Good day and thank you for standing by. Welcome to the Third Quarter Fiscal Year 2023 Stitch Fix Earnings Conference Call. At this time, all participants are in a listen-only mode. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Hayden Blair.

Good afternoon and thank you for joining us today to discuss the results for Stitch Fix’s third quarter of fiscal year 2023. Joining me on the call today are Katrina Lake, Interim CEO of Stitch Fix; and David Aufderhaar, CFO. We have posted complete third quarter 2023 financial results in a press release on the quarterly results 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 results to differ. In particular, our press release issued and filed today, as well as the Risk Factors sections of our annual report on Form 10-K for our fiscal year 2022 previously filed with the SEC and the quarterly report on Form 10-Q for our third quarter of fiscal year 2023, which we expect to be filed tomorrow. Also note that the forward-looking statements on this call are based on 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 press release on our Investor Relations 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 Investor Relations website and a replay of this call will be available on the website shortly. With that, I will turn the call over to Kat.

Thanks, Hayden. Five months ago, I came back as Interim CEO motivated by the opportunity ahead and with a clear understanding of the need to reposition and refocus the company to set ourselves up for success. Today, amidst a challenging macroeconomic climate, preserving profitability and cash flow remain top priorities. Generally, we are focusing on the near term protecting the balance sheet, actively managing our inventory levels, while improving composition and managing the global impact of tightening credit standards on vendors and manufacturers. But we are also mindful of the long-term opportunity ahead and by no means standing still. We understand that focusing on our client is key to success, and we continue to invest in personalization and AI to maximize our long-term potential. We also completed a strategic review of our business operations in Q3, with a critical eye on operational efficiency and effectiveness, while maintaining profitability and cash flow over a longer timeframe as we focus on driving future growth. This was a robust review of our operations and processes across the company to identify areas to enhance the client experience and drive improved business results. One aspect of this review was a full analysis of our network strategy. As we have refocused on our core fixed business, we believe our inventory will be better optimized across a smaller network of warehouses in the U.S. Understanding this, we have developed a three-node strategy that will allow us to more optimally serve the entire country and simultaneously showcase the greatest breadth and depth of inventory to our clients and stylists. This consolidated network will allow us to deliver a better client experience with access to more inventory for a given fix, while at the same time allowing us to operate with lower, more cash-efficient inventory levels. Because of this, we intend to close two additional fulfillment centers in Bethlehem, Pennsylvania, and Dallas, Texas. As we have a lease already expiring in Bethlehem, we are choosing not to renew that. Our analysis has also shown that our remaining three fulfillment centers in Atlanta, Indianapolis, and Phoenix will remain optimal even with a larger client base in the future as we could expand capacity within these locations in the short-term and the long-term. We will undertake a phased approach with the closures to maintain our current high levels of client service. We expect to begin the Bethlehem wind down in Q1 and we will move on to Dallas later in the year. We expect to achieve approximately $15 million in annualized cost savings once the three-node strategy is completed. I want to thank all of our associates and team at the company. We are immensely grateful for your hard work and commitment to our clients. Thank you. Additionally, the continued realities of economic conditions in both the U.S. and the UK have led us to re-examine our geographic footprint. And this morning, we informed our employees in the UK that we are exploring exiting the UK market in FY 2024. In FY 2023, the UK will represent approximately $50 million in annual revenue and negative $15 million of adjusted EBITDA. Though we believe Stitch Fix is a service that will ultimately find success across many geographies, including the UK and Western Europe, today, we are not confident in the path to profitability in the near-term in that market, especially as we prepare for potentially extended periods of complicated macroeconomic conditions in both the U.S. and UK. There are also numerous investments we have made in our core client experience that we have not replicated in our client experience in the UK. Going forward, we would prefer to be investing in our core experience and continue to build it as a more modern, globally capable platform with the ability to scale in many geographies instead of managing multiple tech stacks country by country. We are proud of the UK team and what they have accomplished to date. Consistent with UK law, we will enter into a consultation period with UK employees regarding potentially exiting the UK market prior to making any final decision. While there are a number of moving parts to these operational changes, we know they are the right decisions to make. This review has helped paint a more realistic view of what it will take to change the course of our trajectory, and we have more clarity around the opportunities ahead. We are retooled and refocused on the right metrics that will navigate us through a wide range of macroeconomic scenarios in the short-term and we are setting ourselves up to be in a healthier position for the eventual growth to come. In the meantime, we are committed to continuing to build on our competitive advantages and to further the leadership we have in the space of personalization. We continue to invest in our core client experience, leveraging AI and data science to enable our human stylists, leveraging the advantages of each to further our leadership in personalization and style. For years, we have utilized capabilities in generative AI, injecting scores and language into our personalization engine, and more recently, automatically generated product descriptions. We have also developed and implemented more advanced proprietary tools, such as outfit generation and personalized style recommendations that create a unique and exciting experience we believe is unmatched in the market. A new area we have enhanced our AI capabilities in is our inventory buying. We have historically utilized a number of tools to make data-informed decisions with our inventory purchases. Now, directly leveraging our personalization algorithms, we have developed a new tool that creates an exciting paradigm shift, which will utilize client-level insights to drive company-level buying action. We expect the clarity of demand signals at the individual client level to drive more proactive and efficient inventory decisions as a company. And because of this, we expect to see higher success rates on fixes and drive increases in keep rates and average order value over time. This backend personalization will also allow us to more effectively tailor the depth and timing of our buying decisions, so it will allow us to buy the right inventory in the right amounts at the right time. Early testing of this approach compared against our existing buying tools has shown a 10% lift in keep rate and average order value, and by the end of Q1, we expect 20% of all purchase orders created to be algorithmically informed. We will continue to scale adoption throughout the year and we are excited about the capabilities. It remains a clear example of how we continue to lean into data science and AI to further our differentiators and drive long-term success. Ultimately, we are continuing to build a business that is truly differentiated and we want to lean into these areas of differentiation by investing in capabilities that will both improve the customer experience and prioritize profitability in the short-term. I'm excited about the work we have done. Understanding the work that we have to do and continue to believe we are taking the necessary steps to set the stage for healthy growth in the future. With that, I'll turn it over to David for a deeper dive on the financials.

