Stitch Fix, Inc.  (NASDAQ: SFIX) Q3 2020 Earnings Call Transcript

Stitch Fix, Inc.  (SFIX) Q3 2020 earnings call dated June 08, 2020

Corporate Participants:

David Pearce — Vice President of Investor Relations

Katrina Lake — Founder and Chief Executive Officer

Elizabeth Spaulding — President

Mike Smith — President and Chief Operating Officer

Analysts:

Edward Yruma — KeyBanc Capital Markets — Analyst

Ross Sandler — Barclays — Analyst

Mark Mahaney — RBC — Analyst

Heath Terry — Goldman Sachs — Analyst

Cory Carpenter — JP Morgan — Analyst

Youssef Squali — SunTrust — Analyst

Erinn Murphy — Piper Sandler — Analyst

Ike Boruchow — Wells Fargo — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Mark Altschwager — Baird — Analyst

Presentation:

Operator

Good day, everyone. Welcome to today’s Stitch Fix Third Quarter 2020 Earnings Conference Call. [Operator Instructions]

At this time, I’d like to turn things over to David Pearce, Vice President of Investor Relations. Please go ahead.

David Pearce — Vice President of Investor Relations

[Technical Issues] the results for our third quarter of fiscal 2020. Joining me on today’s call are Katrina Lake, Founder and CEO of Stitch Fix; Elizabeth Spaulding, President; and Mike Smith, President, COO and Interim CFO. I would also like to mention that we’re joining you remotely today from our home offices and we apologize for any technical difficulties this may cause. We have posted complete Q3 financial results in our shareholder letter on the IR 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 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 Katrina.

Katrina Lake — Founder and Chief Executive Officer

Thanks, David and thanks for joining us. After the market closed today, we issued our quarterly shareholder letter with more detail on our results and strategy, which I encourage you to read. Before we dive into the quarter, I first want to acknowledge the context in which we are speaking with you all today. The distressing event in the past few weeks are top of mind for everyone here at Stitch Fix, as I’m sure they are for you, your families, loved ones and communities as well. We have a long and hard road ahead and much work to do to create an equal and more justicity. What has given me hope during this time, is to see our employees stand up for what is right and to have a strong set of values to lean on as we navigate through this together.

With that, I’m pleased to share our third quarter results with you today and to share how we are navigating the effects of COVID and to provide an update on the resilience of both our clients and our business as we look to Q4. Now more than ever, we are confident in our ability to redefine how clients shop and find what they love. As consumers rapidly shift their purchase behavior online at a step change in historic rates, we believe our model were outperformed and continue to take share, which we began to see play out in Q3 and in the early weeks of Q4.

While massive apparel retail declined by 80% in recent months, we saw only a 9% year-over-year dips. Thanks to the resilience of our large auto-ship client base and the strength of direct buy. Even while we faced extreme capacity GAAP across our network tied to COVID, which I’ll discussion in a few minutes. These results in the momentum, we’ve seen in April and May strengthen our belief that the concept of trying on clothes in the comfortable own home has never been more resilient and that an offering that can predict great fit and styles you love is needed more than ever.

With that, I’ll turn to our results. In Q3 ’20, we generated net revenue of $372 million, a decline of 9% year-over-year. Excluding the impact of our warehouse disruptions from COVID, we believe that we would have generated positive year-over-year net revenue growth in Q3. We delivered a net loss of $33.9 million, an adjusted EBITDA loss of $40.3 million. Our adjusted EBITDA excluding SBC loss was $20.7 million. During the quarter, we grew our active client count to 3.4 million, an increase of 285,000 clients or 9.1% year-over-year. In addition, we grew net revenue per active client by 6% year-over-year. Our eight consecutive quarter of growth and a reflection of our ability to deliver value to our clients. We believe this is a very strong signal that speaks to the resilience of our fixed offering, a complementary early momentum and direct buy and that both deliver value to clients as part of our highly personalized offering.

Before I get into the details on our quarter’s performance, I had a few reflections on how we are seeing industry evolve and what that means for us. It has obviously been an incredibly challenging time for most players in the broader apparel industry. In a matter of weeks, we saw a rapid and dramatic change in consumer behavior with people spending more time than ever at home, limiting their immediate needs for work wear and the latest trend and having very limited access to apparel and stores. This has led to more shopping done online with 20% of consumers who had not previously bought apparel online doing so for the first time in March and April.

However, the most significant result of the change in consumer behavior will be aggressive and accelerated share shift to online from traditional brick and mortar retail, we’re nearly 80% of US apparel retail dollars historically has been spent. Even if stores begin to open up balancing health and safety measures will challenge consumers receptiveness the exact features that people loved of our stores. Many consumers will continue to stay home for all non-essential purposes, while others who have never bought clothes online will try and will be seeking better ways to buy apparel online and surface styles jets for then.

Our model addresses all these needs and is a solution that will sustain and enable consumers style preferences in a world with far less ability and appetite for physical retail shopping. While our store-based competitors retrench in the face of negative comp sales and store closings and pulled back their capital investments, we are leaning in and investing in new capabilities like direct buy and automation that position us to take greater share in our near future. In particular given the momentum we’ve witnessed with direct buy and a frictionless entry point we think it represents. We plan to make it accessible to new clients as an acquisition vehicle in the coming months.

With that I’ll spend a few minutes discussing the quarter mainly the strength we saw in the first half, how we effectively navigated COVID-related warehouse constraints in the back half, and ultimately our business momentum entering Q4. We think it’s important to share this level of details, this one-time as we navigate this evolving business environment. First, I’ll start with the distribution side of our business where we have the majority of our COVID-related challenges in Q3. To set a stage, we had a strong start to the quarter. From February through the second week of March, momentum across our Fix and direct buy offerings resulted in net merchandise revenue growth of approximately 20% year-over-year.

Throughout that time, COVID growing global impact had been in the headlines, so we were pleased to see such strong ongoing client engagement and momentum and healthy demand for our model. However, by mid-March, in connection with the declaration of a pandemic and states and counties issuing shelter-in-place orders, our focus became that of our employees’ health and safety and ensuring we put appropriate measures in place. As such in the third week of March, we closed our facilities in South San Francisco, Dallas and Bethlehem Pennsylvania, meaning that we cannot fulfil client orders from half of our US warehouses, which resulted in a Fix and direct buy backlog.

