Please stand by. Good day, everyone, and welcome to the Stitch Fix fourth quarter 2022 earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Hayden Blair. Please go ahead.
Good afternoon and thank you for joining us today to discuss the results for Stitch Fix's fourth quarter and full- year 2022. Joining me on the call today are Elizabeth Spaulding, CEO of Stitch Fix, and Dan Jedda, CFO. We have posted complete fourth quarter and full- year 2022 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 the results to differ, in particular our press release issued and filed today, as well as the Risk Factors sections of our quarterly report on Form 10-Q for our third quarter previously filed with the SEC, and the annual report on Form 10-K for fiscal year 2022, 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 Elizabeth.
Thank you, Hayden, and thank you all for joining us for Stitch Fix's Q4 2022 earnings call. FY 2022 was a pivotal year for Stitch Fix as we embarked on a significant transformation with the full rollout of Freestyle. Freestyle, combined with our original Fix offering, broadens our ecosystem and our ability to solve the hardest consumer shopping and styling problems, fit, discovery, and human relationships. These differentiators remain as relevant as ever as we provide our clients with the right product at the right time. We learned a lot over the course of FY 2022, and we are building on our areas of progress. In this challenging macroeconomic environment, and as we continue to work through our transformation, we recognize that returning to profitability is of utmost importance. This is our top priority.
This will happen by both returning to active client growth and by optimizing our cost base. We are pleased with the progress that we made in Q4 on rightsizing our cost base, and we are on track to exceed the top end of our expected annual savings in FY 2023. Today, I will first provide details on our financial performance in Q4 and FY 2022. I will discuss how we are building on our learnings from this past year to drive net active clients and improve how we operate the business for both scale and profitability. Dan will then share more details on our cost management and productivity efforts. First, on our financials. The realities of record inflation levels and a deteriorating retail landscape resulted in slower discretionary spend in apparel and presented us with an increasingly challenging fourth quarter, particularly in June and July.
Q4 net revenue declined 16% year-over-year to $482 million, driven by a 9% year-over-year decline in net active clients, which ended FY 2022 at 3.8 million. Adjusted EBITDA in the quarter was negative $31.8 million. Revenue per active client grew 8% year-over-year to $546 in the fourth quarter. Looking at our full FY 2022, net revenue declined 1% year-over-year to $2.1 billion, along with an adjusted EBITDA loss of $19.5 million. Despite this, Freestyle revenue grew 21% year-over-year, with penetration from our Fix client base steadily increasing since its launch. Now, let me share more on our go-forward strategy for FY 2023.
First, we're capitalizing on the health of our existing customer base by nourishing our core differentiators and improving our unique experience. Second, we're focused on net active client growth by broadening our marketing portfolio, refining the onboarding experience to capture both new and prospective clients, and targeting strategies that reengage previously active clients. Finally, we're committed to managing our costs efficiently and strengthening our infrastructure in order to build a profitable business that is ripe for future expansion. Starting on the first point, we know we win when our clients feel heard, when we send the right items based on personal preference and fit, and when we push style boundaries in new ways. Our powerful combination of data science and creative human judgment has enabled us to ship over 75 million fixes and to fulfill over 10 million Freestyle orders to date.
We also know that the first few experiences with Stitch Fix represent a critical opportunity to build a long-term relationship and keep our clients coming back for more. In FY 2023, building on our strength of listening and responding to client requests and meeting the moment, we are evolving our stylist request notes to include the ability to add specific occasions so that our stylists can deliver stronger choices in these discovery moments. We also plan to insert more opportunities to collaborate with our stylist community in real time. Additionally, we're working to deliver a diverse assortment that showcases our varying price points, especially in a time when consumers are more cost-conscious. We believe these efforts will drive higher engagement and further cement Stitch Fix as the go-to online styling partner for both current and future customers. On to the second point.
We recognize that reigniting the active client flywheel is vital for growth. We know that success will not only come through new client activation, but also through prospective clients and re-engaging clients who haven't shopped with us for over 12 months. In mid-September, we released our first-ever multinational brand campaign with the goal of communicating how Stitch Fix works and celebrating the personalization that we deliver. While traffic improved through the second half of FY 2022, we expect this campaign to drive a sizable increase in impressions across TV, paid social, and branded content partnerships, and by building brand awareness, we'll increase traffic to our ecosystem. We also launched an affiliate influencer network in early August. Though small today, we plan to scale quickly with a goal of incorporating our stylists throughout FY 2023 as a way to tap more into our unique differentiators.
Lastly, over the course of FY 2022, we made improvements post the Freestyle launch to get conversion to a better place since its low point earlier in the year, and we're making further investments in the client onboarding journey to drive conversion rates even higher. These investments include style quiz simplification and seamless login experiences in order to reduce barriers to entry and more immediately show how we serve client interests. We also have many prospective clients who've given us information but have yet to convert, and many who haven't shopped with us for over 12 months, both of which represent opportunities for re-engagement. We're approaching these moments of re-engagement with new strategies given our expanded offering. As an example, we are enhancing our email programs to include algorithmically generated product previews that better showcase our inventory and are leveraging more stylist-centric messaging and content.