Thank you, Kat, and hello to everyone on the call. Fiscal Q3 results exceeded expectations. Revenue came in at the high end of our guidance range at $395 million, down 20% year-over-year and 4% sequentially. Consistent with some of our retail peers, we saw strength during February and March, but did see increased macroeconomic headwinds in April. Net active clients in the quarter declined 11% year-over-year and 3% sequentially to approximately 3.5 million. While our overall average order value is holding relatively steady year-over-year, similar to Q1 and Q2, our analysis shows that all client cohorts are spending less than in prior years, and we expect this trend to continue in Q4. Q3 gross margins expanded 150 basis points quarter-over-quarter to 42.5%, due to improved inventory composition and less promotional activity in the quarter. We continue to expect gross margins to be around 42% for the fiscal year, and are actively focused on improving gross margins with opportunities to improve product margin, transportation efficiency, and inventory efficiency over time. The network strategy initiative that Kat highlighted in our comments is a good example of that focus. Net inventory ended the quarter at $152 million, down 5% quarter-over-quarter and down 29% year-over-year. We do expect overall inventory levels to decline in Q4 as we continue to manage inventory closer to demand and revise our assortment strategy to better align with our core experience. And this alignment may take several quarters to optimize. Advertising was 7% of revenue in Q3. While we continue to see customer acquisition costs declining year-over-year, we did see an increase quarter-over-quarter due to seasonality in our growth marketing channels and an increased focus on driving brand awareness. This was partially offset by strong re-engagements in the quarter, which were up 34% sequentially and 24% year-over-year. We expect to maintain similar levels of advertising spend in Q4. Q3 adjusted EBITDA came in ahead of our outlook at $10.1 million, due to the continued realization of cost savings in FY 2023 and tight ongoing cost controls. And finally, we once again generated positive cash flow this quarter, delivering $21.9 million of free cash flow in Q3. We continue to feel good about our strong balance sheet and ended the quarter with over $240 million in cash, cash equivalents, and highly rated securities, and no bank debt. Moving on to the outlook. For Q4, we expect revenues to be between $365 million and $375 million reflecting a relatively similar trajectory to what we saw in April. We expect adjusted EBITDA for the quarter to be between $0 and $10 million, largely reflecting the impact of our implemented cost structure initiatives on a sequentially lower top line. Going forward, we will continue to focus on profitability in the short-term, while maximizing our long-term potential. As a reminder, we have already completed $135 million of cost savings initiatives in FY 2023, and the proposed initiatives that Kat discussed earlier will drive an additional $50 million in annualized expense savings. We are mindful that we've been profitable at different revenue levels in the past, and we are making the tough decisions now to endure a wide range of possible macroeconomic scenarios. Over time, we expect the investments in improving our client experience along with the increased leverage in our P&L will enable us to establish a healthy base on which to grow. With that, I'll turn the call over to the operator for Q&A.

