Stitch Fix Inc (SFIX) 2020 Q3 法說會逐字稿

Good day, everyone. Welcome to today's Stitch Fix Third Quarter 2020 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn things over to David Pearce, Vice President of Investor Relations. Please go ahead.

Thank you for joining us on the call today to discuss the results for our third quarter of fiscal 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 are joining you remotely today from our home offices, and we apologize for any technical difficulties this may cause.

We have posted complete Q3 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 the 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 thanks for joining us. After the market closed today, we issued our quarterly shareholder letter with more details on our results and strategy, which I encourage you to read.

Before we dive into the quarter, I first want to acknowledge the context in which we are speaking with you all today. The distressing events in the past few weeks are top of mind for everyone here at Stitch Fix, as I'm sure they are for you, your families, loved ones and communities as well. We have a long and hard road ahead and much work to do to create an equal and more just society. What has given me hope during this time is to see our employees stand up for what is right and to have a strong set of values to lean on as we navigate through this together.

With that, I'm pleased to share our third quarter results with you today and to share how we're navigating the effects of COVID and to provide an update on the resilience of both our clients and our business as we look to Q4. Now, more than ever, we are confident in our ability to redefine how clients shop and find what they love. As consumers rapidly shift their purchase behavior online at a step-change to historic rates, we believe our model will outperform and continue to take share, which we began to see play out in Q3 and in the early weeks of Q4.

While much of apparel retail declined by 80% in recent months, we saw only a 9% year-over-year dip, thanks to the resilience of our large auto-ship client base and the strength of direct-buy, even while we faced extreme capacity gaps across our network tied to COVID, which I'll discuss in a few minutes.

These results and the momentum we've seen in April and May strengthened our belief that the context of trying on clothes from the comfort of your own home has never been more resonant and that an offering that can predict great fit and styles you will love is needed more than ever.

With that, I'll turn to our results. In Q3 '20, we generated net revenue of $372 million, a decline of 9% year-over-year. Excluding the impact of our warehouse disruptions from COVID, we believe that we would have generated positive year-over-year revenue growth in Q3. We delivered a net loss of $33.9 million and an adjusted EBITDA loss of $40.3 million. Our adjusted EBITDA, excluding SBC loss, was $20.7 million.

During the quarter, we grew our active client count to 3.4 million, an increase of 285,000 clients and 9% year-over-year. In addition, we grew net revenue per active client by 6% year-over-year, our eighth consecutive quarter of growth and a reflection of our ability to deliver value to our clients.

We believe this is a very strong signal that speaks to the resilience of our Fix offering, the complementary early momentum in direct-buy and that both deliver value to clients as part of our highly personalized offering.

Before I get into the details on our quarter's performance, I have a few reflections on how we are seeing the industry evolve and what that means for us. It has obviously been an incredibly challenging time for most players in the broader apparel industry. In a matter of weeks, we saw a rapid and dramatic change in consumer behavior, with people spending more time than ever at home, limiting their immediate needs for workwear and the latest trends and having very limited access to apparel in stores.

This has led to more shopping done online, with 20% of consumers who had not previously bought apparel online doing so for the first time in March and April. However, the most significant result of the change in consumer behavior will be the aggressive and accelerated share shift to online from traditional brick-and-mortar retail where nearly 80% of U.S. apparel retail dollars historically have been spent. Even as stores begin to open up, balancing health and safety measures will challenge consumers' receptiveness, the exact feature that people loved about stores. Many consumers will continue to stay at home for all nonessential purposes, while others who have never bought clothes online will try and will be seeking better ways to buy apparel online and to surface styles just for them. Our model addresses all of these needs and is a solution that will sustain and enable consumer style preferences in a world with far less ability and appetite for physical retail shopping.

While our store-based competitors retrench in the face of negative comp sales and store closings and pull back their capital investments, we are leaning in and investing in new capabilities like direct-buy and automation that position us to take greater share in our near future. In particular, given the momentum we've witnessed with direct-buy and the frictionless entry point we think it represents, we plan to make it accessible to new clients as an acquisition vehicle in the coming months.

With that, I'll spend a few minutes discussing the quarter, mainly the strength we saw in the first half, how we effectively navigated COVID-related warehouse constraints in the back half, and ultimately, our business momentum entering Q4. We think it's important to share this level of detail this one time as we navigate this evolving business environment.

First, I'll start with the distribution side of our business where we had the majority of our COVID-related challenges in Q3. To set the stage, we had a strong start to the quarter. From February through the second week of March, momentum across our Fix and direct-buy offerings resulted in net merchandise revenue growth of approximately 20% year-over-year. Throughout that time, COVID's growing global impact had been in the headlines. So we were pleased to see such strong ongoing client engagement and momentum and healthy demand for our model.

However, by mid-March, in connection with the declaration of a pandemic and states and counties issuing shelter-in-place orders, our focus became that of our employees' health and safety and ensuring we put appropriate measures in place. As such, in the third week of March, we closed our facilities in South San Francisco; Dallas; and Bethlehem, Pennsylvania, meaning that we could not fulfill client orders from half of our U.S. warehouses, which resulted in a Fix and direct buy backlog. By the end of March, our U.S. warehouse capacity had fallen by nearly 70%, with our backlog doubling week-over-week in the last 2 weeks of March.

In conjunction with these government orders, we felt it was the right decision to give our warehouse associates up to 4 weeks of paid leave to take care of their families and get flexibility. While that resulted in higher near-term costs to support our people, we're pleased that this investment helps bring our teams back with strength and resolve for our vision and mission.