By the end of March, our US warehouse capacity had fallen by nearly 70% with our backlog doubling week over week in the last two weeks of March. In conjunction with these government orders, we felt it was the right decision to give our warehouse associates up to four weeks of paid leave to take care of their families and give flexibility. While that resulted in higher near term cost to support our people, we’re pleased that this investment helps bring our teams back with strength and resolve our vision and mission.

As March concluded, we began to re-open our previously closed facilities to start shipping Fixes and serving our clients again. Upon re-opening, our distribution centers were staffed on an opt-in basis which we believe was the employee-right approach, but also meant that we had fewer associates in our warehouses per active client reducing fulfillment capacity. Over the course of April, these participation levels improved, resulting in higher fulfillment capacity and accelerated net merchandise revenue. By the end of Q3, associate participation, warehouse capacity and net merchandise revenue had all shown meaningful improvement with week-over-week growth in each of the final four weeks of the quarter.

As we exited Q3, we are at roughly two-thirds capacity but had an aggressive game plan to ensure we drove continued operational improvements throughout the course of May. We’re pleased to share that, as of today’s, we’ve effectively executed against our strategy and are approaching full capacity. With this capacity, we’re tracking to eliminate our Fix backlog by the end of June, putting us in more of a position to play offense in the coming quarters

With that, I’ll provide an update on what we saw from clients in Q3. In aggregate, we saw healthy client demand throughout February and March, with some softness in late March that we attributed to a temporary shift in consumer mindshare as the COVID crisis escalated. Since then, we’ve seen resilience across our client base, especially among our auto-ship and direct buy clients. First, on auto-ship, the large majority of our clients choose to receive Fixes on a recurring basis, whether it’s every two to three weeks on a monthly or quarterly cadence. This provides us with tremendous visibility into forecasting demand trends, buying into inventory and aligning our styling and warehouse workforces to fulfill that demand.

In today’s challenging macro backdrop, these autoship advantages are very apparent and very valuable. In Q3, with our resilient from this large contingent of loyal and highly engaged clients. In particular, auto-ship outrates which help us to gauge how well we’re serving clients’ needs or remarkably strong and consistent throughout the first half of the quarter. In March, week three, we saw an uptick and opt outright, which began recovering the very next week and by late April, we achieved the strongest levels of ownership retention in the last three years. We believe that this level of commitment and engagement from the vast majority of our clients filter strong, personal and ongoing relationship with evidence that our business model is one that will sustain and drive.

Transitioning to new and manual Fix clients. As we noted in our April investor update call, we felt lower conversion trend from these client groups in mid-March, which we believe was tied to heighten COVID-related uncertainties. While we saw more consumer optimism in the weeks that followed, we chose to pull back on marketing to avoid driving client demand into our fulfillment constrained environment. We also through another feature that from clients order another Fix post checkout which typically comprises nearly one quarter of our manual Fix request volume. Following Q3, we have turned this manual Fix feature back on, and we have also begun to ramp up our marketing spend to capitalize on improving consumer optimism in the quarters ahead.

Turning briefly direct buy even in this incredibly challenging in Q3 macro environment, the offering showed no signs of abatement and outpace our pre-COVID expectations in February, March and April. It’s low commitment and low friction path to a personalized shopping experience represents an important gateway to Stitch Fix. And we saw this play out in the quarter with robust client engagement, very low return rate and elevated checkout volume. We see direct buy as a cornerstone of our future experience, complementing our Fix experience for more intent base and impulse purchases that are highly personalized for each of our clients.

In summary, we’ve been very pleased to see the resilience of our auto-ship in direct buy clients and we’re encouraged more broadly, by the fact that week over week demand trends improved every week in April and continue to strengthen in Q4. We’re excited to redeploy marketing dollars in the months ahead to capitalize on these trends among existing and new clients.

With that, I’ll hand it over to Elizabeth to provide an update on all the exciting progress and momentum we’re seeing in direct buy as well as across our broader company evolution.

Elizabeth Spaulding — President

Thanks, Katrina, and hello to all of you on the line. To those, I have not yet had a chance to meet, I look forward to connecting in the quarters ahead and could not be more excited to have joined Stitch Fix, but this exciting next chapter of our evolution. Our model is highly differentiated in the ease and personalization we deliver to consumers and with the major dislocation we are seeing right now in retail, we have the opportunity to dramatically accelerate share shift to Stitch Fix. We believe that more than $30 billion will rapidly shift online, which is 3 times what we would typically see in one year, and we anticipate we’ll get more than our fair share of that given the relevance of our model, particularly with the expansion of direct buy in addition to continued enhancements to our fixed offering.

Today, I’ll discuss a few of the ways we’re planning to capitalize on this market opportunity by accelerating direct buy, evolving our fixed offering and flexing our approach to inventory management. Together these elements foreshodow the key pillars of our evolution as a brand, and we believe they create a differentiated flywheel to fuel our growth and reduce the working capital requirements to grow revenue. First, as Katrina touched on, we believe that direct buy represents a step change in our ability to further penetrate our addressable market and expand the way we serve our clients by meeting their needs for additional purchase occasions. As a reminder, our integrated direct buy offering allows clients to shop and select items they love based on our hyper personalized recommendation directly from our website or mobile app.

This offering was made available to all of our active fixed clients in Q3. We’re very encouraged by its early success, especially given how nascent and imperfect to offering in and yet, in Q3 we still saw direct buy revenue more than triple quarter-over-quarter with consistent momentum every week throughout this time period. In addition, direct buys penetration of our existing base of women’s clients grew from 5% in February to 13% in May. I’ll add that our testing has showned direct buy spending to be highly incremental to Texas. This signals the strong product market fit that this highly personalized shopping experience delivered. This momentum also supports our belief that there is an ongoing structural shift in retail resulting from COVID and that our hyper personalized experience will be an essential way to support client in this new normal.