Thank you. Our first question comes from Youssef Squali with Truist Securities. You may proceed.

Yes. Hi, guys. Thank you for taking the questions. I have a couple of questions. Maybe just a high-level question. Kat, you touched a little bit on this in your prepared remarks. As you look at the long-term opportunity, you're obviously making a lot of changes, refocusing on core fixed business, pulling out of the UK. How should we be thinking about just the way you think about the addressable market as we look at the number of addressable customers? I think you have now 3.4, 3.5 million active clients. Realistically, with this new strategy, maybe just talk to us a little bit of how you kind of size up the market? And then in terms of AI, can you just remind us of basically what are kind of low-hanging fruits ahead of you that you believe you'll be able to realize maybe on the search side on the curation side and over time how do you think AI will ultimately impact the business? So, those are two questions. Thank you.

Yes, great. Thank you for the great questions, Youssef. Firstly, on the long-term opportunity, I feel super excited and optimistic. I think a lot of the strategy right now is focusing on the core, our differentiators, and on the things that we know that we do best, which is really this human-in-the-loop styling of being able to combine the best algorithms with our human stylists to deliver an experience that's truly differentiated. So, to be able to spend this time stabilizing the business while still pushing forward in the areas where we really believe we have long-term competitive differentiation, that's kind of a high-level view of how we're thinking about the business right now and we are really excited. In terms of the addressable market, we continue to feel optimistic. As we think about some of the capabilities that we're really pushing on, which are at the intersection of AI, this is a good link to your question. One of the things that I love about our experience is that we have generative AI in a visual format. The outfits we showcase in our app take into account user preferences along with what we know they own in their closet. To continue enhancing this technology, we can provide users with much more value in their experience with Stitch Fix. This is an example of a capability that aligns with our data and personalization strengths and is unique to us. It could also appeal universally as many people want access to advice on how to wear clothing. As we innovate and invest in AI, we're ensuring these features will add value to a broader universe of clients. We are really excited about those capabilities and look forward to advancing our plans.

Okay. Great. Thank you, Kat.

Thank you. Our next question comes from Simeon Siegel with BMO Capital Markets. You may proceed.

Thanks. Hey, everyone. Hope you're all doing well. Can you quantify any impact with P&L maybe last year, just give us context, how many active clients are there, maybe revenues, EBIT pressures, however you want to help us understand to contextualize that? And then maybe also share what you think P&L impacts might be from closing the two distribution centers? Thank you.

Yes, I'll have David share more color there.

Yes, Simeon, thanks. A couple of things. First on the UK, just a reminder that this is still a proposal, and so there's no decision that's been made. But just size and shape, I think Kat called out that this year, it's around $50 million in revenue and about negative $15 million in EBITDA. If you do the simple math of flow-through, that means there's about $35 million in SG&A expense in the UK. So that's sort of the high-level P&L for the UK. Then on the second question was the distribution centers. With this, it would be about an annualized savings of $10 million to $15 million. It's more of a timing question of ensuring that we do this in a client-friendly way that does not impact the client, which is why we're phasing the closings. And so, savings in FY 2024 would be smaller than that.

Great. Thanks. And then Kat, any color on just anything you're seeing trade down-wise, just thinking about the broader promotional environment out there?

Yes. It's a great question, Simeon. Honestly, we've talked about it a lot internally and we have a wide range of price points. We have items that are in the 20s all the way up to $100. We closely monitor macroeconomic softness, and we've seen customer acquisition being more challenging. However, we've seen more strength in AOV than anticipated. Our strategy is to maintain a broad range of price points to meet the customer where they are. So, we feel very prepared to do that, though we haven't seen significant trade down yet; however, we are keeping an eye on it.

Great. Thanks a lot, guys. Best of luck for the rest of the year. Hope you have a nice summer.

Thank you. You too.

Thank you. You too.

Thank you. Our next question comes from David Bellinger with ROTH MKM. You may proceed.

Hi, thanks for the question. First one, on the inventories and the greater depth available that was mentioned in the release, can you quantify the improved access to inventory for your stylists? And is there any way to frame up how much that's improved from Q2 to Q3? And how much further work needs to be done in order to open up inventory access more fully to the stylist base?

Thanks, David. If I can clarify, are you speaking to the part where we talk about the network? I want to make sure I'm understanding this specific question.

Yes, that's correct.

