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Stitch Fix, Inc. (NASDAQ:SFIX)
Q1 2019 Earnings Conference Call
Dec. 10, 2018 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to the Stitch Fix first-quarter 2019 earnings conference call. Today's conference is being recorded. At this time, for opening remarks, I'd like to turn things over to David Pearce, head of investor relations. Please go ahead, sir.

David Pearce -- Head of Investor Relations

Thank you for joining us on the call today to discuss the results for our first quarter of fiscal 2019. Joining me on today's call are Mike Smith, president and COO; and Paul Yee, our CFO. We have posted complete Q1 financial results in our shareholder letter on the IR section of our website, investors.stitchfix.com. We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements.

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 the 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 Mike.

Mike Smith -- President and Chief Operating Officer

Thanks, David, and thank you for joining us. After the market closed today, we issued our quarterly shareholder letter with more details on our results, which I encourage you to read. As some of you may know, Katrina is on maternity leave, so Paul and I will lead today's call. First, I'd like to take a moment to highlight our results from the first quarter and discuss how we're successfully executing against our strategic road map. In the first quarter, we delivered net revenue and adjusted EBITDA that exceeded our guidance.

Net revenue for the quarter was $366.2 million, representing 24% year-over-year growth. We delivered net income of $10.7 million in the quarter and adjusted EBITDA of $14.3 million. We grew our active client count to 2.9 million as of October 27, 2018, an increase of 534,000 and 22% year over year. These results demonstrate our approach to delivering disciplined growth while continuing to make measured investments in future opportunities in our business.

Paul will discuss our financial results in more detail later on this call. As we've shared in past quarters, our strategic road map consists of three primary growth pillars, which include: expanding relationships with existing clients, attracting new clients, and growing our market opportunity. Today, I'll discuss the positive client reengagement trends we've seen in our women's category as well as provide an update on newer categories, men's and kids. But first, I'd like to take a minute to provide context on two key factors that reflect our strategic decisions and action. Our net revenue is a function of the number of clients we serve and how well we serve them, which are reflected in our active client count and net revenue per client, respectively.

We strive to deliver long-term, sustainable top-line growth between 20% and 25%, and plan to leverage both of these to achieve this. But first, active clients is an important driver of growth and we expect it to continue to grow in the future. Our focus is not to add clients for the sake of adding clients. We seek to attract clients whom we can serve well from the outset and whom we believe will be healthy, long-term clients.

We believe we also have the opportunity to build greater brand awareness and that this will help us further engage existing clients and attract new clients to our platform. The second figure is net revenue per client, which we calculate by dividing net revenue over the trailing 12 months by active clients at the end of the period. This measure demonstrates the effectiveness of our continued efforts to engage and reengage with clients, capture a larger portion of their wallet, and drive higher client satisfaction. In addition, initiatives like Style Pass and Extras as well as continued category mix shift can impact net revenue per active client.

Looking forward, we expect each of these to play a role in driving our top-line performance. In any given quarter, one may outpace the other depending on the initiatives that we deploy in that period. I'd now like to spend a moment to put our Q1 performance in the context of our growth pillars. First, we continue to focus on better serving existing women's clients through our improved assortment and data set. As a result of our efforts in Q1 '19, the number of items our women's clients purchased per Fix reached its highest level on record.

We believe this reflects the strength of our women's offering as well as our ability to serve our clients well and ultimately drives revenue per client. In Q1, there are a couple of factors that helped drive this success. First, we partnered more closely with vendors and capitalized on our increased scale that drive shorter lead times. This enabled us to react more quickly to client feedback and allowed us to better align our assortment with client needs.

We also continue to leverage the additional data set that we collected from Style Shuffle to drive enhanced personalization. We found that Style Shuffle enables us to capitalize on our very highly engaged client base. As of Q1, over 75% of our active clients had played the game, and we now generated more than 1 billion ratings. Our success in delivering more personalized fixes to our women's clients played a large role in driving our second consecutive quarter of growth in net revenue per active client. I'll now give an update on two of our newer categories: men's and kids, which have been key drivers in expanding our addressable market.