On the third and final point on enabling profitable growth and expansion. In the near term, and as Dan will share more, we are taking a variety of important actions to continue to improve our free cash flow. More broadly, we are focused on developing our infrastructure to drive profitable growth and support our future expansion. With our tech infrastructure, we're investing in our structured data platform and more modular architecture to enable faster launch of new client features. We're also innovating on our core algorithms to allow for dynamic engagement and real-time styling. With this complex work well underway, we're confident in our technology strategy. By evolving our underlying infrastructure, we're creating a stable foundation for scale and are setting the stage for profitable growth in FY 2024. I'd like to conclude by thanking our team for all their hard work and innovating on behalf of our customers.
We will continue to adapt as needed to build value for our shareholders without losing sight of the customer-centric culture that defines Stitch Fix. I'm proud of the team that we've built, the strategy we have now set in place, and I feel encouraged by what this next chapter brings for Stitch Fix. We're clear-eyed about the current challenges that the macro environment presents, and we remain focused on the key initiatives discussed today in order to deliver exceptional shopping and styling experiences to our clients and to achieve profitability in the future. With that, I will turn the call over to Dan.
Thanks, Elizabeth, and hello to everyone joining us on today's call. As Elizabeth discussed, our business is undergoing a significant transformation, which we are pushing forward in FY 2023. At the same time, we recognize the challenges presented by the current macro environment, and as such, we continue to direct our business in a financially responsible manner. In Q4, we generated net revenue of $482 million, down 16% year-over-year, driven by softness in Fix volume, which was partially offset by demand in Freestyle. July was especially challenging in tandem with macroeconomic deterioration throughout the summer months and as consumer discretionary spend pulled back from apparel. Notably, these trends have continued in the first half of Q1. Active clients ended Q4 down 3% sequentially and 9% year-over-year at 3.8 million.
Q4 gross margin was 40%, driven largely by increased inventory reserves and higher liquidations to the excess spring and summer goods. Adjusting for this increase in our inventory reserve and higher liquidation, gross margin was 42.5%, a decline of about 400 basis points from a year ago. This reduction is primarily due to tightening product margins from rising inflation and increased penetration of national brands, as well as an increase in transportation costs. Sequentially, gross margin was flat once adjusting for the increased inventory reserves and higher liquidations. Turning to inventory. We ended Q4 with net inventory down 7% year-over-year and down 7% quarter-over-quarter to $197 million. We took action in the quarter to right-size our inventory through our July limited sales event and third-party liquidations, which focused on moving spring and summer product.
Looking ahead, we are continuing our efforts to right-size our inventory position to be in line with demand. For any excess inventory, we'll look at utilizing limited sales events, continuing to use third-party liquidators, and delaying inbound receipts or holding inventory based on the right economic decision. We will likely continue to see elevated inventory levels in the first half of our fiscal year, but we expect to see lower levels relative to demand in the back half. Advertising was just under 10% of net revenue in Q4, slightly down over Q3, but up 390 basis points versus the same quarter last year. For the full- year FY 2022, advertising represented approximately 9% of net revenue.
For FY 2023, we expect to maintain levels of spend at around 9% of net revenue as we grow the virality of Stitch Fix, as well as continue to improve on our core performance marketing channels and expand into newer channels such as SEM, influencers, and affiliates. Moving on to adjusted EBITDA. Q4 adjusted EBITDA was -$32 million. This excluded $26 million in restructuring and other one-time charges. We ended Q4 with no debt and $231 million in cash equivalents, and highly rated securities, as well as an undrawn $100 million revolving line of credit. Now on to our outlook. There are a number of factors impacting the predictability of our forecast. As we turn the page on FY 2022, we are focused on the goal of achieving adjusted EBITDA profitability and positive free cash flow.
Our path to profitability consists of customer-centric actions intended to grow active clients, increasing leverage in gross margin, improving fixed and variable productivity, and driving positive free cash flow. Elizabeth discussed our focus and actions on driving active clients. On gross margin, we expect both Q1 and full- year gross margin to be around 42%, primarily reflecting an improved inventory position and expected lower transportation costs versus the fourth quarter of FY 2022. SG&A, excluding advertising and stock-based compensation, was down 8% sequentially and essentially flat year-over-year when excluding restructuring and one-time charges. While we are pleased with our expense control in Q4, we will continue to focus on reducing fixed cost and improving variable productivity. As we optimize our cost structure, we will continue to evaluate our real estate footprint and prioritize our investment in product and technology.
With these efforts in place, we are on track to exceed the high end of the $40 million-$60 million in expected annual cost savings we discussed last quarter. In addition to cost savings, we are also focused on driving towards positive free cash flow and expect to improve our overall cash conversion cycle in FY 2023 by rightsizing inventory, extending vendor terms, and investing in CapEx with near-term positive ROI. Moving to our outlook. It's important to note that lower active clients in FY 2022 will have an impact on revenue, particularly in the first half of the fiscal year. With this in mind, we expect total revenue to be between $1.76 billion and $1.86 billion for full- year FY 2023. We will manage the business towards a goal of being adjusted EBITDA and free cash flow positive sometime in FY 2023.
For the full- year FY 2023, we expect adjusted EBITDA to be between -$45 million and -$25 million. Moving on to Q1. Largely due to the dynamics previously discussed on the current state of net active clients and the associated ongoing impact of macro challenges, we expect Q1 revenue to be between $455 million and $465 million. Due to our ongoing efforts in reducing our cost structure, we expect Q1 adjusted EBITDA will substantially improve versus Q4 of FY 2022 and be -$15 million to -$10 million. This guidance assumes net active clients will be down quarter-over-quarter, but less so than the sequential change between Q3 and Q4. As we reinforced multiple times during this call, we are laser focused on our return to profitability.
