Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 26, 2019
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-38291
 
 
STITCH FIX, INC.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
27-5026540
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
1 Montgomery Street, Suite 1500
San Francisco, CA
 
94104
(Address of Principal Executive Offices)
 
(Zip Code)
 
(415) 882-7765
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES x NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
Non-accelerated filer
 
x
  
Smaller reporting company
 
¨
Emerging growth company
 
¨
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ¨ NO x
As of March 5, 2019, the number of outstanding shares of the registrant’s Class A common stock, par value $0.00002 per share, was 44,462,344, and the number of outstanding shares of the registrant’s Class B common stock, par value $0.00002 per share, was 55,507,519.

1




STITCH FIX, INC.
TABLE OF CONTENTS
 
 
 
Page No.
  
 
  
  
  
 
  
  
  
  
  
 
 
 
  
  
  
  
  
  
  
  
  
 
In this Quarterly Report on Form 10-Q, “we,” “our,” “us,” “Stitch Fix,” and “the Company” refer to Stitch Fix, Inc. The Stitch Fix logo and other trade names, trademarks or service marks of Stitch Fix are the property of Stitch Fix, Inc. This Quarterly Report on Form 10-Q contains references to our trademarks and to trademarks belonging to other entities. Trade names, trademarks and service marks of other companies appearing in this Quarterly Report on Form 10-Q are the property of their respective holders. We do not intend our use or display of other companies’ trade names or trademarks to imply a relationship with, or endorsement or sponsorship of us by, any other companies.


2



PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
Stitch Fix, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per share amounts)
 
 
January 26, 2019
 
July 28, 2018
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
167,496

 
$
297,516

Restricted cash
250

 
250

Short-term investments
109,363

 

Inventory, net
103,167

 
85,092

Prepaid expenses and other current assets
33,160

 
34,148

Total current assets
413,436

 
417,006

Long-term investments
66,734

 

Property and equipment, net
44,888

 
34,169

Deferred tax assets
16,383

 
14,107

Restricted cash, net of current portion
12,600

 
12,600

Other long-term assets
3,010

 
3,703

Total assets
$
557,051

 
$
481,585

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
86,815

 
$
79,782

Accrued liabilities
66,080

 
43,037

Gift card liability
9,921

 
6,814

Deferred revenue
12,496

 
8,870

Other current liabilities
1,847

 
3,729

Total current liabilities
177,159

 
142,232

Deferred rent, net of current portion
16,420

 
15,288

Other long-term liabilities
10,183

 
8,993

Total liabilities
203,762

 
166,513

Commitments and contingencies (Note 6)


 


Stockholders’ equity:
 
 
 
Class A common stock, $0.00002 par value – 2,000,000,000 shares authorized as of January 26, 2019 and July 28, 2018; 44,270,743 and 35,756,628 shares issued and outstanding as of January 26, 2019 and July 28, 2018, respectively
1

 
1

Class B common stock, $0.00002 par value – 100,000,000 shares authorized as of January 26, 2019 and July 28, 2018; 55,638,058 and 63,043,233 shares issued and outstanding as of January 26, 2019 and July 28, 2018, respectively
1

 
1

Additional paid-in capital
250,699

 
235,312

Accumulated other comprehensive income
141

 

Retained earnings
102,447

 
79,758

Total stockholders’ equity
353,289

 
315,072

Total liabilities and stockholders’ equity
$
557,051

 
$
481,585

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


3



Stitch Fix, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
(In thousands, except share and per share amounts)
 
 
For the Three Months Ended
 
For the Six Months Ended
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Revenue, net
$
370,280

 
$
295,906

 
$
736,516

 
$
591,469

Cost of goods sold
207,131

 
168,523

 
408,199

 
335,071

Gross profit
163,149


127,383


328,317


256,398

Selling, general, and administrative expenses
147,738

 
111,771

 
302,009

 
231,242

Operating income
15,411

 
15,612

 
26,308

 
25,156

Remeasurement of preferred stock warrant liability

 
(1,614
)
 

 
(10,685
)
Interest income
(1,170
)
 
(18
)
 
(2,569
)
 
(35
)
Other income, net
(453
)
 

 
(573
)
 

Income before income taxes
17,034

 
17,244

 
29,450

 
35,876

Provision for income taxes
5,058

 
13,603

 
6,796

 
18,747

Net income
$
11,976


$
3,641


$
22,654


$
17,129

Other comprehensive income:
 
 
 
 
 
 
 
Change in unrealized gain on available-for-sale securities, net of tax
104

 

 
22

 

Foreign currency translation
93

 

 
119



Total other comprehensive income, net of tax
197

 

 
141

 

Comprehensive income
$
12,173

 
$
3,641

 
$
22,795

 
$
17,129

Net income attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
11,968

 
$
3,036

 
$
22,632

 
$
9,794

Diluted
$
11,968

 
$
1,653

 
$
22,633

 
$
3,530

Earnings per share attributable to common stockholders:
 

 
 

 
 

 
 

Basic
$
0.12

 
$
0.04

 
$
0.23

 
$
0.18

Diluted
$
0.12

 
$
0.02

 
$
0.22

 
$
0.06

Weighted-average shares used to compute earnings per share attributable to common stockholders:
 

 
 

 
 

 
 

Basic
99,590,187

 
82,439,351

 
99,278,599

 
54,377,466

Diluted
102,817,838

 
87,954,656

 
103,597,316

 
60,599,568

 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


4



Stitch Fix, Inc.
Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity
(Unaudited)
(In thousands, except share amounts)
 
 
For the Three Months Ended January 27, 2018
 
Convertible
Preferred Stock
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other Comprehensive Income
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Balance as of October 28, 2017
59,511,055

 
$
42,222

 
 
27,026,292

 
$
1

 
$
29,920

 
$

 
$
48,346

 
$
78,267

Issuance of Class A common stock upon initial public offering, net of offering costs

 

 
 
9,175,557

 

 
127,033

 

 

 
127,033

Issuance of Class B common stock upon conversion of convertible preferred stock
(59,511,055
)
 
(42,222
)
 
 
59,511,055

 
1

 
42,221

 

 

 
42,222

Reclassification of warrant liability to additional paid-in capital upon the initial public offering

 

 
 
1,066,225

 

 
15,994

 

 

 
15,994

Issuance of Class B common stock upon exercise of stock options

 

 
 
281,621

 

 
562

 

 

 
562

Repurchase of Class B common stock related to early exercised options

 

 
 

 

 

 

 

 

Vesting of early exercised options

 

 
 

 

 
141

 

 

 
141

Stock-based compensation

 

 
 

 

 
3,237

 

 

 
3,237

Net income

 

 
 

 

 

 

 
3,641

 
3,641

Balance as of January 27, 2018


$

 
 
97,060,750


$
2


$
219,108


$

 
$
51,987


$
271,097

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended January 26, 2019
 
Convertible
Preferred Stock
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Balance as of October 27, 2018

 

 
 
99,434,225

 
$
2

 
$
243,086

 
$
(56
)
 
$
90,471

 
$
333,503

Issuance of common stock upon exercise of stock options

 

 
 
390,308

 

 
(69
)
 

 

 
(69
)
Issuance of restricted stock units, net of tax withholdings

 

 
 
84,268

 

 
(918
)
 

 

 
(918
)
Vesting of early exercised options

 

 
 

 

 
88

 

 

 
88

Stock-based compensation

 

 
 

 

 
8,512

 