In September, we celebrated the two-year anniversary of our men's offering. Since launch, we've used our rich client data to identify opportunities to improve and expand the fit and size options we offer clients. We recently introduced our short offering, which includes 28-inch pant inseams and shorter sleeve lengths as well as big and tall, which includes shirt sizes of up to XXX and waist sizes up to 48 inches. We believe with these expanded fits, we now are able to meet the size needs of approximately 95% of our addressable men's market.

These assortments, along with our ongoing price and inventory expansion initiatives, have also contributed to an increase in men's average order value year over year. Beyond improved fit, we've also leveraged our strong client feedback data to broaden our portfolio of men's exclusive brands. In our recent quarters, our Men's EV assortment has grown to include a broad spectrum of aesthetics and price points, allowing us to better serve clients' diverse needs and lifestyle preferences. This assortment also carries higher initial markups and sell-throughs than the third-party market brands we sell, benefiting gross margins. I'd also like to provide a quick update on Stitch Fix kids we launched in -- which we launched in Q4 of '18 and enables us to serve the entire household.

In our first full quarter of kids, we saw higher-than-anticipated success rates and strength across both market and exclusive brands. We believe the diverse assortment we offer gives kids the freedom to express themselves in clothing that they feel great about wearing. Our offering is both fun and engaging for kids, and we've been excited to see the feedback parents give us on their and their kids' experiences. We look forward to sharing more in this category in quarters ahead. 

Before wrapping up, I'd like to briefly discuss some of the efficiencies we've put in place in our warehouses.

In Q1 '19, we implemented an automated outbound Fix conveyor and labeling system in our Phoenix fulfillment center, which is reducing per-Fix labor cost and improving shipping accuracy. We plan to begin rolling out this system to our other fulfillment centers in the second half of fiscal '19 and anticipate additional investments in automation and cost savings as we move forward. 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. Our first-quarter results reflect our steady, long-term approach to the business, which is to grow the top line sustainably and profitably to drive continuous improvement throughout our operations and to reinvest the resulting free cash flow to drive future growth. Net revenue for the quarter exceeded guidance at $366 million, representing 24% growth versus Q1 2018. These results were driven by year-over-year increases in both our active client count and our net revenue per active client.

As Mike mentioned, through our various product and marketing initiatives, we aspire to drive both metrics, and this was the case in Q1. Active clients in Q1 grew 22% year over year. This increase reflected growth across Women's and Men's as well as our first full quarter of Kids. Revenue per client grew 2% year over year despite the dilutive impacts of our newer categories.

Our Men's clients, for example, spent approximately 80% of what our Women's clients spent. Our growth in revenue per client reflects the success of initiatives like Style Shuffle, Style Pass, Extras, and improved styling algorithms, which together have driven increased client wallet share and engagement. Q1 gross margin was 45.1%, 140 basis points higher than last year's Q1. We've continued to be laser focused in driving efficiencies with our cost of goods.

Our year-over-year improvement was driven by a decrease in inventory reserve, reduced clearance expense, and lower shrink levels. These results are net of the dilutive impact of higher penetration of Men's and Kids, which have lower gross margins than Women's in this earlier stage of their growth. Advertising was 10.6% of net revenue this quarter, compared to 9.5% in last year's Q1. This spend was planned and reflected our strategy to take advantage of channel efficiencies in the fall. Looking ahead to Q2, like last year, we expect to be quieter on the advertising front, given aggressive marketing activity by other retailers during the holiday season.

Other SG&A, excluding advertising, was 31.5% of net revenue in the quarter, compared to 30.9% in Q1 of last year. These results reflect both payroll and SPC investment in technology talent, partially offset by continued savings with our variable labor. Adjusted EBITDA was $14.3 million or 3.9% of net revenue. These results were above the high end of our guidance range, driven by higher net revenue and gross margin and the timing of a cost shifting to later quarters.

Q1 net income was $10.7 million and diluted EPS was $0.10. Finally, we delivered free cash flow of $44 million. While some of the cash flow was due to timing of payments between quarters, it also reflects our continued focus on managing working capital. Quarter-end inventory was up 22% year over year, consistent with revenue growth.

