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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 2, 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
California
 
94104
(Address of Principal Executive Offices)
 
(Zip Code)
(415) 882-7765
Registrant's telephone number, including area code
 
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Trading Symbol
 
Name of Each Exchange on Which Registered
Class A common stock, par value $0.00002 per share
 
SFIX
 
Nasdaq Global Select Market
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 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 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  
 
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
As of December 4, 2019, the number of outstanding shares of the registrant’s Class A common stock, par value $0.00002 per share, was 55,340,765, and the number of outstanding shares of the registrant’s Class B common stock, par value $0.00002 per share, was 46,385,917.

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)
 
 
November 2, 2019
 
August 3, 2019
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
151,779

 
$
170,932

Short-term investments
145,504

 
143,276

Inventory, net
148,502

 
118,216

Prepaid expenses and other current assets
39,702

 
49,980

Total current assets
485,487

 
482,404

Long-term investments
90,532

 
53,372

Property and equipment, net
65,369

 
54,888

Operating lease right-of-use assets
128,717

 

Deferred tax assets
23,865

 
22,175

Other long-term assets
3,358

 
3,227

Total assets
$
797,328

 
$
616,066

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
112,161

 
$
90,883

Operating lease liabilities
23,042

 

Accrued liabilities
86,249

 
69,734

Gift card liability
6,879

 
7,233

Deferred revenue
11,976

 
11,997

Other current liabilities
2,587

 
2,784

Total current liabilities
242,894

 
182,631

Operating lease liabilities, net of current portion
131,694

 

Deferred rent, net of current portion

 
24,439

Other long-term liabilities
14,126

 
12,996

Total liabilities
388,714

 
220,066

Commitments and contingencies (Note 6)


 


Stockholders’ equity:
 
 
 
Class A common stock, $0.00002 par value – 2,000,000,000 shares authorized as of November 2, 2019, and August 3, 2019; 55,207,531 and 54,551,240 shares issued and outstanding as of November 2, 2019, and August 3, 2019, respectively
1

 
1

Class B common stock, $0.00002 par value – 100,000,000 shares authorized as of November 2, 2019, and August 3, 2019; 46,501,115 and 46,846,240 shares issued and outstanding as of November 2, 2019, and August 3, 2019, respectively
1

 
1

 Additional paid-in capital
290,720

 
279,511

Accumulated other comprehensive income
1,396

 
(187
)
Retained earnings
116,496

 
116,674

Total stockholders’ equity
408,614

 
396,000

Total liabilities and stockholders’ equity
$
797,328

 
$
616,066

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

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
 
November 2, 2019
 
October 27, 2018
Revenue, net
$
444,815

 
$
366,236

Cost of goods sold
243,513

 
201,068

Gross profit
201,302


165,168

Selling, general, and administrative expenses
201,142

 
154,271

Operating income
160

 
10,897

Interest (income) expense
(1,653
)
 
(1,399
)
Other (income) expense, net
834

 
(120
)
Income before income taxes
979

 
12,416

Provision for income taxes
1,157

 
1,738

Net income (loss)
$
(178
)

$
10,678

Other comprehensive income (loss):
 
 
 
Change in unrealized gain (loss) on available-for-sale securities, net of tax
(172
)
 
(82
)
Foreign currency translation
1,755

 
26

Total other comprehensive income (loss), net of tax
1,583

 
(56
)
Comprehensive income
$
1,405

 
$
10,622

Net income (loss) attributable to common stockholders:
 
 
 
Basic
$
(178
)
 
$
10,664

Diluted
$
(178
)
 
$
10,665

Earnings (loss) per share attributable to common stockholders:
 

 
 

Basic
$
(0.00
)
 
$
0.11

Diluted
$
(0.00
)
 
$
0.10

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

 
 

Basic
101,557,546

 
98,965,274

Diluted
101,557,546

 
104,539,452

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


3



Stitch Fix, Inc.
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)
(In thousands, except share amounts)
 
 
For the Three Months Ended October 27, 2018
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
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
578,107

 

 
2,000

 

 

 
2,000

Issuance of restricted stock units, net of tax withholdings
56,257

 

 
(1,363
)
 

 

 
(1,363
)
Vesting of early exercised options

 

 
90

 

 

 
90

Stock-based compensation

 