As March concluded, we began to reopen our previously closed facilities to start shipping Fixes and serving our clients again. Upon reopening, our distribution centers were staffed on an opt-in basis, which we believe was the employee right approach, but also meant that we had fewer associates in our warehouses, reducing fulfillment capacity. Over the course of April, these participation levels improved, resulting in higher fulfillment capacity and accelerated net merchandise revenue. By the end of Q3, associate participation, warehouse capacity and net merchandise revenue had all shown meaningful improvement with week-over-week growth in each of the final 4 weeks of the quarter.

As we exited Q3, we were at roughly 2/3 capacity, but also had an aggressive game plan to ensure we drove continued operational improvement throughout the course of May. We're pleased to share that as of today's call, we've effectively executed against our strategy and are approaching full capacity. With this capacity, we're tracking to eliminate our fix backlog by the end of June, putting us in more of a position to play offense in the coming quarters.

With that, I'll provide an update on what we saw from clients in Q3. In aggregate, we saw healthy client demand throughout February and March with some softness in late March that we attributed to a temporary shift in consumer mind share as the COVID crisis escalated. Since then, we've seen resilience across our client base, especially among our auto-ship and direct buy clients.

First, on auto-ship, the large majority of our clients choose to receive Fixes on a recurring basis, whether it's every 2 to 3 weeks or on a monthly or quarterly cadence. This provides us with tremendous visibility into forecasting demand trends, buying into inventory and aligning our styling and warehouse workforces to fulfill that demand. In today's challenging macro backdrop, these auto-ship advantages are very apparent and very valuable. In Q3, we saw resilience from this large contingent of loyal and highly engaged clients. In particular, auto-ship opt-out rates, which help us to gauge how well we're serving clients' needs, were remarkably strong and consistent throughout the first half of the quarter.

In March week 3, we saw an uptick in opt-out rates, which began recovering the very next week. And by late April, we achieved the strongest levels of auto-ship retention in the last 3 years. We believe that this level of commitment and engagement from the vast majority of our clients - built for strong personal and ongoing relationships - is evidence that our business model is one that will sustain and thrive.

Transitioning to new and manual Fix clients, as we noted in our April investor update call, we saw lower conversion trends from these client groups in mid-March, which we believe was tied to heightened COVID-related uncertainties. While we saw more consumer optimism in the weeks that followed, we chose to pull back on marketing to avoid driving client demand into our fulfillment-constrained environment. We also turned off a feature that prompts clients to order another Fix post-checkout, which typically comprises nearly 1/4 of our manual Fix request volume. Following Q3, we have turned this manual Fix feature back on, and we have also begun to ramp up our marketing spend to capitalize on improving consumer optimism in the quarters ahead.

Turning briefly to direct buy. Even in this incredibly challenging Q3 macro environment, the offering showed no sign of abatement and outpaced our pre-COVID expectations in February, March and April. Its low commitment and low friction path to a personalized shopping experience represents an important gateway to Stitch Fix, and we saw this play out in the quarter with robust client engagement, very low return rates and elevated checkout volumes. We see direct buy as a cornerstone of our future experience, complementing our Fix experience for more intent-based and impulse purchases that are highly personalized to each of our clients.

In summary, we've been very pleased to see the resilience of our auto-ship and direct buy clients, and we're encouraged more broadly by the fact that week-over-week, demand trends improved every week in April and continue to strengthen in Q4. We're excited to redeploy marketing dollars in the months ahead to capitalize on these trends among existing and new clients.

With that, I'll hand it over to Elizabeth to provide an update on all of the exciting progress and momentum we're seeing in direct buy as well as across our broader company evolution.

Thanks, Katrina, and hello to all of you on the line. To those I have not yet had a chance to meet, I look forward to connecting in the quarters ahead and could not be more excited to have joined Stitch Fix for this exciting next chapter of our evolution.

Our model is highly differentiated in the ease and personalization we deliver to consumers. And with the major dislocation we are seeing right now in retail, we have the opportunity to dramatically accelerate share shift to Stitch Fix. We believe that more than $30 billion will rapidly shift online, which is 3x what we would typically see in 1 year. And we anticipate we will get more than our fair share of this, given the relevance of our model, particularly with the expansion of direct-buy in addition to continued enhancements to our Fix offering.

Today, I'll discuss a few of the ways we're planning to capitalize on this market opportunity by accelerating direct buy, evolving our Fix offering and flexing our approach to inventory management. Together, these elements foreshadow the key pillars of our evolution as a brand, and we believe they create a differentiated flywheel to fuel our growth and reduce the working capital requirements to grow revenue.

First, as Katrina touched on, we believe that direct-buy represents a step-change in our ability to further penetrate our addressable market and expand the way we serve our clients by meeting their needs for additional purchase occasions. As a reminder, our integrated direct buy offering allows clients to shop and select items they love based on our hyper-personalized recommendations directly from our website or mobile app. This offering was made available to all of our active Fix clients in Q3. We're very encouraged by its early success, especially given how nascent and imperfect the offering is. And yet in Q3, we still saw direct buy revenue more than triple quarter-over-quarter with consistent momentum every week throughout this time period. In addition, direct-buy's penetration of our existing base of women's clients grew from 5% in February to 13% in May.

I'll add that our testing has shown direct-buy spending to be highly incremental to Fixes. This signals the strong product market fit that this highly personalized shopping experience delivers. This momentum also supports our belief that there is an ongoing structural shift in retail resulting from COVID and that our hyper-personalized experience will be an essential way to support clients in this new normal.

In light of this, we've been aggressively hiring additional engineering talent as well as shifting a subset of our engineering team to building the product experience. We believe direct-buy provides a lightweight entry point for both existing and new clients and complements our Fix offering as a highly personalized avenue for window shopping and seeking out specific purchase needs and impulse buying. So we have leveraged this talent to add flexibility across the product.