One of the things as we took a fresh look at our business is that as we think about a styling-first model and channeling clients through a funnel where we are collecting the right preferences for personalization, that model depends on having co-located inventory. Historically, we have had five and even six warehouses at different points. When we spread the inventory across a broader network, it creates pockets of good and challenging inventory. If someone approaches a stylist with a specific request, if we don’t have density of inventory and breadth and depth, it makes it potentially harder for a stylist to meet client-specific needs. Therefore, consolidating our warehouses into three nodes will not disrupt our service, but can enhance our ability to meet the specific requests of our clients and ultimately our stylists' needs.

No. That's perfect. It's very helpful. And then it's my follow-up. Could you talk a bit more about some of the April trends? Is there anything specific you can point to that stood out as you exited the quarter? And can you clarify on the Q4 guidance? Is that consistent with the deceleration you saw later in the period? Is there anything you can comment on regarding quarter-to-date revenue growth? Just would help us in our models.

Yes. David, do you want to answer that?

Yes, David. For April, it wasn't about AOV or pricing that tended to hold steady. We saw macro headwinds around volume, similar to what we've heard from our peers. We saw strength in February and March, which tailed off in April. That is included in our guidance for Q4 as well.

Understood. Thank you very much.

Thank you. Our next question comes from Trevor Young with Barclays. You may proceed.

Great, thanks. First one, just on the reduced distribution center footprint, as that plays out into next year, should we contemplate some further thinning of your inventory on the balance sheet? I'm trying to get a sense of, should inventory continue to decrease a little bit or are we now at a level set on inventory, considering the breadth and depth of what you were talking about, Katrina, that we're right at the right levels here? And then David, just a housekeeping one, just that commentary on advertising, maintaining similar levels of spend in 4Q, did you mean that as a percentage of revenue or in absolute dollars?

Thanks, Trevor. David, do you want to take both of those actually?

Sure. I'll answer the second one first, because that's a quick one. Advertising is a percentage of revenue. We expect that to be similar to the 7% of revenue we saw this quarter. Regarding inventory, there's two things to think about. First, the work that we're doing with the teams really focuses on composition and core experience. That's helping us focus our inventory, and the teams have chased hard into Q4 to curate relevant inventory for our clients. As a result, we expect inventory to decline in Q4. With the closures, that could have additional impact or benefit; the key is to ensure we have the right inventory that matches density and availability for our stylists. We expect inventory turns to increase over time.

Great. Thank you.

Thank you. Our next question comes from Tom Nikic with Wedbush Securities. You may proceed.

Hey, and good afternoon. Thanks for taking my question. So, I know you've done a lot of work to right-size the cost structure of the business, but ultimately, at some point, the top line needs to inflect, and some of the customer attrition needs to ease up and customer accounts need to start rising again. How do we think about potential bottoming of the customer base? Do we think maybe next year customer accounts could start rising again? Or is there more normalization needed, and how do you go about driving a reacceleration of the top line and customer count?

Thanks for the question, Tom. Yes, we totally understand that, and that is our focus. We are focused on cash flow, profitability, and ultimately thinking about longer-term growth. Today, we're focused on efficient marketing spending. We want to prepare for a wide range of macroeconomic outcomes. There are good pockets of data here and there, but as mentioned, April was tougher. We need to be prepared for whatever that means. This business has strong profitable economics, and we've been profitable at lower revenue levels. We aim to stabilize our business and do the right things now to position for growth. We can't provide a specific timeline for when we expect an inflection, but we believe we're taking the necessary steps to set up that growth.

Thanks, guys. Appreciate the color.

Thank you. Our next question comes from Dana Telsey with Telsey Advisory Group. You may proceed.

Hi, good afternoon, everyone. Kat, as you think about what categories worked, what are you seeing in categories? Is there a category realignment you expect to manage the business on given the reduction in distribution center space that you expect Stitch Fix to be known for and what you're seeing in terms of some of this on the subscription model? Lastly, how are keep rates? What are you seeing in the past towards enhancing the customer experience and how is that moving along relative to your plans? Thank you.

Yes, great questions. On the assortment, we're seeing success in the men's side with short-sleeve woven items and across the board, while in women's business, fitted dresses have been a strong performer. We've seen success in dresses that were historically underpenetrated. People are eager to go out and engage, reflected in our business. The consolidation of warehouses enables us to serve a broader variety, as we historically over-indexed in items such as tops. This allows us to serve a wider assortment to clients, hitting underrepresented categories more effectively. In terms of keep rates, as David mentioned, our AOV has been stable even amid macro conditions. We're leveraging algorithms not just for insights but to actually drive our buying decisions, which is exciting as we see new products entering our warehouses.

Thank you.

