Q1 2024 Stitch Fix Inc Earnings Call

Participants

David Aufderhaar; CFO; Stitch Fix, Inc.

Hayden Blair; Senior Director of IR & Treasury; Stitch Fix, Inc.

Matt Baer; CEO & Director; Stitch Fix, Inc.

Aneesha Sherman; Research Analyst; Sanford C. Bernstein & Co., LLC., Research Division

Kunal Madhukar; Analyst; UBS Investment Bank, Research Division

Youssef Houssaini Squali; MD & Senior Analyst; Truist Securities, Inc., Research Division

Presentation

Operator

Good afternoon and thank you for standing by. Welcome to the First Quarter of Fiscal Year 2024 Stitch Fix Earnings Call. (Operator Instructions) Please be advised that today's conference is being recorded.
I would now like to hand the conference over to Hayden Blair.

Hayden Blair

Good afternoon and thank you for joining us today for Stitch Fix First Quarter Fiscal 2024 Earnings Call.
With me on the call are Matt Baer, Chief Executive Officer; and David Aufderhaar, Chief Financial Officer. We have posted complete first quarter 2024 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 section of our annual report on Form 10-K for our fourth quarter and full year 2023 previously filed with the SEC and the quarterly report on Form 10-Q for our first quarter 2024, which we expect to be filed later this week. 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.
In the first quarter of fiscal 2024, we met the requirements to report our U.K. business as a discontinued operation. Accordingly, all metrics discussed on today's call represent our continuing operations. 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.
And now let me turn the call over to our CEO, Matt Baer.

Matt Baer

Thanks, Hayden. Good afternoon.
I'm pleased to share that Q1 revenue came in at the high end of our guidance. and we outpaced our guidance on adjusted EBITDA as a result of the work we are doing to manage the business to profitability. While these results are encouraging, there is much more work to be done to change the trajectory of our business. We began the fiscal year carefully assessing all areas of our company to identify impactful opportunities to transform our operations and improve our performance and that work is ongoing.
All that I have learned and observed in my first 5 months as well as my experience in retail over many years has reinforced my conviction in our company's ability to deliver sustainable, profitable growth. The original vision of Stitch Fix is as powerful, as relevant and as compelling today as it was when it launched.
Over the last 12 years, we have served millions of clients with a more innovative and more convenient way to shop for apparel and accessories. And new technology is making it possible for us to take personalization to a new level. To ensure that we continue to fully realize our vision into the future, we must think differently, work differently and approach our business differently. And we have already begun to do that with 3 significant bodies of work.
First, we are strengthening our foundation and embedding retail best practices throughout the organization. Second, we are building a healthier client base by more precisely targeting high lifetime value clients that we expect will help us expand our client base over time. And third, we are developing a long-term strategy to better serve the clients we have today and those we intend to attract in the future.
We have begun to embed retail best practices that are already changing the way certain choices and decisions are being made. We will make operational excellence the standard for everything we do, and we will ruthlessly prioritize how our teams are spending their time. This approach is intended to be comprehensive from merchandising and pricing science, to transportation and warehouse operations. And to ensure a high degree of rigor and accountability, we have a dedicated team in place to drive efficiency across the organization and transform the way we operate. This may not be headline grabbing, but it is exactly the work that we need to be doing right now, and we believe it will fuel our ability to deliver sustainable, profitable growth. We saw encouraging results in Q1 as we continue to strengthen our foundation and apply those retail best practices across a number of functions.
Let me share a few examples. In merchandising, we began to establish best-in-class buying, assortment planning and inventory allocation strategies, and we increased our focus on private brands. We expect it to improve operational efficiencies, grow margin and ensure we have the right product in the right location at the right time to best serve our clients.
Our private brands play an outsized role in improving both client outcomes and profitability. Over the last few years, we have increased our private brands from approximately 1/3 to nearly 50% of total sales. Because these brands performed well, generating higher keep rates and margins, we plan to emphasize them in our assortments moving forward.
We also continued to refine our brand portfolio in order to better serve our clients, unlock greater operational efficiencies and build deeper relationships with national brand partners. Over the last 2 quarters, we have reduced the number of brands, and we will continue to assess brands and optimize categories to deliver newness and trend while also driving growth.
In technology, we continue to advance a broader set of generative AI initiatives. As one example, we launched a generative AI-enabled tool that makes it easier and more efficient for stylists to personalize the notes clients receive within their fixes. Through the use of this tool, notes are informed by a client's prior purchase history and reflect item-specific descriptions and selling points. This lets us deliver a more robust experience to clients at a lower cost to serve, and led stylists redirect their time to conduct deeper analysis of client profiles, curate the best possible fixes and spend more time building relationships with clients.
We also continue to scale the use of our AI buying tool, which helps to drive more informed decisions and fresher assortments. We already see improved keep rates in the initial phase, and we expect this tool to be utilized in more than 50% of all units ordered by the end of fiscal year 2024.
In our product and technology organizations, we welcomed seasoned leaders with experience at Amazon Fashion, eBay, Airbnb and Nike to solidify and advance these teams. Headlining the addition is Tony Bacos, who joined the company a few weeks ago as Chief Product and Technology Officer. He brings tremendous subject matter expertise, sharp business acumen and exceptional product instincts as well as an impressive track record of delivering results.
We will assess opportunities to advance all of our teams across the organization, carefully evaluating structure and capabilities to ensure that our workforce is aligned to our strategic objectives. We have strong talent in the company and our teams have been stepping up nicely in response to new leadership, new objectives and new expectations.
Speaking to the long term, development of the strategy is progressing well, and we are already transforming our ways of thinking and working. We can and plan to seize the opportunity to methodically widen the aperture of target client segments and introduce many more people to the convenience and benefits of personalized styling. And we plan to radically reimagine the client experience to firmly position and differentiate Stitch Fix within the retail landscape.
As the best practices and operational efficiencies I described take hold, I believe we will have a much stronger foundation to build upon. I look forward to sharing more about our strategy in the future and the specific ways we plan to innovate for our clients, drive growth for our business, and create value for our shareholders.
The past 5 months have given me a solid grounding in where our business is today, a clear understanding of the current obstacles, and increased conviction about the path to return to profitable growth. I'm confident that the work we are doing now is essential to setting Stitch Fix up for future success, and I want to thank our teams for their ongoing commitment to our clients, their openness and enthusiasm around new ways of working and their belief in the bright future of our company.
With that, I'll turn the call over to David, who will speak to our Q1 financial results and future outlook.