 

 
8,512

Net income

 

 
 

 

 

 

 
11,976

 
11,976

Other comprehensive loss, net of tax

 

 
 

 

 

 
197

 

 
197

Balance as of January 26, 2019

 
$

 
 
99,908,801

 
$
2

 
$
250,699

 
$
141

 
$
102,447

 
$
353,289

 
 
 
 
 
 
 
 
 
 
 
 
 

5



 
For the Six Months Ended January 27, 2018
 
Convertible
Preferred Stock
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other Comprehensive Income
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Balance as of July 29, 2017
59,511,055

 
$
42,222

 
 
26,834,535

 
$
1

 
$
27,002

 
$

 
$
34,858

 
$
61,861

Issuance of Class A common stock upon initial public offering, net of offering costs

 

 
 
9,175,557

 

 
127,033

 

 

 
127,033

Issuance of Class B common stock upon conversion of convertible preferred stock
(59,511,055
)
 
(42,222
)
 
 
59,511,055

 
1

 
42,221

 

 

 
42,222

Reclassification of warrant liability to additional paid-in capital upon the initial public offering

 

 
 
1,066,225

 

 
15,994

 

 

 
15,994

Issuance of Class B common stock upon exercise of stock options

 

 
 
492,857

 

 
1,006

 

 

 
1,006

Repurchase of Class B common stock related to early exercised options

 

 
 
(19,479
)
 

 

 

 

 

Vesting of early exercised options

 

 
 

 

 
456

 

 

 
456

Stock-based compensation

 

 
 

 

 
5,396

 

 

 
5,396

Net income

 

 
 

 

 

 

 
17,129

 
17,129

Balance as of January 27, 2018

 
$

 
 
97,060,750

 
$
2

 
$
219,108

 
$

 
$
51,987

 
$
271,097

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended January 26, 2019
 
Convertible
Preferred Stock
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other Comprehensive Income
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Balance as of July 28, 2018

 

 
 
98,799,861

 
2

 
235,312

 

 
79,758

 
$
315,072

Cumulative effect of adopting accounting standards(1)

 

 
 

 

 

 

 
35

 
35

Issuance of common stock upon exercise of stock options

 

 
 
968,415

 

 
1,931

 

 

 
1,931

Issuance of restricted stock units, net of tax withholdings

 

 
 
140,525

 

 
(2,281
)
 

 

 
(2,281
)
Vesting of early exercised options

 

 
 

 

 
178

 

 

 
178

Stock-based compensation

 

 
 

 

 
15,559

 

 

 
15,559

Net income

 

 
 

 

 

 

 
22,654

 
22,654

Other comprehensive income, net of tax

 

 
 

 

 

 
141

 

 
141

Balance as of January 26, 2019

 
$

 
 
99,908,801

 
$
2

 
$
250,699

 
$
141

 
$
102,447

 
$
353,289

 
(1) See Note 2, Summary of Significant Accounting Policies, of the Notes to the Condensed Consolidated Financial Statements for more details on the cumulative effect of adopting accounting standards.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


6



Stitch Fix, Inc.
Condensed Consolidated Statements of Cash Flow
(Unaudited)
(In thousands)
 
For the Six Months Ended
 
January 26, 2019
 
January 27, 2018
Cash Flows from Operating Activities
 

 
 

Net income
$
22,654

 
$
17,129

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Deferred income taxes
(2,288
)
 
5,498

Remeasurement of preferred stock warrant liability

 
(10,685
)
Inventory reserves
4,853

 
7,027

Stock-based compensation expense
14,747

 
5,135

Depreciation and amortization
6,456

 
4,888

Loss on disposal of property and equipment

 
131

Change in operating assets and liabilities:
 
 
 

Inventory
(22,928
)
 
(19,529
)
Prepaid expenses and other assets
1,546

 
5,078

Accounts payable
7,012

 
10,843

Accrued liabilities
17,689

 
4,484

Deferred revenue
3,822

 
3,283

Gift card liability
3,512

 
2,961

Other liabilities
592

 
(2,508
)
Net cash provided by operating activities
57,667


33,735

Cash Flows from Investing Activities
 

 
 

Purchases of property and equipment
(11,903
)
 
(8,232
)
Purchases of securities available-for-sale
(185,994
)
 

Sales of securities available-for-sale
1,163

 

Maturities of securities available-for-sale
9,500

 

Net cash used in investing activities
(187,234
)
 
(8,232
)
Cash Flows from Financing Activities
 

 
 

Proceeds from initial public offering, net of underwriting discounts paid

 
129,046

Proceeds from the exercise of stock options, net
1,931

 
1,006

Payments for tax withholding related to vesting of restricted stock units
(2,281
)
 

Repurchase of Class B common stock related to early exercised options

 
(39
)
Net cash (used in) provided by financing activities
(350
)

130,013

Net increase (decrease) in cash, cash equivalents, and restricted cash
(129,917
)
 
155,516

Effect of exchange rate changes on cash
(103
)
 

Cash, cash equivalents, and restricted cash at beginning of period
310,366

 
119,958

Cash, cash equivalents, and restricted cash at end of period
$
180,346


$
275,474

Components of Cash, Cash Equivalents, and Restricted Cash
 

 
 

Cash and cash equivalents
$
167,496

 
$
266,374

Restricted cash – current portion
250

 

Restricted cash – long-term portion
12,600

 
9,100

Total cash, cash equivalents, and restricted cash
$
180,346


$
275,474

Supplemental Disclosure
 

 
 

Cash paid for income taxes
$
191

 
$
3,091

Supplemental Disclosure of Non-Cash Investing and Financing Activities:
 

 
 

Purchases of property and equipment included in accounts payable and accrued liabilities
$
4,741

 
$
780

Capitalized stock-based compensation
$
812

 
$
261

Vesting of early exercised options
$
178

 
$
456

Deferred offering costs included in accounts payable and accrued liabilities
$

 
$
134

Conversion of preferred stock upon initial public offering
$

 
$
42,222

Reclassification of preferred stock warrant liability upon initial public offering
$

