Stitch Fix, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2018, the three months ended October 28, 2017. Unless otherwise noted, financial amounts below are in millions of dollars. The filing describes Stitch Fix’s personalized apparel, shoes and accessories service, combining stylist selections with data science.
Financial performance and position
| Metric | Quarter ended Oct. 28, 2017 | Prior-year quarter |
|---|---|---|
| Net revenue | $295.6 | $236.0 |
| Gross profit / gross margin | $129.0 / 43.7% | $110.1 / 46.6% |
| Operating income / margin | $9.5 / 3.2% | $26.5 / 11.2% |
| Net income | $13.5 | $13.2 |
| Adjusted EBITDA (non-GAAP) | $11.8 | $28.0 |
| Operating cash flow | $24.8 | $41.6 |
| Free cash flow (non-GAAP) | $20.6 | $36.1 |
- Revenue grew 25.2% year over year, primarily alongside 29.7% growth in active clients, to 2.396 million.
- Gross margin fell 2.9 percentage points. Management attributed the decline to merchandise and shipping costs, inventory obsolescence reserves, clearance and shrink, including costs associated with expansion into Men’s and Plus categories.
- SG&A rose 43.0% to $119.5 million, including advertising expense up $12.9 million and compensation and benefits up $13.8 million. Advertising spend increased to $28.2 million from $15.3 million.
- Net income was affected by a $9.1 million non-cash gain from remeasuring preferred stock warrant liabilities, versus a $1.5 million loss in the prior-year quarter. Excluding warrant remeasurement, non-GAAP net income was $4.4 million versus $14.7 million. Diluted EPS was $0.04 versus $0.14; basic EPS was $0.15 in both periods.
- Cash and restricted cash totaled $140.4 million at quarter-end, including $131.1 million unrestricted cash. Current assets were $235.5 million and current liabilities $159.0 million. Inventory was $87.6 million. The balance sheet lists no borrowings; total liabilities were $178.2 million.
- Operating cash flow declined by $16.8 million year over year, with inventory purchases a significant use of cash. Capital expenditures were $4.2 million, mainly for fulfillment centers, offices and systems. The quarter-end balance sheet also included $9.4 million of restricted cash securing lease-related letters of credit.
Changes, outlook and notable items
- Revenue growth was 25.2%, versus 51.3% growth in the comparable 2016 period, and management cautioned that growth rates may continue to slow.
- Management expected increased spending on marketing, personnel, technology, inventory, fulfillment and infrastructure, and anticipated SG&A to rise in absolute dollars. No specific revenue or earnings guidance was provided.
- Management said existing cash and operating cash flows were expected to cover working-capital and capital-expenditure needs for at least the next 12 months. The company reported positive operating cash flow annually since 2014.
- After quarter-end, the November 2017 IPO raised approximately $110.4 million net from 8.0 million Class A shares sold at $15 per share. Preferred shares converted and warrants were exercised into Class B shares; a further 1,175,557 Class A shares sold in December generated approximately $16.7 million net. These transactions are subsequent events and are not reflected in the October 28 balance sheet.
- The IPO made a performance condition on certain executive options probable, triggering a cumulative stock-based compensation catch-up in the following quarter. Management also expected a further $1.6 million warrant remeasurement gain in the second quarter; no warrant remeasurement gains or losses were expected after the IPO.
- Management identified a material weakness in financial reporting controls related to access, program-change management and computer operations in accounting and proprietary systems. Remediation was ongoing, and disclosure controls were deemed ineffective as of October 28, 2017. Management nevertheless stated that the financial statements fairly presented the company’s financial position and results.
- Management cited risks involving client acquisition and engagement, marketing returns, inventory forecasting and obsolescence, competition, growth execution, data security and technology interruptions. Hurricane Harvey had caused delivery delays and Fix cancellations in affected areas. The company reported no material legal proceedings and did not believe existing litigation or tax matters would materially affect results.
Key facts for investors to verify
- Whether client growth and higher marketing investment translate into durable revenue growth and acceptable acquisition economics.
- Whether gross margin stabilizes as the company expands categories and manages clearance, shrink, shipping costs and inventory reserves.
- How operating cash flow and inventory requirements evolve as the business grows.
- The effect of the IPO-related executive stock-compensation catch-up and subsequent warrant remeasurement on reported results.
- Progress in remediating the material weakness and establishing effective internal controls.
- The post-IPO share count, dual-class voting control, and potential dilution or market supply from future share sales and equity awards.