Thank you for joining us on this special investor update call today. Joining me on today's call are Katrina Lake, Founder and CEO of Stitch Fix; Mike Smith, President, COO, and interim CFO; and Elizabeth Spaulding, President. 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. A link to the webcast of today's conference call can be found on the IR section of our website, investors.stitchfix.com. 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. Recorded results should not be considered as an indication of future performance. Please review our filings with the SEC for a discussion of the factors that could cause our results to differ.
Also, note that the forward-looking statements on this call are based on 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. Reconciliation to the most directly comparable GAAP financial measures are provided in the Q2 shareholder letter previously posted 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. Katrina will offer some prepared remarks before we open the call up for brief live Q&A. I'd now like to turn the call over to Katrina.
Thanks, David, and thanks to everyone for joining us on this business update call. These are unprecedented times for all of us, and we really appreciate that you've joined us today as we navigate this together. I speak for myself and my colleagues on the line when I say our hearts go out to all of our employees, clients, partners, investors, and analysts during these challenging times and hope you and your families are doing well given the circumstances. The purpose of the call today is to share an update on the business impact of COVID and the impact that it has on our short-term and long-term outlook. There'll be four sections of this call. Firstly, to talk about the most short-term, we'll share more color on our decision to withdraw our Q3 and fiscal 2020 guidance.
Secondly, we'll talk about the underlying strength and resilience of our business across a couple of dimensions: our business model, as well as behavior we've seen in clients in these early weeks. Thirdly, we'll discuss our strong balance sheet and how we plan to leverage it during today's challenging environment. Last, but certainly not least, we'll talk about the longer term and how the investments we make today can position us to come out stronger than ever from these turbulent times and set us up to accelerate the shift in market share when the dust settles. Let's talk about our Q3 and 2020 outlook. When we shared guidance a month ago, we foresaw risk to our supply chain that resulted from the COVID-related shutdown in China in early 2020. What we did not have visibility into was how much the crisis would impact our ability to operate our warehouses consistently.
As the COVID threat has grown in the U.S., where we operate five distribution centers ourselves and one through a third party, we've had to make significant reductions in our operating capacity, particularly in the last three weeks. In order to prioritize the health and safety of our employees and our facilities, we temporarily closed three of our facilities and changed how we are operating across our network. The five distribution centers we operate in the U.S. are now all currently open, but with significant precautions implemented, including conducting temperature checks on employees at work, enforcing social distancing protocols, offering protective equipment such as gloves and masks, and staffing medical workers on site. Additionally, these open distribution centers are all currently staffed on a volunteer basis. We have given these employees up to four weeks of flexible paid time to use now or in the months to come.
While we deeply believe in this employee-right approach, it does also mean that we have fewer people in our warehouses, reduced capacity, that we are processing shipments with a delay compared to our normal operations, and that clients are facing delays or extended wait times. While our primary constraint at present is our fulfillment capacity, we also anticipate consumer softness in this economic climate, and we think it's prudent to withdraw our guidance. To move to our second topic, we wanted to share more on trends we are seeing with our clients and demand, as well as some observations on our business model that give us more confidence in our ability to weather the current environment. The initial impact of COVID on our clients has only been broadly seen in our data in the last two to three weeks.
So we'll caveat the below observations in two ways: that it's still early and that it's entirely possible that things will get worse before they get better. At a high level, what we have seen is continued commitment from our high-engagement clients. We have found it more challenging to convert new and infrequent clients into receiving Fixes, but we've seen great promise with direct-b uy across our active client base. As we've shared in the past, the vast majority of our business is from repeat clients, with a meaningful percentage of clients choosing regular Fix cadences. Demand from these clients has continued to be strong, and we have seen only a small percentage increase in auto-ship cancellation. We see this as evidence that our business model's strong personal and ongoing relationships with clients and the need we fulfill for them is one that sustains.
Conversion has been more challenging in this environment, both for infrequent clients to Fixes as well as new clients. This isn't terribly surprising given the great economic uncertainty many households are facing, and it's a trend we'd anticipate to continue as long as the economic uncertainty continues. Most exciting has been the success we've seen in direct-b uy. Our expansion into direct-b uy has continued to outperform our original forecast even through our most recent week. We have seen penetration of our existing client base of women's customers go from 5% in early February to 10% this week, and these purchases continue to be largely incremental to Fixes. This is exciting for us today, of course, but also given the current economic environment, direct-b uy can provide a less committed, lightweight entry point back into Stitch Fix that we believe will be a great engagement and potential acquisition tool.
While the current state of affairs gives us all anxiety about the future, we're really pleased to see the aforementioned resilience in our client behavior. We also want to note the inherent resiliency of our business model. Being in a business with a high degree of variable labor, with almost no long-term marketing commitment and with fast inventory churn means that we are able to flex our business model more easily than many others, and we believe that we can right-size for the short term while continuing to invest in the long term. Lastly, to state the obvious, we're very happy that we don't have the challenge of operating stores. The appeal of trying clothes on at home has never been more resonant.
