Stitch Fix, Inc. (SFIX) Q2 2022 Earnings Call Transcript

Stitch Fix, Inc. (NASDAQ: SFIX) Q2 2022 earnings call dated Mar. 08, 2022

Corporate Participants:

Tanny Shelburne — Investor Relations

Elizabeth Spaulding — Chief Executive Officer

Dan Jedda — Chief Financial Officer

Analysts:

Youssef Squali — Truist — Analyst

Mark Mahaney — Evercore ISI — Analyst

Ross Sandler — Barclays — Analyst

Simeon Siegel — BMO Capital Markets — Analyst

Sarah Goldberg — Baird — Analyst

Tom Nikic — Wedbush Investment Banking — Analyst

Kunal Madhukar — UBS — Analyst

Katie — J.P. Morgan — Analyst

Ike Boruchow — Wells Fargo — Analyst

Roxanne Meyer — MKM Partners — Analyst

Presentation:

Tanny Shelburne — Investor Relations

Good afternoon and thank you for joining us on the call today to discuss the results for our Second Quarter of Fiscal 2022.

Joining me on today’s call are Elizabeth Spaulding, CEO of Stitch Fix; and Dan Jedda, CFO. We have posted complete second quarter 2022 financial results and a press release 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 the results to differ, in particular our press release issued and filed today as well as the risk factors section of our quarterly report on the 10-Q for our first quarter previously filed with the SEC and the quarterly report on the Form 10-Q for our second quarter which we expect to be filed tomorrow. Also note the forward-looking statements on this call are based on information available to us as of today’s date. We disclaim any obligation to update any forward-looking statements except as required by law.

During this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the press release 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 Elizabeth.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Tanny. As we pass the midpoint of our fiscal year, we’ve delivered second quarter results as expected, though we acknowledge we are not yet where we want to be with new client acquisitions and conversion which will weigh on our outlook. As you saw in our press release, we have provided guidance for the third quarter as well as for the full year revenue. However, we have withdrawn our full-year EBITDA guidance at this time, which Dan will discuss later. Before I go into the details of our results, I want to level set on where we currently are in Stitch Fix’s journey and why we continue to be confident in our long-term success despite recent and near-term challenges.

We remain confident we are taking the right steps to become the global leader in personalized styling and shopping. We are continuing to improve on-boarding and client conversion, evolve how we market and enhance our overall client experience. We discussed on our call last quarter that our journey is not a linear one. With that, let me turn to our Q2 results and the factors that influenced our performance. Top-line revenue grew 3% year-over-year to $517 million along with gross margins of 45.1% and $10 million in adjusted EBITDA. RPAC reached a new record high of $549 in the second quarter and Freestyle revenue grew nearly 30% year-over-year. We ended the quarter serving approximately 4 million active clients, an increase of 4% from a year ago.

Active clients declined 4% quarter-over-quarter. There were two factors that largely impacted gross adds. First, conversion of new visitors as for Fix and Freestyle is not where we want it to be. Second, given changes in iOS 14, marketing channels that have historically been effective for us are presenting challenges and effectively targeting clients. I’ll elaborate on each of these points further. However, as a result, we experienced lower gross client additions and also opted to pull back on marketing spend in the second quarter. We invested 6.8% of next — net sales for the second quarter relative to 8.3% in the same period last year. Also, higher dormancies contributed to lower active clients for the quarter.

As a reminder, we had higher dormancies in Q2 due to lapping of the high dollar referrals from last year which we ended in Q3 of 2021. I want to touch on the point I mentioned earlier about conversion and provide some further insight. In our efforts to launch and promote Freestyle, we chose to direct visitors coming to stitchfix.com towards the Freestyle experience. It is important to note that stitchfix.com is the primary landing page for customers interested in ordering a Fix. Therefore, in leading clients to the Freestyle experience first, we inadvertently created friction for those seeking a Fix. In an effort to mitigate this friction, we are beginning to direct stitchfix.com traffic to a clear and easy Fix on-boarding path.

We expect this to boost new Fix client conversion over time. This change in on-boarding flow should not be taken as a change in our long-term vision for Freestyle which is to unlock a much larger TAM through daily shopping, styling and inspiration. As we’ve shared in prior calls, we believe the TAM potential is 2 to 3 times larger than the fixed business alone. We’re still learning how best to onboard Freestyle first clients and recognize we have work to do on the Freestyle experience. We’ve learned that Freestyle first clients are coming primarily through product listing ads and other marketing channels that were not available to us prior to launching Freestyle. We will continue to test, learn and iterate on how best to use these new marketing channels. We also recognize that we have work to do to improve the Freestyle client experience so we can convert more visitors to active client and make Freestyle the growth engine we expect it to be.