First, to date, direct-buy has showcased highly personalized recommendations to clients based on past items they had purchased. In an effort to move direct-buy closer to becoming a client acquisition vehicle, in early June, we introduced the beta for a new offering. This new offering, which we call Trending for you, removes the purchased item requirement and instead allows men's and women's clients to shop hyper-personalized looks based on their style profiles. This change creates more shoppable looks, meaningfully expanding the breadth of items from which clients can choose to purchase and removes the requirement that clients have purchased with us in the past.

Also, later this month, we will launch another collaboration with fashion influencer, Katie Sturino, in which we will offer a curated assortment through direct-buy from which both new and existing women's clients can shop. The assortment will be styled into shoppable outfits with items from our broader inventory pool, showing that we can put items into the context of an outfit that is personalized to each individual client. This collaboration, which is focused on size inclusivity, will serve as a testbed for us to expand the types of looks we show clients and has the potential to create marketing hooks to acquire new clients as we team up with brand partners, influencers and showcase our own exclusive brands.

As part of this more expansive way for clients to interact with direct buy, we also developed a new onboarding experience, which lays the foundation to onboard future clients directly into all types of direct buy experiences such as athleisure or date night that are personalized to each of our clients.

Trending for you and our influencer collaboration are prime examples of how we're adding flexibility to the way clients can experience direct buy and to more effectively attract new clients. In addition, we believe it can fuel conversion among clients who have historically been on the fence. Over the years, we've had a large number of prospective clients complete our style profile and provide us detail on their size, fit and style preferences, but who have not yet converted to scheduling a fix. We believe these high probability clients as well as dormant clients who've received past Fixes offer exciting conversion and reengagement opportunities through direct buy and we plan to begin more aggressively targeting both groups in the months ahead.

Our investment in innovation goes beyond direct buy as well, as we've also begun evolving our Fix offering and expanding our approach to carrying inventory. This set of priorities we believe are critical pillars to expand our offering and to do so with a more capital-light approach to bringing consumers what they love.

On Fixes, we have pilots in sites in both the U.S. and the U.K. that provide clients with increased stylist engagement and the opportunity to select items in their Fixes. These pilots have shown promising early results, including higher keep rates. We are enabling clients to engage directly with stylists to efficiently select the anchor items of their Fix and identify other ways they'd like stylist support.

We will share more in the quarters ahead on this. We believe this enhanced styling experience will appeal to an even broader set of clients as consumers seek high-touch engagement while not going into stores. The feedback data collect from this experience with stylists is a good example of how our Fix and direct buy offerings have formed a virtuous cycle of feedback, which benefits our clients and our business. Through these few complementary offerings, we enable different purchase occasions, one that is often tied to recurring purchases on flexible cadences with a clear surprise and delight and the other serving more lightweight and immediate client needs for higher intent shopping as well as impulse purchases. We think our ecosystem of experience will help us fill on growing gap in the market as consumers hesitate to shop the way that they have in the past.

Lastly, from an inventory standpoint, we believe that the current backdrop provides us with a unique opportunity to lean in to new inventory models to drive better client experiences and business results. We've begun to incubate different models to make inventory available to our clients, while also tying up less working capital as we expand in order to deploy investment in other areas to enable our growth. The early learnings and added flexibility we gain from these will inform our strategy around implementing a more meaningful evolution to our inventory management practices.

As you can see, we're actively driving innovation across our business, which is a reflection of all of the opportunities that lie ahead for Stitch Fix. While other retailers are currently forced to pull back on investment and innovation, we're leaning in and executing against our product road map in ways that we believe will accelerate our gains in the future.

With that, I'll have Mike share more on our financial performance and outlook.

Thanks, Elizabeth, and hello to everyone on the line. First, I'd like to share color from the quarter.

In Q3, we generated net revenue of $372 million, a decline of 9% year-over-year, driven largely by our COVID-related fulfillment challenges across our U.S. network. In connection with our capacity constraints, we also spent less on advertising during the period, which we believe reduced client demand.

We grew active clients to 3.4 million, an increase of 285,000 clients and 9% year-over-year. Net revenue per active client grew 6.5% year-over-year, representing our eighth consecutive quarter of growth. Note that the net revenue per active client calculation is based on the last 4 fiscal quarters and benefits from the extra week in Q4 of '19, while active clients is measured over 52 weeks. The 53rd week contributed approximately 2% to net revenue per active client.

Q3 gross margin was 40.8%, 430 basis points lower than Q3 of last year. This was largely driven by COVID as we increased our inventory reserve as well as higher clearance rate due to top line softness. Partially offsetting this was continued favorability in merch costs.

Q3 advertising was $37.8 million, a decrease of 25% year-over-year compared to Q3 of '19. This reflects our pullback on marketing of approximately $17 million in the quarter, which we plan to deploy in future quarters. Other SG&A, excluding advertising, was 43% of net revenue in the quarter, reflecting investments in talent as well as expenses related to offering our warehouse associates 4 weeks of paid leave to ensure they stayed safe and healthy.

Q3 adjusted EBITDA loss was $40.3 million, driven by softer top line performance largely related to fulfillment constraints, lower gross margins, our additional variable labor expenses and investments in technology talent. Adjusted EBITDA, excluding SBC loss, was $20.7 million. Our Q3 net loss was $33.9 million and diluted loss per share was $0.33.