David Aufderhaar

Thanks, Matt.
In Q1, we continued to focus on near-term profitability and cash flow throughout our organization while also doing the work to strengthen our foundation and set ourselves up for sustainable profitable growth. We successfully ceased operations of our Bethlehem, Pennsylvania, warehouse and are on track to do the same in Dallas by the end of Q3.
We expect this new 3 fulfillment center strategy will have immediate cost savings and be cash flow neutral throughout the transition. Once complete, the reduced warehouse footprint will allow us to have inventory in fewer warehouses and make it easier for stylists to build more personalized assortments for clients. We also expect to realize the benefit of inventory efficiencies as we scale.
Additionally, we completed the wind down of our business operations in the U.K. in the first quarter. On behalf of the leadership team, Matt and I want to thank the teams in Bethlehem, Dallas and the U.K. for their professionalism and hard work during these transitions. Because of the work our teams have done to improve gross margin and variable cost leverage, we continue to have enviable unit and order economics. Our contribution profit remains at the high end of its historical 25% to 30% range. We will continue to identify further opportunities to improve fixed and variable costs in order to increase both contribution margin and fixed cost leverage over time.
Now let me get into the Q1 results. Q1 net revenue was $365 million, flat quarter-over-quarter and at the high end of our guidance range, driven by higher-than-expected volume and stronger sequential AOV heading into the fall/winter season. Net active clients ended the quarter down 4% sequentially at approximately 3 million clients. Revenue per active client declined 6% year-over-year to $506.
AOV improved year-over-year, but we continue to see the lower fixed frequencies we have seen in the last few quarters. Gross margin for the quarter was 43.6%, up 140 basis points year-over-year, driven by continued improvement in inventory health and transportation leverage. Net inventory increased 23% quarter-over-quarter as expected, due to buying ahead of the fall/winter season but was down 24% year-over-year to $161 million. We expect inventory balances to decrease in Q2 and remain at lower levels for the remainder of FY '24 as we align our inventory position with demand and increase the assortment composition of our successful private brands. Advertising was 8% of revenue in the quarter, down $11 million or 27% year-over-year, but up sequentially due to an investment in our fall brand campaign and the scaling of reactivation initiatives.
Q1 adjusted EBITDA came in at $8.6 million up $10 million year-over-year and exceeding the high end of our guidance range as a result of continued successful cost controls. We generated $17 million of cash flow in the quarter and ended the quarter with over $260 million in cash, cash equivalents and investments and no bank debt.
Turning to our outlook. We continue to focus on what is within our control. As Matt highlighted, our first priority is to strengthen the foundation of our business and embed retail best practices throughout the organization. This means continuing to focus on improving the client experience, retaining and attracting clients, maximizing the effectiveness of our marketing, increasing leverage in our cost structure and driving positive free cash flow.
For Q2, we expect total net revenue to be between $325 million and $335 million. We expect Q2 adjusted EBITDA will be between $2 million and $7 million. We expect both Q2 and full year gross margin to be approximately 43% to 44% as we continue to drive improvement in our inventory position with a higher percentage of private brands and ongoing efficiencies in our transportation costs. We expect both Q2 and full year advertising to be between 7% and 8% of revenue, but we will be opportunistic and may increase that if we see the right return on our investment.
For the full year, we are reaffirming our expectations for net revenue to be between $1.3 billion and $1.37 billion. We are now expecting adjusted EBITDA to be between $10 million and $30 million. This guidance still assumes we'll be free cash flow positive for the full year, though we do expect Q2 to be negative due to the timing of working capital requirements related to inventory purchases.
As we strengthen our foundation, stay focused on leverage and profitability, along with acquisition and engagement of high lifetime value clients, I'm confident in our ability to maintain profitability today and provide a solid foundation for the future.
Now let me turn the call back to Matt.

