Stitch Fix, Inc. (NASDAQ:SFIX) Q1 2023 Earnings Call Transcript

Stitch Fix, Inc. (NASDAQ:SFIX) Q1 2023 Earnings Call Transcript December 6, 2022

Operator: Hello and thank you for standing by. Welcome to the Stitch Fix First Quarter Fiscal 2023 Earnings Conference Call. It is now my pleasure to introduce Hayden Blair.

Hayden Blair: Good afternoon and thank you for joining us today to discuss the results for Stitch Fix’s first quarter of fiscal year 2023. Joining me on the call today are Elizabeth Spaulding, CEO of Stitch Fix and Dan Jedda, CFO. We have posted complete first 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 first 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 Elizabeth.

Elizabeth Spaulding: Thanks, Hayden. As we stated on last quarter’s call, following a transformative year with the rollout of Freestyle, we began fiscal year 2023 with a clear focus on growing our client base and achieving profitability. As the macroeconomic environment continues to be uncertain, we are now further balancing the need to optimize our cost structure against achieving the long-term growth objectives of the business. We are confident in this approach and are determined to use this moment as a catalyst to create a leaner, more nimble and profitable Stitch Fix, while continuing to enhance the experience for our clients. In fiscal Q1, the retail industry experienced a meaningful pull forward of the holiday promotional environment, which continues to be more pronounced than expected due to weak consumer sentiment and excess inventories.

We believe this resulted in lower client spending and also had a large impact on our net active clients, which declined 11% year-over-year. Overall, Q1 net revenue declined 22% year-over-year to $455.6 million, which was at the low-end of the range provided on the Q4 call. Despite this, we continue to deliver on operational efficiencies and cost control, which enabled us to beat our provided outlook on adjusted EBITDA and negative $7.4 million for the first quarter. Dan will provide more details on the quarter in his section. Today, I will discuss our plan for the balance of 2023 in a few key areas. First, our focus on profitability and how we plan to further simplify our cost structure to create a more efficient operating model; second, how we continue to strengthen our client experience with an emphasis on our biggest differentiators of discovery, fit and human relationships; and lastly, how we are evolving our marketing strategy to increase our focus on engaging and reactivating the audiences that already know us.

First, on our focus on profitability and a leaner operating model. On the last call, we said that we recognized returning to positive adjusted EBITDA and free cash flow with the utmost important. This remains our central focus and the continued uncertain macro environment underscores the value of a leaner profitable business model that will allow us to adapt quickly in the future. As such, we are increasing our FY €˜23 cost reduction targets that we announced two quarters ago to $135 million from the $40 million to $60 million previously discussed. While much of the new reductions will come from advertising, which I will discuss more later on, we are also targeting more fixed and variable productivity in a number of areas. We recognize we need to operate the business more efficiently and focus on the areas most critical to move us forward in the current environment.

We believe we can execute these initiatives while simultaneously enhancing our client experience and without compromising the long-term growth potential, our highly differentiated business model presents. To reinforce, our biggest focus is on achieving profitability. That said we do want to give you an understanding of what we are working on in the background that is foundational to further enhancing our client experience. Our clients choose Stitch Fix to find items they would not have otherwise found for themselves for the tremendous convenience our styling service provides and for the personalization we deliver in client style and fit. We are the leaders in providing personalized styling support through our fixed model which together with Freestyle’s on-demand styling features like shop your looks and trending for you drive higher conversion and lower return rates relative to traditional e-commerce retail.

Knowing this, there are two specific areas of opportunity we are focused on enhancing to grow and retain our net active client base, making it easier to enter our ecosystem and ensuring our clients feel consistently heard and served in a personalized way to keep them coming back again and again. In terms of entering our ecosystem, we made progress in the first quarter, testing a new outreach strategy to a large number of signed-up prospects who have not yet purchased from us, which increased conversion by 30% over last quarter. We are also working on faster sign-up processes and more personalized search-based landing pages to continue to make it easier for clients to get started with Stitch Fix. In terms of feeling heard and served in a personalized way to keep clients coming back again and again, we see clear opportunities to improve client retention at critical moments with fixed preview and fixed checkout.

For example, we know that when clients keep at least one item and are looking forward to their next fix, they are likely to have multiple future fixes. The inverse is also true. If a client buys zero items in their first fix, they are 3x is likely to cancel their auto shift than clients who bought one item. Given the criticality of these moments, we are testing multiple new ways for richer interaction and listening. Both the four clients receive their fix as well as when they share feedback if we haven’t hit the mark. One test underway includes stylist experts contacting first-time clients who purchased zero items to get to know our clients better and to proactively suggest replacement items from Freestyle for the client so that we can get it right.