 
$
15,994

Deferred offering costs paid in prior year
$

 
$
1,879

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7




Stitch Fix, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
1.
Description of Business
Stitch Fix, Inc. (“we,” “our,” “us” or “the Company”) delivers one-to-one personalization to our clients through the combination of data science and human judgment. Our stylists hand select items from a broad range of merchandise. Stylists pair their own judgment with our analysis of client and merchandise data to provide a personalized shipment of apparel, shoes, and accessories suited to each client’s needs. We call each of these unique shipments a Fix. After receiving a Fix, our clients purchase the items they want to keep and return the other items. We are incorporated in Delaware and have operations in the United States and the United Kingdom.
Initial Public Offering
On November 16, 2017, we completed an initial public offering (“IPO”). In connection with the IPO, we authorized two new classes of common stock: Class A common stock and Class B common stock. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting, conversion, and transfer rights. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Each share of Class B common stock is convertible at any time at the option of the stockholder into one share of Class A common stock and has no expiration date. The Class B common stock automatically converts to Class A common stock upon transfers or any sale. In our IPO, we issued and sold 8,000,000 shares of our Class A common stock at a public offering price of $15.00 per share. We received $110.4 million in net proceeds after deducting $6.2 million of underwriting discounts and $3.4 million in offering costs. Upon the closing of the IPO, all of the then outstanding shares of common stock were reclassified into Class B common stock, all of the outstanding shares of convertible preferred stock automatically converted into 59,511,055 shares of Class B common stock, and all of the outstanding preferred stock warrants were automatically exercised into 1,066,225 shares of Class B common stock. Subsequent to the closing of the IPO, there were no shares of preferred stock or preferred stock warrants outstanding.
In December 2017, we issued an additional 1,175,557 shares of Class A common stock at a price of $15.00 per share following the underwriters’ exercise of their option to purchase additional shares and received $16.7 million in net proceeds after deducting underwriting discounts and expenses.
2.
Summary of Significant Accounting Policies
Basis of Presentation
Our fiscal year is a 52-week or 53-week period ending on the Saturday closest to July 31. The fiscal years ended August 3, 2019 (“2019”) and July 28, 2018 (“2018”) consist of 53 weeks and 52 weeks, respectively.
The unaudited condensed consolidated financial statements include the accounts of Stitch Fix, Inc. and our wholly owned subsidiaries, and have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and the requirements of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted. These financial statements have been prepared on the same basis as our annual consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for the fair statement of our financial information. These interim results are not necessarily indicative of the results to be expected for the fiscal year ending August 3, 2019, or for any other interim period or for any other future year. All intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the fiscal year ended July 28, 2018, included in the Company’s Annual Report on Form 10-K filed with the SEC on October 3, 2018 (“2018 Annual Report”).
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in our condensed consolidated financial statements and accompanying footnotes.
Significant estimates and assumptions are used for inventory, stock-based compensation expense, income taxes, revenue recognition, and, prior to our IPO, common stock valuation and remeasurement of preferred stock warrant liability. Actual results could differ from those estimates and such differences may be material to the condensed consolidated financial statements.

8



Restricted Cash
Restricted cash represents cash balances held in segregated accounts collateralizing letters of credit for our leased properties as of January 26, 2019, and July 28, 2018.
Investment Securities
The Company’s short-term and long-term investments have been classified and accounted for as available-for-sale securities. We determine the appropriate classification of our investments at the time of purchase and reevaluate the classification at each balance sheet date. Available-for-sale securities with maturities of 12 months or less are classified as short-term and available-for-sale securities with maturities greater than 12 months are classified as long-term. The Company’s available-for-sale securities are carried at fair value, with unrealized gains and losses, net of taxes, reported within accumulated other comprehensive income (“AOCI”) in stockholders’ equity, with the exception of unrealized losses believed to be other-than-temporary, which are reported in earnings in the current period, if applicable. The cost of securities sold is based upon the specific identification method.
Foreign Currency
The functional currency of our international subsidiary is the local currency. For that subsidiary, we translate assets and liabilities to U.S. dollars using period-end exchange rates, and average monthly exchange rates for revenues, costs, and expenses. We record  translation gains and losses in AOCI as a component of stockholders’ equity. Net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency are recorded in other income, net in the condensed consolidated statements of operations and comprehensive income.   
Revenue Recognition
We generate revenue primarily from the sale of merchandise in a Fix. Clients create an online account on our website or mobile app, complete a style profile and order a Fix to be delivered on a specified date.
Each Fix represents an offer made by us to the client to purchase merchandise. The client is charged a nonrefundable $20 upfront styling fee before the Fix is shipped. As an alternative to the styling fee, we offer select clients the option to purchase a Style Pass. Style Pass clients pay a $49 nonrefundable annual fee for unlimited Fixes that is credited towards merchandise purchases. If the offer to purchase merchandise is accepted, we charge the client the order amount for the accepted merchandise, net of the upfront styling fee or Style Pass annual fee. For each Fix, acceptance occurs when the client checks out the merchandise on our website or mobile app. We offer a 25% discount to clients who purchase all of the items in the Fix.
We recognize revenue through the following steps: (1) identification of the contract, or contracts, with the customer; (2) identification of the performance obligations in the contract; (3) determination of the transaction price; (4) allocation of the transaction price to the performance obligations in the contract; and (5) recognition of revenue when, or as, we satisfy a performance obligation.
Both our styling fee and Style Pass arrangements consist of one performance obligation, which is the option to purchase merchandise. The upfront styling fee is not a performance obligation as the styling activity is not distinct within the context of the contract. Similarly, the right to receive multiple options under Style Pass does not provide the customer with material stand-alone value and therefore does not give rise to a separate performance obligation. Both the upfront styling fee and Style Pass annual fee are included in deferred revenue until the performance obligation is satisfied when the client exercises his or her option to purchase merchandise (i.e., upon checkout of a Fix) or when the option(s) to purchase merchandise expire(s).
Revenue is recognized when control of the promised goods is transferred to the client. Control is transferred when the client accepts or rejects the offer to purchase merchandise. Upon acceptance by purchasing one or more items within the Fix at checkout, the total amount of the order, including the upfront styling fee, is recognized as revenue. If none of the items within the Fix are accepted at checkout, the upfront styling fee is recognized as revenue at that time. The Style Pass annual fee is recognized at the earlier of (i) the time at which a client accepts and applies the Style Pass fee to an offer to purchase merchandise or (ii) upon expiry of the annual period. Under Style Pass arrangements, if a client does not accept any items within the Fix, the annual fee will continue to be deferred until it is applied to a future purchase or upon expiry of the annual period. If a client would like to exchange an item, we recognize revenue at the time the exchanged item is shipped, which coincides with the transfer of control to the customer.
We deduct discounts, sales tax, and estimated refunds to arrive at net revenue. Sales tax collected from clients is not considered revenue and is included in accrued liabilities until remitted to the taxing authorities. All shipping and handling costs are accounted for as fulfillment costs in cost of goods sold and as selling, general, and administrative expense (“SG&A”), respectively, and are therefore not evaluated as a separate performance obligation. Discounts are recorded as a reduction to revenue when the order is accepted. We record a refund reserve based on our historical refund patterns. Our refund reserve, which was included in accrued liabilities in the condensed consolidated balance sheets, was $2.6 million and $2.3 million as of January 26, 2019, and July 28, 2018, respectively.