 
7,047

 

 

 
7,047

Net income

 

 

 

 
10,678

 
10,678

Other comprehensive loss, net of tax

 

 

 
(56
)
 

 
(56
)
Balance as of October 27, 2018
99,434,225

 
$
2

 
$
243,086

 
$
(56
)
 
$
90,471

 
$
333,503

 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended November 2, 2019
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Balance as of August 3, 2019
101,397,480

 
2

 
279,511

 
(187
)
 
116,674

 
$
396,000

Issuance of common stock upon exercise of stock options
122,668

 

 
518

 

 

 
518

Issuance of common stock upon settlement of restricted stock units, net of tax withholdings
188,498

 

 
(2,212
)
 

 

 
(2,212
)
Stock-based compensation

 

 
12,903

 

 

 
12,903

Net income (loss)

 

 

 

 
(178
)
 
(178
)
Other comprehensive income, net of tax

 

 

 
1,583

 

 
1,583

Balance as of November 2, 2019
101,708,646

 
$
2

 
$
290,720

 
$
1,396

 
$
116,496

 
$
408,614

 
(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.


4



Stitch Fix, Inc.
Condensed Consolidated Statements of Cash Flow
(Unaudited)
(In thousands)
 
For the Three Months Ended
 
November 2, 2019
 
October 27, 2018
Cash Flows from Operating Activities
 

 
 

Net income (loss)
$
(178
)
 
$
10,678

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

 
 

Deferred income taxes
(1,960
)
 
(1,061
)
Inventory reserves
1,801

 
1,563

Stock-based compensation expense
12,126

 
6,637

Depreciation, amortization, and accretion
4,652

 
3,175

Other
13

 

Change in operating assets and liabilities:
 
 
 

Inventory
(31,837
)
 
(23,172
)
Prepaid expenses and other assets
2,973

 
1,252

Operating lease right-of-use assets and liabilities
272

 

Accounts payable
21,721

 
26,008

Accrued liabilities
16,170

 
24,360

Deferred revenue
(25
)
 
2,532

Gift card liability
(354
)
 
(141
)
Other liabilities
2,150

 
(865
)
Net cash provided by operating activities
27,524


50,966

Cash Flows from Investing Activities
 

 
 

Purchases of property and equipment
(7,502
)
 
(6,985
)
Purchases of securities available-for-sale
(67,535
)
 
(169,095
)
Sales of securities available-for-sale
5,306

 
302

Maturities of securities available-for-sale
23,210

 

Net cash used in investing activities
(46,521
)
 
(175,778
)
Cash Flows from Financing Activities
 

 
 

Proceeds from the exercise of stock options, net
518

 
2,000

Payments for tax withholding related to vesting of restricted stock units
(2,212
)
 
(1,363
)
Net cash provided by (used in) financing activities
(1,694
)

637

Net increase (decrease) in cash, cash equivalents, and restricted cash
(20,691
)
 
(124,175
)
Effect of exchange rate changes on cash
1,538

 

Cash, cash equivalents, and restricted cash at beginning of period
170,932

 
310,366

Cash, cash equivalents, and restricted cash at end of period
$
151,779


$
186,191

Components of Cash, Cash Equivalents, and Restricted Cash
 

 
 

Cash and cash equivalents
$
151,779

 
$
173,341

Restricted cash – current portion

 
250

Restricted cash – long-term portion

 
12,600

Total cash, cash equivalents, and restricted cash
$
151,779


$
186,191

Supplemental Disclosure
 

 
 

Cash paid for income taxes
$
7

 
$
42

Supplemental Disclosure of Non-Cash Investing and Financing Activities:
 

 
 

Purchases of property and equipment included in accounts payable and accrued liabilities
$
731

 
$
224

Capitalized stock-based compensation
$
773

 
$
410

Vesting of early exercised options
$

 
$
90

Leasehold improvements paid by landlord
$
7,406

 
$


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

5




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 ending August 1, 2020 (“2020”), and August 3, 2019 (“2019”), consist of 52 weeks and 53 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 1, 2020, 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 August 3, 2019, included in the Company’s Annual Report on Form 10-K filed with the SEC on October 2, 2019 (“2019 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.