We have already made changes to enable a better logged out experience, including the ability to add multiple items to a shopping bag and check out while logged out. We also understand that there are a number of basic but necessary features we need to add to Freestyle such as search functionality, which we plan to introduce in the coming quarters. Ultimately, we believe the efforts I’ve discussed both around Fix and Freestyle will help drive improved new client conversion and we will be prepared to ramp marketing spend when we get the client experience right. The lower net client as we have experienced in the first half of the year have impacted our revenue and are driving our revised outlook for the back half due to the compounding nature of fewer new clients buying. However, to reinforce my comments from the start of the call, we are confident in our long-term strategy and we are seeing clear signals that we are taking the right steps for the future of the business.

We believe the combination of Fix and Freestyle demonstrates the potential of our future ecosystem as we observe behaviors of our existing and new clients. RPAC reached a record $549 in the second quarter, up 18% from a year ago. Our result of higher average order values in our Fix business, which are up 5% from the second quarter of fiscal 2021 as well as the incrementality provided by Freestyle to our existing client base. Freestyle revenue grew 29% year-over-year and penetration from our Fix business is steadily improving with over 32% of our women’s Fix clients purchasing via Freestyle today. Additionally, our recently acquired customer cohorts are engaging with us more holistically, spending over 25% more on average in Fix and Freestyle combined than clients acquired in the comparable month in 2021 and over 15% more on average than in 2020.

The 90-day RPAC, a measure of quarterly net revenue divided by clients that made one or more purchases within the same quarter, is up 8% year-over-year. With the combination of Fix and Freestyle, we believe we are better able to meet the consumer needs of fit and discoveries and search based shopping. The return rates we see in Freestyle which continue to perform at less than half of e-commerce peers underscore why we are confident in our direction. I will share some final thoughts with you after Dan goes through our results and our guidance in more detail.

Dan Jedda — Chief Financial Officer

Thank you, Elizabeth, and hello to everyone on the call. Today, I’ll walk you through our quarterly results as well as share the inputs that build our outlook for Q3 and full-year. In the second quarter, total net revenue of $517 million landed within the guidance range we laid out last quarter and represents 3% year-over-year growth. As Elizabeth noted earlier, revenue for the quarter was largely impacted by client conversion as we iterate on new acquisition and on-boarding methods. We also continue to learn and iterate on Freestyle which grew 29% year-over-year. Our women’s business inclusive of both Fix and Freestyle grew slightly and our men’s business was down as we continue to expand assortment with a focus on adding more nationally recognized brands.

At the same time, we were pleased with the sustained momentum in our kids and U.K. businesses where we saw 19% and 73% growth respectively on a year-over-year basis. Net revenue per active client for the second quarter was $549, representing our third consecutive quarter of record RPAC. As a reminder, RPAC is based on net revenue over the last four fiscal quarters divided by ending number of active clients in the most recent quarter. When we take our newest subset of clients and assessed the related 90-day RPAC, that number continues to ride at a healthy pace, up 8% year-over-year. Additionally, subsequent checkouts per new client have increased nearly 20% since FY ’20 giving us confidence that we are on the right path once clients enter our ecosystem. We ended Q2 with approximately 4 million active clients. This was down 161,000 from the prior quarter as we continue to face challenges on optimizing the client experience and on-boarding for new clients.

Net actives were also impacted by iOS 14 privacy changes that limited our ability to target and measure advertising, as well as higher dormancies due to the lapping, the high dollar referral program for new customers in the first half of 2021. Q2 gross margin was 45.1%, representing growth of 214 basis points from a year ago, primarily driven by leverage and shipping costs due to higher average order values and improved product margins. Gross margin declined 190 basis points quarter-over-quarter driven primarily by higher inventory reserves. Q2 advertising was 6.8% of net revenue, a 149 basis point decrease from the same quarter last year and a sequential decrease of 188 basis points from Q1. As mentioned previously, we continue to face challenges in new client conversion and therefore pulled back on advertising in the second quarter to remain efficient with our spend.

As I’ve stated several times before, we adjust this spend to ensure we are managing to our targeted return on ad spend. As we work to improve on-boarding and conversion, we will ramp our marketing as appropriate to optimize for long-term free cash flow. We’ll also continue to test into new marketing channels and may increase spend in these channels based on our testing results. Other SG&A, excluding advertising, was 44.2% of net revenue in Q2, a 156 basis point increase from the same period last year and a sequential increase of 560 basis points from Q1. The increase year-over-year and quarter-over-quarter was primarily due to increased headcount, including headcount in our product and tech organizations. The increase versus Q1 was also impacted by lower net revenue quarter-over-quarter.