We also ended Q1 with over $355 million in cash and cash equivalent in highly weighted securities and no debt. Now I will provide guidance for Q2 and the full year. For Q2 '19, we expect net revenue in the range of $360 million to $368 million, representing growth of 22% to 24% year over year. We expect adjusted EBITDA in the range of $8 million to $12 million, or an adjusted EBITDA margin of 2.2% to 3.3%. This guidance reflects our expectations for gross margin to come in lower in Q2 than in Q1 for two reasons.

First, while we have lower clearance expense in Q1 due to strong sell-through of products, we expect some of this benefit to be offset in Q2 as we clear fall and winter inventory before the spring season. We saw this phenomenon last year. Second, we don't expect the same level of inventory reserve benefit in Q2 as we did in Q1. In addition, we expect to spend less in advertising in Q2 compared with Q1.

Given this cadence of advertising spending, we expect our Q2 active client count to be relatively flat quarter over quarter. In the meantime, we expect revenue per client to grow. This is consistent with the dynamic Mike discussed. In a given quarter, one of these figures may outpace the other depending on the initiatives we deploy in that period.

Together, we expect they will help us deliver on our goal to drive 20% to 25% top-line growth. For full-year fiscal 2019, we are raising the bottom end of our net revenue range. We now expect growth of 21% to 25% year over year, compared to our prior range of 20% to 25%. This updated range represents net revenue of $1.49 billion to $1.53 billion.

We continue to expect adjusted EBITDA in the range of $20 million to $40 million, reflecting an adjusted EBITDA margin of 1.3% to 2.6%. This range reflects a number of current investments that will step up over the course of the year. These include hiring staff and building warehouse capabilities to support our U.K. launch, investing in our first-ever brand campaign in Q3, and increasing SPC cost as a percent of net revenue as we seek to track and retain top talent. We believe these investments position us well to drive continued long-term shareholder value. With that, we're now ready for your questions.

Operator, over to you. 

Questions and Answers:

Operator

Thank you. [Operator instructions] We'll hear first today from Douglas Anmuth with J.P. Morgan.

Douglas Anmuth -- J.P. Morgan -- Analyst

Great. Thanks for taking the question. I was hoping to just go back to the conversation about net revenue per active client and active clients and how we obviously saw the net revenue per active client increase year over year for the second quarter in a row. That's after I think last quarter when you talked about expecting some declines here.

So just trying to understand a little bit more about how you think those two really run going forward. And then also, how does that play into your CAC and what you're seeing in terms of advertising trends at all as well the active client number? Thanks.

Paul Yee -- Chief Financial Officer

Hi, Doug. It's Paul. I'll start out with your -- first part of your question, then I'll turn over to Mike to talk about marketing spend. You're right in that there are two drivers of our growth in terms of revenue, and it's active client count and net revenue per client.

Those two  can interplay for a given quarter. The upside that we saw in Q1 versus our guidance was really the fact that we're seeing strength in our revenue per client. A lot of initiatives that we put in place to understand our clients better such as the Style Shuffle game and to be able to really ensure the products that we have available and have the right algorithms to match up products with clients is translating to higher revenue per client. We are seeing some very good -- momentum there despite the fact that we have the dilutive impact of newer categories like Men's.

So we're really pleased with the momentum we're seeing on that front and we are noting for Q2 that we're seeing that continued growth going forward. And so again, for a given quarter, we're looking at a variety in the portfolio of initiatives, whether it's product or marketing, and they all tie back to our longer-term commitment to 20%, 25% revenue growth.

Mike Smith -- President and Chief Operating Officer

And this is Mike. I can talk about marketing strategy. Our marketing strategy remains the same, which is staying consistent with having a diversification of channels and also looking for healthy payback and sort of fast payback on our spend. I would say kind of a new component that we touched on briefly was this idea of where brand can play in the mix, and we think that there's a lot of opportunity for brand in the future.

There's just attributes of this model that clients experienced that are around confidence and personalization, fun, that we think have the opportunity to kind of show up in a brand campaign in the future.

Douglas Anmuth -- J.P. Morgan -- Analyst

OK. Thank you both.

Mike Smith -- President and Chief Operating Officer

Thanks, Doug.

Operator

We'll hear now from Ross Sandler with Barclays.

Ross Sandler -- Barclays -- Analyst

Great. First off, knowing Katrina, I'm fairly certain that she's listening to this call, so congrats on the second kid. I guess, two questions for me. Firstly, you guys talked about a record purchase per Fix or keep rate in core Women's in this letter a little bit more prominently than in prior letters, so just wondering what -- could you give some color on what's driving the keep rate in core Women.