We ended Q3 with 0 debt and $329 million in cash, cash equivalents and highly rated securities. While I'm discussing our balance sheet, I'd also like to announce that in early June, we closed a $90 million revolving credit facility, further strengthening our liquidity position. As we've shared throughout this call, we are looking for opportunities to play offense, given what we're seeing across the broader landscape, and having this additional capital puts us in a better position to do just that.

Now to our outlook. While we continue to see momentum across our business, there are too many variables at play to speculate on specific guidance ranges in Q4. Instead, I'd like to provide an update on specific trends we've seen play out so far in the quarter and give additional color to help frame how things might evolve. First, I'll discuss top line trends, and then we'll move down the P&L and provide updates. Again, while we do not want investors to interpret this as providing guidance, we do want to share color around the ongoing momentum we're seeing across multiple areas of our business.

First, our top line performance, we've driven meaningful improvement over the past several weeks. In April, our net merchandise revenue grew week-over-week each week. In May, that momentum continued as we delivered positive year-over-year growth in net merchandise revenue compared to May of 2019. We see this return to positive growth in May as an important milestone and one that reflects the resilience of our U.S. warehouse network, ongoing improvement in client demand and early momentum resulting from a much larger migration of retail spend online. As a result, we expect these trends will continue and that we'll deliver positive year-over-year net revenue growth in Q4, adjusted for the impact of the 14th week in Q4 of '19.

Shifting to gross margin. While our Q3 margin was largely suppressed due to the effects of COVID, we entered Q4 with a more balanced inventory portfolio that was aligned to our top line expectations and client preferences. As a result, we expect to increase our Q4 gross margins by 200 to 300 basis points quarter-over-quarter.

From a marketing standpoint, we've begun to ramp up our Q4 marketing to capitalize on the improved CPA trends we're seeing and a growing demand for our offering. We are optimistic that our healthy warehouse capacity levels will allow us to deploy our marketing to capitalize on these trends. On SBC, our outlook remains in line with what we've shared in past quarters as we continue to invest in technology talent to expand our capabilities and enhance our digital experience.

Excluding advertising and SBC, we expect other SG&A as a percentage of revenue to lever quarter-over-quarter. This will largely be driven by variable labor efficiencies and the reduction of onetime costs we incurred in Q3 associated with COVID. More broadly, we continue to look at costs, the way people work and the places they're working, and we are committed to driving more leverage in the model over time. Translating all of this to EBITDA, we expect adjusted EBITDA, including SBC, to be negative in Q4 and for EBITDA, excluding SBC, to return to positive levels.

Lastly, on cash flow, as our business has improved, we now expect to generate positive free cash flow in Q4. We believe that our ability to quickly shift back into driving healthy free cash flow demonstrates the strength of our unit economics and reinforces the confidence we have in our growth investments, which continue to scale and strengthen. As we look back at Q3, we're proud of the way our team responded quickly and thoughtfully to unprecedented challenges and the decisions we made to support the health and safety of our employees during these difficult times. As we look ahead to Q4 and beyond, we believe our strong business model and balance sheet uniquely position us to thrive, and we're excited to demonstrate that in the quarters ahead.

With that, we're now ready for your questions. Operator, I'll turn it over to you.

(Operator Instructions) We'll hear first today from Edward Yruma with KeyBanc Capital Markets.

Hopefully, you and your families are staying safe during this time. Estimates of existing inventory on the balance sheet, I know that you did see an impact on third quarter gross margin, you're seeing benefit in fourth quarter quarter-over-quarter. But have you reserved against existing inventory? Do you expect to dispose of it in traditional channels? And then kind of a bigger picture question. You talked a lot about share shift to e-comm. As you think about direct-buy, I know it's still early, but what percent of your overall business do you think this will approximate over time?

Thanks, Ed. Thanks very much for your questions. I think we'll have -- Mike, why don't we have you talk a little bit about inventory on the balance sheet and gross margin. And while we probably won't share exactly what we're expecting on the direct-buy side in terms of percentage, I think Elizabeth can share some more color.

This is Mike. Yes, I mean, the strength of the balance sheet is something I'm really proud of. And again, we referenced kind of return to free cash flow positive levels in Q4. We do reserve against inventory -- existing inventory. We changed the methodology a little bit to represent the current thinking and what we're seeing kind of in our inventory levels going into Q4 and into next year. That being said, I think to talk about -- what I talked about in terms of gross margin improvement quarter-over-quarter gives me a lot of confidence going into Q4 that our inventory is at the right level to serve our clients and to have gross margin improvement and get back to the gross margin levels that we've been -- that you've historically seen from us.

Great. And then I'm happy to chime in on the direct buy front. I mean, I think one thing to keep in mind is the distinction between Fixes and direct buy is a very natural way to talk about things, just because that's how our business is evolving. But I think over time, we'll see a lot of that becoming a gray area and blurring between the 2. I mean, ultimately, what we're doing is we're creating a full suite of personalized shopping experiences for our clients that cover all of their purchase occasions. And so what gets us so excited about what we're seeing with direct-buy is we're clearly meeting a very complementary set of needs relative to what our Fixes offer us to address and allows us, we believe, to cover the full addressable market of apparel spending.

And so while this distinction of share of wallet gain and sort of the mix of those 2 is something we'll talk about for the next few quarters, I would imagine that over time, there's just going to be a total blurring between services that are more engaged with styling support versus areas where consumers can shop and engage any time that they want to. I think what we're most excited about is to just see that these 2 offerings are so highly complementary versus any sort of cannibalization between the 2.