Adjusted EBITDA in the second quarter was $10 million, largely reflecting the lower marketing spend during the quarter. Net inventory ended the quarter at $183 million, essentially flat quarter-over-quarter. While we continue to add selection throughout the quarter, we did experience delays in receipts, primarily due to shipping delays in the global supply chain. We are seeing four to five-week delays for a large portion of our product though we do not believe this has had a material impact on our business given our current inventory levels and our mitigation efforts such as earlier bookings. Free cash flow year-to-date was $94 million, primarily due to favorable working capital. In early January, our Board of Directors authorized a $150 million share repurchase program. During the quarter, we repurchased $11 million worth of company’s stock against the $150 million authorization.

We ended the quarter with no debt and $349 million in cash, cash equivalents and highly-rated securities. For Q3, we expect net revenue in the range of $485 million to $500 million, representing a decline of 10% to 7% year-over-year. We expect adjusted EBITDA in the range of negative $30 million to negative $25 million or EBITDA margins of negative 6% to negative 5% of net revenue. This takes into account the lower new client adds for the first half of the year, resulting in continued weaker revenue due to a lower number of subsequent Fixes in the second half of the year. This guidance assumes that net active clients remain flat to slightly down quarter-over-quarter. Given the softness of active clients in the first half and the uncertainty in the timing of improvements in conversion, we are lowering the prior full year revenue guidance we shared on our December 7, 2021 call.

For the full fiscal year, we now expect revenue to be flat to slightly down year-over-year. This full-year guidance assumes active clients are flat through the end of the year as we continue to learn and optimize for new client conversion. We are actively evaluating our marketing spend as we manage these improvements to on-boarding and conversion and therefore are withdrawing full-year EBITDA guidance at this time. We are very disappointed that we are not showing growth for the third quarter and full year. However, the positive unit economics on the Freestyle business gives us confidence that the combined experience is the right path forward. When excluding marketing, the contribution profit of Freestyle is 10 percentage points higher on a per order basis versus our very profitable Fix orders.

Once we scale this business, we believe it will provide leverage in our overall margins. As we previously mentioned, we expect to increase marketing as our conversion improves and as we test into newer marketing channels. We’ll also take a renewed focus on our cost structure with an emphasis on fixed and variable cost productivity. Our efforts will take time and it’s critical that we demonstrate execution over these next few quarters, which includes building an exceptional client experience that leads to increased new active clients and growing penetration in Freestyle. We look forward to updating you on our progress as we go through this transition.

Elizabeth Spaulding — Chief Executive Officer

Thank you, Dan. Looking forward, while we know we have challenges ahead, we remain focused on continuing to expand and transform our offering and to drive awareness of Stitch Fix as the destination for personalized shopping, styling and inspiration, leveraging our unique combination of data science and creative human judgment. As I noted earlier, the Fix model gave us a 10 plus year advantage of bringing data science and creative human judgment together, allowing us to solve and address the most critical pain points for consumers in online shopping, the challenges of fit, discovery and building relationship. On fit, we better meet the consumer needs of fit and search based shopping, highlighted by our return rates in Freestyle which continue to perform at less than half of traditional apparel e-commerce.

On discovery, outfit inspiration is a meaningful differentiator for Stitch Fix. Therefore, we recently scaled our stylist-generated outfit to be a higher percentage of what clients can browse in Freestyle. Since launch, stylists have created nearly 2.5 million outfit, which has resulted in a lift to overall sales. On building feedback based relationship, a core part of what powers our ability to personalized selections are the moments of interaction and engagement that clients have with our stylists and broader Stitch Fix community. Client provide rich actionable feedback as they see the value in getting better Fixes and Freestyle experiences, showcased by the 9.5 billion Style Shuffle ratings to date, item level feedback in Fix Preview and community inspiration board.

By extending our model with Freestyle, we aim to meet the on-demand expectations of today’s consumer in a unique way, powered by personalization and styling capabilities, which is Stitch Fix this core. We continue to deeply believe in Freestyle and appreciate everyone’s patience as we evolve it to be the growth engine we expect. I believe we are well-positioned to execute against our vision and we continue to take steps to further strengthen our team. In addition to the recent appointment of our new CTO, Sachin Dhawan, we have made a number of other seasoned hires across our product, engineering and Algos team. We will plan to share more detail on our progress and road map to improve the client experience in the coming quarters.

With that, we are ready for your questions. Operator, I will turn it over to you.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And we’ll take our first question from Youssef Squali with Truist.