In light of this, we’ve been aggressively hiring additional engineering talent as well as shifting a subset of our engineering team to building the product experience. We believe direct buy provides a lightweight entry point for both existing and new clients and complements our fixed offering as a highly personalized avenues for window shopping and seeking out specific purchase needs and impulse buying. So we have leveraged this talent to add flexibility across the product. First, to-date direct buy has showcased highly personalized recommendations to clients based on past items they have purchased. In an effort to move direct buy closer to becoming a client acquisition vehicle, in early June, we introduced the data for a new offering. This new offering, which we call trending for you remove the purchased items requirement and instead allows men’s and women’s clients to shop hyper personalized book based on their style profile. This change creates more shoppable look meaningfully expanding the breadth of items from which clients can choose to purchase and removes the requirement that clients have purchased with us in the past.

Also, later this month, we will launch another collaboration with fashion influencer Katie Sturino, in which will offer a curated assortment through direct buy from which both new and existing women’s clients can shop. The assortment will be styled into shoppable outfits with items from our broader inventory pool, showing that we can put items into the context of an outfit that is personalized to each individual client. This collaboration, which is focused on size inclusivity will serve as a test-bed for us to expand the types of looks we show clients and has the potential to create marketing hooks to acquire new clients as we team up with brand partners, influencers and showcased our own exclusive brand. As part of this more expansive ways for clients to interact with direct buy, we also developed a new onboarding experience which lays the foundation to onboard future clients directly into all types of direct buy experiences such as athleisure or date night that our personalized each of our clients.

Trending for you and our influencer collaborations are prime examples of how we’re adding flexibility to the way clients can experienced direct buy and to more effectively attract new clients. In addition, we believe it can fuel conversion among clients who historically been on the fence. Over the years, we’ve had a large number of prospective clients complete our style profile and provide a detail on their size, fit and style preferences, but who have not yet converted to schedule effect, we believe the high probability clients as well as dormant clients who received past fixes offer exciting conversion and re-engagement opportunities through direct buy and we plan to begin more aggressively targeting both groups in the months ahead.

Our investment in innovation goes beyond direct buy as well as we’ve also begun evolving our fixed offering and expanding our approach to carrying inventory. This set of priorities we believe are critical pillar to expand our offering and to do so with a more capital-light approach to bringing consumers what they love. On Fixes, we have pilots and flight in both the US and the UK that provide clients with increased stylists engagement and the opportunity to select items in their Fixes. These pilots have shown promising early results including higher keep rate. We are enabling clients to engage directly with style us to efficiently select the anchor items of their Fix and identify other ways they’d like stylist support. We will share more in the quarters ahead on that. We believe this enhanced styling experience will appeal to an even broader set of clients as consumers speak high touch engagement, while not going into stores.

The feedback data we collect from this experience with skylifts is a good example of how our Fix and direct buy offering performed a virtuous cycle of feedback which benefits our clients and our business. Through these two complementary offerings, we enable different purchase occasions. One that is often tied to recurring purchases on flexible cadence’s with a clear surprise and deright. And the other, serving more lightweight an immediate client needs for higher intent shopping, as well as impulse purchases. We think our ecosystem of experience will help us fill a growing gap in the market as consumers hesitate to shop the way that they have in the past.

Lastly from an inventory standpoint, we believe that the current backdrop provides us with a unique opportunity to lean into new inventory models to drive better client experiences and business results. We’ve begun to incubate different model to make inventory available to our clients, while also tying up less working capital as we expand in order to deploy investments in other areas to enable our growth. The early learnings and added flexibility we gained from these will inform our strategy around implementing a more meaningful evolution to our inventory management practices. As you can see, we’re actively driving innovation across our business, which is a reflection of all of the opportunities that lie ahead for Stitch Fix, while other retailers are currently forced to pull back on investment and innovation, we’re leaning in and executing against our product roadmap in ways that we believe will accelerate our gains in the future.

With that I’ll have Mike share more on our financial performance and outlook.

Mike Smith — President and Chief Operating Officer

Thanks, Elizabeth and hello to everyone on the line. First, I’d like to share color from the quarter. In Q3, we generated net revenue of $372 million, a decline of 9% year-over-year, driven largely by our COVID-related fulfillment challenges across our US network. In connection with our capacity constraints, we also spent less on advertising during the period, which we believe reduced client demand. We grew active clients to 3.4 million, an increase of 285,000 clients and 9% year-over-year.

Net revenue per active client grew 6.5% year-over-year representing our eightth consecutive quarter of growth. Note that the net revenue per active client calculation is based on the last four fiscal quarters and benefits from the extra week in Q4 of ’19, while active clients is measured over 52 weeks. The 53rd week contributed approximately 2% to net revenue per active client. Q3 gross margin was 40.8%, 430 basis points lower than Q3 of last year. This was largely driven by COVID, as we increased our inventory reserve as well as higher clearance rate due to top line softness.

Partially offsetting this was continued favorability in merch costs. Q3 advertising was $37.8 million, a decrease of 25% year-over-year compared to Q3 of ’19. This reflects our pull back on marketing of approximately $17 million in the quarter, which we plan to deploy in future quarters. Other SG&A, excluding advertising was 43% of net revenue in the quarter, reflecting investments in talent, as well as expenses related to offering our warehouse associates four weeks of paid leave to ensure they stayed safe and healthy.

Q3 adjusted EBITDA loss was $40.3 million driven by softer top line performance, largely related to fulfillment constraints, lower gross margins, our additional variable labor expenses and investments in technology talent. Adjusted EBITDA, excluding SBC loss was $20.7 million. Our Q3 net loss was $33.9 million and diluted loss per share was $0.33. We ended Q3 with zero debt and $329 million in cash, cash equivalents and highly-rated securities. While I’m discussing our balance sheet, I’d also like to announce that in early June, we closed a $90 million revolving credit facility, further strengthening our liquidity position. As we’ve shared throughout this call, we are looking for opportunities to play offense given what we’re seeing across the broader landscape and having this additional capital, puts us in a better position to do just that.

