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Stitch Fix, Inc. (NASDAQ:SFIX)
Q3 2018 Earnings Conference Call
Jun. 7, 2018 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, please stand by, we're about to begin. Good day, and welcome to the Stitch Fix third-quarter 2018 earnings conference call. Today's call is being recorded. At this time, I'd like to turn the call over to Mr. David Pearce, head of investor relations at Stitch Fix. Please go ahead.

David Pearce -- Head of Investor Relations

Thank you for joining us on the call today to discuss the results for our third quarter of fiscal 2018. Joining me on today's call are Katrina Lake, founder and CEO of Stitch Fix; Paul Yee, our CFO; and Mike Smith, our COO. We have posted complete Q3 financial results in our shareholder letter on the Investor Relations section of our website, investors.stitchfix.com. A link to the webcast of today's conference call can also be found on our site.

We would also like to remind everyone that we will be making forward-looking statements on the call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please review our filings with the SEC for a discussion of the factors that could cause our results to differ.

Also note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements except as required by law.During this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the shareholder letter on our IR website. These non-GAAP measures are not intended to be a substitute for our GAAP results.

Finally, this call in its entirety is being webcast on our IR website, and a replay of this call will be available on the website shortly. I'd now like to turn the call over to Katrina.

Katrina Lake -- Founder and Chief Executive Officer

Thanks, David, and thank you for joining us today. After the market closed today, we issued our quarterly shareholder letter with more details on our results, which I encourage you to read. I'll take a moment to highlight our results from the third quarter and discuss how we are executing against our strategic road map. We delivered strong growth in Q3, exceeding both our net revenue and adjusted EBITDA guidance for the quarter.

We grew our active client count to 2.7 million as of April 28, 2018, an increase of 614,000 and 30% year over year. We delivered net revenue of $317 million, representing 29% year-over-year growth, which exceeded our guidance. We drove strong growth across our women's and men's categories, and looking to future growth opportunities, we are excited to discuss our newest category launch in a moment. Q3 also marked the fifth consecutive quarter of over 20% year over year top-line growth.

In Q3, we delivered $9.5 million in GAAP net income and $12.4 million in adjusted EBITDA, exceeding the high end of our guidance range. These results demonstrate our approach to delivering disciplined growth while continuing to make measured investments in future opportunities for our business. Paul will discuss our financial results in more detail later on this call. Our strategic road map consists of three primary pillars for growth.

First is to continue to expand our relationships with existing clients to drive engagement and increasing wallet share by serving them better and through greater flexibility. In Q2, we announced two initiatives on this front; Style Pass and Extras. Style Pass makes it more frictionless for our clients to get fixes and thus, allows us to access greater wallet share. While still early, what we are seeing so far is that Style Pass' post-launch enrollment rates continue to track above what we observed in the pilot, and service is seeing in great engagement from both male and female clients.

Extras is an initiative that allows clients to shop more of their apparel needs. Clients in our women's category are now able to choose and add items such as intimates and socks to their fixes. This is incremental to the five items they are receiving in their fixes, and the product categories are all previously unserved by Stitch Fix. This service is also still in early days, but we're excited about the capability we've unlocked in being able to build a way for clients to choose items in their fixes and to ship fixes with more than five items.

We've begun leveraging this capability in our newest category, which I'll discuss more in a moment. Our second pillar for growth is in serving new clients. We believe that we have significant opportunities to acquire new clients in our existing business. The 30% year-over-year growth we've seen in active client count is the result of these efforts, efficiently leveraging our performance marketing capabilities and increasing our brand awareness.

Third, we plan to continue growing our addressable market through expansion into new categories, product types and geographies. Men's and plus are, of course, examples of this, and we're excited to share our newest category. Today, we announced our upcoming launch of Stitch Fix Kids, which we are launching just in time for back to school. This category leverages our capabilities as well as our existing client base.

It is a natural extension for us given that we already serve so many parents, and this will offer them an effortless way to shop for the whole family. We will offer unique, affordable kids' clothing across a diverse range of size and style aesthetics to give kids the freedom to express themselves in clothing they feel great wearing. I mentioned earlier in the call about some of the investments we made in our platform to serve Extras. This capability to ship fixes with more than five items supports our kids business as well as kids fixes will be comprised of eight to 12 items for mix of market and exclusive brands.