Youssef Squali — Truist — Analyst

Great. Thank you very much. Youssef Squali at Truist. So two questions from me, please. One, just doubling — double clicking on the issue at hand, the on-boarding and client conversion, client retention, have you been able to figure out exactly what the root cause is because we’ve talked about it on the last earnings call, it seems like the reasons have changed a little bit. I just want to make sure that we’re still talking about the same issues, and then how are you guys — I think, Elizabeth, you talked about some early to try to revert that trend that give you confidence that on-boarding and client conversion will improve over time although it will take time. So that’s the first question.

And second, maybe, Dan, on your withdrawing the EBITDA guidance, so I’m just trying to understand the logic for that since you are guiding to flat to slightly down revenue, what are the puts and takes that we have to take into account as we look at the bottom line for 2022? Thank you.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Youssef. I can start on the first question on on-boarding conversion. Then I’ll hand it to Dan for your second question. So, as we mentioned to some extent in the prior call and now I think we’ve continued to learn more is that we have really focused for stitchfix.com on redirecting that traffic to a Fix first on-boarding flow. We believe that we created friction when we introduced Freestyle to the landing page given the intent of the majority of those clients coming to our site with forced Fix. We’re learning a lot right now about what those expectations are and so we have now — honestly, we probably have realized in retrospect we could have moved faster, but where we want to be now and are now continuing to make progressive improvement and incremental testing.

So we’ve reverted in many ways, make it easy to get directly to that Fix. And then, we’re doing a bunch of other things right now in parallel to make it an even lower friction experience for our clients. Things like testing, newer and improved landing pages, frustration that we had with clients even before we introduced Freestyle was having confidence that they were going to see merchandise and price points that they liked. So introducing testing on the landing page that gives a better sense of what Stitch Fix has to offer, as well as just making it frankly very, very simple and clear of what to expect once inside the experience. Another area that we see opportunity is testing incentives. That’s a pretty common thing with new customers coming into a new experience.

And then what we mentioned on the prior call and we continue to be working on, just more of a progressive on-boarding experience that makes it really easy to get into Fixes plus Freestyle from the very beginning. We require quite a bit of information to personalize and we think there are ways to progressively get that information over time. And then I think the other area in parallel that I mentioned on the call is that we are opening up these new marketing channels that we have yet to scale. So clients that are landing in this logged out experience of our product listing ad, we believe these clients are very high intent Freestyle, they’re ready to buy something and there are a lot of basic but necessary improvements that we’re making to that experience while we’ve begun to already make some like on getting the shopping bag, but over time on getting the expiration of product categories giving access easily to engage with the stylists. And so it’s really a combination of those things that we’re working on now and believe we have a good sense of what needs to improve for consumers. I’ll let Dan answer the EBITDA question.

Dan Jedda — Chief Financial Officer

Yeah, hi, Youssef. To the — to your second question, one of the reasons why we’re not giving that EBITDA guidance for Q4 now is we have a reasonably healthy budget plan for marketing in Q3 as we mentioned as improvement — as conversion improves, we’ll spend more on marketing because it will be within the allowables that we have. And we’re also testing new marketing channels. And so the way to think of Q3 is going to be similar to Q3 of last year and approaching that 10% marker that we have of advertising. And then we’ll see how that performs in Q3 as we continue to look at the conversion and the efficiency of the marketing channels. And then, we’ll make decisions on Q4 and while that has a direct correlation to actives just the revenue is much more predictable, because a lot of the revenue that we get, when we get an active in subsequent quarters and subsequent Fixes. So that’s the reason why we are waiting for Q4. It’s really a function of the marketing that we have planned and how it performs in Q3.

Youssef Squali — Truist — Analyst

Okay. Thank you.

Operator

Thank you. We’ll take our next question from Mark Mahaney with ISI.

Mark Mahaney — Evercore ISI — Analyst

Okay, thanks. Let me try to start off with two questions. What’s happening with retention rate? So I think one of the thoughts we had was that Freestyle would help maybe boost retention of existing customers, more value prop, more use cases. So what’s happening with retention?

And then secondly, on the iOS 14 challenges like how confident are you that there is a workaround and this is kind of an industry-wide — this is obviously an industry-wide issue and do you think that you’ll — what’s your thought about how to get back to where you were before? There were some very effective marketing campaigns run prior to that, that was based on personally identifiable information that’s just not available now? So how does that get solved or does it only get partially solved and where do you think those solutions will come from? Thanks a lot.