And then, Mike, you mentioned the new warehouse automation efforts. I guess stepping back, do you think that there's meaningful improvement in efficiency in cost of goods sold reduction through automation? Or is this -- is there going to be kind of a gradual process? And any color there on long-term thoughts on automation and how that can help drive the business?

Mike Smith -- President and Chief Operating Officer

Yes, I'll take both of those, Ross. So first of all, I think in each quarter as we look at trying to provide color on what's driving the business, in this quarter, our keep rate in Women's was a really good example of that, where we just got better at personalization, we're able to use our scale to really sort of be faster in getting inventory right for the clients. And again, past strategies of expanding our price points and aesthetics and just, frankly, doing a better job with merchandising and doing a better job with styling and doing a better job with matching is what drove that keep rate. So it was a really good quarter in Women's on that front.

On [Inaudible] automation, if I understand your question correctly, yes, there's a lot of opportunity with automation to improve kind of warehouse efficiencies. And we still believe we're in the early innings. The Phoenix warehouse was just a sort of a test that we saw very clearly that we were getting fast payback on that. Now it's time to roll that to the other four warehouses, but we have a number of projects that will help drive efficiencies that are kind of on the table for us.

And again, we think we're in the early innings of getting leverage and efficiency in our warehouses.

Operator

Anything further, Mr. Sandler?

Ross Sandler -- Barclays -- Analyst

No. Thank you very much.

Operator

And from Piper Jaffray, we'll move to Erinn Murphy.

Erinn Murphy -- Piper Jaffray -- Analyst

Great. Thanks. Good afternoon. A couple of questions for me.

First just on the guidance for the second quarter. You talk about new users being flat. I'm curious. Now that we're through a lot of the holiday season, or some of it at least, are you just -- is it just prudence? It's always been a lighter quarter historically, but I don't think we've ever seen flat just particularly given all the new growth initiatives you have underway.

I would love just a little bit more comment on that.

Paul Yee -- Chief Financial Officer

Sure, Erinn. This is Paul. I'll answer your question. So the holidays are a time for us that's actually quite steady in terms of our seasonality compared to other retailers.

We think it's a great thing in terms of not having to step up or necessarily have uncertainty around inventory. And then from a marketing perspective, it's just a very busy time in terms of lots of noise and communications to clients and consumers out there. So, we actively choose to lower our spend from a marketing perspective. And therefore, there is an impact to have on active client count.

On the flip side, we are continuously -- great momentum on the various initiatives to ensure we're delivering a great client experience for existing clients, and that's manifesting in our revenue per client metrics. And that is helping us put together our guidance for Q2, 22% to 24% growth, which, frankly, is sort of in the midpoint of sort of the longer term range we've shared with you on previous calls. So the holidays are a time where clients are focusing on families, and it's something that we're really excited to support them when they come back after the holidays to start to refresh their wardrobes.

Erinn Murphy -- Piper Jaffray -- Analyst

OK. Thank you. And then in the press release, you guys called out a number of exciting brands that you're starting to carry now. I'm curious.

A lot of them just look a little bit higher price point than some -- than your kind of low-price-point strategy. What are you seeing with ASP right now? And is this an opportunity to kind of lift that a little bit higher than your average kind of $55 price point?

Mike Smith -- President and Chief Operating Officer

Yes, I mean I think -- this is Mike, Erinn. We really believe that we can. And we have shown this, so we can represent a lot of different price points, from lower price points to higher price points. Those brands that we recognized in the shareholder letter were more to kind of discuss and show our ability to bring high-quality brands into the franchise.

And clients were asking for those, and we're able to serve clients. And it's a different conversation, as we've talked about. The evolution of brand conversation has been great as we've gotten bigger and as we can point to show these brands exactly what clients will want their product and specifically also how we can make their products better by using the aggregated data set to share back with them. So, it's the same story that we've had with all brands, which is price protection, growth strategy for the brand, and the ability to kind of share data with them in an aggregated level that makes them a better brand.

