Stitch Fix, Inc. quarterly report, Q3 FY2021

Stitch Fix, Inc. — Q3 FY2021 Form 10-Q

Reporting period: Third quarter ended May 1, 2021; year-to-date results cover the nine months ended May 1, 2021. Comparisons are with the periods ended May 2, 2020. Stitch Fix provides personalized apparel and accessories through stylist-selected Fixes and direct-buy shopping. Amounts below are in U.S. dollars.

Key financial and operating metrics

Metric	Q3 FY2021	Q3 FY2020	Nine months FY2021	Nine months FY2020
Net revenue	$535.6 million	$371.7 million	$1,530.1 million	$1,268.3 million
Gross margin	46.0%	40.8%	44.6%	43.8%
Operating loss	$24.2 million	$46.1 million	$84.1 million	$37.4 million
Net loss	$18.8 million	$33.9 million	$30.3 million	$22.7 million
Adjusted EBITDA (non-GAAP)	$11.6 million	$(20.7) million	$9.6 million	$26.6 million

Q3 diluted loss per share was $0.18, versus $0.33 a year earlier; nine-month diluted loss per share was $0.29, versus $0.22.
Gross margin improved year over year, mainly due to lower inventory reserves and merchandise costs; the nine-month improvement was partly offset by higher shipping rates. SG&A rose 36.9% in Q3 and 29.3% year to date, including higher compensation, warehouse wages, and marketing.
Active clients increased 20.2% year over year to 4.107 million. Net revenue per active client was $481, down 3.4% from $498; management attributed the decline primarily to the dilutive effect of recently added clients.
For the nine months, operating cash flow was $(35.1) million and capital expenditures were $23.7 million, resulting in free cash flow of $(58.8) million (company-defined, non-GAAP). Cash and cash equivalents declined to $124.7 million from $143.5 million at August 1, 2020.
At May 1, 2021, short- and long-term investments totaled $177.8 million; cash, cash equivalents, and investments together totaled approximately $302.5 million. Inventory was $215.6 million, up from $124.8 million at fiscal year-end, reflecting purchases to expand assortment and support growth.
Current assets were $495.4 million and current liabilities were $264.2 million. The company reported no borrowings under its then-existing credit facility and said it was in compliance with its covenants.

Material changes and management commentary

Q3 revenue rose 44.1%; management cited 20.2% active-client growth and comparison with the prior-year quarter, when COVID-related fulfillment-center closures constrained capacity and revenue. Nine-month revenue increased 20.6%.
The company continued to report net losses. Nine-month results included a $51.4 million income tax benefit; management said the effective tax rate reflected CARES Act net operating loss carryback provisions and excess tax benefits from stock-based compensation, among other items.
Management said new client demand and auto-ship retention remained strong, while noting that COVID-19’s effects on operations, the economy, and consumer behavior remained uncertain. It cited intermittent fulfillment-center interruptions, hiring difficulty, and rising warehouse wages.
The company closed its South San Francisco fulfillment center during Q3 and was building out a new Salt Lake City center. It expects to lease approximately 700,000 square feet there; the lease is expected to commence in late FY2021 or early FY2022 and carries approximately $33.1 million of fixed operating lease costs over its term through 2030.
Management anticipated additional direct-buy functionality in Q4 FY2021, intended to appeal to new-to-Stitch Fix clients. It expects revenue to increase in absolute dollars, but cautioned that growth rates may slow; it also expects operating expenses and investment in marketing, personnel, inventory, and infrastructure to increase.
In April 2021, the company announced that founder and CEO Katrina Lake would become Executive Chairperson effective August 1, 2021, with President Elizabeth Spaulding expected to become CEO.

Liquidity, financing, risks, and contingencies

Management stated that cash, cash equivalents, short-term investments, and available revolving-credit borrowing were expected to cover working capital and capital expenditure needs for at least 12 months.
On June 2, 2021, after quarter-end, the company replaced its $90 million revolving facility with a $100 million facility, with an option to request up to $150 million of additional capacity. It matures May 31, 2024, is secured by substantially all company assets, and includes financial and other covenants. The company reported no quarter-end borrowings under the prior facility.
Key risks include COVID-related disruption, fulfillment staffing and capacity, inventory forecasting and potential write-offs, shipping delays and costs, consumer discretionary demand, marketing efficiency, and competition. Management also highlighted potential impacts from supply-chain and freight pressures and evolving privacy and advertising-tracking rules.
A consolidated securities class action and related derivative actions remain disclosed. The underlying allegations concern statements about active-client growth and television advertising in 2018. A motion to dismiss the amended class-action complaint was pending; the derivative actions were stayed. The company said it did not believe the disclosed legal or tax matters would have a material effect, while noting litigation outcomes are uncertain.
The company identified no material change to internal control over financial reporting and concluded disclosure controls were effective as of May 1, 2021.

Important facts for investors to verify

Whether client growth translates into stronger spending per client, repeat engagement, and sustainable revenue growth.
Whether gross-margin improvement persists as inventory levels rise, and whether inventory reserves or write-offs increase.
How operating cash use, capital spending, and working-capital needs evolve, particularly with the fulfillment-center expansion.
The terms, covenant headroom, and any borrowing under the amended credit facility, including the collateral and restrictions it imposes.
Execution of the CEO transition and planned direct-buy expansion, and their effects on growth and expenses.
Developments in the securities litigation and the company’s ability to manage fulfillment staffing, shipping, and COVID-related risks.