Elizabeth Spaulding — Chief Executive Officer

Yeah. Thanks, Mark. I can start on the retention and then I’ll hand it to Dan for the second one. Yeah, we really like what we’re seeing on retention rates. I think both we mentioned in the call. The higher average spending for client being up 25% year-on-year with our newer cohorts participating in both Fixes and Freestyle. The other thing though that we’re absolutely benefiting from the combination of, we believe, Fix Preview together with Freestyle are higher retention rates and we look at our seven-day autoship churn, our clients sticking with us on maintaining their programs with an autoship and then we also look at retention after the first Fix. And we’ve actually seen very meaningful improvements on both of those, north of 20% year-on-year. And so we feel very good that the improvements that we’ve made in our experience are driving higher client retention.

We also feel very confident that we’re acquiring very high quality clients. We’re moving things like those high dollar credit referrals that we talked about in the past, the combination of those we think we have a very, very healthy client mix within our ecosystem and more to do with us. Their product categories that are also driving that up where we know clients are spending on different product categories in Freestyle. On iOS 14, I think the one comment I’ll make and then I’ll hand it to Dan is there’s just frankly a ton of marketing channels that we have never participated in that are just very, very early that are now opening up for us that are less impacted by the iOS privacy changes. But let me hand it to Dan to share more there.

Dan Jedda — Chief Financial Officer

Yeah, Mark. On that, we do suspect that the privacy impact will be TV impact will in the short-term until other channels help us to find a way around that. That said, we are optimizing for different creatives and testing ways to continue in the channel. But I think Elizabeth touched on the more important point is the additional channel that we have available to us and some of that mainly SEM based channels, we find traffic to be very positive to the site. Now, again, conversion isn’t where we want to be on the Freestyle experience but we have a lot of added features, a lot more selection coming and a lot of optimizations that we’re working on.

Elizabeth shared some of those early on in the call that we feel will improve conversion in the near and medium term. And as we improve conversion, we will continue to spend more on those channels. So that is not a traffic issue, it’s really a client facing issue that we’re very focused on to improve conversion. So with the different marketing — and that’s just one channel. There are several others that we’re experiencing on and there are several others that we ought to continue to improve, including our organic social and other channels that we think can be significant traffic drivers for potential active clients.

Mark Mahaney — Evercore ISI — Analyst

Okay. Thanks, Dan. Thanks, Elizabeth.

Operator

Thank you. We’ll take our next question from Ross Sandler with Barclays.

Ross Sandler — Barclays — Analyst

Hey, can I follow up on Mark’s question on retention? So I think you said U.K. and kids are growing nicely and Freestyle is growing nicely. So just looking at the core women’s Fix business, could you talk about retention that you’re — what you’re seeing there and in the context of that as you’re building out Freestyle and trying to revitalize the men’s selection, how do you feel about your selection and your inventory position in that core women’s Fix business? And then just remind us, Dan, the high dollar referral program. I know that’s creating a tough comp. When do we fully lap through that, is that — when was that peaking last year, any context on that would be helpful. Thanks a lot.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Ross. I can take the first one, which I think you’re trying to get some insight to women’s and men’s and how that’s performing and we feel good about what we’re seeing on retention. Obviously, women’s being the largest part of our business that drives a lot of those RPAC numbers and we continue to see really good things in terms of overall spend in new categories that are being driven by Freestyle like footwear, second layers, we started to introduce more sleepwear in the Q2 period and all of that, we feel really great about.

That — what we’re seeing in terms of growth rate, there is really a function of the new gross adds that are just lower than where we’d like them to be given all the other part of the conversation here on both improving the client experience, making it easier to enter both through stitchfix.com and then our new landing experience as well as the efficacy of marketing channels. So we feel good about the retention rates. Those are improving. We feel good about average spend. It’s really that driving net new clients into the ecosystem which is something — is that first and foremost priority for the team. On the lapping of the high dollar incentive referrals, Dan, do you want to take that one on when we finish that lapping?

Dan Jedda — Chief Financial Officer

Yeah, I will. We ended that program in late February. So we do have a month that we just finished of lapping. It wasn’t as impactful as Q1 and Q2, but we did have some of the high dollar referrals. But we are through it now as we enter March and go forward. I also did want to just follow up on your question on men’s — the men’s brands. I think that is an area and women’s where we added some national recognized brands, and specifically on the men’s because I mentioned it earlier on, we have added some very prominent brands that we’re happy with Nike, Vans, Levi’s, Champion and UGGs were added. And we have more planned for the back half of the year. So, we are moving forward with bringing more nationally recognized brands for the men’s business.

Operator

Thank you. We’ll move on to our next question from Simeon Siegel with BMO Capital Markets.