6



Significant estimates and assumptions are used for inventory, stock-based compensation expense, income taxes, leases, and revenue recognition. Actual results could differ from those estimates and such differences may be material to the condensed consolidated financial statements.
Restricted Cash
Restricted cash represented cash balances held in segregated accounts collateralizing letters of credit for our leased properties at October 27, 2018.
Short-Term and Long-Term Investments
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 and, to a lesser extent, from direct purchases. 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 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 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 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. For a Fix, 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. For a direct purchase, control is transferred when the item is shipped to the client.
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

7



accepted. We record a refund reserve based on our historical refund patterns. Our refund reserve, which is included in accrued liabilities in the condensed consolidated balance sheets, was $2.5 million and $3.1 million as of November 2, 2019, and August 3, 2019, respectively.
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 $12.0 million, $6.9 million, and $2.6 million, respectively, at November 2, 2019, and $12.0 million, $7.2 million, and $1.6 million, respectively, at August 3, 2019. During the three months ended November 2, 2019, the Company recognized $10.9 million, $1.4 million, and $0.5 million of revenue included in deferred revenue, gift card liability, and other current liabilities at August 3, 2019.
Deferred revenue related to upfront styling fees totaled $9.6 million as of November 2, 2019, and $9.6 million as of August 3, 2019. Deferred revenue related to Style Pass annual fees totaled $2.3 million as of November 2, 2019, and $2.3 million as of August 3, 2019.
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. 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 months ended November 2, 2019, and October 27, 2018, respectively.
Recently Issued Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard requires entities to use a financial instrument impairment model based on expected losses, known as the current expected credit loss model, rather than incurred losses. Under the new guidance, an entity recognizes an allowance for estimated credit losses upon recognition of the financial instrument. We expect to adopt this standard in our first fiscal quarter of 2021. We are currently evaluating the impact that this standard will have on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. The amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This standard is effective beginning in our first fiscal quarter of 2021 on a prospective or retrospective basis, with early adoption permitted. We are currently evaluating the impact that this standard will have on our consolidated financial statements.
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued 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 Accounting Standards Codification (“ASC”) 840. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. Presentation of leases within the consolidated statements of operations and comprehensive income and consolidated statements of cash flow is generally

8



consistent with prior periods presented under ASC 840. However, this standard resulted in a substantial increase in our long-term assets and liabilities on our consolidated balance sheet.
We adopted this standard on August 4, 2019, on a modified retrospective basis through a cumulative-effect adjustment of zero to opening retained earnings. We also elected the package of practical expedients to leases that commenced before the effective date whereby we elected to not reassess the following:
(i) whether any expired or existing contracts contain leases;
(ii) the lease classification for any expired or existing leases; and
(iii) initial direct costs for any existing leases.
Upon adoption of ASU 2016-02, we did not record right-of-use assets or lease liabilities for leases with an initial term of 12 months or less. Payments on those leases will be recognized on a straight-line basis through the consolidated statements of operations and comprehensive income over the lease term. We also elected to combine lease and non-lease components on new or modified leases after adoption. Upon adoption on August 4, 2019, we recorded $133.0 million in right-of-use assets, net of $25.7 million previously recorded as deferred rent on our consolidated balance sheets. We also recorded $22.0 million in current operating lease liabilities and $136.7 million in operating lease liabilities, net of current portion.
In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”). Under ASU 2018-07, 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 adopted this standard in the first quarter of fiscal year 2020. The standard did not have a material impact on our consolidated financial statements.
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 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 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 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 months ended October 27, 2018, was an increase of $0.5 million 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 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 this standard.
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.

9



Our financial instruments consist of cash and cash equivalents, short-term and long-term investments, accounts payable, and accrued liabilities. At November 2, 2019, and August 3, 2019, the carrying values of cash and cash equivalents, accounts payable, and accrued liabilities approximated fair value due to their short-term maturities.
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 November 2, 2019:
 
 
November 2, 2019
 
August 3, 2019
(in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Financial Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
70,429

 
$
155

 
$
(6
)
 
$
70,578

 
$
49,807

 
$
100

 
$

 
$
49,907

Commercial paper
 
35,851

 

 

 
35,851

 
29,761

 

 

 
29,761

Asset-backed securities
 
47,103

 
181

 

 
47,284

 
42,587

 
145

 

 
42,732

Corporate bonds
 
82,025

 
298

 