Erinn Murphy -- Piper Jaffray -- Analyst

Got it. And then if I could just ask one more on the U.K., I'm just curious if you can give us an update on kind of staffing progress. Have you filled up the stylist team there? And then just the vendor base, love if you could talk about how you compare and contrast the potential U.K. vendor base versus what we have here in the United States? Thank you.

Mike Smith -- President and Chief Operating Officer

Sure. So, this is Mike again. We're on track for the U.K. We have started hiring our merchandising team and our styling team.

As a reminder, we're building local operations there because we want to have a localized market strategy in the U.K. The vendor base, it's too early to talk about, but I'll say that the early read is that we're working with all the vendors that we want to work with in the U.K. And there will be opportunities, I think, to be able to share U.K. vendors actually in the U.S. in some point in the future as well. And I think that's one of the great things about this platform, is with each new business launch, we're able to take best practices from Kids and apply it to Men's or Men's and apply it to Women's or U.K. launch and apply it to all of our other businesses, and we see that opportunity as we get started in the U.K. as well.

Erinn Murphy -- Piper Jaffray -- Analyst

Great. Thank you, guys, and all the best. Happy holidays.

Mike Smith -- President and Chief Operating Officer

Thanks. Happy holidays to you too.

Operator

We'll move next to Heath Terry with Goldman Sachs.

Heath Terry -- Goldman Sachs -- Analyst

Great. Thanks. Curious what you guys are seeing in terms of inventory supply, whether or not the issues that we're seeing from a macro perspective with China or just even more broadly, whether or not you're seeing any sort of increases in terms of the cost of the supply and your ability to get the inventory that you're looking for. And to the extent that if at all there's anything implied in your guidance in terms of that changing from the run rate that we've seen over the last few quarters?

Paul Yee -- Chief Financial Officer

Hi. This is Paul. We're all watching the sort of macroeconomic and political dynamics very carefully like all retailers. I can say that the current tariffs enacted have a very immature impact on our business.

The categories under tariffs are not ones that we were heavily invested in. So nothing that we've seen so far, but obviously, we're working carefully and closely with our partners and we have really great relationships with our vendors just to continuously plan and try anticipate various scenarios. So nothing else to sort of further speak on that front at this point. The good news is we have -- beyond the great partnerships we have with our vendors, we have very strong inventory management capabilities.

Our ability to buy the right product up front, using our data science capabilities and also our merchandising expertise to make sure we're buying the right inventory and getting to the right clients, which reduces the risk on the  back end. And so, we're definitely focusing on that as we think about the quarters ahead.

Heath Terry -- Goldman Sachs -- Analyst

And as we look into those quarters ahead, can you give us a sense of just sort of what your expectations are? I know you're targeting 25% or so revenue growth. Should we expect any sort of meaningful mix shift in terms of the makeup of that? You've referenced a few times the trade-off between adding new customers and average order size or average spend per customer. Any reason for us to expect or that you expect that, that mix in the components of that growth to shift materially over the coming quarters?

Paul Yee -- Chief Financial Officer

Yes, I don't know, Heath. The answer's no. I mean, we have a very balanced approach to our growth. We think 20% to 25% growth in terms of a rate is good for our clients, allows us to be able to serve them consistently.

We have to buy inventory that really line up our logistics. And so we think that growth rate's a really healthy one for our clients and for our business. And we look at that target in terms of continuing to build our base of clients and serving them well as evidenced in our revenue per client metric we shared today as well as continue to plant seeds for growth. Men's just hit its two-year anniversary.

Kids is just out the door. We're very excited that we'll be launching in the U.K. this fiscal year. And as we sort of look forward, we kind of continue to have that balanced approach as we ensure that we have the right client experience over the long term.

Heath Terry -- Goldman Sachs -- Analyst

Great. Thank you very much.

Paul Yee -- Chief Financial Officer

Thanks, Heath.

Operator

And from SunTrust, we'll move to Youssef Squali.

Youssef Squali -- SunTrust -- Analyst

Excellent. Thank you very much, and apologies for the background noise here. Can you just speak to the margin side of the business? I think for Q2, you're guiding for a relatively flattish top line, but at the midpoint of EBITDA, it seems like there is a pretty substantial decline at the time when you're talking about the efficiency on the marketing spend. In other words, you're spending less on marketing.