9



The Company has four types of contractual liabilities: (i) cash collections of upfront styling fees, which are included in deferred revenue and are recognized as revenue upon the earlier of application to a merchandise purchase or expiry of the offer, (ii) cash collections of Style Pass annual fees, which are included in deferred revenue and are recognized upon the earlier of application to a merchandise purchase or expiry of the Style Pass annual period, (iii) unredeemed gift cards, which are included in gift card liability and recognized as revenue upon usage or inclusion in gift card breakage estimates, and (iv) referral credits, which are included in other current liabilities and are recognized as revenue when used.
We sell gift cards to clients and establish a liability based upon the face value of such gift cards. We reduce the liability and recognize revenue upon usage of the gift card. If a gift card is not used, we will recognize estimated gift card breakage revenue proportionately to customer usage of gift cards over the expected gift card usage period, subject to requirements to remit balances to governmental agencies. All commissions paid to third parties upon issuance of gift cards are recognized in SG&A as incurred, as on average, gift cards are used within a one-year period. Similarly, referral credits that are considered incremental costs of obtaining a contract with a customer are recognized in SG&A when issued, as on average, referral credits are used within a one-year period.
Contractual liabilities included in deferred revenue, gift card liability, and other current liabilities were $12.5 million, $9.9 million, and $0.9 million, respectively, at January 26, 2019, and $8.9 million, $6.8 million, and $2.7 million, respectively, at July 28, 2018. During the three months ended January 26, 2019, the Company recognized $0.1 million and $0.1 million of net revenue included in deferred revenue and gift card liability, respectively, at July 28, 2018. During the three months ended January 26, 2019, the Company recognized no net revenue included in other current liabilities at July 28, 2018. During the six months ended January 26, 2019, the Company recognized $8.3 million, $0.1 million, and $0.6 million of net revenue included in deferred revenue, gift card liability, and other current liabilities, respectively, at July 28, 2018. All amounts presented as of July 28, 2018, are accounted for under Accounting Standards Codification (“ASC”) 605. All amounts presented as of January 26, 2019, include the transition impact of adopting ASC 606. See “Recently Adopted Accounting Pronouncements” below.
Deferred revenue related to upfront styling fees totaled $10.0 million as of January 26, 2019, and $7.6 million as of July 28, 2018. Deferred revenue related to Style Pass annual fees totaled $2.5 million as of January 26, 2019, and $1.1 million as of July 28, 2018. Deferred revenue related to exchanges totaled zero as of January 26, 2019, and $0.2 million as of July 28, 2018.
The Company expects deferred revenue for upfront styling fees and Style Pass annual fees to be recognized within one year. On average, gift card liability and other current liabilities are also recognized within one year.
Concentration of Credit Risks
We are subject to concentrations of credit risk principally from cash and cash equivalents and investment securities. The majority of our cash is held by three financial institutions within the United States. Our cash balances held by these institutions may exceed federally insured limits. The associated risk of concentration for cash is mitigated by banking with credit-worthy institutions. Our cash equivalents consist of money market funds and commercial paper. The associated risk of concentration for cash equivalents and investments is mitigated by maintaining a diversified portfolio of highly rated instruments. 
No client accounted for greater than 10% of total revenue, net for the three and six months ended January 26, 2019, and January 27, 2018.
Recently Issued Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires lessees to record most leases on their balance sheets but recognize the expenses on their income statements in a manner similar to current practice. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. We expect to adopt this standard in the first quarter of fiscal 2020. We are currently evaluating the impact that this standard will have on our consolidated financial statements but we expect that it will result in a substantial increase in our long-term assets and liabilities.
In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. Under this ASU, the accounting for awards issued to nonemployees will be similar to the accounting for employee awards. This includes allowing for the measurement of awards at the grant date and recognition of awards with performance conditions when those conditions are probable, both of which are earlier than under current guidance for nonemployee awards. We expect to adopt this standard in the first quarter of fiscal 2020. We are currently evaluating the impact that this standard will have on our consolidated financial statements.
Recently Adopted Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which amended the existing FASB Accounting Standards Codification. ASU 2014-09 establishes a principle for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in

10



exchange for those goods or services and also provides guidance on the recognition of costs related to obtaining and fulfilling customer contracts. The new guidance may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption (“modified retrospective method”).
We adopted the standard in the first quarter of fiscal 2019 under the modified retrospective approach. Under the new standard, we recognize estimated gift card breakage revenue proportionately to customer gift card usage over the expected gift card usage period rather than waiting until the likelihood of redemption becomes remote.  Further, we recognize revenue related to exchanges upon shipment by us, rather than upon receipt by the customer.  In the first quarter of fiscal 2019, the Company recorded a cumulative catch-up adjustment resulting in an increase to opening retained earnings, net of tax, of $0.4 million, comprised of the impact of $0.3 million from the change in revenue recognition related to gift cards and $0.1 million from the recognition of exchanges upon shipment. The impact to net revenue for the three and six months ended January 26, 2019, was an increase of $0.7 million and $0.8 million, respectively, as a result of adopting the standard.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory (Topic 740), which amends existing guidance on the recognition of current and deferred income tax impacts for intra-entity asset transfers other than inventory. We adopted the standard in the first quarter of fiscal 2019 under the modified retrospective approach. As a result, a cumulative adjustment of $0.4 million, net of tax, was recorded to reduce opening retained earnings in connection with adoption of Topic 740.
Recently Issued SEC Rules
In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated, or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. This final rule became effective November 5, 2018, and the Company adopted this standard for all periods presented in this Quarterly Report on Form 10-Q, presenting the activity of the convertible preferred stock and stockholders’ equity accounts for each period presented.
3.
Fair Value Measurements
We disclose and recognize the fair value of our assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes three levels of the fair value hierarchy as follows:
Level 1: Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;
Level 2: Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and
Level 3: Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.
Our financial instruments consist of cash and cash equivalents, short-term and long-term investments, accounts payable, accrued liabilities, and, prior to our IPO, the preferred stock warrant liability. At January 26, 2019, and July 28, 2018, the carrying values of cash and cash equivalents, accounts payable, and accrued liabilities approximated fair value due to their short-term maturities. In November 2017, in connection with our IPO, all outstanding preferred stock warrants were automatically exercised into Class B common stock. As a result, we remeasured and reclassified the preferred stock warrant liability to additional paid-in capital upon the closing of our IPO.

11



The following table sets forth the amortized cost, gross unrealized gains, gross unrealized losses and fair values of our short-term and long-term investments accounted for as available-for-sale securities as of January 26, 2019:
 
 
January 26, 2019
(in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Financial Assets:
 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
39,059

 
$
3

 
$
(3
)
 
$
39,059

Commercial paper
 
41,701

 

 

 
41,701

Asset-backed securities
 
33,962

 
4

 
(14
)
 
33,952

Corporate bonds
 
61,341

 
58

 
(14
)
 
61,385

Total
 
$
176,063

 
$
65

 
$
(31
)
 
$
176,097

The following table sets forth the fair value of available-for-sale securities by contractual maturity as of January 26, 2019:
 
 
January 26, 2019
(in thousands)
 
One Year or Less
 
Over One Year Through Five Years
 
Over Five Years
 
Total
Financial Assets:
 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
29,090

 
$
9,969

 
$

 
$
39,059

Commercial paper
 
41,701

 

 

 
41,701

Asset-backed securities
 
7,559

 
26,393

 

 
33,952

Corporate bonds
 
31,013

 
30,372

 

 
61,385

Total
 
$
109,363

 
$
66,734

 
$

 
$
176,097

The following table sets forth our cash equivalents, and short-term and long-term investments accounted for as available-for-sale securities that were measured at fair value on a recurring basis based on the fair value hierarchy as of January 26, 2019:
 
 
January 26, 2019
(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
 
 
 
 

 
 

 
 

Cash equivalents:
 
 
 
 
 
 
 
 
Money market funds
 
$
949

 
$

 
$

 
$
949

Commercial paper
 

 

 

 

Investments:
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
39,059

 

 

 
39,059

Commercial paper
 

 
41,701

 

 
41,701

Asset-backed securities
 

 
33,952

 

 
33,952

Corporate bonds
 

 
61,385

 

 
61,385

Total
 
$
40,008

 
$
137,038

 
$

 
$
177,046

As of July 28, 2018, the Company did not have any financial instruments measured at fair value.
There were no transfers of financial assets or liabilities into or out of Level 1, Level 2, or Level 3 for the three and six months ended January 26, 2019, and January 27, 2018.