We recognize the importance of building a solid foundation so that we can grow from a position of strength. This will be achieved by a return to net active client growth and continuing to optimize our cost structure. With that, I'd like to turn the call over to the operator for Q&A.
If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. In order to allow time for additional analysts to ask their questions, we ask that you please limit yourself to one question and one follow-up question before reentering the queue. Again, press star one to ask a question. We will take our first question from Youssef Squali with Truist Securities. Please go ahead.
Great. Thank you very much. Hi, guys. Just two quick questions for me. One, maybe can you just speak to the onboarding process and improvements you've made there? Obviously, you're deciding to increase your marketing, which would lead me to believe that you believe that your onboarding process and conversion rates, et cetera, have improved relative to where they were even three months ago. Maybe any kind of quantification of where we are in that process would be really helpful. As you look at the business beyond 2023, I know there are a lot of moving parts here, but relative to kind of how you guys looked at the business, I guess you know, a couple years ago, what kind of growth do you think this business can support?
You know, all things considered, looking at the TAM changes, et cetera, is this still, you know, kind of a double-digit business, double-digit growth business, do you feel, or is that something that now we need to adjust as we think through the opportunity? Thank you.
Hey, Youssef. Thanks for the questions. Yeah, on the first point, you know, we've made a lot of progress on conversion over the last couple of quarters, and you know, we have seen a return to levels that we had seen in the past. That said, we believe we can still make progress and upside in some of the consumer pain points that we know of. You know, we made it easier to get back into our Fix experience. We've made improvements in iterative testing on, you know, more of an understanding of what Stitch Fix is about. We know it's an unusual service, and so we've done, I think, a lot of good iterative improvements on making that easy for clients to understand.
You know, that said, we still see opportunity to make it even easier to get inside in terms of seamless login. We still provide kind of that step where you have to provide your email up front. All of those are areas we're gonna keep working on. We've made progress. We continue to make progress, but we see more work ahead. On the marketing front, you know, we're continuing to expand and strengthen our portfolio both with new clients but also with signed-up prospects. Those are folks who have given us all their information but have not converted, as well as reactivation.
You know, we are always super disciplined with how we spend, you know, in that sort of 9%-10% range and are making sure that we are getting a return on any investment we make, and we'll keep broadening that portfolio. Beyond 2023, kind of beyond this fiscal year, I mean, if you think about it, Stitch Fix is still a pretty small business in an enormous apparel market. You know, we're about a $2 billion company in a $400 billion U.S.-only addressable market, and we know that by opening up the Freestyle experience together with Fix, that has both created incrementality within our existing client base, but we believe it 2x-3x increases the TAM of being a Fix-only business.
We're just incredibly focused this year on continuing to improve the customer experience, get on that positive net active track, which we do expect to turn the corner on net active clients sequentially at some point in FY 2023, and just ensuring we have the stable foundation of profitability to build on beyond this year.
Okay, great. Thanks for the help.
We will take our next question from Cory Carpenter with J.P. Morgan. Please go ahead.
Great. Thanks for the question. Just, maybe to start on Freestyle, could you talk about your priorities for Freestyle specifically this year? You know, how much of your marketing spend do you expect to deploy against Freestyle? Related to that, last quarter, you made the decision to direct new customer traffic to the Fix flow exclusively. Is that still the case, and any plans to redirect some of that back to Freestyle in the future? Thank you.
Yeah. Thanks, Cory, for the question. You know, we continue to make improvements in the Freestyle experience. You know, we had talked in the last quarter or two around search, and that's become, you know, that was one of our most asked for features with clients. That has done well. Doing things like beta testing, seeing outfits in search, just continuous improvement of really integrating more of our styling-led differentiation. You know, those three areas that we think we do better than anybody else that are really solving the hardest problems of fit, discovery, and human relationship. You know, really our ambition is to just make that more and more integrated in the Freestyle experience and really this blurring of the Fix and Freestyle offering.
We know our best, happiest clients are engaging with both and just making it easier to be participating across that full ecosystem. You know, if you were to Google search a particular item, you can land on a product detail page or a category page and start right with Freestyle. Our core front door experience, we're really focused on just getting people into our full ecosystem. What we found is starting with a Fix is a great entry point, and so we're very focused there right now just because we like what we're seeing, but we'll continue to experiment with that throughout the year. We do acquire clients through kind of landing on product detail pages, but I'd say our core customer activation focus is really through starting with the full ecosystem and starting with a Fix right now.
Thank you.
We will take our next question from Simeon Siegel with BMO Capital Markets. Please go ahead.
Thanks. Hey, good afternoon, everyone. Sorry if I missed it, but did you say how we should think about the go-forward clients versus RPAC embedded within the 1Q and full-year revenue guides? Maybe just speak to the comfort in the improvement embedded over the year. Thanks.
Simeon, can you just clarify the question? Are you asking what we expect on active clients, or what are you asking?
Just any context. You gave the revenue guidance for the first quarter and full- year, so any context on how that breaks down between price versus clients.
Got it. Yeah, we don't guide specifically to actives. As I mentioned, in the response a moment ago, we do anticipate at some point over the course of this year turning the corner on improvement in positive net actives. I mean, simply by virtue of the fact that we're starting the year with 3.8 million versus over 4 million clients, that just has a really big impact on the absolute revenue for the year. That is really the biggest driver. As you know, like, as we acquire clients, their spending builds over time, and so we're just not gonna see the benefit of that impact. Let me pause there and see if Dan anything to add on that in terms of how it translates to revenue.