We expect this higher level of personal touch and communication will be meaningful in improving client happiness and ultimately improve retention. And lastly, we are evolving our marketing strategy to increase our focus on engaging and reactivating the audiences that already know us, while continuing to lean into new acquisition channels. This is a critical step towards increasing profitability as we will reduce marketing spend in the back half of the year. As a business, we have relied on digital performance-based channels and lower funnel spending on client prospects. While these channels did and still prove to be successful, they are now less efficient than they once were. In addition, we have a pool of over 10 million consumers that have already interacted with us, but have not recently or ever made a purchase that we can more directly target to bring back into our ecosystem.

Recent testing showed the cost per acquisition for reengagement of this pool is significantly less than prospective clients who have never interacted with us. Our experience has continued to evolve and we want to reach those clients who already know us and help them rediscover their love for Stitch Fix. In addition, we are continuing to expand our under-penetrated marketing channels, such as affiliates, influencers and SEO SEM, which will take time to develop into meaningful contributors, but will be important over time for new customer acquisitions. In summary, we remain confident in our unique and differentiated business model and the long-term opportunity ahead of us and we are adapting to meet the moment in these uncertain times. By focusing on these things within our control, we will continue to set ourselves up to achieve adjusted EBITDA and free cash flow positivity in the near-term while maximizing our long-term potential.

With that, I will turn the call over to Dan.

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Dan Jedda: Thank you, Elizabeth and hello to everyone on the call. Q1 net revenue declined 22% year-over-year to $455.6 million, which came in at the low end of our guidance due to lower net active clients and a pull forward of holiday-related promotions across the industry. The deep discounting the industry has experienced well in advance of the normal holiday season, particularly impacted October Freestyle revenue. Adjusted EBITDA for the quarter came in at negative $7.4 million, which was above our outlook largely due to effective cost controls as we continue to drive towards our goal of positive adjusted EBITDA and free cash flow. Net active clients in the quarter declined 11% year-over-year to $3.7 million. While this was an improvement from the sequential loss from Q3 to Q4 of last year, net active clients were lower than what we expected at the onset of the quarter.

While we are seeing an increase in new active customers, we continue to see a high number of customers delaying spending partially due to the macro environment. Revenue per active client was approximately flat year-over-year at $525. However, our analysis does show that clients are spending less across a broad set of cohorts and we expect this to continue given the economic backdrop and the deep discounting we are seeing in the retail industry. Q1 gross margin came in as expected at 42.1%, down 490 basis points year-over-year, driven primarily by higher product costs, higher clearance and unfavorable transportation costs year-over-year. Sequentially, gross margin was up 210 basis points from Q4 due mostly to improved inventory reserves. We continue to believe gross margin will be approximately 42% throughout the rest of FY €˜23.

Advertising was 9% of revenue in the quarter. For the remainder of the year, we expect advertising as a percent of revenue to be lower than our historic rate due to the marketing shift Elizabeth discussed. We will be laser-focused on spending advertising dollars where we see near-term positive ROI and we will continue to build out new marketing channels. For the remainder of this year, we expect advertising to be approximately 5% to 6% of revenue, but we will continue to evaluate our advertising spend to ensure we are managing to the right return on investment. Net inventory grew 20% year-over-year due to higher receipt volume. We did expect this higher inventory given our long lead times from order placement to receipt of inventory. We aggressively adjusted our bond in Q4 of last year and we expect inventory to come down sequentially in Q2 and continue to decline in the second half of the year.

Free cash flow for the quarter was negative $16 million and we ended the quarter with $209 million in cash, cash equivalents and highly rated securities. Now on to our outlook. The challenging economic environment increases uncertainty around the trajectory of net actives and therefore, revenue as we look forward. We know that high rates of inflation are impacting consumer purchases and high levels of inventory are impacting pricing with deeper discounting across the retail industry. Additionally, we are reducing our advertising spend amidst a very promotional holiday season. In these times, we are less certain how the revenue story plays out for the rest of the year. And so our goal continues to be managing our overall costs while continuing to focus on improving our client experience, with the goal of becoming adjusted EBITDA and free cash flow positive in the near-term.

In light of this backdrop, we anticipate revenues to be between $410 million and $420 million for Q2 as we continue to see pressure on net active clients and expect the holiday promotional environment to continue throughout the end of the quarter. We expect adjusted EBITDA for the quarter to be between negative $5 million and positive $5 million, primarily reflecting our ongoing cost structure efforts and a reduced level of advertising spend. Given our current visibility around our marketing and retention efforts and balancing the uncertainty in this challenging backdrop, we are lowering our full year FY €˜23 revenue guide to be between $1.6 billion and $1.7 billion. This assumes no material change in the current competitive landscape and macro environment from where we see it today.