12



The following table sets forth a summary of the changes in the fair value of the preferred stock warrant liability for the six months ended January 27, 2018 (in thousands):
(in thousands)
 
For the Six Months Ended January 27, 2018
Balance at July 29, 2017
 
$
26,679

Change in fair value
 
(10,685
)
Reclassification of warrant liability to additional paid-in capital upon the initial public offering
 
(15,994
)
Ending Balance at January 27, 2018
 
$

See Note 5, Preferred Stock Warrant Liability, for more details on our preferred stock warrants.
4.
Accrued Liabilities
Accrued liabilities consisted of the following:
(in thousands)
 
January 26, 2019
 
July 28, 2018
Compensation and related benefits
 
$
14,009

 
$
10,680

Advertising
 
13,041

 
10,456

Sales taxes
 
5,589

 
7,066

Shipping and freight
 
9,208

 
4,801

Accrued accounts payable
 
8,353

 
4,567

Inventory purchases
 
7,541

 
506

Other
 
8,339

 
4,961

Total accrued liabilities
 
$
66,080


$
43,037

5.
Preferred Stock Warrant Liability
In 2012 and 2013, in connection with financing arrangements, we issued warrants to purchase shares of our convertible preferred stock. For one of the financing arrangements, we issued warrants to purchase 375,230 shares of Series Seed convertible preferred stock at an exercise price of $0.1066 per share and 66,265 shares of Series A convertible preferred stock at an exercise price of $0.22636 per share. For the second financing arrangement, we issued warrants for the purchase of, at the warrant holder’s option, either (a) 624,730 shares of Series A-1 convertible preferred stock at an exercise price of $0.2401 per share or (b) 308,315 shares of Series B convertible preferred stock at an exercise price of $0.486516 per share. Prior to their automatic exercise in connection with our IPO, as described below, the warrants were exercisable for and expired 10 years from the date of issuance. In November 2017, in connection with our IPO, the preferred stock warrants were automatically exercised into Class B common stock and the preferred stock warrant liability was reclassified to additional paid-in capital.
6.
Commitments and Contingencies
Commitments
On October 12, 2018, we executed an agreement with a third-party logistics contractor to lease and operate a fulfillment center in Leicester, England (the “Fulfillment Center Logistics Agreement”). The agreement commits the Company to a five-year contract for logistics services at the Leicester fulfillment center that can be terminated after two years, with six months’ advance notice. Effective with the Fulfillment Center Logistics Agreement, the leasing component of the arrangement will be accounted for as an operating lease with future minimum lease payments over the five-year term of $11.1 million.
Contingencies
We record a loss contingency when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We also disclose material contingencies when we believe a loss is not probable but reasonably possible. Accounting for contingencies requires us to use judgment related to both the likelihood of a loss and the estimate of the amount or range of loss. Although we cannot predict with assurance the outcome of any litigation or tax matters, we do not believe there are currently any such actions that, if resolved unfavorably, would have a material impact on our operating results, financial position, and cash flows.

13



On October 11, 2018, October 26, 2018, November 16, 2018, and December 10, 2018, four putative class action lawsuits alleging violations of the federal securities laws were filed in the U.S. District Court for the Northern District of California, naming as defendants us and certain of our officers. The four lawsuits each make the same allegations of violations of the Securities Exchange Act of 1934, as amended, by us and our officers for allegedly making materially false and misleading statements regarding our active client growth and strategy with respect to television advertising between June 2018 and October 2018. The plaintiffs seek unspecified monetary damages and other relief. We expect the four lawsuits, which have been deemed to be related cases by the court, to be consolidated into one. On December 12, 2018, a derivative action was filed against our directors in the same court, alleging the same violations of securities laws as alleged in the four putative class action cases described above and breach of fiduciary duties.
There have been no other material changes to our commitments and contingencies as disclosed in our 2018 Annual Report.
Indemnifications
In the ordinary course of business, we may provide indemnifications of varying scope and terms to vendors, directors, officers and other parties with respect to certain matters. We have not incurred any material costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in our condensed consolidated financial statements.
7.
Accumulated Other Comprehensive Income
The table below presents the changes in AOCI by component and the reclassifications out of AOCI:
 
 
Changes in Accumulated Other Comprehensive Income
(in thousands)
 
Available-for-sale Securities
 
Foreign Currency Translation
 
Total
Balance at July 28, 2018
 
$

 
$

 
$

Other comprehensive income before reclassifications(1)
 
22

 
119

 
141

Net change in AOCI
 
22

 
119

 
141

Balance at January 26, 2019
 
$
22

 
$
119

 
$
141

 
 (1)The associated income tax effects for gains / losses on available-for-sale securities were $12.
8.    Stock-Based Compensation
2011 Equity Incentive Plan
In 2011, we adopted the 2011 Equity Incentive Plan (the “2011 Plan”). The 2011 Plan provided for the grant of stock-based awards to employees, directors, and nonemployees under terms and provisions established by the board of directors.
The 2011 Plan allowed for the grant of incentive stock options or nonqualified stock options as well as restricted stock units, restricted stock, and stock appreciation rights. As of January 26, 2019, we had only granted incentive and nonqualified stock options under the 2011 Plan. Employee stock option grants generally vest 25% on the first anniversary of the grant date with the remaining options vesting ratably over the next three years. Options generally expire after 10 years. Effective upon our IPO, the 2011 Plan was replaced by the 2017 Incentive Plan.
2017 Incentive Plan
In November 2017, our board of directors and stockholders adopted our 2017 Incentive Plan (the “2017 Plan”). The remaining shares available for issuance under the 2011 Plan became reserved for issuance under the 2017 Plan. Our 2017 Plan provides for the grant of Class A incentive stock options to employees, including employees of any parent or subsidiary, and for the grant of nonqualified stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards, and other forms of stock awards to employees, directors, and consultants, including employees and consultants of our subsidiaries. The number of shares authorized for issuance under the 2017 Plan was 28,423,374 as of January 26, 2019, of which 1,970,751 were available for grant.

14



Stock option activity under the 2011 Plan and 2017 Plan is as follows:
 
 
 Options Outstanding
 
 
Number of
Options
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Life (in Years)
 
Aggregate
Intrinsic
Value
(in thousands)
Balance – July 28, 2018
 
9,052,160

 
$
11.74

 
8.23
 
$
160,856

Authorized
 

 
 
 
 
 
 
Granted
 
817,789

 
$
24.43

 
 
 
 
Exercised
 
(966,677
)
 
$
3.30

 
 
 
 
Cancelled
 
(324,983
)
 
$
12.95

 
 
 
 
Balance – January 26, 2019

8,578,289

 
$
13.52

 
8.08
 
$
82,169

The aggregate intrinsic value is the difference between the current fair value of the underlying common stock and the exercise price for in-the-money stock options.
The following table summarizes the restricted stock unit (“RSU”) award activity under the 2017 Plan:
 
Unvested RSUs
 
Class A Common Stock
 
Weighted-
Average
Grant Date
Fair Value
 
Weighted-
Average
Remaining
Contractual
Life (in Years)
 
Aggregate
Intrinsic
Value
(in thousands)
Unvested at July 28, 2018
2,432,326

 
$
21.58

 
3.50
 
$
71,778

Granted
1,490,995

 
$
32.40

 
 
 
 
Vested
(140,525
)
 
$
19.35

 
 
 
 
Forfeited
(210,929
)
 
$
21.81

 
 
 
 