Matt Baer

Thanks, David.
This is an important time for our company. We are encouraged by all that has been accomplished and we are focused on what is still to come. We are organizing, orienting and galvanizing around transformational work on the foundation and operations of our business. We are making better decisions and marked progress after taking a step back, performing a holistic assessment and challenging prior assumptions. Our teams are energized by new ways of working and motivated by early indicators of what we can achieve. I'm confident that our best days are ahead of us, and we are working to accelerate the pace with which we will reach them.
I said at the beginning of this call that over the past 12 years, Stitch Fix has served millions of clients with a more innovative, more personalized and more convenient way to shop for apparel and accessories.
Let me quantify that. We recently shipped our 100 millionth Fix. That is an extraordinary achievement and it is both a testament to a great idea and a credit to the incredible people who bring their knowledge, skills and determination every day. We celebrated this milestone internally and now I want to take this opportunity to publicly recognize everyone at Stitch Fix for this accomplishment.
Thank you all for joining today's call, and I'll turn it over to the operator so we can take your questions.

Question and Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Youssef Squali from Truist.

Youssef Houssaini Squali

So just 2 quick questions for me. First, as you step back a little bit and you look at kind of the future drivers of positive growth, can you maybe talk about the 2 or 3 key initiatives you believe should help reverse the active client decline? And kind of when do you believe that that could happen? When do we reach that inflection point? Is it possible that we -- it happens in the next 12, 18 months?
And then on the Q2 guide, in particular, the revenue guide implies further deterioration in the topline growth. Maybe can you just help us -- can you help parse out maybe macro versus kind of things that are -- that you guys are doing company-specific that -- that may make sense maybe step back before starting to grow again?