The addition of kids to our category portfolio expands our addressable market and provides marketing scale. We look forward to sharing more information and updates in the quarters ahead.We recently celebrated the one year anniversary of our plus offering. In February 2017, we launched our plus-sized women's category to address a historically underserved market, which is estimated to represent over 50% of women in the United States. In the past year, we've quickly learned about plus preferences and styles, which have informed our diverse brand portfolio consisting of third-party brands as well as our own exclusive brand.

As evidence of our ability to learn quickly about new client segments, the number of items plus clients purchase per fix has already reached parity with what was historically seen in our women's offering. We believe that we are uniquely positioned to serve plus-sized clients because of the combination of our broader business and the many years of learning, paired with the insights our clients share with us. For example, approximately 15% of clients in our plus-size business crossover sizes, meaning they wear either plus-sized tops or bottoms but not both. This insight gives us the advantage of understanding what each of our clients' needs, and our deep history and diverse inventory mix supports us in delivering the right product for her.

We'll continue to keep you updated in the quarters ahead as we execute on our strategic road map. Now I'll turn it over to Mike, who will walk you through some operational highlights for the quarter.

Mike Smith -- Chief Operating Officer

Thanks, Katrina, and hello to everyone joining us on today's call. I'd like to take a moment to discuss two recent initiatives that demonstrate how we're continuing to integrate technology and data science across our business.In 2017, we began testing an interactive, mobile and web-based game with clients that we call Style Shuffle. Participants are shown a variety of Stitch Fix merchandise, which they rate with a thumbs up or thumbs down. The game allows clients to share feedback with us, which strengthens our understanding of client taste and style preferences at both the individual and aggregate level.

Style Shuffle enables us to collect large volumes of item-specific client feedback in between fix shipments, which complements the rich data we already collect through the initial style profile and at fix checkout. We are currently applying the feedback to our styling platform to better inform stylist decisions. While early in Style Shuffle's implementation, we are seeing higher client engagement and satisfaction among the clients who use this game. We also see opportunity to use this data to drive product decisions and further our inventory management capabilities in the future.I would also like to spend a minute to share a recent operational improvement that highlights the opportunities we have to drive cost efficiencies by applying our technology capabilities.

Last November, we piloted a program in one of our warehouses to further integrate our technology and proprietary algorithms to our fix picking process. By April 2018, we had expanded this initiative to all five of our distribution centers and across both men's and women's apparel. Shortly after this expansion, we drove the most efficient, operational week in Stitch Fix' history. Overall, this initiative has driven a 15% improvement in our warehouse efficiency, resulting in significant cost savings.

We believe that many opportunities remain to leverage our engineering and data science capabilities to drive efficiencies and plan to update you on these in the quarters ahead. I will now turn the call over to Paul, who will walk you through our financial performance and outlook.

Paul Yee -- Chief Financial Officer

Thanks, Mike. As we report on Q3 today, we continue our strong financial story. We're delivering consistent revenue and client growth. We have a track record of profitability and free cash flow, and we're making key investments for the long term.

Balancing growth and profitability is a strategic choice we've made and one that we believe is right for our business and our clients. Even with most of our current investments flowing through the P&L, our profitability and thoughtful management of the business have yielded cash flow that we then reinvest. Today's announcement of our upcoming kids launch and more broadly, our Q3 results reflect these principles in action. Our shareholder letter provides an overview of our financials for the quarter and year to date, and allow me to share some highlights.

Our net revenue for the quarter was $317 million, representing growth of 29% year over year and above our guidance of 22% to 26% growth. Driving this accelerated growth were our newer categories of men's and plus, as well as our traditional women's offering. While we're pleased with our Q3 results, we expect our net revenue growth rate in Q4 to be more in line with levels we've seen in prior quarters. As context, last year, we spent Q3 migrating marketing efforts in-house from outside agencies, created some inefficiencies that helped to provide an easier comparison this year.

