Stitch Fix, Inc. Q4 FY2020 Earnings Call

Thank you for joining us on the call today to discuss the results for our fourth quarter and full fiscal year for 2020. Joining me on today's call are Katrina Lake, Founder and CEO of Stitch Fix; Elizabeth Spaulding, President; and Mike Smith, President, COO and Interim CFO. I would also like to mention that we're joining you remotely today from our home offices. We have posted complete Q4 and full year financial results and our Shareholder Letter on the IR section of our website, investors.stitchfix.com. A link to the webcast of today's conference call can also be found on our site. We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please review our filings with the SEC for a discussion of the factors that could cause our results to differ. Also, note that the forward-looking statements on this call are based on the information available to us as of today's date. We disclaim any obligation to update any forward-looking statements, except as required by law. During this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the Shareholder Letter on our IR website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our IR website and a replay of this call will be available on the website shortly. I'd now like to turn the call over to Katrina.

Thanks, David, and thank you for joining us. After the market closed today, we issued our quarterly Shareholder Letter with more details on our results and strategy. As we’ll share today, our business ended Q4 in a position of strength and we're excited about the opportunities that lie ahead in fiscal 2021. Specifically, there are four themes on today's call. First, we navigated the COVID trough and have emerged even stronger. Second, our business is healthy with strong underlying fundamentals. Third, we are well-positioned strategically and financially to take market share and play offense in 2021. And finally, we are accelerating the expansion of our consumer experience due to the momentum we've seen across our Fix and direct buy offering. Combined, these themes give us confidence and optimism for the year ahead. With that, I'd like to rewind the script to talk about the first point and paint a picture of where we were when we last met in June. Our distribution centers were recovering from significant disruption due to the COVID crisis. At one point, half of our warehouse nodes were closed and we were operating at nearly 30% fulfillment capacity. Our supply constraints were not limited to our warehouses. As we spoke about last quarter, we had also pulled back on inventory both in the interest of conservatism as well as recognizing that we anticipated and would see very significant changes in the types of apparel that consumers are looking for. Given this constrained environment, we dramatically reduced our marketing spend from late March, April, and into May to ensure our limited capacity could be used to serve the demand we were seeing from existing customers while minimizing the risk that we would spend to acquire new customers into a sub-optimal and potentially disappointing supply environment. While we recognize that the decision to limit new clients at the time would impact our subsequent Fix demand in the quarters that followed, it was the right decision to prioritize the long-term success, happiness, and profitability of our existing clients. Emerging from the peak of the crisis in the spring, we began to play offense. We rapidly strengthened our foundation and adapted to the consumer. In the new work-from-home backdrop, we realigned our assortment to what was relevant and joyful for our clients. We unveiled new experiences to our active Fix clients with direct buy, and we ramped up our marketing spend in June as we gained confidence in our fulfillment strength and in consumer sentiment. With that backdrop, we are really pleased that we didn't just manage to survive the deepest trough of the crisis, but that we delivered results that we are very proud of. In Q4, we returned to positive year-over-year top-line growth, grew gross margins by over 400 basis points from Q3, and delivered over $50 million in free cash flow. These results are all the more notable when compared to many apparel retailers reporting double-digit declines for the same time period. We are particularly excited about our new client demand. As our distribution center capacity rebounded in late June without marketing back up, in July we saw a 50% year-over-year increase in our first Fix shipments, and we saw elevated growth continue through the month of August. This is the highest sequential first Fix growth rate we've seen in the last three years, so much so that we've had some higher than average Fix wait times as we catch up to support this windfall of new client demand. We believe this elevated first Fix demand will also drive incremental subsequent Fix volume in the quarters ahead, given that the majority of our clients choose to receive Fixes on a recurring basis. The flexibility in our model allowed us to meet the consumer in this moment, with our overall value proposition anchored on the convenience of shopping at home and by adapting our inventory to what is most relevant today. We will continue to pursue this path of adaptability and personalized relevance, which has been central to Stitch Fix since the beginning. Now more than ever, it will help us capitalize on a forever changed apparel retail environment. Before I discuss our Q4 results, I want to provide a quick reminder that Q4 '19 consisted of 14 weeks, which resulted in fiscal 2019 being a 53-week year. As such, when we reference adjusted growth rates in this call, we're noting that we've removed the impact of the extra week in a given month, quarter or year to show you a comparison that we believe more accurately reflects our performance. With that, I'm pleased to share that in Q4, we generated net revenue of $443 million, reflecting 11% adjusted year-over-year growth and 19% sequential growth from Q3. We delivered a net loss of $44.5 million and an adjusted EBITDA loss of $8.3 million. Our adjusted EBITDA, excluding stock-based compensation was positive at $11.8 million. During the quarter, we