Now to our outlook. While we continue to see momentum across our business, there are too many variables at play to speculate on specific guidance ranges in Q4. Instead, I would like to provide an update on specific trends we’ve seen play out so far in the quarter and give additional color to help frame how things might evolve. First, I’ll discuss top line trends and then we’ll move down the P&L, and provide updates. Again, while we do not want investors interpret this as providing guidance. We do want to share color around the ongoing momentum we’re seeing across multiple areas of our business.

First, our top line performance. we’ve driven meaningful improvement over the past several weeks. In April, our net merchandise revenue grew week over week each week. In May that momentum continued as we deliver positive year-over-year growth in net merchandise revenue compared to May of 2019. We see this return to positive growth in May as an important milestone and one that reflects the resilience of our US warehouse network, ongoing improvement in client demand and early momentum resulting from a much larger migration of retail spend online. As a result, we expect these trends will continue and will deliver positive year-over-year net revenue growth in Q4, adjusted for the impact of the 14 week in Q4 of ’19.

Shifting the gross margin. While, our Q3 margin was largly suppressed to the effects of COVID, we enter Q4 with a more balanced inventory portfolio that was aligned to our top line expectations and client preferences. As a result, we expect to increase our Q4 gross margins by 200 basis points to 300 basis points quarter-over-quarter. From a marketing standpoint, we’ve begun to ramp up our Q4 marketing the capitalize on improved CPA trends we’re seeing and the growing demand for our offering. We are optimistic that our healthy warehouse capacity levels will allow us to deploy our marketing to capitalize on these trends. And as we see our outlook remains in line with what we shared last quarters as we continue to invest in technology and talent to expand our capabilities and enhance our digital experience.

Excluding advertising and SBC, we expect other SG&A as a percentage of revenue to lever quarter-over-quarter. This will largely be driven by variable labor efficiencies and the reduction in one-time costs we incurred in Q3 associated with COVID. More broadly, we continue to look at costs, the way people work and the places they are working and we are committed to driving more leverage in the model over time. Translating all this to EBITDA, we expect adjusted EBITDA including SBC to be negative in Q4 and for EBITDA excluding SBC the return to positive levels.

Lastly on cash flow, as our business has improved, we now expect to generate positive free cash flow in Q4. We believe that our ability to quickly shift back into driving healthy free cash flow demonstrates the strength of our unit economics and reinforces the confidence we have in our growth investments, which continue to scale and strengthen. As we look back at Q3, we’re proud of the way our team responded quickly and thoughtfully to unprecedented challenges and the decisions we made to support the health and safety of our employees during these difficult times. As we look ahead to Q4 and beyond, we believe our strong business model and balance sheet uniquely position us to thrive and we’re excited to demonstrate that in the quarters ahead.

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

Questions and Answers:

 

Operator

Thank you. [Operator Instructions] We’ll hear first today from Edward Yruma with KeyBanc Capital Markets.

Edward Yruma — KeyBanc Capital Markets — Analyst

Hey. Good evening. Thanks for taking my question and hope that you and your families are staying safe during this time. Estimated to existing inventory in the balance sheet, I know that you did see impact of third quarter gross margin your seeing benefit in fourth quarter, quarter-over-quarter, but have you reserved against existing inventory? Do you expect to dispose of it in traditional channels? And then kind of a bigger picture question, you talked a lot about share shift to e-com. As you think about direct buy I know it’s still early, but what percent of your overall business you think this will approximate over time? Thank you.

Katrina Lake — Founder and Chief Executive Officer

Thanks, Ed. Thanks very much for your questions. I think we’ll have — Mike, why don’t we have — you talk a little bit about inventory on the balance sheet in gross margin and while we probably won’t hear exactly what we’re expecting on the direct direct buy side in terms of percentage. I think Elizabeth can share some more color.

Mike Smith — President and Chief Operating Officer

Yeah. Hey, Ed. This is Mike. Yeah. And in the strength of the balance sheet is something I’m really proud of and again, we referenced kind of return to free cash flow positive levels in Q4. We do reserve against inventory, existing inventory. We changed the methodology, a little bit to represent, is the current thinking and what we’re seeing kind of in our inventory levels going into Q4 and into next year. That being said, I think the talk about and what I talked to in terms of gross margin improvement quarter-over-quarter, it gives me a lot of confidence going into Q4, but our inventory is at the right level to serve our clients. And that gross margin improvement and get back to the gross margin levels that we have been that you can sort of see from us.

Katrina Lake — Founder and Chief Executive Officer

Great. And then I’m happy to try on the direct buy front. I mean I think one thing to keep in mind is that distinction between fixes and direct buy is a very natural way to talk about things because that’s how our business is evolving, but I think over time we will see a lot of that becoming a gray area and blowing between the two. I mean ultimately what we are doing is we are creating a full suite of personalized shopping experiences for our clients that cover all of their purchase occasion. And so what gets us so excited about with what we are seeing with direct buy is we are clearly needing a very complimentary set of needs relative to what our fixers offered us to address. And allows as we believe to cover the full addressable market of apparel spending.

And so while this distinction of share quality and sort of the mix to both two is something we will talk about through the next few quarters, I would imagine that over time there is just going to be a total blowing between services that are more engaged with silence report versus areas where consumers can shop and engage any time that they want to. I think what we are most excited about is to see that these two offerings are so highly complimentary versus any sort of cannibalization between the two.

Edward Yruma — KeyBanc Capital Markets — Analyst

Thanks so much.

Katrina Lake — Founder and Chief Executive Officer

And just to add, this is Katrina again, just jump backing on the inventory side front, more of the assortment angle, I think one think that I guess throughout this whole crisis we have been really grateful for being a digital first business, and on the inventory side, that’s definitely true too. And so I think there is a lot of other retailers that might have kind of inventory or in the stores or and kind of inventory that they weren’t access — able to access during this time and we were — our buyers works really hard to right size our inventory both from a cyber business perspective and then also from an assortment of what’s the most relevant assortment perspective. And so I think we reflected the changes that we saw in our gross margin this quarter. But I think relative to a lot of other retailers we don’t quite have as much risk there.

Edward Yruma — KeyBanc Capital Markets — Analyst

Great, thanks so much.