Matt Baer

Youssef. I appreciate the question. You've got Matt here. I'll speak to the first part of your question in terms of the future drivers of positive growth. We'll let David add any additional context to that as well as answer your question around the Q2 guide and implications for the balance of the year.
In terms of the future drivers of positive growth, I think important just to reframe and reinforce that where our focus remains is just to ensure that -- at the moment is to ensure that we have a healthy foundation for our business. This healthy foundation that includes a seamless client experience. It includes compelling assortment. It includes well-planned inventory. It includes the emphasis that we're putting on efficient and scalable operations and a best-in-class customer service that we offer our clients. It also includes the continued advancements that we're making in the technology that's deeply rooted and embedded within our company and throughout this Stitch Fix ecosystem.
As part of that, we also remain committed to building a healthy client franchise, and that's through a judicious marketing strategy that rationalizes every dollar spent. We do that to ensure our investment acquires high lifetime value clients. We're also, as we discussed on prior calls, equally committed to engaging our current clients in an effort to reduce any future dormancy as well as building on our successes to reengage those clients that may have lapsed.
And as I mentioned on the call, a lot of the ways that we're building this foundation is to focus our efforts on retail operation best practices. A couple of things that we're doing there that have already proven positive results for us. The first is our focus of the team to improve that foundational client experience, and that's across all of our touch points in order to drive conversion through the onboarding as well as all of our shopping funnels. And as that experience improves, we'll see conversion through the funnel improve, that will also unlock greater efficiencies than for all of our media investments.
Another example is our continued investments within our CRM capabilities. And within those, we have an outsized emphasis on continuing to evolve and improve our SMS and push notification communications. This is a critical tool for us as we focus on that engagement and reengagement of our clients as well as to introduce more content into the experience and capitalize on promotional opportunities to drive the topline.
And all this work that the team has been doing has begun to show some early and positive results. We've seen our 90-day revenue per active client, our keep rates and our AOV all moving in the right direction.
Now we've also seen some softness in our client conversion and some opportunities to drive a more efficient client acquisition cost. And going forward, we'll continue to balance those bright spots with our opportunities and remain judicious across all of our investments.
And importantly, we just continue to have this very strong perspective that a continued focus on the healthy foundation and healthy client franchise, that will unlock sustainable profitable growth in the future and ensure that when that inflection point incurs, we will be set up for long-term profitable growth.

David Aufderhaar

And then, Youssef, just some adds on the guide. From a revenue perspective, just a reminder, I think we touched on this last time that the negative active clients from prior periods, so from what we saw in FY '23 and in Q1, that is a contributor to the revenue headwinds. I think we also talked about expecting lower fixed frequency within our existing client base. And so that's another factor in the revenue guide.
To what Matt called out earlier, we did see higher AOV this quarter, and that's certainly an encouraging sign. And then also for Q2, we are expecting active clients to be negative for the quarter. And we expect that to be pretty much similar or slightly higher sequentially from a percentage standpoint than what we saw in Q1.
And for that, we don't provide a full year guide. But as we've said in the past, we will continue to focus on driving healthy, engaged active clients. I think Matt touched on this as well in what he just said. But we are seeing, from a near-term perspective, the clients that are converting are healthier. We're seeing a higher 3-month active RPAC. We've seen that this quarter and last quarter. And part of that, we're also seeing increased fixed frequency in some of those newer client cohorts.

Operator

Our next question will come from the line of Aneesha Sherman from Bernstein.

Aneesha Sherman

So I just wanted to continue that same discussion topic around the client -- the clients you're attracting. So Matt, it sounds like you're saying you're improving, you said client experience, assortment, et cetera, and it sounds like you're focusing on retention and reengagement.
So how do you square that within the expectation of continued negative net adds? Is there still some adverse selection from Freestyle first clients that you're now seeing turning out before your base is healthy? Or why do you expect the net adds number to continue to be negative while you're seeing all of these retention metrics start to improve? And then I have a follow-up as well.

Matt Baer

Yes, Aneesha, I appreciate the question and happy to provide a little bit more context. And what I would do is I would reference back to what I mentioned in this conversation as well as on our last earnings call, and that's just how judicious we're being in terms of where we're spending our marketing dollars. So the customers or the clients that we do acquire are those that are delivering -- going to deliver a high lifetime value. And I've been witnessed the organizations or practices where chasing short-term revenue growth or short-term client acquisition and if you're doing that without a really firm conviction that those clients are going to deliver high lifetime value for you, that becomes a losing proposition.
And as I and David just mentioned, we are seeing some promising signs in terms of those newer clients that we have acquired. But it's also early innings there, and we want to continue to be judicious and be methodical in terms of that spend.
As I've onboarded into Stitch Fix, I've also learned more and more about the uniqueness of our business model. And it's one that's different from traditional e-commerce in many ways, as you know. And in this particular instance, I think the relevant context is that when you're going out in traditional e-commerce to acquire new clients, you're often thinking about it at a transactional level. Even some of the largest retailers out there are acquiring every single visit and every single purchase from even their most loyal clients.
For us, we have that really unique competitive advantage and the differentiation of our business model such that when we acquire the right client, we get organic reengagement over the long term from them. You see that in terms of where our media or marketing investment has been relative to that client -- the client results that we just spoke to. In other retailers, you're normally going to see that from a one-to-one degradation standpoint in terms of your reduction in median -- reduction in client count.
For us, we have that benefit where once we get the right client on board and they get it fixed and they're happy with that, a subsequent fix, another fix. We get that organic reengagement, that organic recurring revenue stream, but it also takes time to ensure that investment is fully optimized as that occurs over a period of several months as opposed to something that you're able in other e-commerce business is able to assess in much closer to real time.
So we're going to make sure to continue to be judicious, continue to be methodical and we are encouraged by these early results, and we'll continue to build on those and invest into those into the future as we see appropriate.