grew our active client count to 3.5 million. This represents a year-over-year increase of 286,000 clients, a 9% growth. In addition, net revenue per active client increased by 2% year-over-year on an adjusted basis. Now turning to our second theme, I'd like to share more color on how we delivered this Q4 performance and the strength we're seeing across our business. Over the last few months, our business has exhibited some of the strongest levels of performance we've seen since going public. Each of our major categories performed well, and we saw notable tailwinds in demand including increased adoption of our offerings. Our first Fix shipments accelerated and we saw continued strong retention of our auto ship consumer base. We also saw growing momentum in women's and Plus, continued growth in men’s, and notably real gains in both the scale and margin profile of our most nascent Kids and UK businesses. On top of all of this, our expansion into direct buy, a critical part of our future, has shown unabated growth, both pre- and post-COVID, and we believe it will unlock our total addressable market in new and very material ways. With that, I'll now provide some updates on each of our client categories to give you a sense of the momentum we're seeing. One of the main contributors to strengthen overall Fix trends has been the health and heightened demand in Women. We've seen ongoing improvement in the last few months and in Q4, Women's first Fixes grew approximately 25% year-over-year on an adjusted basis. We've also shifted volume out of categories like workwear and blazers that have been hit harder by COVID and into more in-demand product categories like athleisure. Our Women's activewear assortment, in particular, has surged in demand in the past few months as clients seek apparel that balances comfort and style. In the last few years, we expanded our activewear mix, which has allowed us to capitalize on recent trends and work-from-home mandates. In Q4, Women's activewear revenue grew by over 350% year-over-year on an adjusted basis, benefiting from strength across both Fixes and direct buy. We also delivered year-over-year growth in success rate and client satisfaction in Q4 as key brands such as Reebok and Beyond Yoga resonated with clients, and we feel well-positioned to continue serving clients’ activewear needs in the month ahead. In Q4, our Women's category also benefited from accelerated growth in our Plus offering. While we believe Plus size has historically been an underserved market by traditional retail, it's one that we’ve served well due to our understanding of fit and sizing and our ability to address client preferences through our exclusive assortment and strong market vendors. As traditional Plus channels contract due to store closures, we saw higher demand in Q4 with Plus first Fix growth exceeding 35% year-over-year on an adjusted basis. Plus also benefited from year-over-year growth in success rate and average order values in Q4 and FY'20 as we broadened our assortment across price points and end uses. While Plus represents a low double-digit percent of Women’s clients today, we think it comprises 40% of our Women's addressable market and we plan to invest aggressively in Plus inventory in FY'21 to support further acceleration. Similar to Women's, our Men's category benefited from the surge in demand for activewear and drove improvement in first Fix demand in Q4. In particular, we saw brands like New Balance and Public Rec resonate with clients as well as our own exclusive activewear brand, 01.Algo, and we're broadening our assortment in fiscal 2021. Beyond Women's and Men’s, we drove momentum in our more nascent Kids and UK categories during the last quarter. In Q4, we celebrated the second anniversary of Kids which has been especially resilient during COVID, with Kids surpassing even our pre-COVID expectations for the year. As Kids has scaled, we've leveraged client feedback data to improve our personalization capabilities and strengthen our inventory assortment. In the two years since launching Kids, we've improved success rates by over 15%. In Q4, our Kids clients kept the highest proportion of items in their Fixes since the category launched. These improved outcomes have also been a function of our enhanced exclusive brand assortment, with sales of our exclusive Kids products doubling on an adjusted basis year-over-year in FY'20 and fueling the category’s year-over-year gross margin expansion. While Kids is still in its early days, it is quickly scaling and on a similar profit trend line as our larger offerings, underscoring why we're so excited for this emerging category. We also recently celebrated the one-year anniversary of our UK launch. Six months ago, when we discussed the UK, we highlighted a few of our early challenges and uncertainty around Brexit. Now, six months later, we are optimistic about our UK trajectory. As with our other rollouts, we've taken a launch and learn approach in the UK and have focused on collecting client feedback and leveraging learnings to improve our recommendations, buying, and merchandising strategies. These enhancements resulted in UK success rates and average unit retail price each growing by approximately 20% year-over-year in FY'20, translating to a lift in average order value of over 40%. These improvements meaningfully strengthen our unit economics and margins, but also demonstrate how quickly we're learning and refining our UK offering. In Q4, we also saw highly efficient client acquisition trends which we believe were a function of strong organic and referral demand, as well as the broader pullback in digital spend by other retailers. While our UK offering is still in its early stages, we believe its momentum validates the viability and strength of our personalization model in other geographies, and we remain very excited by the progress we’re seeing in this promising new market expansion. Across the board, we're excited by the health and momentum we're seeing across the business and the opportunities that lie ahead. With that, I'll hand it over to Elizabeth to share more on our future direct buy ramp-up and how we plan to take share in the year ahead.