Unvested at January 26, 2019
3,571,867

 
$
26.17

 
3.40
 
$
82,439

Stock-Based Compensation Expense
Stock-based compensation expense for employees was $8.1 million and $14.7 million for the three and six months ended January 26, 2019, respectively, and $3.1 million and $5.1 million for the three and six months ended January 27, 2018, respectively. Stock-based compensation expense is included in selling, general, and administrative expenses in our condensed consolidated statements of operations.
The weighted-average grant date fair value of options granted during the six months ended January 26, 2019, was $11.03 per share. The weighted-average grant date fair value of options granted during the six months ended January 27, 2018, was $7.65 per share. As of January 26, 2019, the total unrecognized compensation expense related to unvested options and RSUs, net of estimated forfeitures, was $135.0 million, which we expect to recognize over an estimated weighted average period of 3.1 years.
We record stock-based compensation of stock options granted to employees by estimating the fair value of stock-based awards using the Black-Scholes option pricing model and amortizing the fair value of the stock-based awards granted over the applicable vesting period of the awards on a straight-line basis. The fair value of stock options granted to employees was estimated at the grant date using the Black-Scholes option-pricing model with the following assumptions:
 
For the Three Months Ended
 
For the Six Months Ended
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Expected term (in years)
5.5 - 6.5

 
5.4 - 6.6

 
5.1 - 6.5

 
5.4 - 6.6

Volatility
42.1 - 42.1%

 
41.4 - 43.5%

 
41.7 - 42.1%

 
41.4 - 43.5%

Risk free interest rate
2.9 - 3.0%

 
2.1 - 2.5%

 
2.8 - 3.0%

 
1.9 - 2.5%

Dividend yield
%
 
%
 
%
 
%
In July 2017, we granted options to certain members of our executive management team to purchase an aggregate of 1,097,463 shares of Class B common stock which had both a service-based condition and a liquidity event-related performance condition.

15



Such options vest ratably over the 24-month period following the fourth anniversary of the grant date, subject to an IPO occurring within 12 months of the grant date and the option holder’s continuous service through each vesting date. The aggregate grant-date fair value of such option awards was $14.0 million.
Since an IPO is not deemed probable until such event occurs, no compensation cost related to the performance condition was recognized prior to the consummation of our IPO in November 2017. Subsequently, we recorded stock-based compensation expense of $0.5 million related to periods prior to the IPO.
9.
Income Taxes
The following table summarizes our effective tax rate from income for the periods presented:
 
 
For the Three Months Ended
 
For the Six Months Ended
(in thousands)
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Income before income taxes
 
$
17,034

 
$
17,244

 
$
29,450

 
$
35,876

Provision for income taxes
 
5,058

 
13,603

 
6,796

 
18,747

Effective tax rate
 
29.7
%
 
78.9
%
 
23.1
%
 
52.3
%
 
We are primarily subject to income taxes in the United States. Our effective tax rate for the three and six months ended January 26, 2019, differs from the federal statutory income tax rate primarily due to lower tax rates in foreign jurisdictions where international expansion expenses are incurred, and certain nondeductible expenses and state taxes, partially offset by the benefits of stock-based compensation deductions and allowable credits.
Our effective tax rate for the three and six months ended January 27, 2018, was based on our historic statutory tax rate of 26.96%. Our effective tax rate for the three and six months ended January 27, 2018, differed from the federal statutory income tax rate primarily due to remeasurement of the preferred stock warrant liability, state taxes, remeasurement of existing deferred tax balances, and certain other nondeductible expenses, partially offset by the benefits of certain stock-based compensation deduction
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Tax Act”), which significantly changed U.S. tax law. The Tax Act contains several key tax provisions including the reduction of the corporate income tax rate from 35% to 21%, as well as a variety of other changes including the acceleration of expensing of certain business assets and reductions in the amount of executive pay that could qualify as a tax deduction. The federal statutory tax rate reduction is effective January 1, 2018.
Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”) permitted companies to make changes as a result of future changes in interpretation, information available, assumptions made by the Company, and/or issuance of additional guidance. During the period ended July 28, 2018, the Company remeasured the deferred tax balances based on the tax rates at which they are expected to reverse in the future, which resulted in an increase in income tax expense of $6.7 million. In the six months ended January 26, 2019, the Company has not made any changes to the remeasurement of deferred tax balances.
We continue to monitor the progress of ongoing discussions with tax authorities and the impact, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions.
10.
Earnings Per Share Attributable to Common Stockholders  
Basic and diluted net income per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities. We consider convertible preferred stock and early exercised share options to be participating securities. In connection with our IPO, we established two classes of authorized common stock: Class A common stock and Class B common stock. As a result, all then-outstanding shares of common stock were converted into shares of Class B common stock upon effectiveness of our IPO. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting, conversion, and transfer rights. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Each share of Class B common stock is convertible at any time at the option of the stockholder into one share of Class A common stock.
Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic net income per share attributable to common stockholders is computed by dividing the net income attributable to common stockholders by the weighted-average number of common shares outstanding during the period. All participating securities are excluded from basic weighted-average common shares outstanding.
For the calculation of diluted earnings per share (“EPS”), net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities. Diluted net income per share attributable to common stockholders is computed by dividing the net income attributable to common stockholders by the weighted-average number of common shares outstanding, including all

16



potentially dilutive common shares. The undistributed earnings are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year have been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while diluted net income per share of Class B common stock does not assume the conversion of Class A common stock as Class A common stock is not convertible into Class B common stock.
A reconciliation of the numerator and denominator used in the calculation of basic and diluted EPS attributable to common stockholders is as follows:
 
 
For the Three Months Ended
 
 
January 26, 2019
 
January 27, 2018
(in thousands, except share and per share amounts)
 
Class A
 
Class B
 
Class A
 
Class B
Numerator:
 
 

 
 

 
 
 
 

Net income
 
$
5,166

 
$
6,810

 
$
312

 
$
3,329

Less: noncumulative dividends to preferred stockholders
 

 

 
(11
)
 
(122
)
Less: undistributed earnings to participating securities
 
(4
)
 
(4
)
 
(41
)
 
(431
)
Net income attributable to common stockholders - basic
 
5,162


6,806


260

 
2,776

Less: change in fair value of preferred stock warrant liability (net of tax)
 

 

 
(1,614
)
 
(1,614
)
Add: adjustments to undistributed earnings to participating securities
 

 

 
231

 
211

Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares
 
6,806

 

 
2,776

 

Reallocation of undistributed earnings to Class B shares
 

 
103

 

 
147

Net income attributable to common stockholders - diluted
 
$
11,968


$
6,909


$
1,653

 
$
1,520

Denominator:
 
 

 
 

 
 
 
 

Weighted-average shares of common stock - basic
 
42,956,285

 
56,633,902

 
7,075,605

 
75,363,746

Conversion of Class B to Class A common shares outstanding
 
56,633,902

 

 
75,363,746

 

Effect of dilutive stock options and restricted stock units
 
3,227,651

 
2,721,015

 
5,295,401

 
5,271,550

Effect of potentially dilutive preferred stock warrants
 

 

 
219,904

 
219,904

Weighted-average shares of common stock - diluted
 
102,817,838


59,354,917


87,954,656

 
80,855,200

Earnings per share attributable to common stockholders:
 
 

 
 

 
 
 
 

Basic
 
$
0.12

 
$
0.12

 
$
0.04

 
$
0.04

Diluted
 
$
0.12

 
$
0.12

 
$
0.02

 
$
0.02


17



 
 
For the Six Months Ended
 
 
January 26, 2019
 
January 27, 2018
(in thousands, except share and per share amounts)
 
Class A
 
Class B
 
Class A
 
Class B
Numerator:
 
 

 
 

 
 
 
 