Operator

We’ll hear next from Ross Sandler with Barclays.

Ross Sandler — Barclays — Analyst

Katrina, you mentioned how should we do that three-year highs in April. Can you use your line is that I think you said in the past that the majority of revenue size of that bucket versus manual. And then, are both of those growing in the July quarter, any comment about growth rates going forward. And the second question is just the experiment you guys are doing with influencer marketing for direct buy what have you seen so far and how could this change of approach going forward if you prove successful. Thanks a lot.

Katrina Lake — Founder and Chief Executive Officer

Yeah, thanks for your — thanks for your questions and I’ll take your first part — rest of just kind of speaking a little bit to auto ship and then, and then we can talk about the influencers and experiment running down probably it was this time in there. And in terms of what we’re seeing on the auto ship side. I think we’ve shared before as the majority of our revenue and we see that most often people opt into a monthly for women and every other month for men’s, but it’s a majority of our revenue and majority of our clients who will get fixated on some kind of recurring basis. And we, and we’ve seen trends be really positive.

And I think through the end of last quarter through the end of the quarter we’re talking about and then also I think in the first few weeks of this quarter and so, and that I guess I could just a lot of, and it gives us a lot of confidence in the resilience of our model right now. And we’ve been seeing a lot of growth and in both channels and so that’s been very exciting. On the important part maybe I’ll kind of talk at a high level and Elizabeth can chime in a little — chime in on kind of what it means. But I think what’s really exciting is as we thought about direct buy — direct buy has really been more accessible to, it’s really been oriented around the things that you’ve already bought, and we haven’t really had a space for it to be pragmatic and for us to kind of and to showcase other perspectives and other ways curating.

And so, and maybe a little bit I will probably share a little bit about what’s coming. And then I think what’s really exciting is more of what is enabling in terms of on how you can imagine, this form factor being a powerful engagement tool in our service.

Elizabeth Spaulding — President

Yeah, happy to describe it. I mean this is we think one specific manifestation of many more things we can do in the future. I think as Katrina mentioned, the way we began direct buy has been incurred around items that after clients who have purchased in the past, which has allowed us to make it an incredibly personalized experience and leveraging our data science to be able to make it as highly relevant as possible. We obviously want to be able to expand on that the clients who may haven’t necessarily bought fixes with us in the past. And so part of it influencer collaboration that we’ve launched, we will be launching in the next couple of weeks is essentially allowing new clients to on-board by telling us a bit about what they like about this particular collection.

And that will then power for us a shopping experience that they can immediately dive into. And so I’d say there is really two things that this represents. One is an expansion around the flexibility overall of direct buy and building more power into our personalization platform that remove that kept item requirements that we’ve had in the past and some of the other things that we’re doing like trending for you that I mentioned on the call earlier. They both represent ways to be able to bring in new clients, without necessarily having that prior purchase experience with us.

The other thing that it represents is a creative way to think about marketing and expanding this to either other influencers, other brand partners, showcasing things like our own exclusive brands that continue to gain great traction and customer success where it allows consumers to be particularly excited about a product or a fashion icon that may be with somebody that they really appreciate. So we see it is really twofold in terms of the flexibility of the platform as well as excitement around different ways that we can market new experiences.

Operator

We’ll hear now from Mark Mahaney with RBC.

Mark Mahaney — RBC — Analyst

Thanks. I want to ask two questions please, first on the impact of direct buy, we obviously had some major events happened at maybe it made this hard to test, but if you, if I think about it in terms of the spend or the loyalty or the engagement the tenure of a customer who is also used direct buy what that, how much incremental revenue that’s created. Is there anyway you could quantify that, do you have enough of the sample size and maybe just have net normal conditions to really do that, but how much of a boost to company — sorry to customer that’s already on it was already a fixed — fixed the customer having direct buy to what that’s done to that customer.

And then secondly is if your supply challenges are kind of largely now solved — will be solved by the end of this month. I think about the end of June, is it reasonable to assume that you could get back to 20% year-over-year growth in the October quarter. Thank you.

Katrina Lake — Founder and Chief Executive Officer

Thanks very much for the questions, Mark, and so on — I think on the impact in direct buy. So what we have shared we’ve been, we’ve been testing this feature for a while now. So we do have a reasonable sample size. And I think what we want to better understand is more of the length of time and so what we shared is that it’s very incremental. And so we see that people who have access to direct buy and when we look at it on a pure A, B test and you have one group that had access and the other that doesn’t, the group that has access more is happier is and is delivering more revenue to Stitch Fix and so we’re capturing more of their share of wallet and so and so that, that we know and we haven’t shared any specifics on that. I think that’s something that we can certainly contemplate for the quarters to come.

In terms of the October quarter I think right now we’re not in a position to be able to share guidance on that. But what I will say is that through the end of this quarter through the early weeks of this current quarter we were really excited about the momentum that we’ve seen. We believe that’s going to bring us to positive comps in the next quarter and I think longer term, we really do believe that there is a huge market share capture opportunity and I think make analysts at this point we are really gearing up to be playing offense during this time.

And this is a time when even in this last quarter, we saw on the entire apparel industry shrink and we, and we had been capturing share of that that kind of contracted pie right now with an eye towards as people start spending again. And as people have more occasions to be buying for that we can kind of maintain and grow that that kind of extra part of that pie. And so I think it’s too early to share specifics, but we’ve been really pleased with the trends that we’ve seen thus far.

Mark Mahaney — RBC — Analyst

Thank you, Katrina.

Operator

We will hear from Goldman Sachs, we will move to Heath Terry.

Heath Terry — Goldman Sachs — Analyst

Great, thanks. Really appreciate some of the details that you’re sharing. I’m wondering if you could give us a little bit of a sense of sort of what your expectations are as you move more into some of these customers that hadn’t shop with you in the past or as you’re seeing customers that are, that are experimenting with some of the, the other ways that they can buy with you. How your expectations for returns and where it’s appropriate to keep rates are evolving. And then with customers that are on automated fixes and have been on automated fixes through this this period where their lifestyles are obviously changing pretty, pretty dramatically. I’m curious what kind of change you’ve been seeing in keep rates?