So just help us understand the puts and takes there. Maybe touch a little bit on the gross margin, where I think you talked about Q2 likely to show some negative efficiency. So just trying to understand how much of it is just maturity that isn't built into it. How much of it is really just maybe a slight decline in gross margin, reverting back to what you've done in prior quarters? And I have a follow-up.

Paul Yee -- Chief Financial Officer

Hi, Youssef. So, a couple things are reflected in my EBITDA guidance for Q2. One, I did note, we had a really gross margin in Q1 . I'm really proud of our results, 140 basis point increase year-over-year really due to our ability to manage inventory.

And so, we had lower clearance rates and a positive inventory reserve impact because we have healthy inventories into the quarter. So with a look to Q2, which is our holiday quarter, I did note that our clearance rates will be a little higher as we sort of get ready for the new season, which is spring. And we saw that phenomenon last year. So quarter over quarter, you'll see a slight impact on our gross margin.

And then also, I would say the inventory reserve impact in Q1 was higher than average. While the dynamics of improving our clearance abilities over time will also go forward, we've noted that the inventory reserve impact in Q2 will not be as material as it was in Q1. I would think also in terms of comparing the two quarters, we're starting to continuously ramp up in our investments. We -- the U.K., Mike just mentioned, that we're hiring talents who are also building our warehouse capability, so that will start to play out.

And finally, talent investment is something that we're very focused on ensuring that we continue to have great talent to drive our business, especially in our engineering and data science teams. So you'll see SPC as a percent of revenue increase over the course of the year, including Q2. So nothing's really changing our strategy. We continue to think long term in our investments, and that's reflected in our EBITDA guidance and that's helping us also to drive sort of the long-term top-line growth that I've shared.

Youssef Squali -- SunTrust -- Analyst

OK. That's helpful. And then on the exclusive brands commentary that you have in there, can you just speak to maybe the benefits of having exclusives on the platform? Any quantifiable benefit, maybe like the higher keep rates or higher ASP, that you can point to? Thank you.

Mike Smith -- President and Chief Operating Officer

Yes, Youssef. This is Mike. I mean, the benefits are being able to just offer a wide range of aesthetics and price points in ways that a brand can't. Other retailers that are sort of more singularly focused in the aesthetic or price point that they offer, we're be able  to broaden that range very clearly, and we're able to sort of take the data that we get from clients where they tell us like, oh, you don't have -- what about this product for this occasion or I need this price point.

And when we don't find it in the market, we can develop that product ourselves. And we've just gotten really good at developing exclusive brand product, and some of that flowed through, you'll see in gross margin. So Men's has a higher penetration of exclusive brands, and some of that shows kind of in the margin improvement that we're seeing. But we are confident in our ability to develop exclusive brands for all of our businesses, and we'll continue to develop that product to make sure we have a wide range.

Youssef Squali -- SunTrust -- Analyst

Thank you.

Mike Smith -- President and Chief Operating Officer

Thanks, Youssef.

Operator

[Operator instructions] We'll hear next from Mark Mahaney with RBC.

Mark Mahaney -- RBC Capital Markets -- Analyst

OK. A lot of my questions have been answered or asked and answered, so let me just try to broaden. So just talk high level about brand advertising campaigns. You already talked about the next quarter -- I mean, at a higher level.

Like how do you think about ramping that up over the course of the next year or two? What kind of impact do you expect to have from that? Maybe some details about how you would spend that. You've done broad kind of TV campaigns before, but they've been kind of performance-marketing oriented, performance oriented not brand oriented. Can you just talk about your plans on that? And then secondly, can you just again go through some the details of what kind of traction you're seeing for two specific products, Extras and -- it's not a product but Style Pass, like usage of that? Thanks a lot.

Mike Smith -- President and Chief Operating Officer

You're welcome, Mark. This is Mike. I'll take both of those. So I think it's too early to talk about specifics on ramping up brand advertising.

And one of the things that we're doing research on now and feel really good about is this ability to understand the clients' experiences on the platform in a way that is above and beyond just like a transaction. They really enjoy getting their Fixes. It's a gift to themselves. It is confidence inducing.