Net income
 
$
9,220

 
$
13,434

 
$
1,114

 
$
16,015

Less: noncumulative dividends to preferred stockholders
 

 

 
(50
)
 
(718
)
Less: undistributed earnings to participating securities
 
(9
)
 
(13
)
 
(427
)
 
(6,140
)
Net income attributable to common stockholders - basic
 
9,211

 
13,421

 
637

 
9,157

Less: change in fair value of preferred stock warrant liability (net of tax)
 

 

 
(10,685
)
 
(10,685
)
Add: adjustments to undistributed earnings to participating securities
 
1

 
1

 
4,421

 
4,133

Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares
 
13,421

 

 
9,157

 

Reallocation of undistributed earnings to Class B shares
 

 
182

 

 
719

Net income attributable to common stockholders - diluted
 
$
22,633

 
$
13,604

 
$
3,530

 
$
3,324

Denominator:
 
 

 
 

 
 
 
 

Weighted-average shares of common stock - basic
 
40,404,333

 
58,874,266

 
3,537,803

 
50,839,664

Conversion of Class B to Class A common shares outstanding
 
58,874,266

 

 
50,839,664

 

Effect of dilutive stock options and restricted stock units
 
4,318,717

 
3,393,581

 
5,584,167

 
5,581,484

Effect of potentially dilutive preferred stock warrants
 

 

 
637,934

 
637,934

Weighted-average shares of common stock - diluted
 
103,597,316

 
62,267,847

 
60,599,568

 
57,059,082

Earnings per share attributable to common stockholders:
 
 

 
 

 
 
 
 

Basic
 
$
0.23

 
$
0.23

 
$
0.18

 
$
0.18

Diluted
 
$
0.22

 
$
0.22

 
$
0.06

 
$
0.06

The following common stock equivalents were excluded from the computation of diluted earnings per share for the periods presented because including them would have been antidilutive:
 
For the Three Months Ended
 
For the Six Months Ended
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Restricted stock units
1,821,371

 
177,180

 
1,601,328

 

Stock options to purchase Class A common stock
1,659,061

 

 
1,214,086

 
276,769

Stock options to purchase Class B common stock
3,335,064

 
762,918

 
389,158

 
927,366

Total
6,815,496


940,098


3,204,572


1,204,135

11.
Subsequent Events
We entered into an amendment to our fulfillment center arrangement in Dallas effective February 20, 2019 (the “Amendment”). The Amendment increases our existing square footage at this location by approximately 174,000 square feet to approximately 490,000 square feet, and extends the original lease term by approximately eighteen months to June 2024. Effective with the Amendment, the arrangement will be accounted for as an operating lease with future minimum lease payments of approximately $10.0 million through June 2024.


18



ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and related notes thereto included in Part I, Item 1 of this report and with our audited consolidated financial statements and related notes and our Annual Report on Form 10-K for the year ended July 28, 2018, filed with the Securities and Exchange Commission on October 3, 2018. We use a 52- or 53-week fiscal year, with our fiscal year ending on the Saturday that is closest to July 31 of that year. Each fiscal year typically consists of four 13-week fiscal quarters. The fiscal years ended July 28, 2018, and August 3, 2019, include 52 and 53 weeks of operations, respectively. Throughout this Quarterly Report on Form 10-Q (this “Quarterly Report”), all references to quarters and years are to our fiscal quarters and fiscal years unless otherwise noted.
Special Note Regarding Forward-Looking Statements
This Quarterly Report contains forward-looking statements that involve risks, uncertainties, and assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report that are not purely historical, including without limitation statements in the following discussion and analysis of financial condition and results of operations regarding our projected financial position and results, business strategy, plans, and objectives of our management for future operations, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management, which are in turn based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties, and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors” included under Part II, Item 1A below. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
Stitch Fix is transforming the way people find what they love, one client at a time and one Fix at a time.
Stitch Fix was inspired by the vision of a client-first, client-centric new way of retail. What people buy and wear matters. When we serve our clients well, we help them discover and define their styles, we find jeans that fit and flatter their bodies, we reduce their anxiety and stress when getting ready in the morning, we give them confidence in job interviews and on first dates, and we give them time back in their lives to invest in themselves or spend with their families. Most of all, we are fortunate to play a small part in our clients looking, feeling, and ultimately being their best selves.
We are reinventing the shopping experience by delivering one-to-one personalization to our clients through the combination of data science and human judgment. This combination drives a better client experience and a more powerful business model than either element could deliver independently.
Since our founding in 2011, we have helped millions of clients discover and buy what they love through personalized shipments of apparel, shoes, and accessories, hand selected by Stitch Fix stylists and delivered to our clients’ homes. We call each of these shipments a Fix. Clients can choose to schedule automatic shipments or order a Fix on demand after they fill out a style profile on our website or mobile app. For each Fix, we charge clients a styling fee that is credited toward items they purchase. Alternatively, select clients may purchase an annual Style Pass, which offers unlimited styling for the year for a $49 fee that is also credited towards items they purchase. After receiving a Fix, our clients purchase the items they want to keep and return the other items, if any, at no additional charge. In addition, our Extras feature allows clients to select items such as socks, bras, underwear, and other intimates that are then added to the five items their stylist selects for their Fix.
Stitch Fix was founded with a focus on Women’s apparel. In our first few years, we were able to gain a deep understanding of our clients and merchandise and build the capability to listen to our clients, respond to feedback, and deliver the experience of personalization. More recently, we have extended those capabilities into Petite, Maternity, Men’s, Plus, and Kids apparel, as well as shoes and accessories. Our stylists leverage our data science and apply their own judgment to hand select apparel, shoes, and accessories for our clients from a broad range of merchandise.
We are successful when we are able to help clients find what they love again and again, creating long-term, trusted relationships. Our clients share personal information with us, including detailed style, size, fit, and price preferences, as well as unique inputs, such as how often they dress for certain occasions or which parts of their bodies they like to flaunt or cover up. Our clients are