Katrina Lake — Founder and Chief Executive Officer

Sure. I think I can answer most of these and over that Mike may weigh in. On the first is just how, what our expectations around returns and keep rate and what’s evolving. Our Northstar is really around how do we help — how do we help clients find things that they love. And so that kind of naturally always is driving us toward features and functions and ways to be able to deliver more value for our clients and really drive that keep rates and we then just, you know, we’ve been very mean, I think at the very low return rates that we had even in our, in our direct buy experience, which I think is a little bit more like “normal e-commerce”.

But I think it’s a real testament to our ability to be able to and to get size right to get style right in that channel. And on the keep rate side as well. I think this is a place where Elizabeth just mentioned some of the testing that we’ve been doing as pilot and a lot and those tests have actually had pretty high keep rates attached to them and so and so I think those are, I think those are some examples of things that we’re doing to ultimately drive these metrics. I think these metrics that people keeping things that they love is ultimately like the true Northstar of our business and that’s really where we’re orienting a lot of our efforts again. And on your second question, oh sorry Elizabeth why don’t you jump in?

Elizabeth Spaulding — President

Well I was just going to say that in general, we’ve been really pleased in this time period to continue to see the incredibly low return rates have dropped by that we were seeing even prior to on the macro uncertainty and that in general over the last several weeks, we’ve actually seen an expansion on our keep rates, both of which we think point to the resilience of our model and our ability to adapt to product that people are looking for right now, which we have seen different requests really escalate as you might expect, things like work from home. I think we’ve measured sort of the natural language and those types of request is that as you might anticipate 10x to pre-COVID levels, and we’ve been able to really adapt to that to make sure, consumers are getting what they want.

Operator

We’ll go next to —

Katrina Lake — Founder and Chief Executive Officer

Did we answer your question, Terry Heath?

Operator

We’ll hear now from Cory Carpenter, JP Morgan.

Cory Carpenter — JP Morgan — Analyst

Hey, thanks for the questions. Just on direct buy as you roll out to new large customers, could you provide some more color on how you’re thinking about the timeline in terms of the roll out or when the right time we can start putting marketing dollars behind initiative. And then, maybe for Mike on fulfillment what would have been some of the biggest constraints are challenges in anything bank debt capacity and once you do work through the backlog. How do you think about the operating, operational environment going forward and the need to potentially expand on the warehouse footprint or headcount? Thanks.

Katrina Lake — Founder and Chief Executive Officer

Sure, yeah. I’ll have Elizabeth talk a little bit more on the color around direct buy and then Mike, you can take the question on the fulfillment.

Elizabeth Spaulding — President

Yeah, thanks for the question. As I mentioned on the call, there is a few steps on our way to fully opening up direct buy to new clients. And so, one thing that we’ve introduced is this concept of trending for you with our current active clients that allows us to have client’s shop, but it’s not incurred on prior purchases, but instead on data that we have on things like their style profile and things like Style Shuffle. And then also our collaboration with the influencer is another way to test and learn from a new onboarding experience that does not require prior purchases.

And so we are currently building on both of those things as well as adding more talent to our team to be able to more rapidly expand the offering. So our intent is over the next quarter or two to fully ramp this up to new active clients as you can imagine, there is a fair amount of work to do here and really we hold just a such a high bar of a highly personalized, really well dialed and experience that we want to make sure that we have that in a good place as we ramp it up. And so as we do so, we do intend to ramp up marketing along, excited as well and have been actually doing quite a lot of testing on our marketing messages associated with the shopping experience through CRM and other channels with our active clients and have a very good sense of now how to tell that story.

Mike Smith — President and Chief Operating Officer

Yeah, hey, Cory, I can talk about fulfillment. So the biggest capacity constraint really was just attendance. Katrina talked about it in terms of making sure people are safe and we ask people to stay home, but since then, as we referenced, we’re in really good shape in terms of throughput and attendance. And I think it’s because we were very caring about people safe and health and come back and we’re super excited to sort of the mission.

I’d say the second on changes to the footprint or changes to capacity going forward. There’s not a lot. I mean in the warehouse it looks different obviously because the things we need to do to make sure people are safe and physical distancing in the warehouse. But it should be — we’ve always been about gaining efficiency and improving throughput and that hasn’t changed. And so those improvements I think should offset what we’re seeing from just social distancing that we’re seeing in our warehouse. But, so I don’t expect that to be a constraint going forward, I expect us to continue to improve throughput and get and get leverage and fulfillment over time.

Cory Carpenter — JP Morgan — Analyst

Great, thank you.

Katrina Lake — Founder and Chief Executive Officer

And just one quick add to that I think is that one of the things that the teams have been really creative in doing is certainly figuring out ways that people can be distancing on the warehouse but also actually adding shifts. So that, so that we can kind of minimize the number of people in our facilities and so — so I think we still, we feel like we have a lot of runway and we’ve been just amazed and really proud of, on how much the team has been able to deliver during this crazy time.

Operator

We’ll hear next from you Youssef Squali with SunTrust.

Youssef Squali — SunTrust — Analyst

Great, thank you very much. Two questions from me please. Mike, I was wondering if you could maybe drill a little deeper into the gross margin. Maybe help us understand the puts and takes up 40% this past quarter kind of shows some negative leverage even though your revenues were kind of back to where you guys were into Q2 of 2019 when your gross margins were more like 44% or plus. So, is that mostly related to inventory reserves and write-down or is there anything else going on and with Q4 I think you guys are talking about revenue snapping back to pre-COVID levels or Q4 of last year’s levels. Why wouldn’t gross margins snap back to the same levels. I think you’re 200 to 300 basis points, only implies well in price you guys getting halfway there may be a little better, but not a full snap back.

And then last question maybe to you as well, just in terms of backlog and/or delivery delays, how many weeks are we now running versus say at the trough. Thank you.

Mike Smith — President and Chief Operating Officer

Yes, sure Youssef. I’ll take both of those and the gross margin, there is the reserving that we talked about, but they’re all as we’ve talked about previously with you guys we had higher level of inventory levels going into Q3 and we were — while we were able to cut some receipts going into Q4 and future quarters, the great partnership with our vendor base. We were able to cut everything that we want to kind of growth of the top line. So those are the biggest kind of inputs.