As we've grown the top line, it's worth noting, in Q3, we also saw expansion year over year in both our gross margin and our EBITDA margin. While a commitment to investing for the long term may impact future margins, we're proud of our team's rigor and execution, which drove this quarter's results. Gross margin was 43.6%, representing a 60 basis point increase from 43% in Q3 of last year. This improvement was largely driven by a lower inventory reserve expense as a result of improvements to our inventory management.

This is partially offset by year-over-year increase in shipping and freight expenses and to a lesser extent, shrink. We have leveraged SG&A even as we continue to make strategic investments. Advertising expense in the quarter was $25.2 million or 8% of net revenue. This represents a $1 increase from last year's Q3 spend at $21.3 million, but a 70 basis point improvement on a percent of revenue basis year over year.

Our cost of acquisition in Q3 remained stable versus prior quarters. Other SG&A, excluding advertising, was 32.6% of net revenue, a 10 basis point improvement versus 32.7% in Q3 '17. This leverage was driven by continued efficiencies in our warehouse and styling teams and helped to offset our investments in hiring more engineers and data scientists. These results also include $5 million in stock-based compensation, which we noted in our last call was increasing as we seek to attract and retain the best talent.

Adjusted EBITDA in the quarter was $12.4 million or 3.9% of net revenue. These results exceeded the high end of our guidance range of $5 million to $10 million, driven by higher net revenue and our continued expense management. On a latter point, we did see some timing shifts of costs from Q3 to Q4, which we reflected in our Q4 guidance. Our estimated effective tax rate for the year-to-date period is 42.8%, revised downward from the prior quarter due to tax benefits from stock-based compensation deductions and R&D credits based on a completed study.

Finally, we delivered free cash flow of $49.5 million year to date. Our disciplined approach to inventory management and our relatively light capital investments contributed to these results. Regarding our outlook, for the fourth fiscal quarter, we expect net revenue in the range of $310 million to $320 million, representing growth of 20% to 24% year over year. This range includes the impact of our kids launch, which we expect not to be material in Q4 from a net-revenue standpoint.

We expect adjusted EBITDA in the range of $6 million to $11 million or an adjusted EBITDA margin of 1.9% to 3.4%. Our adjusted EBITDA range reflects the shift in some operating expenses from Q3 into this quarter, as well as the impact at people and marketing investments we made in support of our kids launch. Based on this guidance for Q4, guidance for the full fiscal year is as follows. We are raising our net revenue outlook to reflect a range of $1.22 billion to $1.23 billion, representing growth of 25% to 26% year over year.

This is an increase from our prior range of 22% to 25% growth. In the terms of adjusted EBITDA, we're slightly increasing the midpoint of our range and narrowing that range to $48 million to $53 million or an adjusted EBITDA margin of 3.9% to 4.3%. For reference, our prior range was $45 million to $55 million. We will provide guidance for Q1 2019 and full fiscal 2019 on our next earnings call.

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] And we'll take our first question from Chris Merwin with Goldman Sachs. Please go ahead.

Chris Merwin -- Goldman Sachs --Analyst

All right. Thank you very much, and congrats on a great quarter. So just a couple for me. I was wondering if you could give us a little bit more detail about what drove the upside to guidance in the quarter.

I think revenue per active client was flattish in the quarter after declines in prior quarters, so just curious what drove that specifically and if that's something we should expect going forward. And then maybe from a category perspective, can you talk a bit about what categories outside of women have shown the most progress so far? I guess, plus was highlighted in the letter, and I think you mentioned that there are 75,000 people on the waiting list. Is that the ballpark for active customers? Or is there any other way we can think about milestones for that category? Thank you.

Katrina Lake -- Founder and Chief Executive Officer

Great. Thanks, Chris. I'll take your questions on category and then maybe a little bit just directionally on revenue per active client, and then I'll have Paul take the part on guidance. In terms of categories and what's been successful, men's and plus have both been great additions to the business.

And the way to think about those is each of those really kind of doubled the audience of available customer and warm bodies out there that could benefit from Stitch Fix. With men, of course, that's obvious. With women, there's a lot of research that shows that women -- that more than half of women in the U.S. are a size 14 or higher.