19



motivated to share these personal details with us and provide us with ongoing feedback because they recognize that doing so will result in more personalized and successful experiences. This feedback also creates a valuable network effect by helping us to better serve other clients.
The very human experience that we deliver is powered by data science. Our data science capabilities consist of our rich data set and our proprietary algorithms, which fuel our business by enhancing the client experience and driving business model efficiencies. The vast majority of our client data is provided directly and explicitly by the client, rather than inferred, scraped, or obtained from other sources. We also gather extensive merchandise data, such as inseam, pocket shape, silhouette, and fit. This large and growing data set provides the foundation for proprietary algorithms that we use throughout our business, including those that predict purchase behavior, forecast demand, optimize inventory, and enable us to design new apparel. We believe our data science capabilities give us a significant competitive advantage, and as our data set grows, our algorithms become more powerful.
Our stylists leverage our data science through a custom-built, web-based styling application that provides recommendations from our broad selection of merchandise. Our stylists then apply their judgment to select what they believe to be the best items for each Fix. Our stylists provide a personal touch, offer styling advice and context to each item selected, and help us develop long-term relationships with our clients.
We offer merchandise across multiple price points and styles from established and emerging brands, as well as our own private labels, which we call Exclusive Brands. Many of our brand partners also design and supply items exclusively for our clients.
In October 2018, we announced that we are planning to launch operations in the United Kingdom by the end of our fiscal 2019.
We believe our success in serving clients has resulted in our rapid and profitable growth. We have achieved positive cash flows from operations on an annual basis since 2014, while continuing to make meaningful investments to drive growth. For the three and six months ended January 26, 2019, we reported $370.3 million and $736.5 million in net revenue, respectively, representing year-over-year growth of 25.1% and 24.5% from the three and six months ended January 27, 2018, respectively. As of January 26, 2019, and January 27, 2018, we had 2,961,000 and 2,508,000 active clients, respectively, representing year-over-year growth of 18.1%.
Net income for the three and six months ended January 26, 2019, was $12.0 million and $22.7 million, respectively, an increase of $8.3 million and $5.5 million, respectively, from the three and six months ended January 27, 2018. Included in net income for the three and six months ended January 27, 2018, was a $1.6 million and $10.7 million gain, respectively, on remeasurement of our preferred stock warrant liability prior to our initial public offering (“IPO”) and a $4.7 million remeasurement expense on our net deferred tax assets related to the Tax Cuts and Jobs Act (the “Tax Act”), which was enacted on December 22, 2017.
Key Metrics
We report our financial results in accordance with generally accepted accounting principles in the United States (“GAAP”). However, management believes that certain non-GAAP financial measures provide users of our financial information with additional useful information in evaluating our performance. Management believes that excluding certain items that may vary substantially in frequency and magnitude period-to-period from net income and earnings per share (“EPS”) provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily compare these metrics between past and future periods. Management also believes that adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, and that this supplemental measure facilitates comparisons between companies. We believe free cash flow is an important metric because it represents a measure of how much cash from operations we have available for discretionary and non-discretionary items after the deduction of capital expenditures. These non-GAAP financial measures may be different than similarly titled measures used by other companies. For instance, we do not exclude stock-based compensation expense from adjusted EBITDA or non-GAAP net income. Stock-based compensation is an important part of how we attract and retain our employees, and we consider it to be a real cost of running the business.
Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are several limitations related to the use of our non-GAAP financial measures as compared to the closest comparable GAAP measures. Some of these limitations include:
our non-GAAP net income and non-GAAP EPS – diluted measures exclude the impact of the remeasurement of our net deferred tax assets following the adoption of the Tax Act;
our non-GAAP net income, adjusted EBITDA and non-GAAP EPS – diluted measures exclude the remeasurement of the preferred stock warrant liability, which is a non-cash expense incurred in the periods prior to the completion of our IPO;

20



adjusted EBITDA excludes the recurring, non-cash expenses of depreciation and amortization of property and equipment and, although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
adjusted EBITDA does not reflect our tax provision, which reduces cash available to us;
adjusted EBITDA excludes interest income and other income, net, as these items are not components of our core business; and
free cash flow does not represent the total residual cash flow available for discretionary purposes and does not reflect our future contractual commitments.
Adjusted EBITDA
We define adjusted EBITDA as net income excluding interest income, other income, net, provision for income taxes, depreciation and amortization, and, when present, the remeasurement of preferred stock warrant liability. The following table presents a reconciliation of net income, the most comparable GAAP financial measure, to adjusted EBITDA for each of the periods presented:
 
 
For the Three Months Ended
 
For the Six Months Ended
(in thousands)
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Adjusted EBITDA reconciliation:
 
 

 
 

 
 

 
 

Net income
 
$
11,976

 
$
3,641

 
$
22,654

 
$
17,129

Add (deduct):
 
 

 
 

 
 

 
 

Interest income
 
(1,170
)
 
(18
)
 
(2,569
)
 
(35
)
Other income, net
 
(453
)
 

 
(573
)
 

Provision for income taxes
 
5,058

 
13,603

 
6,796

 
18,747

Depreciation and amortization
 
3,790

 
2,618

 
7,184

 
4,888

Remeasurement of preferred stock warrant liability
 

 
(1,614
)
 

 
(10,685
)
Adjusted EBITDA
 
$
19,201

 
$
18,230

 
$
33,492

 
$
30,044

Non-GAAP Net Income
We define non-GAAP net income as net income excluding, when present, the remeasurement of preferred stock warrant liability and the remeasurement of our net deferred tax assets in relation to the adoption of the Tax Act. The following table presents a reconciliation of net income, the most comparable GAAP financial measure, to non-GAAP net income for each of the periods presented:
 
 
For the Three Months Ended
 
For the Six Months Ended
(in thousands)
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Non-GAAP net income reconciliation:
 
 

 
 

 
 

 
 

Net income
 
$
11,976

 
$
3,641

 
$
22,654

 
$
17,129

Add (deduct):
 
 

 
 

 
 

 
 

 Remeasurement of preferred stock warrant liability
 

 
(1,614
)
 

 
(10,685
)
Impact of Tax Act (1)
 

 
4,730

 

 
4,730

Non-GAAP net income
 
$
11,976

 
$
6,757

 
$
22,654

 
$
11,174

 
(1) The U.S. government enacted comprehensive tax legislation in December 2017.  This resulted in a net charge of $4.7 million for the three and six months ended January 27, 2018, due to the remeasurement of our net deferred tax assets for the reduction in tax rate from 35% to 21%. The adjustment to non-GAAP net income only includes this transitional impact. It does not include the ongoing impacts of the lower U.S. statutory rate on current year earnings.

21



Non-GAAP Earnings Per Share – Diluted
We define non-GAAP EPS as diluted EPS excluding, when present, the per share impact of the remeasurement of preferred stock warrant liability and the remeasurement of our net deferred tax assets in relation to the adoption of the Tax Act. The following table presents a reconciliation of EPS attributable to common stockholders diluted, the most comparable GAAP financial measure, to non-GAAP EPS attributable to common stockholders diluted for each of the periods presented:
 
 
For the Three Months Ended
 
For the Six Months Ended
(in dollars)
 
January 26, 2019
 
January 27, 2018
 
January 26, 2019
 
January 27, 2018
Non-GAAP earnings per share  diluted reconciliation:
 
 

 
 

 
 

 
 

Earnings per share attributable to common stockholders - diluted
 
$
0.12

 
$
0.02

 
$
0.22

 
$
0.06

Per share impact of the remeasurement of preferred stock warrant liability(1)
 

 

 

 

Per share impact of Tax Act(2)
 
$

 
$
0.05

 
$

 
$
0.08

Non-GAAP earnings per share attributable to common stockholders  diluted
 
$
0.12

 
$
0.07

 
$
0.22

 
$
0.14

 
 (1) For the three and six months ended January 27, 2018, the preferred stock warrant liability was dilutive and included in earnings per share attributable to common stockholders - diluted. Therefore, it is not an adjustment to arrive at non-GAAP EPS - diluted.
(2) The U.S. government enacted comprehensive tax legislation in December 2017.  This resulted in a net charge of $4.7 million for the three and six months ended January 27, 2018, due to the remeasurement of our net deferred tax assets for the reduction in tax rate from 35% to 21%. The adjustment to non-GAAP earnings per share attributable to common stockholders diluted only includes this transitional impact. It does not include the ongoing impacts of the lower U.S. statutory rate on current year earnings.
Free Cash Flow
We define free cash flow as cash flows provided by operations reduced by purchases of property and equipment that are included in cash flows used in investing activities. The following table presents a reconciliation of cash flows provided by operating activities, the most comparable GAAP financial measure, to free cash flow for each of the periods presented:
 
 
For the Six Months Ended
(in thousands)
 
January 26, 2019
 
January 27, 2018
Free cash flow reconciliation:
 
 

 
 

Cash flows provided by operating activities