 
82,323

 
73,969

 
279

 

 
74,248

Total
 
$
235,408

 
$
634

 
$
(6
)
 
$
236,036

 
$
196,124

 
$
524

 
$

 
$
196,648


The following table sets forth the fair value of available-for-sale securities by contractual maturity as of November 2, 2019:
 
 
November 2, 2019
 
August 3, 2019
(in thousands)
 
One Year or Less
 
Over One Year Through Five Years
 
Over Five Years
 
Total
 
One Year or Less
 
Over One Year Through Five Years
 
Over Five Years
 
Total
Financial Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
38,979

 
$
31,599

 
$

 
$
70,578

 
$
44,772

 
$
5,135

 
$

 
$
49,907

Commercial paper
 
35,851

 

 

 
35,851

 
29,761

 

 

 
29,761

Asset-backed securities
 
5,422

 
41,862

 

 
47,284

 
5,412

 
37,320

 

 
42,732

Corporate bonds
 
65,252

 
17,071

 

 
82,323

 
63,331

 
10,917

 

 
74,248

Total
 
$
145,504

 
$
90,532

 
$

 
$
236,036

 
$
143,276

 
$
53,372

 
$

 
$
196,648


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 November 2, 2019:
 
 
November 2, 2019
 
August 3, 2019
(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
 
 
 
 

 
 

 
 

 
 
 
 

 
 

 
 

Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
204

 
$

 
$

 
$
204

 
$
6,427

 
$

 
$

 
$
6,427

Commercial paper
 

 

 

 

 

 
11,970

 

 
11,970

Investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
70,578

 

 

 
70,578

 
49,907

 

 

 
49,907

Commercial paper
 

 
35,851

 

 
35,851

 

 
29,761

 

 
29,761

Asset-backed securities
 

 
47,284

 

 
47,284

 

 
42,732

 

 
42,732

Corporate bonds
 

 
82,323

 

 
82,323

 

 
74,248

 

 
74,248

Total
 
$
70,782

 
$
165,458

 
$

 
$
236,240

 
$
56,334

 
$
158,711

 
$

 
$
215,045


There were no transfers of financial assets or liabilities into or out of Level 1, Level 2, or Level 3 for the three months ended November 2, 2019, and October 27, 2018.


10



4.
Leases
On August 4, 2019, we adopted ASU 2016-02. Upon adoption, we recognized operating lease right-of-use assets and operating lease liabilities of $133.0 million and $158.7 million, respectively. As part of this adoption, we elected to not record operating lease right-of-use assets or operating lease liabilities for leases with an initial term of 12 months or less and to combine lease and non-lease components on new or modified leases into a single lease component.
Our leasing portfolio includes various lease arrangements for our corporate offices and fulfillment centers. Such leases generally have original lease terms between five and eight years, and often include one or more options to renew. We include options to extend in the lease term if they are reasonably certain of being exercised. We do not currently consider our renewal options to be reasonably certain. We do not have residual value guarantees associated with our leases. Short-term lease payments were not material for the three months ended November 2, 2019.
The following table includes the components of our rent expense recorded in selling, general, and administrative expense:
 
 
For the Three Months Ended
(in thousands)
 
November 2, 2019
Operating lease cost
 
$
7,213

Variable lease costs
 
1,509

Sublease income
 
(374
)
Total
 
$
8,348

Certain leases contain variable payments, which are expensed as incurred and not included in our operating lease right-of-use assets and operating lease liabilities. These amounts primarily include payments for maintenance and utilities on our office and fulfillment center leases. Operating lease right-of-use assets and operating lease liabilities are recognized based on the present value of future minimum lease payments at lease commencement. The Company calculates the present value of its leases using an estimated incremental borrowing rate, which requires judgment. Our incremental borrowing rate is determined for each lease using a peer group of companies with similar credit profiles, adjusted for the impact of collateralization and lease term.
The following is a schedule by year of the maturities of operating lease liabilities with original terms in excess of one year, as of November 2, 2019:
(in thousands)
 
November 2, 2019
Remainder of 2020
 
$
21,965

2021
 
29,573

2022
 
27,315

2023
 
25,062

2024
 
20,899

2025
 
16,362

Thereafter
 
40,326

Total undiscounted future minimum lease payments
 
181,502

Less imputed interest
 
(26,766
)
Total discounted future minimum lease payments
 
$
154,736

A schedule of the future minimum rental commitments under our non-cancelable operating lease agreements with an initial or remaining term in excess of one year as of August 3, 2019, were as follows:
(in thousands)
 