So these are both totally new audiences for us that were not addressable in our market before and add a significant amount of total addressable market opportunity for us. Both of those have been very successful, and both are -- provide a lot of kind of longer-term paving the path for growth. Plus directionally, 75,000 was actually the number of people that were waiting on the waitlist before we even launched the business. So today, while we won't be providing exact numbers, the number of people that are benefiting from that service is significantly higher than that and certainly continues to grow.

So I think with the -- from a category perspective, men's, plus size, and hopefully we'll see the same thing with kids, are all great opportunities for us to be able to have many, many paths for long-term growth, and we've been really excited about all of those. In terms of revenue per active client, I think there's multiple dynamics there. And so we just talked about the many new businesses that we have -- that we've entered. Men's, for example, historically have -- within Stitch Fix have spent about 80% of what our women's clients have spent.

So that spend on an annual basis is going to be a little bit lower, so you can imagine that will be a drag on revenue per active client. As we look forward, kids, for example, will also likely be lower, so those are things that we should consider as drag. At the same time, two of the things that we talked about in the last quarter, Style Pass and Extras, those are both capabilities where the intention and impact really is to expand wallet share. And so with Style Pass, we certainly shared -- we shared that we saw that last quarter.

This quarter, we shared that we've seen higher-than-expected enrollment, higher enrollment than what we saw in the beta, and so that's certainly been a great addition to the business. And with Extras, a lot of the product that we're selling in Extras is pure incremental to what we were selling in fixes before. And so for revenue per active client, that's not something we're going to -- we're providing guidance on, but there's kind of both waves, the growth wave and then also the -- how wallet share wave are both countervailing effects there.

Paul Yee -- Chief Financial Officer

Just to add on to our results for the quarter, our 29% retail growth -- retail sales growth was above our range of 22% to 26% and really went -- from a driver's standpoint, we grew active clients by 30% year over year, and that's both for our women's and men's categories. And we're really pleased with efficiencies we've seen with our marketing spend to attract new clients as well as ability to reengage and engage clients with the various tools we have to really please our clients. I think what I'll also note for Q3, we did have, as I noted in my prepared remarks, some transition last year from a marketing-activity standpoint. So we saw inefficiencies last year that helped boost our quarterly growth year over year, which we're so pleased with.

But we expect the growth rate to normalize for the quarter in Q4. Stepping back, when we look at the full year, I'd guided to 25% to 26% growth, and that's certainly reflective of our strategy to drive profitable, sustainable growth for long term, and we'll give you an update for the full year in the fall.

Chris Merwin -- Goldman Sachs --Analyst

OK. Thank you very much.

Operator

Our next question comes from Doug Anmuth with JPMorgan. Please go ahead, sir.

Doug Anmuth -- J.P. Morgan -- Analyst

Thanks for taking the question. I just wanted to follow up on that a little bit more. Just trying to understand the gap obviously tightened up a lot between active client growth and revenue growth. Just hoping you could elaborate on that a little bit more.

And then, Mike, you talked about some of the efficiencies that you gained in terms of logistics and warehousing and everything, and probably you can talk a little bit about what some potential areas could be going forward, whether there's still room to gain further efficiencies.Thanks.

Katrina Lake -- Founder and Chief Executive Officer

Great. So I think at a high level, to speak to kind of the 20% -- 30% active client and 29% revenue growth and that being a tighter kind of tighter set, I guess, than they have been in past quarters, I think those are the countervailing effects of -- on the one hand, we do expect that revenue per client number to be dragged down as we add more and more clients from our newer categories such as men's and eventually kids, where these are still huge markets that are great longer-term growth trajectories for us but where you'll see lower annual spend than in the women's business. And then at the same time, I think what you're seeing is the benefit of our initiatives. And so to be able to see greater retention, greater engagement, those will all be reflected in wallet share and be a countervailing effect to the changing composition of our client base.

So I think those are the two factors that are at play there. Mike, do you want to talk about efficiencies?

Mike Smith -- Chief Operating Officer

Yes. I can talk about efficiencies. Yes, I think there's still a lot more room that we have in efficiencies and getting leverage in the model. I'll talk about two main ones.