No, the only thing I'd add on the active clients and RPAC, you know, I did say in the earlier remarks that while net actives will be down for Q1, they'll be down less so than the Q3 to Q4 sequential change that we saw in FY 2022. You know, as we get closer to adding net active clients, that will likely have the impact of bringing RPAC down simply because these newer clients aren't on our platform long enough to spend disproportionately to clients that have been here and spending on a regular cadence with us. That's the way we think about RPAC here. Again, as we continue to diminish the decline in net actives and ultimately start to grow net actives, I would expect RPAC to be impacted by that.
It will have a net positive, of course, on revenue as subsequent fixes and subsequent engagement with Freestyle take on with our newer clients.
Great. Just given the strength of the data that you have, are there any learnings between the clients that have lapsed? Is there any, I don't know if there's age, demographic, shopping tendency, like just you guys have a wealth of data. As you look at the cohorts or you look at the groups that have peeled off, anything that you can learn from that?
Yeah, I mean, I would say a few things. In general, our clients are the happiest when they feel like we heard their preferences, and we responded accordingly and present the right product at the right time, which, you know, we get right a lot of the time, but we don't always get it right. Our ability to immediately address, you know, if we didn't get it right through, you know, redoing their Fix experience or connecting them with a stylist, like that's actually a lot of what we're gonna be focused on this year, is bringing more of that, stylist front and center and that active listening. I mean, it is a big part of what has made us so successful.
Using that data to both reactivate clients, which we actually have a pretty healthy reactivation rate. We see more upside there. It was actually positive year-on-year, our reactivations of FY 2022 versus FY 2021, actually entirely driven by growth in Freestyle. You know, what we believe is the broadening variety of our assortment, the broadening of price points, all of those good things will benefit the broader client population over time. But ultimately, it's that sense of a client feeling, you know, deeply heard, and we put the right product in front of them at the right time. Anytime we have, you know, that signal of where we can improve it is where we're focused, you know, both frankly with our active clients as well as with lapsed clients.
Great. Thanks so much.
Just to add on to that, I will say it's not a learning, but it is for us, 'cause we've known it for a while. It is worth reiterating, you know, our clients' desire to get fit right, which we do very well, is really important. They love that. We've talked about fit a lot in prior calls, and it's just worth repeating how important that is, and how we focus on that and, you know, continue to try to get better and better at fit.
Great. Thanks. Best of luck for the rest of the year.
Thanks, Simeon.
We will take our next question from Mark Altschwager with Baird. Please go ahead.
Hi, this is Amy Teske on for Baird. Beyond the broader apparel pullback, I was hoping you would dig in a little bit more into consumer behavior changes, what you're seeing in terms of box frequency, keep rates, average sales price, and any details you can provide on trends in specific product categories.
Yeah. Thanks, Amy. You know, I think we do a lot of research of what consumers are asking for. We get signal on, you know, the majority of our fixes of where the preferences are, and then of course, we're always tracking what average unit retails and what price points are resonating. You know, I would say a couple things. First on just like category trends, we've definitely seen that continued shift back to workwear, both with our men's and our women's segments. Blazers are back to pre-COVID levels. You know, men's polos have been a strong trend. We are seeing kind of category trends that we've, you know, thankfully been prepared for. I will say that consumers are telling us they are feeling more cash constrained.
You know, we have different experiences within Freestyle, you know, where we highlight items under 50. In general, we have seen our price points that are at more affordable average unit retails outperforming, which is a strong signal that consumers are looking for value right now. We do ask our clients about sort of their anticipated spending going forward, and we have heard clients, you know, both in serving consumers in the U.K. and the U.S., that they may be buying fewer items per fix in the future. We're just really preparing to have the right product at the right time. I think thankfully in our business, over half of it are clients who are getting, you know, auto shipment with fixes, but we wanna make sure that we're providing the value for them in this moment.
We'll also be beta testing later this year some new loyalty-based programs. Our focus is really just making sure we're both providing right product, right time, and rewarding loyalty and value with our customers. That early signal that we get is incredibly valuable to make sure we have the right product.
Very helpful. Thank you.
We will take our next question from Edward Yruma with Piper Sandler. Please go ahead.
Hey, guys. Thanks very much for taking my question. I guess twofold. First, you know, I know you've been pretty tactical with SG&A reductions, but if you could kinda help us just understand fixed versus variable SG&A, particularly in light of what could be a tougher demand environment. As a follow-up to that, I just wanna understand the markdown reserves that are embedded on the inventory right now. How should we think about that? Are they kinda trued up at this point? Was there a true-up in the quarter? Thank you very much.
Yeah. Thank you, Ed. Let me hand that one to Dan to answer both of those.
Yeah. I on the SG&A reduction, you know, as we said earlier, we are on track to achieve the high end, to exceed the high end of the $40 million-$60 million that we talked about last quarter. The bulk of that is in fixed, which is what we targeted from a cost reduction standpoint. I will say, though, that on the variable side, which is our warehouse, our stylists and our customer service, we've seen improvement, quite a bit improvement quarter-over-quarter in that area as well, across our variable nature. We feel really good about our SG&A costs and the continuing leverage that we get both on fixed and variable.
I think they're both. We're gonna see leverage on both in FY 2023. That's the answer to your first question. To your second question on inventory reserves, as I talked about earlier, we did increase our inventory reserves primarily for excess spring and summer goods, good inventory. You know, we are looking. We do expect the back half of FY 2023 to improve our inventory position. A lot of that depends, of course, on the macro environment. You know, we do feel like we have hit the top end of that reserve, and we're not expecting increases in reserves going forward simply because we're focused very much on rightsizing our inventory. We feel very good about the fall and winter inventory that we've got coming in.