Thanks, Katrina, and hello to all of you on the line. On top of the company's success Katrina shared, this moment in history is a once-in-a-lifetime opportunity and a shift in apparel retail and we are playing offense. Consumers are rapidly moving their apparel buying online approximately three times faster than in the pre-COVID period. While overall demand for apparel is undoubtedly not what it was pre-COVID, the pandemic is completely resetting enduring client behaviors. Consumers are changing their habits, and we are here to help them establish these new shopping behaviors, providing the personalized discovery and guidance that was previously met offline. We are also able to rapidly toggle our inventory to what is most relevant right now. As a result, now is our moment to define a new apparel model as the traditional apparel retail sector shakes out. We saw this shift very much underway in Q4 and into Q1, with surging growth in our new customer shipments. As traditional retailers close their doors, consumers are shifting to Stitch Fix as evidenced by our increased demand and growth validating that we're taking share. When retail spend rebounds in the coming months, we expect more than $30 billion of market share to move online over a 12 to 18 month period. We anticipate capturing more than our fair share of this, given the relevance of our model, particularly with the expansion of direct buy. We will be focused on the consumer segments, categories, and elements of our offering that we believe will enable us to take disproportionate share in this time. Now, let me share how we started to play offense in Q4, with the results we delivered through direct buy, and by enhancing our experience to appeal to a greater set of purchase occasions. In June 2020, we launched Trending For You which expands our feed-based shopping experience, enabling more shoppable looks, widening the breadth of items from which clients can choose to purchase, and removing the requirement that clients have purchased with us in the past. This will set the stage for new-to-Stitch Fix customers engaging with us through direct buy in the quarters ahead. In the first two weeks of introducing Trending For You, our weekly direct buy orders grew by over 30%, suggesting that as we add features and broaden ways to engage in shop, we will be able to capture a greater share of wallet with clients. This expansion is part of our robust product roadmap that will continue to give clients more reasons to engage with us and broaden our offering to appeal to a larger consumer set. We are preparing for more of these enhancements in FY’21 to widen product discovery for both inspiration-based as well as higher intent purchases. In July, we also introduced an algorithmic recommendation engine exclusively for direct buy clients that uses our direct buy data set to more fully capture clients’ interactions and preferences. Compared to our prior Fix-based recommendations, clients purchased more items on average, bought products with higher average prices, and converted at higher rates. This new engine was also built to work in real time with clients who are onboarding directly into shop, and we plan to test this cold start recommendation capability in Q1. Now, I'll share a few updates on direct buy financial performance. In Q4, it continued to meaningfully outperform our expectations, driven by faster existing client adoption, higher purchase rates per client, and greater levels of engagement. While we won’t share direct buy penetration every quarter, we’ll note that Women’s penetration grew into the high teens percent, while Men’s grew into the high single digits with both categories demonstrating strong traction but also meaningful headroom for growth. We have also achieved very high success rates, driven by our ability to pair data-driven recommendations with clients’ high-intent purchase decisions. As a result, return rates associated with direct buy have been less than half that found in traditional apparel eCommerce. These client outcomes have led to strong repeat purchase behavior. From the launch of direct buy through the end of Q4, nearly two-thirds of clients who completed a direct buy purchase returned to make a subsequent purchase. These factors have reinforced direct buy’s impressive unit economics, with the offering delivering contribution margins that are already at parity with our Fix offering. In addition, in August, we introduced our shopping bag functionality to all direct buy clients, and we believe that this cart-like feature which combines multiple items into fewer shipments, will drive incremental cost savings and thus further margin expansion. Offerings like direct buy, which we believe can offer a step change in our growth trajectory, bolster our belief that the investments we're making in our people and across our business will result in outsized market share gains. Many in our industry pulled back their growth investments in response to COVID. We did the opposite and we see results, share gain, and adoption of new experiences. We continue to invest in engineering, data science, and products to broaden our experience and innovate our personalized shopping experience that complements our unique personalized styling service. We've made significant progress in demonstrating real gains in our new direct buy platform, as well as in early stages of testing and piloting of enhancements to our Fix offerings, which we believe is more relevant than ever as consumers shop from home. With our Fix form factor, we're enhancing the client experience to leverage our differentiated styling team to deliver stronger client outcomes. One initiative that is currently in play in the UK enabled clients to engage directly with stylists to select anchor items in their Fix and identify other ways they'd like stylist support before their Fix ships. This data has driven strong early results and we believe this approach appeals to an even broader set of clients as consumers seek higher touch engagement, especially while reducing their frequency of shopping with stores. Based on the results of this initiative today, we plan to introduce it to U.S. clients in the quarters ahead. Beyond product innovation, we're also investing in our distribution centers to support higher levels of demand. As we continue to expand our offering, we believe these investments will help to remove limiting factors tied to capacity constraints and allow us to fulfill higher demand in conjunction with our more aggressive marketing strategy. We're very excited about the opportunity that lies ahead, and we are confident that we're well-positioned to expand our market share.

