Stitch Fix, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter of 2019, three months ended October 27, 2018; compared with the three months ended October 28, 2017. Stitch Fix provides personalized apparel, footwear and accessories through its Fix service. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 FY2019 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $366.2 million | $295.6 million | +23.9% |
| Gross profit / gross margin | $165.2 million / 45.1% | $129.0 million / 43.7% | Margin +1.4 percentage points |
| SG&A | $154.3 million / 42.1% of revenue | $119.5 million / 40.5% | +29.1% |
| Operating income / margin | $10.9 million / 3.0% | $9.5 million / 3.2% | Income +14.2% |
| Net income | $10.7 million | $13.5 million | -20.8% |
| Diluted EPS | $0.10 | $0.04 | Comparability affected by prior-period items and share-count changes |
| Adjusted EBITDA (non-GAAP) | $14.3 million | $11.8 million | +21.0% |
| Operating cash flow / free cash flow (non-GAAP) | $51.0 million / $44.0 million | $24.8 million / $20.6 million | Both increased |
Management attributed revenue growth primarily to active clients increasing 22.3% year over year, to 2.93 million. Gross-margin improvement primarily reflected lower inventory obsolescence reserves and, to a lesser extent, lower clearance and inventory shrink. SG&A growth reflected higher compensation, stock-based compensation, and advertising; advertising expense rose to $38.9 million from $28.2 million.
Prior-year net income included a $9.1 million noncash benefit from remeasurement of preferred stock warrants, which converted in connection with the IPO and will not recur. The current quarter’s effective tax rate was 14.0%, versus 27.6% a year earlier.
At October 27, 2018, the company had $173.3 million of cash and cash equivalents, $12.9 million of restricted cash, and $168.9 million of available-for-sale investments. Current assets were $398.3 million and current liabilities were $192.0 million. No borrowings or debt are reported on the balance sheet. Cash, cash equivalents and restricted cash declined $124.2 million during the quarter, principally because the company purchased $169.1 million of investment securities; investing cash outflow was $175.8 million. Operating cash flow benefited from higher accounts payable and accrued liabilities, partly offset by a $23.2 million inventory increase.
Material changes, outlook and risks
- Growth and expansion: The company launched Stitch Fix Kids in July 2018 and announced plans to launch in the United Kingdom by fiscal year-end 2019. It signed a five-year logistics and fulfillment-center agreement in Leicester, England, terminable after two years with six months’ notice; the related lease component has $11.1 million of minimum payments over five years.
- Outlook: No quantitative earnings or revenue guidance is provided. Management expects revenue to increase in absolute dollars but cautions that revenue growth may continue to slow. It expects continued significant marketing investment and higher spending on personnel, technology, inventory, fulfillment and international expansion, with no assurance those investments will be cost-effective.
- Inventory and margins: Merchandise is often ordered well before demand and trends are confirmed, exposing the company to forecasting errors, write-offs and margin volatility. Management notes that new categories, including Kids, may initially carry lower margins; merchandise mix can also shift margins.
- Litigation: Three putative federal securities class actions filed between October 11 and November 16, 2018 name the company and certain officers. They allege misleading statements about active-client growth and television-advertising strategy between June and October 2018; damages sought are unspecified. The company expects consolidation and says it does not believe current legal or tax matters will materially affect results, but litigation outcomes are uncertain.
- Controls: A previously identified material weakness in financial-reporting controls remained unremediated at quarter-end, involving access, program-change management and computer-operations controls for accounting and proprietary systems. Management reported disclosure controls were not effective. Remediation work is ongoing; the independent auditor had not assessed internal-control effectiveness.
- Accounting and other items: The company adopted ASC 606 using the modified retrospective method. Adoption increased current-quarter revenue by $0.5 million and increased opening retained earnings by $0.4 million for gift-card breakage and exchange-recognition changes. Management expects the new lease standard, planned for fiscal 2020 adoption, to substantially increase reported long-term assets and liabilities.
- Other risk exposures: Risks include client acquisition and retention, marketing returns, inventory management, competition, data security and privacy, international execution, supply-chain and shipping disruptions, and consumer discretionary spending. A 10% hypothetical interest-rate or foreign-exchange movement was not expected to have a material impact for the quarter.
Most important facts for investors to verify
- Whether active-client growth and repeat-client engagement translate into sustained revenue growth and whether the higher advertising spend generates acceptable acquisition returns.
- Whether gross-margin gains from improved inventory management persist as the company adds categories and enters the UK, and how inventory levels and write-offs evolve.
- Whether operating cash generation remains strong after considering working-capital timing, capital spending and the significant transfer of cash into investment securities.
- Progress and independent validation of remediation of the material weakness, and any related financial-reporting effects.
- Developments in the securities lawsuits, UK launch costs and execution, and the company’s ability to absorb growth-related spending without weakening profitability.
- Voting implications of the dual-class structure: Class B shares carry ten votes per share, compared with one vote per Class A share.