This current environment is likely to further accelerate bringing apparel buying online, and we feel incredibly well-positioned in the business of a convenient at-home shopping experience personalized to every person's fit and style. Moving on to our third topic, we have been building our balance sheet with our cash flow positive and profitable business model since 2014. We have had a long history of strong unit economics. We have gross margins in excess of 45%. We acquire customers that pay back on a gross margin basis in a matter of quarters, and we've been EBITDA positive on an annual basis since 2015. We generated nearly $50 million in free cash flow in 2019 alone. Years of operating with financial responsibility is evident by our balance sheet. We ended fiscal Q2 with zero debt and nearly $400 million in cash equivalents and highly rated securities.
In the past few weeks, we have stress-tested our business across many scenarios, including scenarios such as a full warehouse closure and depressed demand. Even in situations such as these, with our business's profitability profile and healthy balance sheet, we feel very confident that the business will not only be able to survive and weather short-term challenges, but that we will be able to invest in capabilities that will help us to thrive and accelerate market share gains as the economic environment of today subsides. Which brings us to our last topic. In spite of the macro headwinds that have made efforts to survive all-consuming for apparel retailers, we are fortunate to have had the bandwidth and balance sheet to invest in our future and innovate.
Our convenient at-home model offers an obvious structural advantage in the new reality of the world, but we believe that continuing to innovate across a few key dimensions of our model is even more important as we look to a future of massive market dislocation and opportunity to capture share. We spoke earlier about the success we're seeing in direct-b uy. We have been aggressively shifting a greater share of our engineering team to building this product experience and plan to broaden the product to be able to drive activation of new clients as well as re-engagement. We've always believed in the possibility of direct-b uy across these new formats but feel that it's especially important as we are thinking about consumer spending in the future.
We believe that when consumer spending rebounds, our ability to offer low-commitment and low-friction ways to have a personalized shopping experience will be an important gateway for Stitch Fix. The dislocation that is happening in the market gives us the opportunity to pull forward testing and pilots. This includes experimenting with different inventory models as well as tests to capitalize on the incredible stylist resource that we have and engage with clients in new and different ways. Thank you again for the time you've spent with us today and for your support. This has been an incredibly challenging time. I hope the most challenging I'll ever have to lead through. The silver lining of this crazy time is the pride that I feel in our company's leadership and the grit and resilience of this team. Right-sizing the business in the short term has meant having to make some difficult decisions.
Even in the face of these challenges, I'm proud of the many decisions we have made as a company to support our people, not only through our policies such as the four weeks of flexible paid time off we referenced earlier, but also through programs we are initiating. We are setting up a program to provide financial support to single parents in our warehouses who are affected by school closures. We are separately establishing a Stitch Fix employee emergency fund to provide general financial support to hourly employees as this crisis continues. We are also using our small but mighty cut-and-sew factory in Pennsylvania to manufacture medical masks, with our first deliveries landing next week. This time period will be a defining moment for many businesses.
We'll be defined by how we get through this together, by what we'll do, and how we act in the face of uncertainty and challenge. We'll be defined by how we emerge and all that we'll be capable of on the other side, and we're here for it. We now have about 10 minutes to take a few questions.
Thank you. At this time, if you do have a question, please signal us by pressing star one. Again, that will be star one for questions. We'll hear first today from Ross Sandler with Barclays.
Hey, guys. Thanks for doing the call. Katrina or Mike, you could answer one on kind of logistics, but given the warehouse shutdowns, I guess what percent of orders or inventory were coming from those affected warehouses? And then what are you guys doing to kind of move things around to the other warehouses? And are you able to just fulfill?
To go back to recordings, please press one. Otherwise, hang up.
Can you guys hear me?
I can, yeah.
Yeah. Okay. Sorry. What are you guys doing to kind of manage the inventory in the warehouses, with some inventory being in places that are affected? And then it sounded like there was a lot of different things going on around existing clients spending more on direct- buy, but maybe less on Fixes, and then new clients dropping off. Any sense of just what overall GMV is growing right now relative to the trend line before? Any color you can give on just aggregate GMV would be helpful. Thanks.
Yeah. Just to start out on the last one, I think here we'll share more in our next Q around what specificity will look like. We're not planning to update or share guidance around Q3 or the full year. The last four weeks have all been very different from one another, and so I think we need a little bit more time to be able to have a fully formed view on what we expect for the rest of the year. On the first two, on the warehouse shutdown, I mean, let's see. In totality, I think we've had. We operate five of our own distribution centers. We have one with Fix, one with a third party. Most of them have had some period of closure over the last few weeks.