Thanks, Elizabeth, and hello to everyone on today's call. First, I'll share more detail on our results from the quarter and full fiscal year. In Q4, we generated net revenue of $443 million, representing 3% growth year-over-year or 11%, excluding the impact of the extra week in Q4'19. Fiscal '20 net revenue was $1.7 billion, growing 9% over the prior year, or 11% on an adjusted basis. In the quarter, we grew active clients to 3.5 million. This represents a year-over-year increase of 286,000 clients, a 9% growth. Q4 net revenue per active client was approximately flat year-over-year on a 53-week basis and grew 2% on an adjusted basis. Note that the net revenue per active client is based on the last four fiscal quarters such that Q4'20 revenue per active client of $486 is not impacted by the extra week from Q4'19. Q4 gross margin was 44.9%, representing a 410 basis point increase quarter-over-quarter driven by a reduction in our inventory reserve as we stabilized our inventory position. We’re proud of this large sequential margin improvement and our ability to execute against the directional guidance we provided during June earnings. Full year gross margin was 44.1% or 50 basis points lower than last year. Advertising was 9.9% of net revenue in Q4 compared to 9% in Q4 of '19, and was 9.8% of net revenue in fiscal '20 compared to 9.6% fiscal '19. Other SG&A excluding advertising was 38.3% of net revenue in Q4 compared to 34.6% in Q4‘19, and was 37.3% for the full year compared to 33.4% in fiscal '19. This reflects ongoing investments in technology talent and the associated stock-based compensation expenses. Q4 adjusted EBITDA loss was $8.3 million and fiscal '20 adjusted EBITDA loss was $29.1 million. This performance was in line with our expectations and reflects lower gross margins in Q3'20, as well as ongoing strategic investments we made to support long-term growth. In fiscal '20 these investments totaled approximately $110 million dollars and included $68 million in stock-based compensation as we invested in technology talent, roughly $25 million in supporting our UK category as it scales, and nearly $15 million in one-time COVID-related expenses. Adjusted EBITDA excluding stock-based compensation was $11.8 million in Q4 and $38.4 million in fiscal '20. Q4 net loss was $44.5 million and diluted loss per share was $0.44. For fiscal '20, net loss was $67.1 million and diluted loss per share was $0.66. And finally in Q4, we delivered free cash flow of $51.8 million and ended the quarter with no debt and $381.6 million in cash, cash equivalents, and highly rated securities. Before I discuss our outlook, I'll note one change we're making in FY'21 on how we report EBITDA. As we look ahead, stock-based compensation will remain an important lever for us as we invest in growing our data science and engineering teams. We also note that most comparable companies exclude stock-based compensation from EBITDA. As a result, going forward, we will only provide adjusted EBITDA excluding stock-based compensation as we believe it more closely reflects our operating performance. Now, on to our outlook. As Katrina mentioned, we've been very pleased with first Fix demand trends in July and August which we believe will bolster our active client growth in the year ahead. One prevailing trend she also mentioned is lower subsequent Fix volume impacted by our demand side pullback in Q3 of '20. Let me explain this temporary phenomenon in greater detail. As we shared in Q3'20, our COVID-related fulfillment challenges led us to pull back significantly on marketing for nearly eight weeks, which we knew would lower our active client count and the subsequent base of clients we served in the quarters thereafter. Given the fact that repeat clients comprise such a large portion of our business, we expect the loss of those new March through May clients, who would on average receive multiple Fixes and spend hundreds of dollars with us in their first year, will roll forward and particularly impact subsequent Fixes in the first half of fiscal ‘21. However, as we enter the second half of fiscal, we expect the effects of the temporary pullback in marketing to subside, giving us confidence in our accelerating growth for the year ahead. In addition, as Katrina referenced earlier, we're playing catch up to support the renewed surge in client demand. As such, in Q1 we expect to deliver mid to high single-digit revenue growth which reflects robust recent demand trends, offset by lower subsequent Fix volume I just mentioned. It also reflects some of the benefit from our new client growth moving into Q2. Given the uncertain macro environment, we also think it’s prudent to hold off on providing specific full-year guidance at this time. However, we do expect year-over-year revenue growth to accelerate meaningfully in the second half of fiscal '21 as the impact of COVID stay-at-home orders subside. Now, I'll share how we're thinking about our investments and implied margins in FY'21. Fiscal 2019 and 2020 were heavier investment years for us as we invested in initiatives that will fuel long-term growth such as our Kids and UK categories, as well as data science and engineering talent. In fiscal 2021, we plan to continue investing in growth opportunities like the UK but at lower levels than last year as the category continues to gain traction and scale. Even with this continued investment, we plan to begin showing expense leverage in our adjusted EBITDA excluding stock-based compensation. Our only caveat is by saying that we will be flexible in how we allocate marketing dollars in FY'21 and if we see the opportunity to invest and to drive outsized share gains, we may seize that opportunity. In line with Elizabeth's earlier comments, we plan to invest higher levels of CapEx in FY'21 to increase our operating capacity, which should mitigate growth constraints and also drive leverage in our model over time. CapEx has historically comprised less than 2% of revenue and in FY'21 we expect it will increase by 100 basis points to 200 basis points over historical levels. This is part of our longer-term investment in our inventory management strategy, which we will share more about in the quarters to come. In summary, we're proud of the results we delivered in FY'20 and our ability to return to generating positive top-line growth in Q4. We have a healthy cash position, no debt, and an undrawn revolving credit facility, and we're generating cash flow. As we look into 2021, we believe that our strategic and financial position will allow us to capture outsized share gains, while we also deliver accelerated year-over-year growth and continued profitability. With that, we're ready to open it up for questions.