Thank you. Our next question comes from Ashley Helgans with Jefferies. You may proceed.

Hi. Thanks for taking our questions. First, just any color on the declines in active clients? I know in the past you've talked about targeting marketing to reactivate clients. Any update on how that's progressing? Thank you.

Yes. Thanks for the question. On active clients, we were down 97,000 quarter-over-quarter, around 3%. We saw higher gross adds compared to Q2 due to increased acquisition spend and strong re-engagements, which were up 34% sequentially and 24% year-over-year. We continue to expect active clients to be negative in Q4 as we are still experiencing impacts from prior high client dormancy. Last year in Q3 and Q4, we spent over $50 million each quarter on marketing, much of that focused on the 'Freestyle first' client acquisition.

Great. Thank you so much.

Thank you. Our next question comes from Edward Yruma with Piper Sandler. You may proceed.

Hey, guys. Thanks for taking the question. I guess first a housekeeping question. I know the stock-based compensation is down pretty significantly year-over-year, but less so on that trailing nine-month basis. Is this kind of the trend we should think about going forward? Then, Kat, just a bigger picture question: do you think you need a more supportive macro to bring the business back to growth? Or do you think you have the levers and tools today that even if macro remains tough you could try to drive that client growth in the medium term?

Thanks, Ed. I will take the second question, and then maybe David you can address SBC. It's a great question. We know the macro has an effect on our business. That being said, it’s hard for us to quantify, and spending too much time quantifying it isn’t necessarily productive. There are opportunities, and we are currently working on our strategic plan for the next fiscal year, identifying clear opportunities to deliver better experiences and more compelling value propositions. We believe, regardless of the macro, we can pursue actions to positively impact our business and clients. We want to be prepared for a range of potential macroeconomic conditions over the next 12 to 24 months.

On the SBC side, this quarter we came down from last quarter, around 12% down from last quarter and approximately 28% down year-over-year. The current level is probably the right level from a near-term perspective, and we want to leverage this in alignment with our cost structure.

Thank you. Our next question comes from Lauren Schenk with Morgan Stanley. You may proceed.

Great, thanks. I just wanted to dig a little deeper into your comments about investing more around AI, just any incremental color you can share there? And then just bigger picture, how are you thinking about AI as a competitive threat, whether that be personal assistance, etc. over the coming months and years? Thanks.

Yes, thanks, Lauren. We could probably spend an entire hour on this. So, let me share a few highlights. AI has been part of our story since the beginning. We've used data science and machine learning to power our business. There's real competitive differentiation we've established over ten years that benefits us now. Many are looking into this space, but we plan to have the best of both worlds. We have technology teams developing an AI roadmap as part of our strategic plan for next year, combining off-the-shelf advancements with our proprietary data which has been built for over a decade and is highly predictive. We’re excited about opportunities to leverage AI capabilities, like inventory buying, where we use individual-level data to optimize our operations, allowing us to enhance the client experience and drive better outcomes for our business.

Great. Thank you.

Thank you. Our next question comes from Aneesha Sherman with Bernstein. You may proceed.

Great. Thank you. There have been a lot of ups and downs in the last few years, but if we rewind back to pre-COVID levels in February 2020, you had about 3.5 million active customers—kind of the same number you have now. You seem stronger today with higher awareness levels, better customer data, better algorithms, and broader assortment. Why are those same 3.5 million customers generating lower total revenue? What's different about their behavior? Are they buying lower-priced items? Are the keep rates different? Can you help us contextualize what is different compared to pre-COVID?

It's hard without precise data from you, but at a high level, we’ve seen client engagement decline from those brought in during the freestyle approach. Clients from Freestyle do not generate the same revenue and engagement as our traditional consumers, partly due to insufficient data collection during those days. The good news is, we’re regaining traction and investing in algorithms to enhance buying experiences. This is a paradigm shift from pre-COVID practices. We’re confident moving forward as we strive to usher our clientele back into active engagement with our services.

Aneesha, I want to add one more point related to the client tenure. Although we have the same number of clients, there's a different mix from a client perspective. Clients tend to be more active earlier in their lifecycle until it stabilizes, and that is certainly one of the factors.

Okay. That's really helpful color. To follow-up, based on your earlier comment, you're seeing higher churn for your newer cohorts than for your older cohorts?

Not necessarily the newer cohorts, it's more specifically those Freestyle first clients that we were bringing in. Those are certainly some of our newer clients, but they're a specific cohort, and for that cohort, we're definitely seeing higher churn rates.

Thank you. And this concludes today's conference call. Thank you for participating. You may now disconnect.