August 3, 2019
2020
 
$
27,018

2021
 
27,680

2022
 
25,451

2023
 
23,258

2024
 
19,696

Thereafter
 
56,687

Total
 
$
179,790



11



The weighted average remaining term for our leases as of November 2, 2019 was 6.7 years. The weighted average discount rate for our leases as of November 2, 2019 was 4.4%.
Supplemental cash flow information related to our leases is as follows:
 
 
For the Three Months Ended
(in thousands)
 
November 2, 2019
Cash paid for amounts included in the measurement of operating lease liabilities
 
$
6,960

Operating lease right-of-use assets obtained in exchange for operating lease liabilities
 
133,091


5.
Accrued Liabilities
Accrued liabilities consisted of the following:
(in thousands)
 
November 2, 2019
 
August 3, 2019
Compensation and related benefits
 
$
14,797

 
$
9,494

Advertising
 
15,135

 
12,922

Sales taxes
 
8,904

 
6,956

Shipping and freight
 
8,408

 
7,045

Accrued accounts payable
 
8,930

 
7,550

Inventory purchases
 
18,235

 
15,703

Other
 
11,840

 
10,064

Total accrued liabilities
 
$
86,249


$
69,734


6.
Commitments and Contingencies
Commitments
In November 2019, the Company executed an agreement for cloud computing services. The agreement was effective as of November 1, 2019, and continues through October 30, 2022. The Company has a total minimum commitment of $23.5 million with annual commitments ranging from $7.5 million to $8.0 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.
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. The four lawsuits have been consolidated and a lead plaintiff has been appointed. On September 18, 2019, the lead plaintiff in the consolidated class action lawsuits filed a consolidated complaint for violation of the federal securities laws. On October 28, 2019, we and other defendants filed a motion to dismiss the consolidated complaint. The lead plaintiff’s opposition to the motion to dismiss is due on December 9, 2019, and defendants’ reply in support of our motion to dismiss is due on December 30, 2019. A hearing on the motion to dismiss is currently set for January 23, 2020.
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. The derivative action has been stayed pending the outcome of the motion to dismiss in the related class action lawsuits.
There have been no other material changes to our commitments and contingencies as disclosed in our 2019 Annual Report.

12



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 (loss) before reclassifications(1)
 
(82
)
 
26

 
(56
)
Net change in AOCI
 
(82
)
 
26

 
(56
)
Balance at October 27, 2018
 
$
(82
)
 
$
26

 
$
(56
)
 
 
Changes in Accumulated Other Comprehensive Income
(in thousands)
 
Available-for-sale Securities
 
Foreign Currency Translation
 
Total
Balance at August 3, 2019
 
$
391

 
$
(578
)
 
$
(187
)
Other comprehensive income (loss) before reclassifications(1)
 
(172
)
 
1,755

 
1,583

Net change in AOCI
 
(172
)
 
1,755

 
1,583

Balance at November 2, 2019
 
$
219

 
$
1,177

 
$
1,396

 
 (1)The associated income tax effects for gains / losses on available-for-sale securities were $67 and $409 for the three months ended October 27, 2018, and November 2, 2019, respectively.
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. Only incentive and nonqualified stock options were granted 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 22,207,698 as of November 2, 2019, of which 5,283,769 were available for grant.
2019 Inducement Plan
In October 2019, our board of directors adopted our 2019 Inducement Plan (the “2019 Plan”). Our 2019 Plan provides for the grant of Class A nonqualified stock options and restricted stock unit awards to individuals who satisfy the standards for inducement grants under the relevant Nasdaq Stock Market rules. The number of shares authorized for issuance under the 2019 Plan was 1,750,000 as of November 2, 2019, of which 1,496,972 were available for grant.