We'll hear first today from Edward Yruma with KeyBanc Capital Markets.

I guess first on the success of direct buy, obviously lots of great commentary and we appreciate that. With the basket sizes, wondering if that's changed now that you have the shopping bag capability where you've seen kind of the benefit I think in August and post that? And then as a follow up, Mike, I think you'd mentioned in the release about the inventory reserve, really that helps gross margin. As you rebuild inventory, does that weigh in on the P&L? Thanks.

Thanks for the questions, Edward. We will have Elizabeth probably answer the question on direct buy. And then Mike, you could take the one on inventory.

Yes. Hi, there, Ed. This is Elizabeth. I think we've been really pleased to see the momentum, as you mentioned, with direct buy. And in terms of the shopping cart, we had it in a beta mode for a few months and we just very recently launched it to our full client set. So in terms of the kind of incrementality that I think you're asking about, a little bit early days to share that. I mean, I think one thing that's interesting is, even pre having the shopping cart, we had clients converting to multiple purchases even through the Buy Now feature. And so, I think we'll know more in the months to come. I think what we're excited about is that the gross margins of direct buy were already at parity with our Fix offering and now with the kind of benefit of consolidated shipping that we'll be incorporating, we would expect to see margin enhancement, as well as other new features that we're launching with the cart, where if something ends up being out of stock, we can help recommend items that are similar to consumers. So more to come as the cart is in place for a longer period of time, but we were seeing people buy multiple items pre-cart as well.