All of them currently are reopened, and so our new philosophy is that we are going to have to live with the threat of COVID for the foreseeable future. And so what we've done is to start thinking about how we can operate our warehouses in a way that allows for social distancing, in a way that is kind of as much as we can, putting health and safety first. In the short term, that's meant that we have reduced capacity today, but I think we're trying to figure out what is the new normal of how we're going to be able to operate so that our facilities can no longer be our primary constraint. But the reality is right now, our facilities not being at 100% capacity is definitely our primary constraint. In terms of, I mean, you asked a specific question around what percent of orders.
It's just more of a harder question to answer because there was maybe a week where we had two warehouses that were fully closed and one that was reopened but with not that much attendance, and then as we're ramped, I mean, it's just every day truly has been different. Our warehouses are open on a volunteer basis, so people have time off they can use flexibly, which means they can choose to come to work or not come to work, and so that means that we have variable attendance rates in our distribution centers, but it's been a meaningful capacity decrease over the last couple of weeks, but we do believe that over the next eight to 12 weeks, we'll be able to get back to a new normal.
Okay. Can I squeeze one more? So that sounds like there's a backlog that's been built on Fixes that are kind of yet to be fulfilled. Are they being canceled, or are they just kind of being delayed, and you think that clients are going to accept them just at a maybe a later date once the warehouses are moving a little bit quicker?
Yeah. I mean, there is a deferred revenue component of this where we both from the client perspective, where I think our clients are relatively forgiving during this time period, and as the Fix arrives later, it doesn't really impact their experience as much currently. And so that's an element of it. There's another element which is more processing. And so when a return comes back and we process that shipment, those transactions have also been delayed. That's also kind of an element of deferral. And then I realize you also had a question around kind of the client behavior that we're seeing. And what we're seeing is that our kind of auto-ship clients, clients that are loyal clients to Stitch Fix, we've seen that group be very stable. And for that, that group is also engaging with direct-b uy in really positive ways.
We're seeing direct-b uy resonate across a lot of our kind of client populations. And then I would say the one place that's been challenging has been conversion, conversion of brand new clients, conversions of clients that might do more à la carte Fixes where they're scheduling every once in a while. And as I said in the call, I think that lower conversion is kind of an experience that you see pretty characteristically during times when there's kind of financial uncertainty and when people have some questions around the economic security of their household. So we believe those things, once people feel that they have a little more economic security, we believe that those will improve. But the good news is that we're seeing auto- ship be very stable.
Great. Thank you.
Our next from Mark Mahaney with RBC.
Two questions. One, in the wake of this, it's unclear to me, in terms of kind of your growth plans, your hiring plans, expansion in the U.K., does all that get put on hold? Do you kind of continue with it? You've got plenty of you don't have any liquidity issues, and eventually this too shall pass. So what you're thinking on in terms of your growth investment expansion plans, everything put on hold, continue until proven otherwise, I guess that's question one, and then the second question is a real simple one. The revenue shortfall, it sounds like it's more supply-driven than demand-driven. I know you talked about some of the demand problems. You're not seeing the conversion rates as much from infrequent and from new customers. But given the it sounds like all in, it's more that you just had problems fulfilling demand. Am I capturing that right?
That it's more of a supply issue in terms of the impact on revenue? Thank you.
Thanks, Mark. Yeah. The second question is yes. I mean, the primary reason for us having this call is really around the supply-driven shortfall. The demand side, we talked a little bit about places that we see weakness, and so there's reason to anticipate that that could be a challenge in the future. But right now, our primary challenge is supply. On growth plans, I mean, this is interesting. I mean, I think we agree that this too shall pass. It doesn't feel like that every day, but we do believe that. And we actually believe that there's a lot that we can do right now in order to set us up to really thrive when this passes. And I think there's a lot of trends that this is going to accelerate. Bringing apparel dollars online is one of the big ones.
I mean, this year, at the beginning of this year, about 20% of apparel was bought online. People buy a lot more percentages of a lot more categories online. And so I really do believe that this is going to accelerate some of that share shift and that a model like ours is going to be really well positioned to capture some of that share. I think direct-b uy is something as a potentially lightweight way to engage people that's not super high commitment that, as an economy is recovering, might be able to be a good entry point into our model. Those are all examples of ways that we believe that we can be investing now in order to capitalize on what will be the market share opportunity when we exit this.
And so the answer to your question is the reality is short term, we are having to make some adjustments because our short term volume, when our warehouses are not at full capacity, it means that we don't have as much Fixes to style that we're going to be able to get out the door right now. It means that we have to be looking at our inventory and what is the right inventory that we want to have from a seasonality perspective? Realistically, do we want to be doing any marketing during this time period?