And just, Ed, this is Katrina again. Just to jump back in on the inventory side from more of the assortment angle. I think one thing that, I guess, throughout this whole crisis, we've been really grateful for being a digital-first business. And on the inventory side, that's definitely true too. And so I think there's a lot of other retailers that might have kind of inventory orphaned in stores or kind of inventory that they weren't access -- able to access during this time. And we were -- our buyers work really hard to rightsize our inventory, both from a size of business perspective and then also from an assortment of what's the most relevant assortment perspective. And so I think we reflected the changes that we saw in our gross margin this quarter. But I think relative to a lot of other retailers, we don't quite have as much risk there.

We'll hear next from Ross Sandler with Barclays.

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Great. Katrina, you mentioned that auto-ship renewal is at 3-year highs in April. Can you just remind us that -- I think you said in the past that the majority of revenue, the size of that bucket versus manual. And then are both of those growing in the July quarter? Any comment about growth rates going forward? And the second question is just the experiment you guys are doing with influencer marketing for direct-buy. What have you seen so far? And how could this change your approach going forward if you're pretty successful?

Yes. Thanks for your questions. I'll take the first part. Rest, just kind of speaking a little bit to auto-ship and then we can talk about the influencers and the experiment running there, and I'll have probably Elizabeth chime in there. In terms of what we're seeing on the auto-ship side, I think we've shared before the majority of our revenue. We feel that most often, people opt into a monthly for women and every other month for men's. But it's -- a majority of our revenue, a majority of our clients who will get Fixes on some kind of recurring basis, and we've seen trends be really positive. I think through the end of last -- through the end of the quarter we're talking about and then also, I think, in the first few weeks of this quarter. And so or that -- I guess, I could just -- a lot of -- it gives us a lot of confidence in the resonance of our model right now. We've been seeing a lot of growth in both channels. And so that's been very exciting.

On the influencer part, maybe I'll kind of talk at a high level and Elizabeth can chime in a little -- chime in on kind of what it means. But I think what's really exciting is, as we thought about direct-buy, direct-buy has really been more accessible to -- it's really been oriented around the things that you've already bought. We haven't really had a space for it to be thematic and for us to kind of -- to showcase other prospectives and other ways of curating. And so maybe, Elizabeth, I'll have you share a little bit about what's coming. And then I think what's really exciting is more of what it's enabling in terms of how you could imagine this form factor being a powerful engage tool in our service.

Yes. Happy to describe it. I mean, this is, we think, one specific manifestation of many more things we can do in the future. I think as Katrina mentioned, the way we began is direct buy has been anchored around items that active clients have purchased in the past, which has allowed us to make it an incredibly personalized experience and leveraging our data science to be able to make it as highly relevant as possible. We obviously want to be able to expand on that with clients who may haven't necessarily bought Fixes with us in the past. And so part of this influencer collaboration that we've launched -- or we will be launching in the next couple of weeks is essentially allowing new clients to onboard by telling us a bit about what they like about this particular collection. And that will then power for us a shopping experience that they can immediately dive into. And so I'd say there's really 2 things that this represents.

One is an expansion around the flexibility overall of direct buy and building more power into our personalization platform that removes that kept item requirements that we've had in the past. And some of the other things that we're doing like trending for you that I mentioned on the call earlier, they both represent ways to be able to bring in new clients without necessarily having that prior purchase experience with us.

The other thing that it represents is a creative way to think about marketing and expanding this to either other influencers, other brand partners, showcasing things like our own exclusive brands that continue to gain great traction and customer success where it allows consumers to be particularly excited about a product or a fashion icon that they view as somebody that they really appreciate. So we see it as really twofold in terms of the flexibility of the platform as well as excitement around different ways that we can market new experiences.

We'll hear now from Mark Mahaney with RBC.

I want to ask 2 questions, please. First, the impact of direct buy, we've obviously had some major events have happened that maybe have made this hard to test. But if you -- if I think about it in terms of the spend or the loyalty or the engagement, the tenure of the customer who has also used direct-buy, what that -- how much incremental revenue that's created? Is there any way you could quantify that? Do you have enough of a sample size? And maybe we just had an abnormal conditions to really do that, but how much of a boost to company -- I'm sorry, to a customer that's already on and is already a Fix customer having direct-buy to what that's done to that customer? And then secondly is, if your supply challenges are kind of largely now solved or will be solved by the end of this month, I think, by the end of June, is it reasonable to assume that you could get back to 20% year-over-year growth in the October quarter?

Thanks very much for the questions, Mark. So on -- I think on the impact of direct buy, so what we have shared, we've been testing this feature for a while now. And so we do have a reasonable sample size. And I think what we want to better understand is more of the length of time. And so what we've shared is that it's very incremental. And then so we see that people who have access to direct-buy, and when we look at it on a pure AB-test, then we have one group that has access and the other group that doesn't. The group that has access spend more, is happier, is delivering more revenue to Switch Fix. And so we're capturing more of their share of wallet. And so that, we know. We haven't shared any specifics on that. I think that's something that we can certainly contemplate for the quarters to come.

In terms of the October quarter, I think right now, we're not in a position to be able to share guidance on that. But what I will say is that through the end of this quarter, through the early weeks of this current quarter, we've been really excited about the momentum that we've seen. We believe that's going to bring us positive comps in the next quarter. And I think longer term, we really do believe that there's a huge market share capture opportunity. And I think Mike analyzed this point, we are really gearing up to be playing offense during this time. And this is a time when even in this last quarter, we saw the entire apparel industry shrink. And we have been capturing share of that kind -- of that kind of contracted pie right now with an eye towards as people start spending again and as people have more occasions to be buying for that we can kind of maintain and grow that kind of extra part of that pie. And so I think it's too early to share specifics, but we've been really pleased with the trends that we've seen thus far.

From Goldman Sachs, we'll move to Heath Terry.