And hey, Ed, this is Mike. Yes, we feel pretty confident about managing inventory. Given the surge in demand, there’s a chance we’ll need to acquire more inventory to meet client demands. From a gross margin perspective, without providing specific guidance, we feel really good about our Q4 performance and anticipate maintaining that number for the rest of the year, and we believe our inventory is in great shape.

We'll hear next from Ross Sandler with Barclays.

Hey, Katrina, I have a question about the first Fix, which is up 50% compared to the repeat. Are these new first Fix customers similar to those you brought in during other time periods? Are you having the same success converting them to autoship, or is there a tendency for them to be more of a one-and-done situation given the current environment? I'm trying to understand this in relation to the guidance Mike provided for the first and second halves of the year. And Mike, regarding CapEx, is this investment going into automation? If so, what will that enable Stitch Fix to do now or in the future that you're not currently doing, particularly in terms of improving processing time and managing inventory?

Thanks for the questions, Ross. Yes, on the first question, we're seeing really great trends on the client demand side. And we really see this as just confirmation that right now the model of trying and buying personalized selections of clothing at home is more relevant than ever. In terms of the dynamic between repeat and new clients, as a reminder, in Q3, we pulled back pretty significantly on marketing. And what that means is, in our business, the clients that we acquire don't just generate revenue in the quarter that we acquire them, but they generate revenue over a much longer period of time. So, which means that in Q3, if we acquired fewer clients, we'll see the impact of that temporarily this quarter or next quarter. But the flip side of that is that the really good trends that we're seeing on new client acquisition will sustain for multiple quarters ahead. The client trends that we're seeing, while we haven't shared anything specific as to autoship for opting in, what we've shared is that we've seen almost best-ever trends in terms of people retaining and staying on autoship in terms of the dynamics we're seeing within the Fixes, and we don't see any reason to believe that that will change. But right now, I think we're at a place where we're looking at kind of a first half that really is anniversarying some of the client demand trends that we saw in Q3, and what that looks like for temporary effects but really optimistic as we think about the trends that we're seeing now in July and kind of what that goodness will look like in the back half of the year. Mike, why don't you take the question about CapEx?

Yes, sure. I mean, there's a few things going on, Ross. One is that we can add more automation to improve efficiency. So that's one area that we're going to continue to invest in. Nothing other than improving the efficiency within our operations. But the second thing is we need more space. Given demand trends and some of the things that Elizabeth touched on in the last two quarters in terms of new inventory models, we need more space, so there's a combination of efficiency within the four walls and more square footage.

We'll move next to Mark Mahaney with RBC.

I would like to ask about the direct buy functionality and its impact on the UK. I initially thought that this feature would lead to increased customer retention and spending per customer, with a gradual effect on attracting new customers. However, it seems you're experiencing a more balanced impact across all three areas. Could you provide some insights on how it's affecting customer acquisition and retention? Additionally, regarding the UK, have you implemented any new strategies there? Do you believe you've achieved a critical mass, and could you discuss your current position in terms of your playbook and success in that market?

This is Elizabeth, Mark, I can answer both of those. On direct buy and the impact of your questions around retention, relative to spend per customer and new customers, it's interesting because, as we've said, we've not yet unleashed this, so to speak, to brand new customers. We did a very small amount of testing with the influencer program that we did in June. But that was very much on a small scale relative to the big idea so far, which is just driving incremental spend of our existing customers. And I do think this is probably something another reason to stay longer or stay more with Stitch Fix. The majority of what you're seeing is actually really more in retention and spend per customer. That new customer demand that Katrina was talking about, that 50% year-on-year Fix growth within July and into August, I mean that is clients opting into Fixes, opting into autoship. The benefit is now as soon as they come in, we're marketing our shop offering to them as well. But the spend per customer is really what we've seen to-date and just penetrating our existing base. And then we have done some work already in beginning to do dormant reactivation of historic clients. The early read on those tests have been quite successful. So we'll continue doing that as well as clients that we consider to be prospects, meaning those who've shared a lot of information with us in the past, but not yet converted. So those are attractive pools that we will be going after. But that new customer idea is actually the big white space ahead of us. And then on your UK question, on critical mass, I mean I think we're just seeing a lot of really good things that the learning over the last year has really benefited us. So as Katrina mentioned in the call earlier, we've seen 20% year-on-year improvements in both the average unit retail prices and keep rates per customer, and that's translating to this 40% improvement in average order value. What that means is just we're really getting on the glide path of great contribution margin and something that gets us excited about the growth. I also just think our model has really been relevant in this moment. The customer acquisition that we saw, I'd say, starting in mid to late April and throughout the last few months, just had great momentum, both on the organic and referral side as well as on paid acquisition, where we think a number of our competitors have probably just had to pull back. Just some creative things we've done to educate more about our offerings. So we introduced a stylist ambassador program, where we've helped our stylists really map large Instagram followings and using that vehicle to help customers better understand this model, which I think now that it's gaining more awareness, we're just seeing greater traction.