One, it's just as new businesses scale, we added another warehouse for men's as an example, and we're seeing some -- a lot of leverage just in that business in terms of contribution margin just by being in three warehouses versus just two. And we've talked about in the past all new businesses sort of start in one to ensure that we deliver great customer experience, but as they get bigger and we get scale, we benefit by being able to have the network of five warehouses where we can start putting those businesses in other warehouses. The second one is just within the four walls of the warehouse. So we've talked about the 15%, but there's still a lot more opportunity I think.

That was in one area in the warehouse, but there's more opportunity for automation in other areas of the warehouse as well as continue to use data science to get more creative in picking and just the way we handle returns. So I think there's more room for sure, and we'll talk about that in future calls as we roll those initiatives out.

Doug Anmuth -- J.P. Morgan -- Analyst

OK. Just as follow-up, can you just help us understand how to think about the margin profile around the kids business? And any kind of different dynamics there?

Katrina Lake -- Founder and Chief Executive Officer

Yes. I think it's probably going to be a little bit too early, and we're definitely not going to be able to share specific guidance on it. But one of the interest -- one of the important elements of the kids business is both as we think about the kind of average size of the order the -- and as we think about the different patterns of the way that people purchase kids' clothes, having a higher number of units in the fix is important. And so one of the -- we talked about Extras last quarter.

We talked a little bit about how it wasn't necessarily Extras is the -- our opportunity but that it was really the capability to be able to kind of expand our service and add more flexibility. And this is our -- kind of putting that to use. And so our kids fixes will have between eight and 12 items in it. That can range from a pair of leggings for $12 to an occasion dress for girls.

That could be $35. And so of course, as with our regular Stitch Fix offering, people will opt into the price points that they want to see, but you'll see that, that kind of average unit will likely be significantly lower than what we're seeing in the men's and the women's business but that we hope that kind of the number of items having eight to 12 and we see that people buy kids' clothes in more of a bulk fashion, we think that, that will counterbalance that. And so we've done the numbers, and we definitely think it's a big opportunity. It's definitely profitable.

It'll be accretive. It's a big opportunity to take advantage of the households that we're already serving at Stitch Fix, and so we do expect that it'll have a big growth and growth potential for us. But I don't think we're in a place where we're going to be able to share specifics.

Paul Yee -- Chief Financial Officer

I would just add to Kat's comments the progress we made with men's is going to be -- so the journey that we expect kids to follow. This -- so three areas of investments within categories include lower initial margins as we have smaller buys upfront. We have the higher shipping cost due to fear of distribution centers from which we distribute the product, and finally, clearance rates are higher based on the fact we buy more inventory to really align with sort of the new clients and make sure we can serve them well. In all three fronts, our men's 18 months in are better year over year.

We have lower clearance rates as we're optimizing our algorithms and getting better with our merchandising assortments. We added the third warehouse that Mike just described this quarter. And then I mentioned last quarter that our initial margins are higher as our teams are leveraging to scale the business. So that journey, we expect for kids as it has been for our -- of our recent categories that we added.

Doug Anmuth -- J.P. Morgan -- Analyst

Great. Thank you for the color.

Operator

Mark Mahaney with RBC Capital Markets. Please go ahead with your question.

Shweta Khajuria -- RBC Capital Markets -- Analyst

Hi, this is Shweta for Mark. Two questions please. So regarding algorithmic repurchasing, you've mentioned in the past it has driven client satisfaction, engagement and average order value. Could you do talk about its impact on margins given that it improved the odds of clients finding and keeping their fixes? That's question one.

And the second question is related to men's and plus' dilutive impact on gross margins. So how much did men's initial markup grow this quarter? And how about shrink, how much did that grow? Thank you.

Katrina Lake -- Founder and Chief Executive Officer

Great. I'll take the question on algorithmic repurchasing. Yes, undoubtedly algorithmic repurchasing also helps our gross margins. It helps our gross margins because we are, in many cases, ordering exactly what we know that there is demand for.

And so for example, we may see -- in a style of denim, we may find that for a certain style we only want to be reordering sizes 12 to 14 or we only want to be reordering certain washes in certain sizes. And that's all based on what we know there's demand for. And so that means that we're selling through the product faster. We're turning it faster.

We're more cash efficient on that product and that, ultimately, we're ending up with better margins because we end up with much, much less clearance on that product. And so the benefits of algorithmic repurchasing are significant to the client but also to our business as well. On the second question on margin, Paul, do you want to take that one?