At this point, I think we're in a good position from an inventory reserve perspective.
Thank you.
We will take our next question from Lauren Schenk with Morgan Stanley. Please go ahead.
Great. Thank you. I guess, as we think about the factors that are weighing on net adds, is traffic really the biggest headwind, followed by conversion and then churn? Or how should we think about kind of the different factors within net adds? Any update on what percentage of Fix customers have tried Freestyle or made more than one purchase on Freestyle? I know you'd given some of those stats in the past. Thanks so much.
Hey, Lauren. Thanks for the questions. Yeah. You know, I mentioned on the call that we saw steady improvements in traffic in the back half of FY 2022, and so we like the progress we're seeing. We've also made progress on conversion. You know, our best traffic is that sort of direct and organic traffic, and that's what we're continuing to push and make progress on. You know, I think we all just saw a huge, you know, rush to e-commerce a couple years ago. Some of that has leveled back off, and so our ability to just continue to strengthen the mix of our marketing portfolio and sort of, you know, continue to expand our toolkit there beyond what was, I would say, a pretty heavily growth marketing focus a couple years ago. We like the progress we're seeing.
Still have more to do. You know, that first multinational campaign that we just launched, we think is gonna help build consideration, things like our new affiliate influencer network. It's really a combination, I would say, of continuing to improve high quality traffic sources, bringing back in clients that we can reactivate together with continued gains in the conversion funnel, which we, you know, have gotten back to levels that we were at in the past, but we still see more upside by just making it more frictionless and seamless to enter. I would say it's really a combination of the two. Then on your Fix into Freestyle, you know, I'd say that stayed at pretty heavy levels.
I think we've reported in the past that you know it resonates with around a fifth of clients that come back again and again if they're a Freestyle first purchaser. I think you're asking though specifically how many of our Fix clients get into Freestyle. I think we've shared in the past something like around 30% of our women's clients we've penetrated with Freestyle and that's remained steady which we believe is below full potential frankly. We're looking for the next ways to kind of reduce what I would say is the cognitive load of a brand-new Fix customer learning about Freestyle and just continuing to make that easier and easier. You know as an example in every Fix we send we have these ways to wear it style cards that we send in a Fix.
You know, we see a future of just making those incredibly easy to buy with the Fix checkout process as an entry point into Freestyle. Essentially just finding that next frontier of ways of moving that, a further step change. I'd say it's been pretty steady, at that level to date, but we don't think it's full potential.
Thank you.
We will take our next question from David Bellinger with MKM Partners. Please go ahead.
Hey, thanks for taking my questions. I've got a couple. My first one, just on the guidance, it seems like there's some active client growth embedded in the back half of the year. What gives you the confidence that the clients will rebound? Is there anything you're seeing into Q1 on traffic or conversion to support that? This is my second one. RPAC expected to be down again in Q1 and understanding the dynamic you spoke about earlier that, you know, initial users aren't spending much right away. But are you seeing anything beyond that? Anything on average order values or some type of trade down effect or mix shift, that's affecting that RPAC number? Thanks.
Got it. Thanks, David. I'll take the first one, and then I'll let Dan talk more about RPAC. Yeah, I mean, I think all of the things that we mentioned on the prepared remarks and some of what I've responded with in the last few questions, just the initiatives and the progress we're making on, you know, continued improvement on onboarding, continued focus on bringing our signed-up prospects, reactivation, new traffic channels into our experience. You know, we are making progress and, you know, based on what we're seeing and based on what we believe will be, kind of lapping on a year-on-year basis, we anticipate that over the course of this year, we will turn the corner. On the RPAC side, let me hand it to Dan to share more on that.
Yeah, a couple of comments on the behavior of our clients who are purchasing. Of course, you know, the average age, the average tenure of our client has increased as a result of our net active declines. When that happens, the older clients tend to have a slightly lower keep rate than newer clients simply because their closets get filled up over the course of, you know, 10, 20, 30, 40, 50 fixes. But we are still seeing very solid keep rates and AOVs in both Fix and Freestyle on the new clients coming in on a relative basis. There's nothing, you know, Elizabeth had talked about potentially, you know, some AI impact, and we do see it around the fringes on the clients that come in.
They might be lower priced clients, but when you look at it holistically, the AOVs both for Fix and Freestyle on a cohort basis of the new clients coming in still look very strong.
Got it. Thank you.
We will take our next question from Trevor Young with Barclays. Please go ahead.
Great. Thanks. Dan, on the full-year guide, can you help us understand how you're thinking about that revenue growth cadence throughout the year in light of the down 20% in 1Q and the easing compares? It sounded like 1H under pressure, maybe some inventory overhang, kind of challenging holiday, but then maybe second half is improved. What would need to go right for you to exit the year in positive growth territory?
Yeah, it's a good question. You know, in Q1 of last year, we had a very strong quarter. We were up 18% year-on-year. That is at the time that we started to see the issues with our Fix funnel that we've discussed many times. The impact of subsequent fixes gave us a very strong quarter. We see we have an easier comparative as we go forward within FY 2023. That coupled with our net actives declining at a far slower rate. As Elizabeth mentioned, we do have goals and hope to get to and will get to sequential improvement in net actives in a quarter this year.
