Stitch Fix, Inc. — Q2 FY2020 Form 10-Q
Reporting period: The quarter and six months ended February 1, 2020; comparisons are to the periods ended January 26, 2019. Stitch Fix provides personalized apparel shipments (“Fixes”) and direct-buy merchandise in the U.S. and U.K.
Financial and operating results
| Metric | Quarter | Six months |
|---|---|---|
| Net revenue | $451.8 million, up 22.0% | $896.6 million, up 21.7% |
| Gross profit / margin | $202.2 million / 44.8% | $403.5 million / 45.0% |
| Operating income / margin | $8.5 million / 1.9% | $8.7 million / 1.0% |
| Net income | $11.4 million, versus $12.0 million | $11.3 million, versus $22.7 million |
| Adjusted EBITDA | $14.3 million, versus $19.2 million | $19.4 million, versus $33.5 million |
| Adjusted EBITDA excluding stock compensation | $30.1 million, versus $27.3 million | $47.3 million, versus $48.2 million |
| Operating cash flow / free cash flow | Not separately provided for the quarter | $38.2 million / $26.8 million |
Quarterly diluted EPS was $0.11, versus $0.12; six-month diluted EPS was $0.11, versus $0.22. Stock-based compensation was $15.8 million for the quarter and $27.9 million for the half year.
Active clients reached 3.465 million, up 17.0% year over year; revenue per active client was $501, up 8.3% (including an approximately 2% contribution from FY2019’s extra week). Cash and cash equivalents were $166.0 million, with $231.2 million in short- and long-term investments. Current assets were $486.3 million and current liabilities $220.1 million. The filing reports no borrowings; operating lease liabilities totaled $149.4 million after adoption of the lease standard.
Changes and management commentary
- Revenue growth reflected more active clients and higher revenue per client. Gross margin improved 70 basis points for the quarter and 40 basis points for the half, mainly from merchandise-cost improvements and operating efficiencies, partly offset by higher shipping costs.
- SG&A rose 31.1% for the quarter and 30.7% for the half; it increased to 42.9% and 44.0% of revenue, respectively. Management cited higher compensation, headcount, stock-based compensation, and advertising. The resulting operating margin contracted to 1.9% for the quarter and 1.0% for the half.
- Operating cash flow fell from $57.7 million to $38.2 million for the half, primarily reflecting increased inventory investment. Inventory was $147.2 million at February 1, up from $118.2 million at August 3, 2019.
- The company launched Shop Your Looks in February 2020, enabling personalized direct purchases. Management said it planned to spend less on marketing in the second half of FY2020 than previously anticipated, while continuing to invest in growth. It planned $25–35 million of FY2020 investment in U.K. merchandise, styling, and operations.
Outlook, risks, and unusual items
- No specific full-year revenue or earnings guidance is provided in the filing. Management said existing cash and operating cash flows should cover working capital and capital expenditure needs for at least 12 months.
- In January 2020, Stitch Fix agreed to lease approximately 700,000 square feet for a Plainfield, Indiana fulfillment center, expected to commence before FY2020 year-end. The lease expires in 2030; estimated lease costs are approximately $28.6 million over its life. The company also entered a cloud-services agreement with a $23.5 million minimum commitment through October 2022.
- The company identified novel coronavirus-related supplier shipment delays and warned of possible effects on supply chains, operations, employee productivity, and consumer spending. Other key risks include inventory forecasting and markdown/write-off exposure, customer acquisition costs, competition, international expansion, tariffs, data security and privacy regulation, and shipping and fulfillment disruptions.
- Disclosure controls were deemed ineffective because of material weaknesses involving oversight of certain outsourced IT service providers and related COSO control and monitoring activities. Remediation was ongoing; management nevertheless stated the financial statements fairly present the company’s financial position and results.
- Consolidated securities class actions and two related derivative actions remained pending; a motion to dismiss the consolidated complaint was under submission. The filing also describes an appeal concerning the enforceability of the company’s federal exclusive-forum provision for Securities Act claims. Management said it did not believe current litigation or tax matters would materially affect results, financial position, or cash flows.
- The CEO and CFO were interim CFO Michael Smith’s context at filing: the company disclosed that its CFO and CMO left in December 2019. The reported income tax benefit reduced the effective tax rate to negative 14.9% for the quarter and negative 3.0% for the half, primarily reflecting credits and excess stock-compensation tax benefits, among other factors.
Important facts for investors to verify
- Whether client growth and higher revenue per client can continue, and whether direct-buy offerings improve engagement and revenue.
- Whether marketing, staffing, and expansion spending can be controlled sufficiently to stabilize operating margins and earnings.
- Inventory quality, turnover, and reserve adequacy given the inventory increase and exposure to changing consumer preferences.
- Progress and testing results for remediation of the material weakness in internal controls over financial reporting.
- U.K. expansion, the Indiana fulfillment-center commitment, cloud-services obligations, and potential coronavirus or other supply-chain effects.
- Developments in the securities litigation and Delaware forum-provision appeal; the filing does not provide a clear estimate of potential loss.