Paul Yee -- Chief Financial Officer

Sure. In the last call, I mentioned, in Q2, our men's initial markups are up 190 basis points year over year as we have leveraged our scale and grown that business. We won't be giving that number every quarter, but I can tell you that the men's continues to grow that margin year over year, including in Q3. Specific to shrink, our shrink as a percent of revenue stayed fairly constant quarter over quarter.

It's still a focus for us like any other operating cost as we do things like engineering work to reduce the chances of fraudulent transactions. And we'll give you updates in future quarters. There's just nothing new to report otherwise on that front.

Shweta Khajuria -- RBC Capital Markets -- Analyst

Thank you, both.

Operator

We'll take our next question from Ross Sandler with Barclays. Please go ahead.

Ross Sandler -- Barclays -- Analyst

Great. I had one question on kids and one follow-up on the gross margin. So Katrina, on kids, so do we know what percent of our clients actually have kids? Do you guys have the data? And is the value prop here going to be different than what we have with men's and women's? Is this more about time-saving? Like how critical is the stylist process for the kids strategy? Just any stuff you could flesh out on how you expect us to evolve and what you think organic inbound conversion to look like versus having to acquire new customers that have kids would be helpful. And then on the gross margin, any color on -- was Extras a meaningful boost sequentially to gross margin? It seems like you guys have lapped a lot of that headwind and now we're going up sequentially, so congrats.

Any color on what's driving that up beyond what you just said on previous questions? Thank you.

Katrina Lake -- Founder and Chief Executive Officer

Great. Thanks, Ross. I'll take some of your questions on kids. So firstly, on the what percentage of our clients have kids, and we do know that, that is a question that we have on our onboarding survey.

Well more than half of the majority of our clients are having kids, and we don't know, I guess, exactly if their kids are going to be between the ages of two and 14, which is what our kids offering is going to be. But it gives us a really good signal as to what households we may be able to serve well. And to maybe skip ahead to your other question around marketing, this certainly is a very, very significant advantage for us. So what we noticed with the men's businesses is that we did see a lot of women who are influencing men in their lives and we were seeing people who became Stitch Fix households.

And there was some marketing scale that we saw going into the men's business coming from the women's business. We expect kind of greater marketing scale and even greater marketing scale in this case. And so with men and women, men are still the primary decision-maker in kind of the choices that they're going to make of where they buy their clothes, but the parents are the ultimate decision-maker with kids. And so to be able to have many households and many parents who are already getting Fixes, it's a pretty significant advantage that we can leverage.

In terms of the value prop, we -- I think we will still have a styling element, but we're looking to scale it in more in a -- I guess, scale it better, I think, given that we're going to be shipping Fixes of eight to 12. And so the styling element, however we find, I think is still important. And in focus groups that we've done with kids, kids have their own preferences. This isn't just about convenience.

Many kids -- we heard kids who wanted clothes to help them feel fat. We had kids who wanted fabrics that felt really soft, who didn't want to be constrained by jeans. I mean, you hear very similar things about -- from kids that you would hear from adults. And actually, the little boy who wanted to be fat was really cute because it's the same value proposition as adults of like you want to feel confident.

You want to feel great at your job. You want to feel the best in your job. In this little boy's case, to him, that meant being fat. And so to be able to listen to what kids are looking for and to be able to help them feel confident, it's very similar in value proposition to what we do in our men's and women's businesses.

But I think the capabilities that we've built there help us to deliver that with greater scale and greater ease because we have $1 billion of history serving this market already. Did I get all your questions on kids?

Ross Sandler -- Barclays -- Analyst

Yes. I guess, the only other one would be any -- I guess, how would -- Doug asked this earlier. But how do you expect the unit economics to differ? I mean, are the -- marketing will be lower. It seems like your keep rate will probably be higher.

Do you -- is the merchandise margin here going to be similar? Any color on pricing? That would be helpful. Thanks.

Katrina Lake -- Founder and Chief Executive Officer

Yes. To be honest, I think most of this, we'll have to update you as we go. I think as we've modeled the business, we're hopeful that we'll be able to drive similar unit economics. What that will actually materialize to be, I think we haven't -- once we get into market, we'll probably be able to provide more color.