Great. Really appreciate some of the details that you're sharing. I'm wondering if you could give us a little bit of a sense of sort of what your expectations are as you move more into some of these customers that hadn't shopped with you in the past? Or as you're seeing customers that are experimenting with some of the other ways that they can buy with you, how are your expectations for returns, and where it's appropriate, keep rates are evolving? And then with customers that are on automated Fixes and have been on automated Fixes through this period where their lifestyles are obviously changing pretty dramatically, I'm curious what kind of change you've been seeing in keep rates?

Sure. Well, I think I can answer most of these and a little bit that Mike may weigh in. On the first is just how -- what are expectations around returns and keep rate and what's evolving. Our North Star is really around how do we help clients find things that they love. And so that kind of naturally always is driving us towards features and functions and ways to be able to deliver more value to our clients and really drive up keep rates. We've been just -- we've been very amazed, I think, at the very low return rates that we have even in our direct buy experience, which I think is a little bit more like "normal e-commerce", but I think it's a real testament to the -- our ability to be able to get size right, to get style right in that channel. And on the keep rate side as well, I think this is a place where Elizabeth mentioned some of the testing that we've been doing with stylists. And those tests have actually had pretty high keep rates attached to them. And so I think those are -- I think those are some examples of things that we're doing to ultimately drive these metrics. I think these metrics of people keeping things that they love is ultimately like the true North Star of our business. And that's really where we're orienting a lot of our efforts against.

On your second question -- sorry, Elizabeth, why don't you jump in?

Well, I was just going to say that, in general, we've been really pleased in this time period to continue to see an incredibly low return rates of direct-buy that we were seeing even prior to the macro uncertainty. And that in general, over the last several weeks, we've actually seen expansion in our keep rates, both of which we think point to the resilience of our model and our ability to adapt to products that people are looking for right now, which we have seen different requests really escalate. As you might expect, things like work-from-home, I think we've measured sort of the natural language of those types of requests that, as you might anticipate, 10x to pre-COVID levels. And we've been able to really adapt to that to make sure consumers are getting what they want.

We'll hear now from Cory Carpenter, JPMorgan.

Just on direct-buy, as you roll out to new and [lapsed] customers, could you provide some more color on how you're thinking about the time line in terms of the rollout or when the right time is to start putting marketing dollars behind the initiative? And then maybe for Mike. Fulfillments, what have been some of the biggest constraints or challenges in anything backup capacity? And once you do work through the backlog, how do you think about the operating -- operational environment going forward and the need to potentially expand the warehouse footprint or headcount?

Sure. Yes, I'll have Elizabeth talk a little bit more on the color around direct-buy. And then, Mike, you can take the question on the fulfillment.

Yes. Thanks for the question. As I mentioned on the call, there's a few steps on our way to fully opening up direct buy to new clients. And so one thing that we've introduced is this concept of Trending for you with our current active clients that allows us to have clients shop, but it's not anchored on prior purchases, but instead on data that we have on things like their style profile, in things like style shuffle. And then also our collaboration with the influencer is another way to test and learn from a new onboarding experience that does not require prior purchases. And so we are currently building on both of those things as well as adding more talent to our team to be able to more rapidly expand the offering. So our intent is over the next quarter or 2 to fully ramp this up to new active clients. As you can imagine, there's a fair amount of work to do here. And really, we hold just such a high bar of a highly personalized, really well-dialed in experience that we want to make sure that we have that in a good place as we ramp it up. And so as we do -- so we do intend to ramp up marketing alongside it as well and have been actually doing quite a lot of testing on our marketing messages associated with the shopping experience through CRM and other channels with our active clients and have a very good sense of now how to tell that story.

Yes. Cory, I can talk about the fulfillment stuff. So the biggest capacity constraint really was just attendance. Katrina talked about it in terms of making sure people were safe, and we asked people to stay home. But since then, as we referenced, we're in really good shape in terms of throughput and attendance. And I think it's because we were very caring about people's safe and health and they've come back and are super-excited to serve the mission. I'd say the second on changes to the footprint or changes to capacity going forward, there's not a lot. I mean, in the warehouse, it looks different, obviously, because the things we need to do to make sure people are safe and physical distancing in the warehouse. But it shouldn't be -- we've always been about gaining efficiency and improving throughput, and that hasn't changed. And so those improvements, I think, should offset what we're seeing from just social distancing that we're seeing in the warehouse. But -- so I don't expect that to be a constraint going forward. I expect us to continue to improve throughput and get leverage and fulfillment over time.

Great. And just one quick add to that, I think, is that one of the things that the teams have been really creative in doing is certainly figuring out ways that people can be distancing in the warehouse, but also actually adding shifts so that we can kind of minimize the number of people in our facilities. And so I think we feel like we have a lot of runway, and we've been just amazed and really proud of how much this team has been able to deliver during this crazy time.

We'll hear next from Youssef Squali with SunTrust.

2 questions from me, please. Mike, I was wondering if you could maybe drill a little deeper into the gross margin, maybe help us understand the puts and takes. At 40% this past quarter, it kind of shows some negative leverage, even though your revenues were kind of back to where you guys were in Q2 of 2019 when your gross margins were more like 44% plus. So is that mostly related to inventory reserves and write-down? Or is there anything else going on? And with Q4, I think you guys are talking about revenue snapping back to pre-COVID levels or Q4 of last year's levels. Why wouldn't gross margins snap back to the same level? As I think your 200 to 300 basis points fully implies -- well, it implies you guys are getting halfway there, maybe a little better, but not a full snap back. And then last question maybe to you as well. Just in terms of backlog and/or delivery delays, how many weeks are we now running versus say at the trough?