And from Piper Sandler, we'll hear from Erinn Murphy.

I have a couple of questions. First for Elizabeth or Kat, following up on the surge in first Fix demand seen in July and August, can you share what type of customers are engaging with this? Is there a difference in age demographics, and how does the mix compare to historical surges in first Fix demand? Secondly, regarding the shift of stylists, I recall that last quarter the plan was to transition about 1,400 stylists into lower-cost regions. I would love an update on that—how smooth has that process been? Have there been any challenges?

Yes. Thanks for the great question. I think first on first Fix demand, what we're seeing, we're seeing really a lot of strength in Women's and Kids. And I think in Women's, what's been really exciting is really seeing that strength in Plus size. I see that as both just a reflection of what's happening in the Plus size market, which was historically very dependent on physical in-store experiences and kind of our ability to be able to capture some of that demand. I think it's also a testament to just like the convenience of our model and really being right where the customer wants. We're thrilled about kind of what we're seeing there. I don't think there’s a time in terms of how these clients look different from past clients. Plus size is one place that we're pretty excited about. Actually, one last thing I'd add on Plus too is that we've really focused on inclusivity in marketing and in the imagery that you'll see, and I think that's another factor that's now helping that side of the business. On the stylist side, so far, it's been great. Right now, we have a lot of open positions in the many other geographies that we hire stylists, such as Minneapolis, Texas, and Ohio. The hiring of stylists has never been a challenge for us. We really have found that there's a great labor pool to draw from. We've been used to kind of hiring at scale and high volumes. Currently, we will be hiring about 2,000 stylists across those geographies. We feel pretty good about our ability to onboard them seamlessly and that there will be great demand for the stylist front for us to draw from.

We'll hear next from Heath Terry with Goldman Sachs.

I just wanted to dig a little bit further into the comments that you made around advertising. You mentioned the decline in advertising spend that we saw kind of quarter-over-quarter. Just if you can quantify for us kind of what you mean by that, just given the increase that we saw in absolute dollar spend? And then as we think about the second half recovery that you're seeing or expect to see as we get into next year, how much of that do you expect to be just recovery in overall average apparel spend versus a significant increase in the wallet share that you're seeing with your customers, particularly relative to kind of what you're seeing along that dynamic now of apparel spend versus wallet share?

Yes. I'll take a stab at the first part on marketing, and the second question is really around kind of wallet share so I'll take a stab at those two. And I think Elizabeth and Mike, if I miss anything, you can jump in. The marketing pullback was really speaking to Q3 primarily, where for about eight weeks we pulled back pretty significantly on marketing. That was really because of supply-side constraints that we had during that time period. Pulling back during those eight weeks has a knock-on effect because the clients that we acquire during those eight weeks don't just generate revenue then, but they generate revenue for the weeks and months and years to come. So when we're talking about the pullback, we're really talking about that. As we've moved out of our backlog at the end of June, July, August, we've been able to turn marketing pretty fully back on, and we've been really pleased with what we've been seeing on that front. We've already talked about the 50% year-over-year growth in Fix rates that we've seen, and that's been the result of being able to trend that marketing engine fully back on. In terms of our expectations around where that spend is going to come from, I mean, there's definitely all the dynamics that you spoke to. I think this is undoubtedly a strange time and that people are buying less apparel for very good and obvious reasons, they are still buying apparel, however. One of the really great benefits of our model is that we've been able to shift our assortment to what clients need. You may not have thought that Stitch Fix would be known for activewear and athleisure a year or two years ago, and now we're really able to sell that effectively to our clients and meet them where they are. While this is a very challenging time for apparel retail, in general, as people's behaviors are changing dramatically, and people are buying less volume today, we do believe that the behavior shifts happening today are going to be permanent and those will be significant tailwinds and benefits to our business long-term.