All that means that the growth rates that we see in the back half of the year will improve relative to the growth rates that we see in the first half of the year. In response to your second question, what do we have to see to exit the year? We talked a little about net actives growing. As we go through quarter by quarter and see net actives improve, we do think we'll end the year in a very strong position. In the meantime, you know, as you could see from our EBITDA guide, our cost structure, we're very focused on that, both in Q1 and full year. Given our focus on fixed and variable costs, we feel that we will end Q4 and the back half of FY 2023 in a strong position.
Great. Thank you.
We will take our next question from Ike Boruchow with Wells Fargo. Please go ahead.
Hey, everyone. Just two quick ones. I think you said the Freestyle was up 21% in Q4. Can you just say specifically what the subscription business was down in Q4? Dan, on the gross margins, can you walk us through the reserve impact to gross margin? Like how we should basically think about the puts and takes on gross margin for next year. I think you said it's 42% for Q1 and the full- year. Should there be much volatility for the remaining, you know, Q2 to Q4, or should this be pretty much 42%, you know, almost every quarter? If there's just any variability to call out. Thanks.
Yeah. Thanks, Ike. I can take the first one, and then Dan can add on and talk about gross margin. That Freestyle growth rate, just to clarify, was our full- year FY 2022 growth rate, not a Q4 growth rate. On our full- year basis, we were about -1% for the total business. We don't actually break out by business unit, but you can infer from that there was growth in Freestyle and slight decline within the Fix business. I mean, overall, it's really just this function of getting the net active growth back on track. You know, we entered the year of FY 2022 with more clients than we exited, and so that's a big driver of that Fix number.
Just, you know, continued adoption and rollout of Freestyle, which we know has been largely accretive and incremental to our existing Fix client base. Let me let Dan comment on the growth margin question.
Yeah. Ike, to your question on gross margin, you know, we talked, we referenced it earlier that once you adjust for our incremental inventory reserve and third-party liquidation sales, Q4 was at 42.5%. We guided for Q1 to be 42% in full- year. We feel good about our overall product margins. We feel good about all our gross margin line items. The one caveat, of course, is just the timing of inventory. A lot of our inventory, most of our inventory that we will receive in our first half was ordered six months ago. We ordered inventory early because of supply chain challenges back then. A lot of those supply chain challenges have since alleviated.
The timing of the inventory is a little bit uncertain as we go into our H1 for our fall/winter, and that could create some variability, but we do expect the 42% to be consistent quarter on quarter, absent of any inventory surprises, which at this point we're managing quite closely. You can infer that the 42% is relatively stable, pending some small changes quarter on quarter.
Got it. Thank you.
We will take our next question from Ashley Helgans with Jefferies. Please go ahead.
Hey, thanks for taking our questions. Just on the fiscal year guide, what kind of macro backdrop are you assuming throughout fiscal year 2023? A lot of retailers have been talking about higher promotions heading into the back half of the year. Can you update us on your promotional strategy now that you have the ability to use Freestyle as a promotional tool? Thanks.
Yeah, I can start. Thanks for the questions, Ashley. I'll start with the promotional kind of behavior and then let Dan talk about the full year guide expectations. Yeah, I mean, when we were a Fix-only business, we really had no release valve or promotional offerings for our clients, with the exception of our buy five discount, which obviously has been very popular with our customers. Over the course of the last eight months or so, we've been able to experiment with a couple limited time offers where we're, you know, taking advantage of showing value to our Freestyle clients, as well as testing and experimenting with inventory that's not moving as quickly. We had the first of those back in, I think it was in Q.
Late Q2, early Q3, and then again within Q4, and then we also did a Labor Day event a few weeks ago. You know, overall, we like what we've seen. Those events have exceeded our expectations. You know, in certain situations, we really like the ability to drive halo to the rest of our products. You know, we are gonna be really thoughtful to do these episodically, deliver value to our clients. We know the reason people come to Stitch Fix are different than, you know, being a promotional retailer, and those are the places we need to most differentiate, which are around fit, product discovery, and human relationships. That said, we also wanna make sure we're presenting our clients with value and benefits over time.
We anticipate continuing to use those kinds of events, I would imagine probably around the cadence of once a quarter, with maybe some experimenting along the way. I think one thing that's really unique about the Freestyle experience is that each store is unique to each of our clients. Over time, as we build more of our pricing capabilities, more of our loyalty capabilities, being more even one-to-one focused in nature with what we offer to our clients is an opportunity down the road. But overall, you know, we now have this, release valve that we wouldn't have had with a Fix-only business. I'll let Dan talk about the full year question.
Yeah, Ashley, to your question on our full- year, I would say that we have not factored in any deep improvements or deep changes from where we're at now based just on the visibility we currently have. It's basically a status quo on where we're at now and what we feel is the right guidance to give on everything that we know now and what we've seen over the last, you know, several months with our trends.
Great. Thanks for the color.
We will take our next question from Tom Nikic with Wedbush Securities. Please go ahead.
Hey, good afternoon. Thanks for taking my question. I want to follow up on Ike's question earlier about the gross margins. You know, Dan, for many years, this is a business that had gross margins kind of in the mid-40s% and, you know, now, you know, you've kind of been in the low 40s%, like the 42% range, you know, the last couple quarters, and that's the guide for FY 2023. Is this essentially like the new, you know, gross margin for the company long term? Are there opportunities to take the gross margins higher?
How do we think about, you know, puts and takes on gross margin and like, can you get back to that kinda mid-40s% gross margin that the company had, you know, for many years before the recent quarters?
