What Stitch Fix Is Getting Right

Stitch Fix (SFIX 3.69%) has enjoyed an admirable run since landing in the public markets in November of last year. Below, the Industry Focus team highlights both the challenges and successes that are driving results at this rapidly growing company.

A full transcript follows the video.

This video was recorded on June 5, 2018.

Vincent Shen: Stitch Fix was the most recent to debut. Their IPO priced in November. The stock has only been trading for about half a year. Shares are up, though. They priced at about $15 -- they're now trading at over $19 per share. The stock has actually shed a lot of the gains that it managed to rack up earlier in 2018. When fellow Fool Adam Levine-Weinberg and I talked about Stitch Fix last year, some similar themes actually came up that we've already mentioned for Blue Apron, in that you have a subscription-based business with, at the time, strong growth, and also a need to increase marketing spend to reach new customers. That actually spun Stitch Fix's bottom line around from a $33 million profit in 2016 to about break even last year. I'm curious to hear, Asit, what has been some of the big developments lately that have jumped out to you?

Asit Sharma: Vince, the company is still growing its customer base, and that is a trailing phenomenon of this great word of mouth it has. This last reported quarter, Stitch Fix is going to come out with new earnings on June 7th. Again, we're going back quite a while here. But as of three months ended Jan. 27th, 2018, the company grew its client count to 2.5 million. That's an increase of 31% over the prior year, or nearly 600,000 customers. Revenue grew to $296 million, and that's 24% year over year growth. I like the strong growth story. And I actually like that it's both cash flow positive and profitably from a GAAP net income basis, although we're looking this quarter to see if that equation maybe buckles a little bit and we see a slight loss.

What Vince mentioned is this need to up the spend to now move from a word of mouth phase to an aggressive capture market share phase. In its most recent quarter, Stitch Fix spent $19.8 million on advertising. That's versus $10.2 million in the prior year comparable quarter. That's an increase of 94%. In the first half of the fiscal year, it spent $48 million on advertising, versus $25.5 million. That's an 88% increase. Like many of the companies that are in this so-called subscription box model, marketing, advertising is the key to capturing customers.

Now, I will say that Stitch Fix has a more analytical, data-driven, algorithmic approach to everything it does. The CEO, Katrina Lake, is a graduate of Harvard MBA School, and she is very keen on using data and analytics to drive everything the company does, from choosing inventory to finding reorder points, to how the company markets online. I do believe it has a little bit of an edge over a company like Blue Apron, in that its marketing spend may be more efficient. The company certainly knows its customer, it's a more specialized product than a meal kit system. Maybe, Vince, I'll let you refresh listeners on the nature of its ordering and product cycle.

Shen: Sure. The last thing you mentioned, in terms of that analytical focus, is probably the main thing that, when I was learning and getting up to speed on Stitch Fix originally, that really caught my eye. Management is incredibly focused on using data. And that really just doesn't come up quite as often in conference calls and in financial filings for other apparel companies. It's kind of a unique situation here.

The CEO, she spoke at a conference not too long ago, I think three weeks ago. They spent a decent amount of time talking about how, for example, with the data that they have for a customer, and based on all of the input and feedback that they've received, they can come up on a situation and say to themselves, "We believe that there is a 20% probability that the customer will like this one item and a 90% probability that they'll like this other item." To be able to even make that kind of statement, I think it's rare in this industry.

And of course, that approach, you mentioned inventory management, they know, based on their subscriber base and the demand that goes with that looking ahead, exactly how many pairs of jeans to order, how many sweaters to order, what sizes. That kind of granularity, I think, can be very effective for a company to run efficiently and to maximize how much customers are satisfied, essentially, which each Fix or order that they receive, whether it's month to month or every quarter or whatever it is.

So, a few opportunities that have come up for the company, as we look forward. They're in the early stages of their men's business and expanding into that. That right there is basically doubling the size of their target market. They've also spoken about expanding into plus sizes, and how, I think they mentioned that 50% of women in the U.S. are at size 14 or higher. They were only previously servicing up to size 14, so again, really expanding their customer base in that way.

And they're testing other early efforts, things like a pass where, currently, if you receive a Fix, there's a flat fee of $20 charged to you for the styling that's associated with that. If you purchase an item, they'll take $20 off the cost of that order. If you don't, you have to pay the $20 upfront. They've noticed -- again, through some of the analytics -- that for their best customers, people who are purchasing every month, for example, that isn't the best way for them to structure their pricing. So now, they might charge a flat fee of $45 a year, for example, for all the styling fees for a customer in a given period of time. And with that, they'll find that the overall revenue for a customer rises thanks to the change in that system.

I really like to see that the company is experimenting. They're expanding not only the target market but also the kind of products that they're offering customers, finding more partnerships with different apparel brands. In terms of the subscription industry, that space, this is definitely a really interesting company to follow, I think, that has unique situations that you just don't see in apparel otherwise. This is a company that I've been following pretty closely since their debut, and it's been fun to see their progress. I'm very much looking forward to seeing their results coming up in just a couple of days. Any final thoughts from you, Asit, on the company before we wrap up here?

Sharma: Absolutely, I have two. Listeners, when you see this report coming out, focus in on that advertising expense and compare that to overall revenue as a percentage versus the last quarter. That will be very important, because we're trying to get a sense, as these quarters roll on, on how much the company will need to spend to attract its customers.

The second thing is: Don't become too concerned with the fluctuations in customers. Unique to this company, there's a really lumpy pattern of how its customers order. When the company issued its S-1 registration statement, before its IPO, CEO Katrina Lake, as I mentioned, had a very interesting observation. She just recounted this on a recent conference call, that over 660,000 of the customers of Stitch Fix won't use the service for four months or longer, and then, to use their terminology, they need their Fix. [laughs] So after four months, "I have to have my Stitch Fix!" and they'll reengage. So while we're used to seeing stuff very linearly -- we talk about companies like Blue Apron and look very closely every quarter, well, how did the customer metrics change -- don't get too caught up in customer metric changes from quarter to quarter with this company. You're going to have to watch it for a period of a year or two years to really get a feel for the rhythm of how the customers engage. I think that's, to me, one more positive about this company. Customers seem to be loyal. They're fashion-forward, and obviously they're being provided with things that really satisfy that itch or craving for a curated fashion experience.

Overall, I too am curious and positive on Stitch Fix but need more data. As we always say with IPOs, it's a several-quarter exercise to figure out, ultimately, whether it's a long-term holding or not. But so far, I'm pretty positive on the company.

Shen: Yeah. I'll take one more minute here, because I'm really glad that you brought up the kind of retention and how the company looks at that. They did talk about churn during that conference that I mentioned from last month. I think this came up the last time we talked about Stitch Fix, the idea where you have Blue Apron, where, people have to eat every day, obviously. If somebody is ending their subscription with Blue Apron, they're simply going somewhere else. But the way management at Stitch Fix looks at their product, if they're doing a good job, there's going to be a point where their customers simply have a whole wardrobe, or their budget is tapped out for new clothing, and they're going to stop that. The company is very careful not to overload a customer. They're really thinking about the long-term relationship, in terms of becoming a partner with their customers and how there might be a time when they stop their Fixes, but when they're looking for that fresh item or items for their wardrobe again, they're going to come back to Stitch Fix, so long as they continue to have a good experience with the stylists and the items they're getting. And that, I think, is a good long-term focus for management to have.