But if you look at our gross margin contraction versus the rest of retail, I’m actually very proud only being down 359 basis points year-over-year versus the rest of retail felt I think it’s down 10 to 15 points of gross margin. And then if I look at Q4 there and we feel good about the decisions we made sort of cut receipts to sort of align inventory more with our sales are coming in and to your point, 200 to 300 basis points is a little bit lower than what we have historically seen, but we also have growth in other parts of our business so that like in kids in the UK where we’ve seen improvement in those areas that our gross margin dilutive relative to Women’s and Men’s because of the scale that they’re at today.

We actually think that’s good news given that those businesses ultimately will scale to what we’ve seen in demand. So we’re actually excited about that. And then to your last question, I think about how clean we are on sort of delays, we’re really clean now. We’ve caught up on the backlog, the capacity constraints that is virtually gone away. And so there is no real delay kind of in shipments versus what we saw pre-COVID.

Youssef Squali — SunTrust — Analyst

All right. Thanks, Mike.

Mike Smith — President and Chief Operating Officer

Thank you, Youssef.

Operator

From Piper Sandler, we will move to Erinn Murphy.

Erinn Murphy — Piper Sandler — Analyst

Great, thanks, good afternoon. Two questions if I may. The first is with respect to stylists, I believe you like there is 1500 pilots in the California area. I guess is the intent to re-hire the same number, but just in lower cost labor markets or are you finding ways as we navigate through COVID-19’s impact on the model to new fewer stylists going forward. And then my second question is, Mike, maybe for you if you kind of expound on what you saw in the quarter in the UK from a topline perspective. And is it following a similar trends quarter-to-date as your overall fitness. Thank you.

Katrina Lake — Founder and Chief Executive Officer

Thanks, Erinn. I can take the one on silos and then Mike can take the O&M, and Elizabeth might have a little bit more color to — I think whichever way you guys want to jump in. But on stylists. Yeah, I mean, we made a very, very difficult decision to part ways with almost 1500 stylists here in California, and yes, the intent is to move to effectively move those up lower cost markets. So we’re offering relocation for stylists who want to take us up on that we recognize as a part-time job that that not everybody will be able to do that, but stylists are still an incredibly important part of our model. We want to continue to invest in our stylists but the reality was that we look at and look at kind of our aggressive goals and if it’s a decision that was a hard one, the one that we needed to make.

In terms of using fewer stylists right now, we’re not, I think right now, we’re really thinking about how can the stylists add as much value as they possibly can. I think such a differentiated part of our model, especially today and as we’re thinking about being truly a replacement for going into stores, I think that higher touch that high entity model is really, really valuable and our efforts now are how can we, how can we make the most of that and how can we really continue to innovate on that. Elizabeth said a few tests that we’re doing which leveraging kind of a combination of a stylists working with the client to improve outcomes in fixes. And that’s been a super exciting place to invest in and so our intention is to and continue to invest in stylists.

Stylists are still a very important part of our model. And then I have Elizabeth share a little bit of color on the UK.

Elizabeth Spaulding — President

Yeah, happy to. So I think we’ve been really pleased actually to see the momentum in the UK across April and May and just in general, that’s a market where we’ve seen consumer demand really bouncing back and in general, few of the other things we’ve now been in that market a little over a year. And one of the areas that we’ve been really working hard at is just continuing to fine-tune the model and make sure we’ve got the right products for clients. Obviously, it’s a new market for us and we’ve been very pleased to see just great momentum in terms of our keep rates there. And that’s obviously our core offering and as Katrina just alluded to, we’ve also been testing and incubating some of our new experience within that market, which has further enhanced and shown opportunity on top of that to keep rate.

So overall, we’ve been adding more brand partners within that market. Just getting smarter and smarter at our inventory buying the same way that we did over time in the US. And overall, both of those things we’ve seen the results starting to really pay off.

Erinn Murphy — Piper Sandler — Analyst

Thank you. I appreciate that.

Operator

We’ll move next to Ike Boruchow with Wells Fargo.

Ike Boruchow — Wells Fargo — Analyst

Hi, good afternoon everyone. Hope you are staying safe. One of these are Mike referred by some to pick on some like I think you had mentioned on the ad spend you guys pulled back in the third quarter, you’re going to slowly kind of kind of ramp that back up over future quarters just kind of curious, how does that play into your 4Q spend and then next fiscal year kind of develops.

And then on the, on the gross margin outlook for 4Q. I guess my question is, do you expect any more reserves you think you’ve reserved enough on just, it sounds like it’s going to be one of the most promotional next couple of months for the soft line retail we’ve ever seen within all the reserves taken across in all the apparel retailers. So I guess just more color on your thought process on what you’re expecting over the next couple months more on a competitive standpoint would be great. Thanks.

Katrina Lake — Founder and Chief Executive Officer

Thanks for the questions, Ike. And we actually I’ll start out with some color around how we’re thinking about promotional activity and then and can probably have Elizabeth weigh in on marketing and then Mike can certainly talk about how that affects gross margin as well. I mean at the high level, we — a couple of things I think we were kind of wondering how promotional this environment was going to be. And the reality is actually like things have been pretty promotional for the last few months, both online and then now we’re seeing things happen in stores and despite the promotional activities online in stores in the last few weeks, our business has been holding up very strongly.

And at the end of the day, our business has never been one that necessarily is about the absolute cheapest price. This is of course we’re always going to be matching prices and making sure we have the right price. But the reality is, people shop with us because they are getting clothes that fits them really well because they’re getting clothes that fit their occasion really well. And so I think that that’s really the value proposition of our business and it’s continuing to hold up really well. And one other piece and you maybe hearing this from kind of other people in the industry.

But one thing that’s been interesting is that I think we may have expected that we got a worried a little bit, but there would be this huge glut and that everybody will be massively over-inventoried and I do think a lot of people had inventory of stranded in stores. But in terms of kind of I think a lot of our vendors and a lot of people on the manufacturing side also shut down or reduced their capacity during this time period. And so I think my belief is that it’s not going to be as much of a crazy over-inventoried challenges we may have had in past periods. And so I think right now we feel usually confident that our offering is going to stand strong regardless of what’s kind of happening externally. And I mean, we feel we’ve made really a lot of great decisions on the inventory side, that we can, that we can show for our customers really well.