They really have a lot of fun and we do see that it's a better, smarter, just a more fun way to shop. And as a result of that, because we only really been doing marketing for a couple of years in terms of paid, we have this opportunity to invest in brand in a way that sort of elevates those attributes. But as far as like how we will employ them and what attributes we'll elevate, that's what -- the work we're doing right now in research, and I think in future quarters, we can talk more specifically about the effect that the brand marketing campaign has on the business, but we think there's a lot of opportunity. On Extras and Style Pass, they're still two really great capabilities that expands -- for Extras, it allows us to gain more -- gather more market share.

There's no reason why a client has to go outside of our platform for buying things like socks and underwear, and Extras provides that opportunity. And then Style Pass, we're still using a very disciplined --[Inaudible]

Operator

Stand by. Just a moment, everyone. Again, everyone, please stand by as we reestablish our main speaker line here. It should be just a moment.

And, everyone, please continue.

Mike Smith -- President and Chief Operating Officer

Hey, Mark. This is Mike. We got cut off. I think I was in the middle of answering your second question about Extras and Style Pass.

Mark Mahaney -- RBC Capital Markets -- Analyst

Yes.

Mike Smith -- President and Chief Operating Officer

Did you get...

Mark Mahaney -- RBC Capital Markets -- Analyst

Yes. Yes, keep going, Mike. Keep going. Sorry about that. My question is a bit complicated.

Mike Smith -- President and Chief Operating Officer

Yes, the technology couldn't handle it. So -- no, I mean, Extras and Style Pass are great capabilities to, again, add more flexibility to the service, gather more -- garner more wallet share and so there's no updates really on Extras. We use it when we're able to test some things like socks or underwear, and we've had really good kind of uptake from that. And then on Style Pass, we're still very disciplined in the way that we roll that out.

We want to roll it out to clients that we know that it's great for. Again, as a reminder, it's a $49 offering. The $49 is a sort of a down payment for anything that you keep in your Fix, but then you get unlimited Fixes based on -- for that year. And we're seeing higher engagement in that, higher average order size.

And as a result of that, we feel really confident that for those clients that it makes sense for, we'll continue to have a disciplined approach to rolling it out.

Mark Mahaney -- RBC Capital Markets -- Analyst

OK. Thanks a lot.

Mike Smith -- President and Chief Operating Officer

Sure.

Operator

We'll hear next from Adrienne Yih with Wolfe Research.

Adrienne Yih -- Wolfe Research -- Analyst

Good afternoon. Thank you for taking my questions. Paul, I was wondering if you could expand upon the comment, in the second quarter, there's a focus on growth in revenue per acquired customer. What is the assumption for the retention rate there? And when you focus on that, is it increased ad dollars that are deployed to retain customers? Is it from add-ons, keep rate or both? Any color there would be great.

And then my second question is also a clarifying question. The ad expense looks like it seasonally is lower in the second quarter, and so I'm just wondering if we should be thinking about year-on-year growth rate being lower than that in the first quarter? Thank you so much.

Paul Yee -- Chief Financial Officer

Hi, Adrienne. I'll try to answer your two questions. I might need a clarification on the second one. So your first one, you're correct in that I've noticed that the revenue per client growth will be accelerating in Q2.

There's nothing specific I'm pointing as the driver of that. You've heard a lot of initiatives that we have in place around being that partner for our clients when they're ready to buy clothes. And I think our abilities through Style Shuffle, the data that we get, and really being able to understand styles, our clients' styles better over time is certainly helping. We have a variety of products that our merchandising teams are continuing to broaden in terms of our capabilities to please clients.

Certainly, that's -- that ends that, but nothing specific. It's just the fact that we'll continue to get better. The fact that we had our highest ever keep rate in Women's is a testament to kind of the capability to build over time. But nothing specific to call out in terms of -- and issues that you haven't yet heard about.

Your second question, I just want to make sure I understood. You mentioned something around expenses. Can you just repeat that again, please?

Adrienne Yih -- Wolfe Research -- Analyst

Yes, so the advertising expense, I believe you had mentioned that it would be obviously growing at a slower rate, and that's what, in part, would drive the flat customer -- active clients. So when I'm looking at it, obviously in the first quarter it looks like the ad expense grew, call it, 37%, somewhere in that range. When I look last year, it looks like there's a natural absolute reduction in the ad spend. So when I -- I'm just trying to figure out if we should be growing that ad expense line 25% year-on-year or in line with the customer growth, which obviously is flat to the prior quarter but growing over 20% year over year.