Simeon Siegel — BMO Capital Markets — Analyst

Thanks. Hey, good afternoon, everyone. Maybe a mouthful but the 90-day RPAC is a helpful metric. Thanks for giving that. Do you want to give the actual dollar number that — that there in addition to the growth rate? Do you plan on giving that metric going forward and then do you have a similar 90-day type of active client growth metric? And then, Dan, just any color, I guess, the marketing conversation because as you think about 3Q and the full year, any color on gross margin or non-marketing SG&A you can speak to? Thanks.

Dan Jedda — Chief Financial Officer

Yeah. We are looking at different metrics on active on the 90-day side and what we’re waiting on is just to understand the Freestyle active and what that looks like. It might — there might be mix impact there and so we’re hesitant to give that number out until we actually see the trend on it, so we can explain it better. It’s a great question and it’s something we want to actually look at doing. So we just need a little bit more time. As we look at the clients who come in directly to Freestyle versus those who come in with Fix and then engage in Freestyle. And so there is some mix going on in there. And so we want to make sure that we can explain that adequately. So stay-tuned for that.

And to your question on more insight into marketing, I just wanted to clarify, I said earlier that on the marketing for Q3, it’s going to be around that 10% mark of revenue which is something that we generally have hit in the past and that’s where it is for Q3. And then to the point on margins, we do expect margins to be in line with where we have them right now with some potential pressure in Q4 as again just given the cost structure. We don’t think it’s going to be meaningful yet, although we are starting to see that. So we said last quarter that for the full year, we expect gross margins in that 45% and we’re still on that trend.

Simeon Siegel — BMO Capital Markets — Analyst

Great, thank you. And then just maybe holistically, you mentioned the higher margins of Freestyle, so as you scale. That helps. Do you want to just talk through maybe why, so what makes Freestyle margins higher?

Dan Jedda — Chief Financial Officer

Yeah, it’s a great question. And so there are different puts and takes on Freestyle in the gross margin line, but the biggest impact is the relatively small styling component. So when we do styling for Freestyle, it scales across the whole Freestyle experience and so we do have stylists working actively on outfits and other features within Freestyle but it scales across the whole experience. And so we see a significant improvement in contribution profit. I think the other side of that is just the AOVs, the average order values, that we see in Freestyle are very strong and very healthy and they’re not — as Elizabeth mentioned, our return rates are relatively low versus normal in the industry and that helps AOV net of returns. And so we have lower return shipping costs because of that. So those are the two primary factors that drive that improvement in contribution profit which is excluding marketing that I referenced earlier in the call.

Simeon Siegel — BMO Capital Markets — Analyst

Great, thanks a lot. Best of luck for the rest of the year, guys.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Simeon.

Operator

Thank you. We’ll take our next question from Mark Altschwager with Baird.

Sarah Goldberg — Baird — Analyst

Hi, good afternoon. This is Sarah Goldberg on for Mark. Thanks for taking our questions. We’re hearing more brands and retailers strengthen work in occasion driven categories. Are you seeing the same and is your inventory mix positioned to take advantage of a recovery in these categories?

Elizabeth Spaulding — Chief Executive Officer

Yeah, thanks Sarah for the question. I can answer that. I think we actually see a lot of fluctuation, depending on the month and a lot of the benefit of the signal we get from clients whether it’s in our Request Note, whether it’s — whether engaging with in Freestyle gives us quite a lot of ability to adapt. So in Q2 versus Q1, we saw an uptick in casual for women’s both in Fix and Freestyle. We did see an uptick in social on occasion wear during Q2, in part because we increased our investments as the merchandise seems to add more for the holiday season for our clients. And then on the workwear front, we did begin to see some increases there pre-January, but in the month of January, we actually saw a reduction relative to the growth we’ve seen at the beginning of the quarter and we often see that trend as we have seen spikes in COVID.

And so with the Omicron variant, we think that was a big driver of it. That might have been questioning a bit some of the return to work and so we saw bigger gains in athleisure during that month. So it’s been a little bit up and down. I mean, I think if we look over the arc of the last six-plus months, we have seen growth in those work and use occasions and more going out than we did a year ago. But we continue to see a lot of strength in athleisure and the comfortable categories that we believe will continue to be a big driver, especially with hybrid work. We feel really good about overall our merchandising mix and our ability to adapt and also just the higher quality of trend spotting that we have between client notes and a lot of the signal that we capture in these areas.

Sarah Goldberg — Baird — Analyst

Great, thank you.

Operator

Thank you. We’ll take our next question from Tom Nikic with Wedbush Investment Banking.