Yes, sure. So I'll take both of those. So the gross margin, there is the reserve thing that we talked about, but they're all -- as we've talked about previously with you guys, we had higher level inventory levels going into Q3. And while we were able to cut some receipts going into Q4 and future quarters with great partnership with our vendor base, we weren't able to cut everything that we wanted to cut relative to the top line. And so those are the biggest kind of inputs. But if you look at our gross margin contraction versus the rest of retail, I'm actually very proud of only being down 359 basis points year-over-year versus the rest of retail. I felt like it was down 10 to 15 points of gross margin. And then if I look at Q4, there we feel good about the decisions we made to sort of cut receipts to sort of align inventory more with where sales are coming in. And to your point, 200 to 300 basis points is a little bit lower than what we have historically seen. But we also have growth in other parts of our business like in kids in the U.K., where we've seen improvement in those areas, that our gross margin is dilutive relative to women's and men's because of the scale that they're at today. We actually think that's good news, given that those businesses ultimately will scale to what we've seen in women's and men's. And so we're actually excited about that.

And then to your last question, I think, about how clean we are on sort of delays, we're really clean now. We've caught up on the backlog. The capacity constraint has virtually gone away. And so there's no real delay kind of in shipments versus what we saw pre-COVID.

With Piper Sandler, we'll move to Erinn Murphy.

Two questions, if I may. The first, just with respect to stylists, I believe you let go 1,500 stylists in the California area. I guess, is the intent to rehire the same number, but just in lower cost labor markets? Or are you finding ways as you navigate through COVID-19's impact on the model to use fewer stylists going forward? And then my second question is, Mike, maybe for you, if you can just expound on what you saw in the quarter in the U.K. from a top line perspective. And is it following a similar trend quarter-to-date as your overall business?

Thanks, Erinn. I can take the one on stylists. And I'd like to take the one on U.K., but Elizabeth might have a little bit more color. So I think whichever one of you guys want to jump in. But on stylists, yes, I mean, we made a very, very difficult decision to part ways with almost 1,500 stylists here in California. And yes, the intent is to move -- to effectively move those jobs to lower cost markets. So we're offering relocation for stylists who want to take us up on that. We recognize it's a part-time job that not everybody will be able to do that. But we -- stylists are still an incredibly important part of our model. We want to continue to invest in our stylists. But the reality was, as we look at kind of our aggressive goals, this was a decision that was a hard one, but one that we needed to make.

The -- in terms of using fewer stylists right now, we're not -- I think right now, we're really thinking about how can the stylists add as much value as we possibly can. I think such a differentiated part of our model, especially today, as we're thinking about being truly a replacement for going into stores, I think that higher touch, that high empathy model is really, really valuable. And our efforts now are how can we make the most of that and how can we really continue to innovate on that. Elizabeth spoke to a few tests that we're doing, which is leveraging kind of a combination of a stylist working with the client to improve outcomes in Fixes, and that's been a super-exciting place to invest in. And so our intention is to continue to invest in stylists. Stylists are still a very important part of our model. And then I'll have Elizabeth share a little bit of color on the U.K.

Yes, happy to. So I think we've been really pleased actually to see the momentum in the U.K. across April and May. And just in general, that's a market where we've seen consumer demand really bouncing back. And in general, a few of the other things, we've now been in that market a little over a year. And one of the areas that we've been really working hard at is just continuing to fine-tune the model and make sure we've got the right product, the clients. Obviously, it's a new market for us. And we've been very pleased to see just a great momentum in terms of our keep rate there. And that's what's, obviously, our core offering. And then as Katrina just alluded to, we've also been testing and incubating some of our new stylist experience within that market, which has further enhanced and shown opportunity on top of that with keep rate. So overall, we've been adding more brand partners within that market, just getting smarter and smarter at our inventory buying the same way that we did over time in the U.S. And overall, both of those things, we've seen the results starting to really pay off.

We'll move next to Ike Boruchow with Wells Fargo.

(inaudible). 2 quick ones. So Mike, I think you had mentioned on the ad spend, you guys pulled back in the third quarter. You're going to slowly kind of ramp that back up over the future quarters. I'm just kind of curious, how did that play into your 4Q spend and then as next fiscal year kind of develops? And then on the gross margin outlook for 4Q, I guess, my question is, do you expect any more reserves? Do you think you reserved enough? Just it sounds like it's going to be one of the most promotional next couple of months for soft launch retail we've ever seen, all the reserve dating across all the apparel retailers. So I guess, just more color on your thought process on what you're expecting over the next couple of months from a competitive standpoint would be great.

Thanks for the questions, Ike. Maybe I'll start out with some color around how we're thinking about promotional activity and then can probably have Elizabeth weigh in on marketing. And then Mike can certainly talk about how that affects gross margin as well. I mean at the high level, we -- a couple of things. I think we were kind of wondering how promotional this environment was going to be. And the reality is actually, like, things have been pretty promotional for the last few months, both online and then now we're seeing things happen in stores. And despite the promotional activities online and in stores in the last few weeks, our business has been holding up very strongly. And at the end of the day, our business has never been one that necessarily is about the absolute cheapest price. This is -- of course, we're always going to be watching prices and making sure we have the right price. But the reality is people shop with us, because they are getting clothes that fit them really well, because they're getting clothes that fit their occasion really well. And so I think that's really the value proposition of our business, and it's continuing to hold up really well.