So there are a lot of things in the short term that we are having to look at our cost structure and say, "Where do we want to right-size the business in order for us to be matching with what our short term expectations are?" But what we're really trying to do is to continue to invest in those things that we believe are going to help us to win long term and to continue to invest in things like direct- buy and to continue to be in the U.K. And I think that market is going to have a similar challenge as the U.S., but I think at some point that market will also rebound, and we want to be there to capture that.
Okay. Got it. Thanks, Katrina.
Over next to KeyBanc Capital Markets, Ed Yruma.
Hey, good afternoon. Thanks for taking the question. I guess on marketing expense, in an environment where the consumer's attention is elsewhere, how do you think about trying to drive new customer acquisition? Is that a focus at all in this environment? And then second, as you think about inventory levels, are you adjusting buys for the rest of the year in anticipation that either demand will slacken up a little bit or that you may have excess inventory from pieces that aren't operating at full optimization? Thank you.
[crosstalk] Yeah. Why don't you start, Elizabeth?
Yeah. I'll start on the marketing one, and then Katrina can talk about the inventory question. So I mean, I think we're very fortunate in the sense that we're so data-driven, and the plurality of our media spend is performance marketing, so we're able to make daily, weekly adjustments to what we're seeing. And so I think, as Katrina talked about, we have seen dampening of consumer demand in terms of conversion. It's a moment where a lot of people are pulling back their ad spend, so we have also seen a reduction in CPMs. But the conversion rates are such that we have made weekly adjustments where we're pulling back on some of our ad spend.
We are still spending because we have seen new client conversions over the last few weeks, but we're doing so at the rate that we've held ourselves in the past in terms of our customer lifetime value and our cost per acquisition. We're just managing towards that equation in a period of dampened demand so that we can really ramp that spend back up once we see consumers in the behavior model that we've seen historically. I think the benefit of our model is we don't have big media upfronts in terms of TV, and we tend to be buying on a very real-time basis, so we have that flexibility right now. I'll hand it to Katrina for the inventory one.
Yeah. On the inventory side, I mean, our merchandising teams are very hard at work kind of reworking the assortment through the rest of this year and thinking about next year. And the rest of this year is a little bit about trying to flow through the capacity constraints that we have in the short term that we have right now with our warehouses and understanding what is the impact going to be on our inventory, meaning what are we going to potentially need less of, what are we going to be pushing out to the future, what are seasonal categories where we might just want less in the short term. And so our teams are working hard at right-sizing the inventory in the short term. And to be frank, I mean, longer term a little bit as well.
We have some vendors who are canceling their own orders, who are saying, "We're actually not even going to have a collection for this upcoming season." And so we're having to kind of reshuffle that way. There are obvious things like there are certain categories like athleisure that is doing very well right now where we want to be really well positioned for. And so the merchandising team is reacting very real-time. This is where we have two really great benefits, and one is the kind of over five, six times inventory turn that we do. That really gives us a lot of flexibility on the assortment side. And then, of course, the great relationship we have with our vendors.
We've talked about being a kind of retailer of choice, a partner of choice to our vendors because of the model that we've had, because of the growth that we've given them. And now is really a time that we really especially love being in that seat because we can be at the top of the line. We can be the one that our vendors really want to work with and really want to make sure that we're happy. And so our merchandising team is working really hard, but we definitely have a little bit of reworking the assortment that we're doing right now.
Great. Thanks so much, guys.
Our final question today will be from Heath Terry with Goldman Sachs.
Great. Thanks. Appreciate all the details at this point. Maybe a little bit of more of a strategic thing, especially to the extent that we do end up in this maybe a little bit longer. But is this in any way you mentioned sort of testing some other models? Does this in any way sort of give you the opportunity or make you want to accelerate sort of considering any of the non-apparel categories that you've maybe thought about, looking at options in household goods, for example? Is that something that, given maybe a slightly longer time horizon, that you would consider around this?
Yeah. Thanks for the question. I mean, at a high level, I think an environment like this does allow us to lean a little bit more into risk. And so we mentioned a couple of things on the call that we're excited to test: having stylists engage in new ways, exploring inventory models, whether that be kind of different methods, like who's holding the inventory, where is it shipping from. Those are some things that we can really experiment with. And especially, I think right now is a time when there is going to be a lot of inventory that's potentially available. I think that allows us to do more testing. And so we're excited about testing on those fronts. Longer term, I think we have a lot of things on our strategic roadmap of things that we think are going to be great opportunities.
I'm not sure that household goods is going to be at the very top of the list right now, but I think your question is a really great one because right now, this is part of the conversation that we're having around, given this is a time when we feel like kind of a higher appetite to take risks, a higher wanting to take risks. What are those things that we can push the bounds of? And I think this provides a great environment for us.
Great. Thanks, Katrina.
Katrina, I would like to turn things back over to you for any closing or additional remarks.
Thank you, everybody, again for joining us, and hope everybody and their families are staying safe.
That will conclude today's conference. Again, thank you all for joining us today.