Tom Nikic — Wedbush Investment Banking — Analyst

Hey, everybody. Yeah, thanks for taking my question. I want to follow up on the — bit about the on-boarding conflict and the kind of directing people to Freestyle first on probably, call it, attraction for the Fix, I guess, the Fix first customers? This may sound a little silly, but I mean given that Freestyle has a much bigger TAM opportunity than Fix has as you kind of mentioned and favorable order economics, you could make the case that if not necessarily a bad thing kind of having the on-boarding be more Freestyle oriented and maybe you would have some friction in the near term, but as Freestyle grew, that would become less and less of a hindrance. I guess, I’m kind of trying to think like why not go maybe more aggressive towards Freestyle or all in on Freestyle and let Fix maybe dwindle down over time into things like the prospects for Freestyle and the economics of Freestyle are much more favorable?

Elizabeth Spaulding — Chief Executive Officer

Thanks, Tom, for the question. I think we absolutely believe in the growth potential for Freestyle and really what we think of as the ecosystem of Freestyle plus Fix, Freestyle in many ways equal dialing on demand. It takes the best parts of what Stitch Fix said that so unique which is removing all the noise for consumers and helping them [Indecipherable] things that demonstrate their preferences in style and with the value added touch of outfits and styling advice and how to wear a things, we all get dressed even though we might buy one item at a time. We want to know how we’re going to actually wear it. And all of those things are demonstrating the results we really love to see in Freestyle.

That said, the ecosystem together is where we see tremendous value and our best clients are participating in both in a very value-added way, they love the advice from the guidance that they get through the Fix experience and we would imagine over time that duality much more around inspiration and community being really a rich part of the overall experience. And so in terms of going after just Freestyle, it’s really the ecosystem that we see as valuable and meeting all of these purchase the needs for consumers and we know that there are some consumers that really would love for us to do all the work for them. They will probably be very Fix focus customers and then there is a lot of consumers who love to shop.

In fact, what we think is the highest value women’s segment, a more fashion-forward segment who spends the most really does enjoy shopping and sort of leaning forward and that’s for Freestyle and that on-demand experience, we think, is giving us the ability to better capture that consumer segment, their share of wallet. And so it’s more of an and then an or in our minds and getting better and better and better at an exceptional customer experience and allowing landing through high search based intent channels that Dan mentioned. Those are still really nascent for us. For many e-commerce players 80% to 90% of their traffic is coming from channels that we historically have not participated in at all whether it’s SEM, SEO, item-based advertising.

We just haven’t participated in those channels. And while we’re starting to see really healthy traffic from those, we still haven’t scaled the marketing to do that. And so I think what we believe in terms of the core.com is, let’s make sure we’re getting it right for Fixes today that’s still where a lot of our core.com traffic is coming from. But over time, what we would imagine is converting those clients into a combination of six plus Freestyle right out of the gate and making it very easy for them to access personalized shopping immediately and we’re not even really in the testing mode of that yet, but that’s where we see the future, and to your point, fully unlocking the TAM, which we think is 2 times to 3 times the Fix business along.

Tom Nikic — Wedbush Investment Banking — Analyst

That’s helpful. Thanks very much.

Operator

Thank you. We’ll take our next question from Kunal Madhukar with UBS.

Kunal Madhukar — UBS — Analyst

Hi. Thanks for letting ask questions. A couple if I could. One, on the core Fix side and the other one on Freestyle, and so as you look the core fix style — side, the way I understood was this high dollar referral customers were like 75,000 to 100,000 in aggregate. What you lost this quarter was like a 161 which means that the gross adds product come in much, much lower. Does that potentially point to like maybe a saturation out there in terms of you’ve already hit anyone that was ever interested in subscription and so now you’re like you’re looking at much lower gross add number in the future. That’s on the corporate side.

On the Freestyle, as you look at like with the market kind of open mobility opened up, Omicron gone, you are facing a lot more competition from offline, online, omnichannel retailers, the whole world. So as we think off like Freestyle economics going into the future, should we think of like the higher marketing intensity associated with Freestyle just because the competition is so much higher? And then a quick follow-up to that would be if you are going to institute a search based experience for customers, then where is the styling algo and all the data that you’re using to present just the right thing for the right customer? How does that work with search if I’m like — if I’m telling you exactly what I want? Thank you.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Kunal. Lots of good questions there. Why don’t I start and then, Dan, feel free to chime in. I think your first question was around the health and acquisition of core Fix given the lapping of referrals and I think a lot of that’s been answered in our prior questions around conversion and marketing spend. Given the conversion funnel improvements that we need to continue to make together with reductions in marketing spend, that really is the driver versus, I think, that’s hitting a saturation point of Fixes. We feel confident there is still headroom there to be able to bring clients into that business. Your second question around Freestyle, and how that will be impacted by stores opening, backup, omnichannel, I think we believe that we are highly differentiated in our ability to address the biggest challenges that e-commerce faces and even frankly in store try on of apparel which is fit, discovery, as well as human relationships.