One other piece then -- you may be hearing us from kind of other people in the industry. But one thing that's been interesting is that I think we may have expected that we got worried a little bit that there would be this huge glut and that everybody will be massively over-inventoried. And I do think a lot of people had inventory that is stranded in stores. But in terms of kind of -- I think a lot of our vendors and a lot of people on the manufacturing side also shut down or reduced their capacity during this time period. And so I think my belief is that it's not going to be as much of a crazy over-inventory challenge as we may have had in the past periods. So I think right now, we feel surely confident that our offering is going to stand strong regardless of what's kind of happening externally. And we feel like we've made really a lot of great decisions on the inventory side that we can fulfill for our customers really well.

Great. And on the marketing side, maybe I'll just give a little bit of color. As we mentioned, we saw some shift in consumer mind share in kind of mid- to late March. And then for us, for the most part, we've been dealing with a very supply-constrained environment. So we've been very careful to be pulling back on spend when we know we can't deliver Fixes on time. But what we've been doing is basically monitoring CPN -- CPA trends week-on-week for the last several weeks. And what has been great is we've basically seen dramatic improvement on those over the course of April and into May. And so we have been gradually adding back spend every week as we feel we can fulfill that demand for consumers.

And in general, what we've observed is actually CPAs are below what we would have seen in the same period last year. And so our general approach is, we're very lucky in terms of having a really dynamic approach to how we deploy spend. We're still actually doing a number of tests right now to see where consumers are most responsive by media channel. And in general, we've been adding more spend back, for the most part, I'd say every week since late April, with the intent to continue to turn that on as our supply is fully in place and as we continue to see this positive environment in terms of customer acquisition and a moment where, I think, in general, we just feel like our model is going to continue to be one that attracts new consumers, given their desire to now shop more from home.

And from Healthy Advisory Group, we'll go next to Dana Telsey.

As you think about some of the nonapparel items that basically took -- that you were getting from direct-buy and that were beginning to take hold during this year, what have you seen so far from that and how do you see that impacting inventory and margin going forward?

Well, Dana, I think I can speak in broad terms. The -- what we've been seeing on direct-buy is that direct-buy overall as a channel has been really successful and has outpaced a lot of our expectations for it. And I think to the points that we've made in earlier calls, that means that we're seeing kind of disproportionate categories like bags and shoes be successful in those channels. And so I think the strength is direct-buy correlate to kind of some assortment changes. However, I mean, the broader assortment differences that we've really seen has been, I think, these types of events tend to accelerate trends. And the biggest assortment trends that we're really seeing is one towards -- I think the ultimate trend of casualization of the workplace is one that we're certainly seeing.

And so as we -- Elizabeth spoke earlier to just how many more requests we're getting for more casual apparel. And that's absolutely true in terms of request in terms of sales. And we believe that, that trend is pretty likely to continue. So that's kind of a broader thing that we're -- a broader theme that we're seeing. And luckily, we talked a little bit about kind of our ability to rightsize our inventory. And one of the main things that we did when this crisis started was to look at our assortment and, look, where do we want to be invested more, where do we want to be invested less. And we were able to get out of a lot of our commitments around workwear, and we were able to shift a lot of our assortment into the casual world. And so we feel really good about our ability to react to that.

And we have time for one other question today. That will be from Mark Altschwager with Baird.

So first off, with the return to growth in the fourth quarter, can you just expand a little bit on the drivers there? And Is that primarily going to be existing customers returning to pre-COVID spending patterns? Or would you expect to see net client adds quarter-over-quarter? And then separately on direct-buy, I was hoping you could touch a little bit more on the efforts regarding reactivation of clients and what the time line looks like there?

Thanks for the questions, Mark. Yes, in terms of the growth in the fourth quarter, we actually -- our existing clients really have been strong throughout. And so when we're looking at growth, we are talking about year-over-year growth that we are expecting to see that is contributed by new clients. And so we expect that our revenue year-over-year will increase. We also expect clients, revenue per client, that those will also increase as those are all kind of drivers in that. And so I think the fortunate part about our model is that we've had this great existing client base that was continuing to be really strong during COVID. I think our constraint was really around acquiring new clients during that time period, because we are supply-constrained, because we didn't want to be spending marketing dollars to bring people into a supply-constrained environment. And so the part of our business that was suppressed during that time period is going to be more in the new activity. And so now as we are catching up to our backlog and as we are in a more -- a better position to be playing offense, I think that growth is really going to be coming from our ability to invest into this side.

And then -- I'm sorry, just the other part of the question was on the direct-buy and the reactivation of clients, if you have any comments there.

Oh, I'm sorry about that. Yes, I think Elizabeth, I'll have you take that one. You're a little closer.

Yes, absolutely. I mean as we think about who we want to be targeting with that offering, it's obviously new prospective clients. It's also our active clients, which we've been very successful with today, taking that penetrated base from 5% to 13% of our women's clients. But then yes, we also have a large group of clients that have signed up with their style profile, but not converted to Fixes. We also have a group of dormant clients who bought Fixes in the past. And we see both of those as populations that we want to reengage. So we've done some testing already of that dormant population and then with the group of people where we have their style profiles. That's a lot of what we're testing right now with things like Trending for you, as I mentioned, and the influencer collaboration to make sure that we're really delivering highly engaging, highly personalized experience. We really like what we're seeing so far on the Trending for you. And so our intent is to really improve and enhance that experience with the intent of then ramping it up. And we have a lot of information on those prior clients, but we do intend to target them in the coming months and quarters once we ramp that back up. But we view that as well as pure new clients is both bigger as an opportunity.

And at this time, I'd like to turn things back to you for -- Katrina for any closing remarks.

Thank you, and thank you, everybody, for joining us. We wish everyone the best in these very challenging times and look forward to spending time with many of you in the weeks to come. Thank you.

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