David Aufderhaar

And Aneesha just add one more data point. On sort of the dormancy side of active clients, we expect similar levels of dormancy from a client perspective, and I think I touched on this earlier. But as we said on some of the prior calls, we saw a dip in first Fix engagement last year and that's impacted dormancy results over the last few quarters. Again, early results, but we're seeing progress here where recent client cohorts. We saw improved first Fix outcomes in Q1 with higher retention in both quarter over quarter and year-over-year. But the challenge with that is dormancy is a lagging metric. So it's one of those things that's going to take a little bit for us to see that come through in the overall metrics.

Aneesha Sherman

Okay. That makes sense. And a quick follow-up, please. So what is inherently different about the new clients that is making them higher quality? Is it a demographic difference or a behavioral difference? Can you give a little bit more color about why you're seeing this much higher quality in your new client base?

Matt Baer

Yes. Happy to speak to that at a high level. And, David, feel free to add any additional context. So in terms of the new clients that we've been acquiring, I think it starts with, again, a conversation we started on the last call is just in terms of how we're going to market. We have our marketing team that's really working hard to find the right balance between upper funnel, brand-driven messaging that creates the right awareness and consideration for potential clients that we onboard into the system such that they have an understanding of the service, they demonstrate interest. And when we get them into the onboarding funnel and they become a client of ours, they have a high intent and a high knowledge and level of interest in the service and are more likely to become not just a client that has a first Fix shipped to them, but has a subsequent and then a third fix and so forth.
So I think we've done a really good job in terms of finding that balance in our media and marketing spend such that we can build awareness, build consideration in the upper funnel as well as have a really optimized lower funnel programmatic marketing campaign in order to acquire all of those clients towards the bottom of the funnel.

David Aufderhaar

And I think where we're seeing that in the metrics is the RPAC callout that we talked about earlier that we are seeing encouraging signs in 3-month RPAC and that's both sides of it. We're seeing positive signs from new clients who are receiving more fixes in their first few months compared to new clients last year. And I think we also mentioned that fixed AOV was a strong point for total RPAC as well, and that was driven by hitting a multiyear high in Q1 that helped to boost up the 3-month RPAC.

Operator

(Operator Instructions) Our next question is from the line of Kunal Madhukar from UBS.

Kunal Madhukar

Continuing along the same line in terms of RPAC and given that fiscal second quarter, the AOV should be much higher (inaudible) why should we think that the guide that you've given, the topline guide, flat Q-over-Q should be the case? Why shouldn't the revenue come in much higher simply because the trends are on improving and the AOV will be much higher in the fiscal second quarter?

David Aufderhaar

Yes. Kunal. Sorry, I just had a little bit difficulty hearing the question. But if I understood correctly, one of the things that we're seeing, though, is new clients versus the total client base. And I think one of the things that we had highlighted earlier is RPAC -- the reason it declined from a quarter-over-quarter standpoint is because we continue to see the challenges from a fixed frequency perspective that we've seen in the last few quarters. And that's more of the drag on clients. And then we also have the active client loss as well, and that plays into the revenue guide. And so those are probably the 2 factors that would be impacting that.

Kunal Madhukar

Got it. And then as far as onetime and restructuring expenses are concerned, are we done with everything? Or do you still anticipate some more restructuring expenses in the second quarter?

David Aufderhaar

We may have some small charges related to it just because we're still closing out the warehouses that we had identified before but nothing very material to call out.
And also, Kunal, on the active clients, just one more point on the active clients. Just to clarify, the quarter-over-quarter in Q2, we expect a decline to be -- similar from a percentage standpoint, slightly higher negative from a percentage standpoint than what we saw this quarter.

Operator

And with that, I see no further questions in the queue. Thank you for your participation in today's conference. This does conclude the program. You may all disconnect. Have a great day.