13



Stock option activity under the 2011 Plan, 2017 Plan, and 2019 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 – August 3, 2019
 
7,070,125

 
$
14.48

 
7.72
 
$
73,861

Granted
 
269,346

 
$
22.64

 
 
 
 
Exercised
 
(122,668
)
 
$
4.33

 
 
 
 
Cancelled
 
(67,513
)
 
$
20.33

 
 
 
 
Balance – November 2, 2019

7,149,290

 
$
14.92

 
7.58
 
$
62,803


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 and 2019 Plan:
 
Unvested RSUs
 
Class A Common Stock
 
Weighted-
Average
Grant Date
Fair Value
Unvested at August 3, 2019
4,428,845

 
$
27.30

Granted
1,246,443

 
$
20.09

Vested
(188,498
)
 
$
29.80

Forfeited
(275,885
)
 
$
27.21

Unvested at November 2, 2019
5,210,905

 
$
25.49


Stock-Based Compensation Expense
Stock-based compensation expense for employees was $12.1 million and $6.6 million for the three months ended November 2, 2019, and October 27, 2018, respectively. Stock-based compensation expense is included in selling, general, and administrative expenses in our condensed consolidated statements of operations and comprehensive income.
The weighted-average grant date fair value of options granted during the three months ended November 2, 2019, was $11.30 per share. The weighted-average grant date fair value of options granted during the three months ended October 27, 2018, was $17.22 per share. As of November 2, 2019, the total unrecognized compensation expense related to unvested options and RSUs, net of estimated forfeitures, was $158.5 million, which we expect to recognize over an estimated weighted average period of 2.9 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
 
November 2, 2019
 
October 27, 2018
Expected term (in years)
6.0 - 6.2

 
5.1 - 6.2

Volatility
51.2
%
 
41.7 - 42.0%

Risk free interest rate
1.7
%
 
2.8 - 3.0%

Dividend yield
%
 
%



14



9.
Income Taxes
The following table summarizes our effective tax rate from income for the periods presented:
 
 
For the Three Months Ended
(in thousands)
 
November 2, 2019
 
October 27, 2018
Income before income taxes
 
$
979

 
$
12,416

Provision for income taxes
 
1,157

 
1,738

Effective tax rate
 
118.2
%
 
14.0
%
 
We are primarily subject to income taxes in the United States. Our effective tax rate for the three months ended November 2, 2019, differs from the federal statutory income tax rate primarily due to impacts from tax reform, certain nondeductible expenses, tax expense related to employee share-based awards, and state taxes which are offset by the benefit of allowable credits.
Our effective tax rate for the three months ended October 27, 2018, differed 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 on stock-based compensation deductions and allowable credits.
10.
Earnings (Loss) Per Share Attributable to Common Stockholders
Basic and diluted earnings (loss) 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 (loss) per share (“EPS”), net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities. Diluted net income (loss) 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 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 (loss) per share of Class A common stock assumes the conversion of Class B common stock, while diluted net income (loss) 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.

15



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
 
 
November 2, 2019
 
October 27, 2018
(in thousands, except share and per share amounts)
 
Class A
 
Class B
 
Class A
 
Class B
Numerator:
 
 

 
 

 
 
 
 

Net income (loss)
 
$
(96
)
 
$
(82
)
 
$
4,084

 
$
6,594

Less: undistributed earnings to participating securities
 

 

 
(5
)
 
(9
)
Net income (loss) attributable to common stockholders - basic
 
(96
)

(82
)

4,079

 
6,585

Add: adjustments to undistributed earnings to participating securities
 

 

 
1

 

Reallocation of undistributed earnings (loss) as a result of conversion of Class B to Class A shares
 

 

 
6,585

 

Reallocation of undistributed earnings (loss) to Class B shares
 

 

 

 
85

Net income (loss) attributable to common stockholders - diluted
 
$
(96
)

$
(82
)

$
10,665

 
$
6,670

Denominator:
 
 

 
 

 
 
 
 

Weighted-average shares of common stock - basic
 
54,867,211

 
46,690,335

 
37,850,643

 
61,114,631

Conversion of Class B to Class A common shares outstanding
 

 

 
61,114,631

 

Effect of dilutive stock options and restricted stock units
 

 

 
5,574,178

 
4,260,911

Weighted-average shares of common stock - diluted
 
54,867,211


46,690,335


104,539,452

 
65,375,542

Earnings (loss) per share attributable to common stockholders:
 
 

 
 

 
 
 
 

Basic
 
$
(0.00
)
 
$
(0.00
)
 
$
0.11

 
$
0.11