would be part of the 5-item Fix.
But I would say another big thing as we think about Nike and other brands is just the value that we provide to brands and the conversations that I have talked about before that we have with brands today versus a year or 2 years ago. I mean, we still are very valuable to a brand. We provide full price for a brand. We provide growth to a brand.
We have high brand integrity. We care about brands. And more specifically, the data that we can provide to brands, which is something Nike and other brands are excited about, allow them to be better brands and have better product that meets the needs of their clients.
So yes, we are excited about our partnership with Nike, but we are excited about all the brands that are coming to us to kind of talk about the ways that they can work with us based on our dataset..
Great. Thank you, all.
Thanks, Erinn..
[Operator Instructions] We will hear from Ryan Domyancic with William Blair..
Hey, good afternoon and thank you for taking my question.
So, to continue down that path of adding brands to the platform, what happens on the customer side when you include large brands into the fix? Do they come in at a higher price points and are there stronger keep rates for these bigger, more well-known brands than your house brands or boutique brands?.
Yes, I will take that. I mean, we see great success with our brands. I wouldn’t say with these bigger brands that they are higher success rates. I mean, I think we are seeing that we do have really good job with matching brands like big brands or market brands, like boutique brands or our own exclusive brands with the client.
And so as a result of matching in the algorithms and the way the stylist works, we are able to get the product to the clients that want that product. So, we are excited about the partnership that we have with brands, but I wouldn’t say that it’s a lot different than what we are seeing across the rest of the portfolio..
I’d also add that it just depends a lot category by category. In some categories like shoes, for example, we rely almost entirely on branded products versus other categories. We have less reliance there.
And I think we have also seen that there is a benefit to the client to seeing brands that they know and love in their fix alongside the brands they are discovering. And so in some cases, I think it could be a keep rate or success rate benefit, but I think in a lot of cases it’s also a trust benefit as the way that they perceive the service..
Okay, that’s very helpful. And there is the quick question on Style Pass. I know we touched on it both in the prepared marks and the Q&A.
But with those early tests, any comments about how frequency increased and by how much it increased relative to a typical customer?.
Yes. I think in the test what we can share is that we saw that overall average revenue per client increased. And I think the intuition would be that you would see people getting more fixes, because there is less friction. And so I think that intuition is likely going to play out. But I think it’s a little bit too early to tell.
And I think what we are most excited about frankly is just that people have much higher satisfaction, people think of the service more favorably and net-net they spend more with us. And so underneath, there is probably going to be some puts and takes, but I think the net result we see is very positive..
Alright. That’s all very helpful. Good luck. Thank you..
Thank you..
And at this time, I would like to turn the conference back over to management for any additional or concluding remarks..
Great. Well, thank you very much for joining us today. We look forward to seeing analysts and investors on the road at conferences and we will keep you posted on our quarterly calls and press releases. Thank you..
Ladies and gentlemen that does conclude today’s presentation. We do thank everyone for your participation and you may now disconnect..