We'll move on to Cory Carpenter with JPMorgan.

So I just wanted to dig in a bit more on margins. Maybe relative to the strategic investments you called out last year, was $110 million in the Shareholder Letter. Could you just talk about your biggest priorities this year and how it differs from last year? And then where you expect to see the better leverage to really drive the margin expansion you guided to? And then as a follow-up, you mentioned still for any catch up on the supply side. Could you just expand some around where you're into constraints and your ability to address those in the near term?

Yes. I can take the first one about supply constraints. And then Mike, I'll have you take the question around margins, we'll do a little bit in reverse order. But on supply constraints, we've largely worked through a lot of the supply constraints that we talked about, which were ones that were temporary to the time period that really were COVID-related. We shared in the prior quarters that we had given our warehouse that flexibility with four weeks of additional PTO to be able to stay out of our facilities if they needed to. Now we're in a place where we feel pretty good about our ability to coexist with the threat of COVID in our warehouses. We figured out how to systematize and operationalize and operate safely. While there could be small disruptions in the future, we don't anticipate significant disruption. We've been seeing such great demand on the first Fix side, that we see some elevated wait times, which means that we're a little bit above where we anticipated being. That’s a really nice problem to have. We feel good about our supply-side operations. We feel good about the inventory dynamics and the inventory that we have coming in our doors right now. We've pretty much worked through a lot of the supply side constraints. Now Mike, why don't I have you take the question about margin?

Yes. Cory, I mean, there are a few things. One is, as we referenced, accelerated growth in the back half of the year, so just expected higher revenue numbers against the cost basis that from where we are today. The second is just scale of the business. We continue, as we grow the business, to find opportunities to get leverage in certain cost parts of our business. Scale helps on inventory costs as an example and other parts of our variable expenses. The third is what we referenced on the call, which is just the way businesses like the UK and Kids are scaling and the improvement in contribution margins that we're seeing in those businesses, as they grow. We’re excited about that. As I said, '19 and '20 were heavier investment years; we talked about that with you guys for a long time. We knew '21 would likely be a little bit less, but we also felt like now is the time to continue to invest because of things like direct buy and initiatives that are driving better client experiences.

And from Baird, we'll hear from Mark Altschwager.

I also wanted to follow-up on the marketing backdrop. Maybe first, can you talk about some of the efficiencies you're seeing in the various channels? And maybe how you're feeling about ROIs relative to earlier this summer? And then separately, just given this unique moment here with customers accelerating the adoption of online shopping, many perhaps haven't refreshed their looks in a while given the pandemic and work from home. Just curious if there's any change to your approach to advertising over the fall and holiday this year versus how you've approached it historically? Then separately, just for Mike, when you spoke to leverage, you have the caveat in there that you'll be responsive to opportunities on the advertising front. Curious if your thoughts on that 9% to 11% range have changed at all? I guess you were slightly below the midpoint of that in fiscal 2020. So I'm trying to get a sense of how much of the swing factor that could be in fiscal 2021?

Yes. Thanks for the questions, Mark. In terms of the efficiencies that we're seeing, the efficiencies that we're seeing in June and/or in July and August, this really has been as we've ramped up marketing again. Spending less in June and May was really about capacity and not efficiency. One of the best things about this is that we have such a diverse set of channels to market that we can shift dollars to. We're always looking at ROIs. We're always looking at where we're seeing better ROIs on different messaging and different channels. We will continue to do that. I think there will be a shift that happens in between channels but not significantly. Our message around being able to adjust our messaging and imagery to be right with where customers are today is our goal and that is how we’ll make that shift. Mike, I think there was a second question there.

Yes, Mark, you picked up on it. I mean, and Katrina has talked about it; we will continue to have a very ROI-focused approach to how we're spending our marketing dollars. There’s a chance that we could pursue a higher percentage of sales contribution to advertising based on what we've seen in the competitive landscape, and the contribution margins that we've seen from customer experience that improves the lifetime value of those customers. More to come, but again, it will likely be opportunistic if we're in the market, and we see opportunities to take share on a very comfortable ROI basis.

And that will conclude today's question-and-answer session at this time. I'd like to turn things back to Katrina for closing remarks.

Thank you, everybody, for joining us today. We look forward to keeping you up-to-date on our business in the quarters to come. Stay safe.

And that will conclude today's conference. Again, thank you all for joining us.