Stitch Fix, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Three and nine months ended April 28, 2018. The fiscal quarter is the third quarter of fiscal 2018. Financial figures below are in millions unless otherwise stated.
Business context
Stitch Fix provides personalized apparel, shoes and accessories through its Fix shipments, combining stylist selection with data science. Revenue is primarily from merchandise clients choose to keep. The company reported 2.688 million active clients at quarter-end, up 29.6% year over year. It launched Style Pass in December 2017 and Extras in February 2018, and announced Stitch Fix Kids in June 2018.
Financial results and liquidity
| Metric | Three months ended Apr. 28, 2018 | Year-over-year change | Nine months ended Apr. 28, 2018 | Year-over-year change |
|---|---|---|---|---|
| Net revenue | $316.7 | +29.2% | $908.2 | +26.3% |
| Gross profit / margin | $138.2 / 43.6% | Margin +0.6 percentage points | $394.6 / 43.4% | Margin -1.4 percentage points |
| Operating income / margin | $9.8 / 3.0% | +$5.7; margin +1.4 points | $34.9 / 3.8% | +$3.5; margin -0.6 points |
| Net income (loss) | $9.5 | Prior-year loss of $9.6 | $26.6 | +$22.7 |
| Diluted EPS | $0.09 | Prior-year loss of $0.38 | $0.15 | Prior year $0.02 |
| Adjusted EBITDA (non-GAAP) | $12.4 | Prior year $6.1 | $42.4 | Prior year $58.1 |
For the nine-month period, operating cash flow was $61.5, capital expenditures were $12.0, and free cash flow (company-defined, non-GAAP) was $49.5. Cash was $287.3 and restricted cash $12.9 at April 28, 2018. Current assets of $386.7 exceeded current liabilities of $143.7 by $243.0. No borrowings or debt balance is shown on the balance sheet. Management said existing cash and operating cash flows should fund working capital and capital expenditure needs for at least 12 months.
Material changes and unusual items
- Revenue growth was driven mainly by the 29.6% increase in active clients. Nine-month revenue growth moderated to 26.3%, versus 36.7% in the prior-year comparable period.
- Quarterly gross margin improved as inventory obsolescence reserves declined, partly offset by higher shipping and freight costs and inventory shrink. Nine-month gross margin fell due primarily to shipping and freight costs and inventory shrink.
- SG&A increased 26.7% for the quarter and 23.7% for the nine months, reflecting higher compensation, headcount, stock-based compensation and advertising. Advertising expense was $25.2 for the quarter and $73.2 for the nine months, compared with $21.3 and $46.8, respectively, a year earlier.
- The nine-month results include a $10.7 gain from remeasurement of preferred stock warrants before the IPO and a $4.7 tax expense from remeasuring deferred tax balances under the Tax Act. The warrants converted into Class B shares at the November 2017 IPO; there is no warrant liability at period-end.
- The IPO generated $127.1 of net proceeds as reported in the equity statement. Class B shares carry ten votes per share, compared with one vote for each Class A share.
Outlook, risks and contingencies
The filing provides no numerical revenue or earnings guidance. Management expects revenue to grow in absolute dollars, while acknowledging growth rates may slow. It expects continued significant investment in marketing, personnel, technology, inventory, fulfillment, logistics and office capacity, and expects SG&A to increase in absolute dollars. The company said these investments may not prove cost-effective.
Key operating risks include client acquisition and retention, marketing returns, changing apparel preferences, inventory forecasting and write-offs, competition, vendor and shipping dependencies, and execution of new categories. The company disclosed a ten-year headquarters lease expansion that increased minimum lease payments from approximately $43.8 to $115.3; a subsequent amendment changed the occupancy date for one floor to July 16, 2018. A warehouse logistics amendment added approximately $1.0 of future minimum lease payments and can be terminated on six months’ notice.
Management reported that disclosure controls were not effective as of April 28, 2018 because a previously identified material weakness in financial-system access, program-change and computer-operation controls remained under remediation. Management nevertheless concluded the financial statements fairly present the company’s financial position and results. The company reported no material legal proceedings and no currently known contingencies expected to have a material effect. A stockholder derivative action concerning the validity of the federal exclusive-forum provision is disclosed.
Important facts for investors to verify
- Whether active-client growth and higher marketing spend are producing durable engagement and returns as revenue growth moderates.
- Whether gross-margin trends improve, particularly given shipping costs, inventory shrink, reserve changes and the expected mix of new categories.
- How recurring operating performance compares with reported net income and adjusted EBITDA, which include or exclude specified nonrecurring and non-cash items.
- Progress and testing of remediation for the material weakness in internal controls, and any resulting changes to financial reporting.
- The cash and operating impact of expanded lease commitments, planned infrastructure investment, and the June 2018 launch plans for Stitch Fix Kids.
- Potential share-sale pressure following expiration of IPO lockups, alongside dilution and voting-control implications of the dual-class structure.