Does that make any sense?

Paul Yee -- Chief Financial Officer

Yes, well, I guess, -- yes, it does. Thank you for clarifying. And what I can share with you is that, as a percent of revenue, advertising will be declining in Q2 as a -- relative to Q1. So last year, you saw three points of -- a 3-point drop in terms of revenue -- percent of revenue in terms of advertising spend.

And so I would point to that as history in terms of the fact that, in Q2, we are less focused on our advertising spend. So all of these sort of assumptions are embedded in both my revenue, EBITDA guidance for the quarter. And I think sort of last year is sort of a been an indicator of that.

Adrienne Yih -- Wolfe Research -- Analyst

OK. So just a summary. This is more seasonal in nature than a new proactive strategy. Would that be fair?

Paul Yee -- Chief Financial Officer

That's correct. It's just the fact that it's just a very competitive time, and we choose not to advertise in terms of investing.

Adrienne Yih -- Wolfe Research -- Analyst

Great. Thank you very much and best of luck.

Paul Yee -- Chief Financial Officer

Thanks, Adrienne.

Operator

And our final question today will be from Edward Yruma with KeyBanc Capital Markets.

Edward Yruma -- KeyBanc Capital Markets -- Analyst

Hey. Thanks for taking the question. I guess, first, on the higher average annual revenue per client, I know, obviously, you had some success increasing take rate -- or excuse me, keep rate. How should we think about frequency, in particular as it relates to the core female customer? Is she coming in more frequently for Fixes? And then second, I know that you gave some color on the U.K. or said it was a drag to EBITDA. Give us a little bit more color on how much of a drag it was in the quarter and how we should think about the drag building as the year progresses. Thank you.

Mike Smith -- President and Chief Operating Officer

Hey, Edward. This is Mike. I'll answer the first one. We talked about frequency on -- for folks that are on Style Pass, it is more frequent.

I think people really enjoy getting Fixes. They pay the $49 and they are more engaged in driving higher average order values. I'd say we will balanced between those two things, both kind of how frequently someone's getting a Fix and also the Fix characteristics with keep rate. So there's -- I don't think there's -- it really varies by business line and it varies across men's, Kids, and Women's.

But I think Style Pass drives some of it up, but there's no kind of real news to kind of share as it relates to any big change that we're seeing in frequency.

Paul Yee -- Chief Financial Officer

Hi. This is Paul. In response to your question about the U.K. spending cadence, there will be a step-up in Q2 relative to Q1.

Q1, the costs are relatively small. And as we build out our team in-country from a merchandising, styling and customer service standpoint, that will increase our payroll costs. In addition, I mean, Q2, we're starting to build out of our warehouse capabilities. We'll be having a warehouse in-country, and we want to make sure that's set up appropriately to fulfill the supply chain.

So those two investments are going to start to show up more materially in Q2, and that's reflected in my EBITDA guidance for the quarter.

Edward Yruma -- KeyBanc Capital Markets -- Analyst

Great. Thanks so much. Best of luck.

Mike Smith -- President and Chief Operating Officer

Thanks, Ed.

Operator

And at this time, I'd like to turn things back to Mike Smith for closing remarks.

Mike Smith -- President and Chief Operating Officer

Thank you all for joining us on today's call. Have a great rest of your holiday season.

Operator

[Operator signoff]

Duration: 42 minutes

Call Participants:

David Pearce -- Head of Investor Relations

Mike Smith -- President and Chief Operating Officer

Paul Yee -- Chief Financial Officer

Douglas Anmuth -- J.P. Morgan -- Analyst

Ross Sandler -- Barclays -- Analyst

Erinn Murphy -- Piper Jaffray -- Analyst

Heath Terry -- Goldman Sachs -- Analyst

Youssef Squali -- SunTrust -- Analyst

Mark Mahaney -- RBC Capital Markets -- Analyst

Adrienne Yih -- Wolfe Research -- Analyst

Edward Yruma -- KeyBanc Capital Markets -- Analyst

More SFIX analysis

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Editor's note: This transcript has been corrected to show that Mike Smith is president and chief operating officer.

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