Yeah, it's a good question, Tom. You know, the sequential changes that you're talking about, you know, where in H1 of FY 2022 we were closer to the 45%, and in H2 we were closer to the 42% is really, as I said earlier, the result of inflationary costs, from a product standpoint, along with transportation costs, which is well documented on the increase that's going on in the form of the, from the carriers. While we do expect that to continue on in FY 2023, there are opportunities to ultimately grow and improve margin. For example, we've talked about this in the past, our network is not optimized yet to have the lowest amount of transportation costs from a carrier or split shipments perspective.
These are things that we're working on currently. In these areas that are the biggest drivers of gross margin, mainly transportation and product costs, there is opportunity, you know, should the inflationary environment reside or, you know, as we get better and better with transportation and optimizing our carrier networks. Again, that's more longer term. I wouldn't say that the 42% is the normal going into FY 2024, 2025, and we'll look at that and update you guys as we get closer to the end of the year. For now, 42% is more of the realistic, just given the inflationary costs that we're seeing in both transportation and on the product side.
Understood. Thanks, Dan.
We will take our next question from Kunal Madhukar with UBS. Please go ahead.
Hi. Thanks for taking my question. Let's start with, you know, the traffic increase that you talked about. You said there is a steady improvement in traffic in this back half. Conversion rates also improved. Yet, you know, a couple of things. One is, your, you know, your LTM active client number declined significantly high single digits on a year-over-year basis. You are also talking about the average age of the client base has increased, which means you're retaining some of the older customers. What am I missing here? You're probably adding more customers, and yet you have more older customers. Who do you lose, and why is the LTM number down? Then I have a quick follow-up.
Hey, thanks, Kunal. Yeah, I did mention that we saw steady gains in the back half relative to earlier in the year on traffic, and then we have made progress on conversion, so those are both true. Conversion rates are obviously different depending on the source of traffic and channel. You know, we like what we're seeing on driving more to the experience. The area that we still have room to improve is that direct and organic traffic, which tends to be the highest converting traffic. While on an apples-to-apples basis, we've made steady progress on conversion, you know, we still see opportunity to drive that really high considered traffic that is super high intent on coming to Stitch Fix. Areas of opportunity that we're very focused on are those signed-up prospects who've already come and given their information but not converted.
You know, increasing the penetration of those customers we see as a big opportunity. You know, reactivating prior clients where they know, you know, they found what they needed in the past, but maybe lapsed over time and bringing them back. Things like, I mentioned like, you know, the early efforts to begin to scale our affiliate influencer. All of those tend to drive, especially the former, that very high intent traffic. Not all traffic is apples to apples as part of what you're hearing. On the tenure point, you know, we just have not added the same magnitude of new customers is really the core issue.
It's not that it's a different customer base, it's more we just haven't had the same order of magnitude of new customers, which early in life cycle, clients just tend to spend more with us than over, you know, say the two to three-year timeframe, their spend tends to go down a bit. Those are the dynamics that I think you're hearing.
Okay.
I don't know, Dan, if you want to add anything to that.
No, I think, I'll just add on to what Elizabeth said, which I fully agree with, in that once we do turn the corner and add net actives, that average tenure will come back down. We will see that impact over the subsequent timelines as these new customers engage more with Fix and Freestyle over their tenure. We would expect that trend to reverse when we add new actives.
Got it. The follow-up is on Freestyle. Freestyle started in the middle of last fiscal year, effectively. If it started virtually from scratch in the middle of last fiscal year, you know, and maybe had six to nine months of, you know, revenue, and then it grew 21%. Did it grow from like, you know, 4% of total revenue to, you know, 10% of total revenue? Or, you know, how big is Freestyle right now?
Yeah, I can start, and Dan, feel free to add. Kunal, we actually began an experience of being able to shop your looks, shop items you'd bought in the past, Fix experience kind of late in fiscal 2020. We started to ramp up more features in that shopping experience in fiscal 2021 just as an add-on feature for existing clients, and we've continued to build out more features and functionality, and we'll continue to do so. It was just in last fiscal year of FY 2022 that we made it possible that you could start with that experience. It was not brand new halfway through last year, but the features and the expansion and the branding of Freestyle happened last fall.
Got it. Thank you so much.
Yeah. Sounds good. Thank you.
Sounds good. Bye.
We will take our next question from Janet Kloppenburg with JJK Research Associates. Please go ahead.
Hi, everybody. I just had a couple follow-on questions about merchandising execution and the inventory content. I was just wondering, you talked about the wear-to-work trends being good, and I think that might be helping drive the average spend per customer. Not sure. But wondering if you feel like your inventory investments there are where they should be, or if they're improving now, and that's helping drive the improved performance that you're seeing right now. Maybe if you could talk a little bit about, you know, your investments in wear-to-work and special occasion versus casual and trends you're seeing there, and also on the men's performance, because I know that gender had been weaker than women's. Just lastly, Dan, on the inventory, I know you're comfortable that it's coming down.
I'm just wondering again on content and seasonal carryover, particularly due to late deliveries of summer, maybe because of supply chain delays and how that looks going forward. Thank you.
Yeah. Janet, I can start on the merchandising. I mean, we definitely have seen particular strength recently in just you know categories that frankly have been less popular during the COVID timeframe are really starting to come back. As I mentioned, you know, blazers being a good example of that. In women's, we also saw, like, a 30% increase in seasonal heels. You know, clearly people are going back into the work environment, even if it's hybrid work. Things like dresses has continued to be strong particular types of dresses like midi and maxi. Then with men's, things that are versatile, like polo shirts, have continued to show strength. But I would say, like, athleisure, comfortable clothes, those tend to still be very strong categories for us.