But we do expect that people will be buying more per -- more unit per shipment. We are launching with exclusive brands, and we do expect exclusive brands will be a significant part of the portfolio as it has been for men's and plus. And this is a business that's already leveraging our capabilities and our marketing to your point. And so for all of those reasons, we feel really good about the economics of the business, but we'll be sure to share along the way as we see any meaningful differences.

Paul Yee -- Chief Financial Officer

And I'll take the gross margin question. As noted, we saw expansion of 60 basis points year over year, so that's the first time in over a year we saw expansion as we invest in new categories as -- like men's and plus. To be honest, Extras, which you kind of hypothesized might have been a factor, is not. It's still -- we're happy with the incremental business, but it's still very immaterial in size.

And Extras has really been about the capability that technology's allowed us to do things like add more than five items per fix, which in turn has allowed us to launch kids. When you think of our gross margins, one thing we -- I noted in my comments, and I'll take a few moment to go deeper on this, is we actually had an improvement in our inventory reserve year over year and also quarter to quarter. Basically, we looked at our inventories end of each quarter, and we have a reserve against that. Within a portion of that, inventory will be cleared ultimately.

What we've done from a rate standpoint is look historically at our clearance rates because that's the best sort of evidence of sort of future. And basically, as our clearance rates have improved sequentially quarter over quarter, that's allowed us to lower that inventory reserve amount, and that change flowed to the P&L. So that -- so really the -- so a testament to our algorithm, our styling and our buying capabilities coming together to improve our clearance rates is what's helping drive our gross margins for this quarter and hopefully for the future.

Ross Sandler -- Barclays -- Analyst

Great. Thanks.

Operator

Ryan Domyancic from William Blair. Please go ahead next with your question.

Ryan Domyancic -- William Blair -- Analyst

Hi. Good afternoon, and thank you for taking my question. So first on the advertising side, did you make any progress during the quarter in getting better personalization around emails or display ads or anything like that? And did that benefit customer acquisition cost in any way?

Katrina Lake -- Founder and Chief Executive Officer

So what we've seen in customer acquisition cost over the last few quarters is stability, and Paul alluded to the fact that right now we're anniversarying just, I guess, exactly a year ago now was as -- was before as we were bringing channels in-house. And so we've seen quite a bit of efficiency and learnings as we've been able to do that. And so we -- I think there is still -- I think what we've been able to do so far is to bring those channels in-house, bring a lot of those learnings in-house. The opportunity you referenced around emails, for example, that's an area we've been good at, but I think there's still a lot of opportunity.

And so looking forward, as we think about how to take the next step in our marketing, it's really around how can we bring algorithmic and personalization capabilities into our email in a one-to-one way the same way we do with our fixes. And so today, while we can look at client life cycle, we can see kind of where clients are in their life cycle and their sentiment, what we're not doing is necessarily looking at that on kind of a one-to-one basis. And so that's certainly an opportunity that we still see as an opportunity for us in the future.

Ryan Domyancic -- William Blair -- Analyst

OK. That's helpful. And then I think one more for me that I think that over the past few quarters, you've been adding lower price point selection to your inventory to offer to customers. Where are you at in terms of having that lower price point selection? Is it the right amount? Do you have more to add to it? And then is there any early evidence that, that lower price point selection is helping unlock a new set of customers?

Katrina Lake -- Founder and Chief Executive Officer

Yes. To take the latter part of your question, it definitely is. We did substantial testing on the kind of lower price point inventory, which, as a reminder, is kind of this product in between $30 and $50 for the most part. And that product, we did significant test on that last year -- about a year ago actually before we chose to invest in that inventory, and what we found is that being able to have that inventory helped us to be able to serve a client base we weren't serving well before and drove better retention and better wallet share with those customers.

And so we feel really confident in that learning. And your first question around is it the right amount, yes, I think we're -- it's close, I would say. We're -- we always can be calibrating that. A great part of our businesses is that our clients are telling us exactly what price points they want, so every single cohort and every single individual, we have a sense of do we have the right products for them.