Despite this, we are raising our outlook on adjusted EBITDA for the year to be between negative $10 million and positive $10 million reflecting our reduced advertising levels and ongoing cost management initiatives. Before we turn it over to Q&A, I want to remind everyone that even at current levels, our unit and order economics continue to be strong, with contribution profit, excluding advertising in the range of 25% to 30%. We know there is further opportunity to improve both fixed and variable costs and therefore, we see an opportunity to increase our contribution margin in addition to improving fixed leverage. In the meantime, we will continue to focus on the things we can control, deepening our differentiation improving our client experience and rightsizing our overall cost structure, all with a focus on near-term positive adjusted EBITDA and free cash flow.

Doing this sets us up to be in a strong position, producing healthy and profitable leverage as the economy improves and for a return to growth. With that, I will turn the call over to the operator for Q&A.

Q&A Session

Operator: Thank you. And our first question comes from the line of Youssef Squali with Truist.

Youssef Squali: Great. Thank you very much. Hi guys. So just a couple of questions for me. One, on the last earnings call, you guys talked a little bit about some of the new product enhancements, personalization features, efforts that you guys were doing to drive engagement and improve the user experience. You also had a brand campaign that was launched, if I remember correctly, in mid-September. Can you just speak to the one, the efforts you are making, where are you there? Second, how the campaign did relative to your own expectations? And then broadly speaking, how are you kind of positioned for the rest of the year from kind of an inventory standpoint? Where would you like inventory to be at the end of the year? Thank you.

Elizabeth Spaulding: Hey, thanks, Youssef. I can take the first part of that and then I’ll let Dan speak to our inventory position. On the customer experience, I think I alluded to some of this on the call, but we are pleased with the progress that we are making on clients entering our user experience. That was an area that we have been focused on over the last several quarters and we are significantly off our lows in new client conversion, which gives us confidence that we are doing the right things to create an even more seamless entry into new to Stitch Fix customers and that’s starting to pay dividends. We did things like improved our dynamic landing pages depending on where clients were coming from, including some improvements to the style quiz and we have begun to experiment with what we are really featuring and talking about in terms of how it works in the Stitch Fix experience and sort of the unique differentiators of our styling experience.

And we are leaning into further improvements on that as we enter Q2 with things like delaying our e-mail capture, one-time login, just areas that we are very aware of, that create friction. So pleased with the progress that we are making and continuing to focus on doing more there. More broadly, within the user experience I also had mentioned these kind of critical moments of truth within fixed preview as well as within the checkout experience. And so we have made a number of improvements on how we are surfacing inventory to our clients. I mentioned fixed preview, that one were a little bit €“ that as we launched and rolled that out over time increased our overall AOV and retention as we rolled that out a year or two ago. We now see kind of the next wave of improvements of client listening and learning, and we’re eager to dive in there.

We like what we’re seeing in these very early tests, but we’ve yet to scale them and more to come over the coming quarters. And then kind of related to the €“ those landing pages and how we’re educating consumers, that’s a good bridge into your question on the brand campaign, that was the first time we had done a campaign that was consistent across the UK and the U.S. and really focused on an always on messaging around how it works and really educating consumers on the unique differentiators. And so the consumer qualitative feedback that we’ve received from that is strong. We like what we’re hearing in terms of consumer appreciation of the value proposition. We also saw some improvements in organic traffic conversion that we think could be attributed to the relevance of that campaign.

It’s something that we imagine kind of being layered within how our influencers are talking about Stitch Fix, how we talk at €“ within TV and OTT. So it’s something that we anticipate we will build on in the future and is part of really conveying our unique value proposition. I will let Dan touch on the inventory position question.

Dan Jedda: On inventory, as we mentioned in the prior call, we did expect us to increase inventory, and we did expect this quarter, the $220 million to be the peak. And we are seeing that decrease throughout November and even through the first week of December. So the trajectory is right where we expected. We will be lower in Q2. We’re going to continue to be lower in Q3 and Q4 sequentially because we have rightsized our buying for the second half of the year. So that inventory will go down, and I suspect it will be negative on a year-on-year basis in the back half of the year.

Youssef Squali: That’s helpful. Thank you.

Operator: Thank you. And our next question comes from the line of Simeon Siegel with BMO Capital Markets.