It's really the portfolio of products that I think have benefited us and that we've kind of played across. You know, we're not just athleisure, we're not just work wear. We're really able to adapt to the signal that we're hearing from our clients. You know, over the course of this last year, we did add a number of national brands that we've tested into, but the majority of our sales are still with kind of the combination of Stitch Fix only and private label that we're able to adapt reasonably quickly based on client preference. Obviously, some categories are longer lead time, like footwear. I would say we're seeing kind of continued consumer demand in things like athleisure in addition to work wear. It's not just a full-on shift to those categories.
Are you comfortable that your inventories are aligned in sync with the category demand?
I think we're feeling like we have the right presence of categories. I think like most of our category, just the overall discretionary investment is what I think kind of all of apparel is probably experiencing right now. In terms of having, you know, affordable price points, having the categories that consumers are looking for, I think probably the bigger headwind within, you know, retail apparel overall is just the shift that consumers are making given inflation, gas prices. I think it's more of a macro than a micro. I know you had the supply chain speed question.
Thanks so much.
I'll let Dan take that one.
Hi, Dan.
Yeah. The question on the spring and summer goods, that was the reason we gave when we talked about the 250 basis point impact.
Oh, it's.
on the gross margin.
From 40
Right
percent that we had in Q4. I feel very good about the spring and summer goods. We've adequately reserved for that. We've actually executed quite a bit on right-sizing that inventory. I will say, of course, the supply chain issues as it relates to fall and winter is where we're focused on now. A lot of those orders were placed six months ago, and so we have one more cycle here before we feel we can right-size our inventory, and I would expect inventory to go up sequentially, you know, in Q1, although we're still working on right-sizing that inventory.
For the spring/summer, I feel very good, and I also feel pretty good. I feel very good about the back half, that we'll have our inventory right-sized by the back half of our FY 23.
Okay. Thanks so much. I'll follow up on it later.
We will take our next question from Dana Telsey with Telsey Advisory Group. Please go ahead.
Hi. Good evening, everyone. Just following up on Janet's question on inventory. When you talk about right-sizing the inventory, what levels do you expect it to be, and is there a marker for the first half of the fiscal year and by the end of the fiscal year as you're looking at it? Then on expense reduction, which I believe last quarter you had talked about the $40 million-$60 million annual cost savings. How is that progressing? Then the one-time restructuring charges of $15 million-$20 million in this past fourth quarter, is that done or is there anything more we should look at? Then just Elizabeth, on product, as you think about planning for the holiday season, what are you leaning into? What are you seeing from brands, from your own private label, and how do you expect that mix to shape? Thank you.
Great. I'll let Dan take the first couple questions.
Yeah. Hi, Dana. To your first question, you know, we don't provide a forecast for inventory. That said, you know, we feel that we can get upwards of 4x-5 x turns on a gross inventory basis. We're not there now, but we feel ultimately we eventually can get to that level. That's probably longer term, but we're making good progress, or we plan to make good progress throughout FY 2023 on rightsizing our inventory and keeping it at the right level of turns on a go-forward basis. We'll update you more in future earnings calls on where we're at with respect to our inventory position.
On the cost savings initiative, you know, we mentioned last quarter that $40 million-$60 million is what we expected to receive. We are on track, as we said earlier, to exceed that number. Most of that, you know, a lot of it is operationalized. There's still a lot of initiatives that we have that we're working on, so we'll give an update on what that is going to be as we go through FY 2023. I feel very good on the $40 million to $60 million, on exceeding that $60 million threshold. The bulk of that is on the fixed cost side.
On top of that, we are expecting to get variable productivity for a lot of the work that we did in Q4 on both the warehouse and the styling side of the business. That will help in the cost savings initiative going forward. Finally, to your question on the restructuring charges, we may have small amounts of restructuring. We don't anticipate anything for Q1 as big as Q4. There might be some small restructuring and one-time charge initiatives. We'll update you guys on that as we go into Q2. It will not be like it was, of course, in Q4. Again, stay tuned on restructuring and one-time charges.
I can just mention, I think, Dana, you were asking a question of some of the trends we're seeing on our assortment and heading into the holiday season. I would just say broadly, you know, we've learned a lot on sort of the discovery within Freestyle of some of the brands that we've added. In particular, I think we've seen popularity with contemporary brands with accessible price points and limited distribution. You know, some of our top brands that we've seen in Freestyle have been brands like Modern Citizen, VERO MODA, you know, brands that are basically priced at that sweet spot of under $150, in addition to particular strength in a number of our exclusive brands.
You know, Market & Spruce and 41 Hawthorn continue to be some of the biggest brands within our portfolio of both Fix and Freestyle. You know, I think we're hearing in terms of client signal in our request notes are, you know, going out again and preparing for the holiday season. We are more of a self-purchase occasion still rather than gifting, so our focus is probably gonna be on that in terms of, you know, dresses and going out wear, and we're ready for that. Thank you for that question.
Thank you.
There are no further questions at this time. Ms. Spaulding, I'd like to turn the conference back to you for any additional or closing remarks.
Thank you everybody for joining us today and all the questions. We look forward to updating you on our progress.
This concludes today's call. Thank you for your participation. You may now disconnect.