Elizabeth Spaulding — President

Great. And on the marketing side, maybe I’ll just give a little bit of color as we mentioned, we saw some shift in consumer mind share and kind of mid to late March and and for us for the most part we’ve been dealing with a very supply constrained environment very careful to be pulling back on spend when we know we can’t deliver fixed of on time, but what we’ve been doing it basically monitoring CPA trends we can week for the last several weeks. And it has been great is basically seen dramatic improvement on those over the course of April and into May, and so we have been gradually adding back spend every week as we feel we can fulfill that demand for consumers and in general, what we’ve observed is actually CPAs are below what we would have seen in the same period last year.

And so our general approach is we’re very. I think in terms of having a really dynamic approach to how we deploy spend and we’re still actually doing a number of tests right now to see where consumers are most responsive by media channel and in general, we’ve been adding more spend back for the most part I’d say every week since late April with the intent to continue to turn that on as our suppliers pulling to place and as we continue to see this positive environment in terms of customer acquisition and a moment where I think in general, we just feel like our model is going to continue to be one that attracts new consumers, given our desire to now shop Morrison Homes.

Ike Boruchow — Wells Fargo — Analyst

Got it. Thank you.

Operator

From Telsey Advisory Group, we will move next to Dana Telsey.

Dana Telsey — Telsey Advisory Group — Analyst

Good afternoon, everyone. As you think about some of the non-apparel items that basically took what that you’re getting from direct buy and that we’re beginning to take hold during this year. What did you seen so far from that and how do you see that impacting inventory and margins go forward. Thank you.

Katrina Lake — Founder and Chief Executive Officer

Again, I think I can speak in broad terms, what we’ve been seeing on direct buy is that direct buy overall as a channel has been really successful and has an outpaced a lot of our expectations for it and I think to the point that we’ve made in earlier calls that means that we’re seeing kind of disproportionate categories like bags and choose the successful us in those channels. And so I think the strength is direct buy and correlate to kind of some assortment changes, however. I mean the broader assortment differences that we’ve really seen has been I think these types of events tend to accelerate trends and the biggest assortment trends that we’re really seeing is one towards I think the ultimate trend of casual realization of the workplace is one that we’re certainly seeing.

And so as we — Elizabeth spoke earlier to just how many more requests we’re getting for more casual apparel and that’s absolutely true in terms of requests, in terms of sales and we believe that that trend is pretty likely to continue and so that’s kind of a broader thing that we’re — a broader theme that we’re seeing and luckily we talked a little bit about kind of our ability to rightsize our inventory, and one of the main things that we did when this crisis started was to look at our assortment and look where do we want to be invested more, where do we want to be invested less and we were able to get out of a lot of our commitments around work wear and we are able to shift a lot of our assortment into the casual world and so we feel really good about our ability to react to that.

Dana Telsey — Telsey Advisory Group — Analyst

Thank you.

Operator

And we have time for one other question today that will be from Mark Altschwager with Baird.

Mark Altschwager — Baird — Analyst

Good afternoon. Thanks for taking my question. First off, with the return to growth in the fourth quarter, can you just expand a little bit on the drivers there and is that primarily going to be existing customers returning to pre-COVID spending patterns or would you expect to see net client adds quarter-over-quarter. And then separately on direct buy, I was hoping you could touch a little bit more on the efforts regarding reactivation of clients and what the timeline looks like there. Thank you.

Elizabeth Spaulding — President

Thanks for your question, Mark. Yeah, in terms of the growth in the fourth quarter, and we actually our existing clients really have been strong throughout. And so we’re looking at growth, we are talking about year-over-year growth that we are expecting to see and that is contributed by new clients. And so what we expect that our revenue year-over-year will increase. We also expect clients revenue per client that those will also increase as those are all kind of drivers of that and so I think the fortunate part about our model is that we’ve had this great existing client base that compete with continuing to be really strong during COVID.

And I think our constraint was really around acquiring new clients during that time period because we are supply constrained because we didn’t want to be spending marketing dollars to bring people into a supply constrained environment and so that the part of our business that was suppressed during that time period is going to be more on the new activity, and so now as we are catching up to our backlog and as we are in a more, a better position to be playing offense I think that growth is really going to be coming from our ability to invest in this side.

Mark Altschwager — Baird — Analyst

Thank you. And then — sorry, I just — the other part of the question was on the direct buy and the reactivation of points, if you had any comments there. Thank you.

Katrina Lake — Founder and Chief Executive Officer

I’m sorry about. Yeah, I think Elizabeth — I am going to have you take that on a little closer.

Elizabeth Spaulding — President

Yeah, absolutely, I mean, as we think about who is going to be targeting with that offering, it’s obviously new perspective clients. It’s also our active clients, which we’ve been very successful with to date taking that penetrated based on 5% to 13% of our Women’s clients. But then, yes we also have a large group of clients that have signed up with their style profile but not converted to fixes. We also have a group of dormant clients who bought fixes in the past and we see both of those populations that we want to engage.

So we’ve done some testing already of that dormant population and then with the group of people, where we have their style profile that’s a lot of what we’re testing right now with things like trending for US I mentioned and the influencer collaboration to make sure that we’re really delivering a highly engaged and highly personalized experience. We really like what we’re seeing so far on the trending for you. And so, our intent is to really improve and enhance that experience with the intent to been ramping it up, and we have a lot of information on those prior clients. So, we do intend to target them in the coming months in orders once we ramp that back up, but we view that as far as pure new clients is both big areas of opportunity.

Operator

And at this time, I’d like to turn things back to you, Katrina for any closing remarks.

Katrina Lake — Founder and Chief Executive Officer

Thank you and thank you everybody for joining us. We wish everyone the best in these very challenging times. And I look forward to spending time with many of you in the weeks to come. Thank you.

Operator

[Operator Closing Remarks]