And we certainly have made a ton of improvement this year versus last year in being able to serve well the clients who are looking to get fixes. There could be probably a little bit more that we would do in that assortment. But right now I think it's definitely a lot better than it was in the beginning of the year, and we're in a good place with it today.

Ryan Domyancic -- William Blair -- Analyst

OK, great. Thank you so much.

Operator

We'll take Erinn Murphy with Piper Jaffray. Please go head.

Eric Johnson -- Piper Jaffray -- Analyst

Hi, guys. This is Eric on for Erinn. First on freight and shipping. You mentioned that was a pressure on gross margin in the quarter.

I was just curious if you can provide an update there. Anything you're doing proactively to mitigate that? How much do you guys use the spot market versus contract rates?

Paul Yee -- Chief Financial Officer

Eric, I can speak to that. Mike, if you have any other color, please squeeze that on. So every year, we obviously face some inflation as we work with our partners, and we absolutely strive and aim to mitigate those -- that inflation. So we have a couple of tools that we use.

First is leveraging our scale. We're now over $1 billion in revenue, and we seek and achieve a volume discount and skip the benefit with our scaled existing carriers. We're also diversifying our carriers, looking at both major carrying to integrate them into our system as well as looking at the benefits of more regional carriers to allow us to reduce our shipping costs. And then more recently, we added what we call rate shopping.

It's basically I'm allowing our warehouse teams to understand perhaps based on the requested receipt they buy, our clients can actually slow down that shipment. Maybe it was packed a little early. And so we can not only improve our client experience but also reduce our shipping costs by optimizing delivery times. So the whole variety of ways that we're looking at reducing that cost to defeat inflation and again, we'll continue to be tenacious on that front.

Eric Johnson -- Piper Jaffray -- Analyst

Great. Thanks. And then just pulling up one more on the kids side of things. Is there going to be any capabilities to ship with a parent fix? And how are you thinking about pricing, styling on a kids fix if it is going to be a stand-alone transaction or purchase?

Katrina Lake -- Founder and Chief Executive Officer

So today, it is going to be a stand-alone business. And so while a parent will be able to use their Stitch Fix account to sign up a kid and order a kids fix, so at the account level, there will be -- you'll be able to do that. The shipment level, we -- they will ship as two separate shipments for now. In terms of, I guess, how the styling and the shipping varies, there will still be a styling fee.

There will still be a buy all discount. Of course, there are more units that we have to qualify for that buy all discount, but that will be the same that we have today in men's and women's. And we'll see as we go to see if this is the right offering for this audience. But we're excited about the incrementality of this business to kind of serve the parents and children even better.

Mike Smith -- Chief Operating Officer

This is Mike. The only thing I'd quickly add to it is just that we've learned, over the years, that this is a very emotional and fun experience for all of our clients, whether it's men's, women's or soon to be kids. And we did do a lot of market research sort of asking about do you want a family fix, do you want, if you have two kids, your fixes in the same box. And it was pretty clear that the kids want their own fixes, and they want to have that emotional experience with their name on it.

And that is something that we want to bring that joy just like we're bringing, I think, with men's and women's at a personalized and individualized basis.

Eric Johnson -- Piper Jaffray -- Analyst

OK. Thank you. That's very helpful, guys.

Operator

And there are no further questions in the queue at this time. I'd now like to turn the call over to Ms. Katrina Lake for closing comments.

Katrina Lake -- Founder and Chief Executive Officer

Great. Thanks, everybody, for joining us today. We hope we have the opportunity to serve your kids, so let's get them signed up. And we look forward to seeing everybody on the road and at conferences.

Thank you.

Operator

[Operator signoff]

Duration: 42 minutes

Call Participants:

David Pearce -- Head of Investor Relations

Katrina Lake -- Founder and Chief Executive Officer

Mike Smith -- Chief Operating Officer

Paul Yee -- Chief Financial Officer

Chris Merwin -- Goldman Sachs --Analyst

Doug Anmuth -- J.P.Morgan -- Analyst

Shweta Khajuria -- RBC Capital Markets -- Analyst

Ross Sandler -- Barclays -- Analyst

Ryan Domyancic -- William Blair -- Analyst

Eric Johnson -- Piper Jaffray -- Analyst

More SFIX analysis

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