If you think of it as a consumer even walking into a physical store, 98% of what you’re seeing in that store is not relevant and a lot of the frustrations that consumers have around finding items that fit them and finding things that are going to love and that match their style and push their boundaries. And that’s what we do best. And so we believe firmly that consumers will continue to migrate and look for more convenience based experiential ways of shopping, and that’s what we believe we are uniquely suited in a category of one to deliver. On higher marketing, I think we’re learning all these new channels and that’s still early days and remain to be seen how that evolves. And then on your last point on search-based shopping, we want to do that as most consumers that are highest as per feature within Freestyle even for existing clients that love what Freestyle is, they might be trying to find a particular brand. They might be in the mood for a very particular item.

And what we intend to do is launch an alpha version of that feature very soon. But over time make it really unique to what Stitch Fix does that. We’ll only be focussing items that are in your size, but will also add features over time like showing it in an outfit-based laydown, showing how you could wear it maybe with items that are already in your closet. And so we see a table Fix version of the importance of search to just make the overall Freestyle experience better. But over time, we intend to further enhance the way we do search to be a uniquely Stitch Fix based experience.

Dan Jedda — Chief Financial Officer

Yeah. I’ll just add one comment in the middle question on the Freestyle experience. Again, just to give a data point is in our outfits-based widget which is highly personalized, we have nearly 40% of our purchases coming from that which just shows you how different our Freestyle experience is relative to others. And we’re going to do more on that. Elizabeth talked about the search — a search bar or search widget being differentiated. So I just wanted to throw that data point out there, it’s very meaningful. It’s something we’re very happy to see that and there is so much more we can do with that just given our technology and our stylists.

Kunal Madhukar — UBS — Analyst

Thank you. And if you don’t mind and if [Indecipherable] one quick follow-up question on one of the things that we had heard all through is that you have a list of humongous number of people that have been Stitch Fix customers in the past that you could target with Freestyle. How good the response has been on that front? Thank you so much but [Indecipherable] my questions.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Kunal. Yeah, that’s a great question. We actually really like what we’re seeing there. We think it’s still nascent. But to your point, we have several million clients who have entered that dormancy stage that we think would love to come back to Stitch Fix. So we always have kind of always on channels within our CRM to activate historic client and our historical activation was obviously a Fix. We introduced Freestyle an activation channel a year ago — a little over a year ago plus once we have that available to our clients. What we’ve seen year-on-year for Q2 is that our reactivations are actually up over 10% and the entirety of that increase is through Freestyle.

So Fixes were about flat in terms of reactivations that Freestyle was a whole new channel of being able to reactivate clients, which gives us a lot of optimism that that is an exciting way to bring clients back in. And I think part of that is signing up the right way to reach and meet the attention of those clients. We largely do that by email today. And so as we continue to explore and get better at a lot of these new marketing channels we’ve been talking about, what are the ways to reignite excitement with those historic clients that may be loved that before and might love us again, especially as we’re expanding our ecosystem.

Kunal Madhukar — UBS — Analyst

Thank you. Really appreciate for taking all the questions.

Elizabeth Spaulding — Chief Executive Officer

Thanks, Kunal.

Operator

Thank you. We’ll take our next question from Cory Carpenter with J.P. Morgan.

Katie — J.P. Morgan — Analyst

Hi, this is Katie [Phonetic] on for Cory. Thanks for taking the question. We noticed Stitch Fix ran its first ever sale in January. Can you just back out when and any lessons learned, would you consider doing it again. And can you talk about your promotional strategy more broadly. Thanks.

Elizabeth Spaulding — Chief Executive Officer

Yeah. I’ll let — thanks, Katie. I’ll let Dan take that one.

Dan Jedda — Chief Financial Officer

Yeah, we did run a promotional event. We’ve also run a clearance event. As you probably saw and I think we’ve said or I’ll say that the clearance event is really just us looking at some inventory and clearing it out in a way that we can benefit our clients as well as just better for us financially. It was very small. It was under 3% of our inventory that participated and we view that as a test and we thought it went very well. And so we will potentially do more of that in the future albeit at probably a programmatic way. And then we have run some different promotional events as well, some get X dollars of X orders and that also was very successful. Our clients do like that and it’s a way for us to engage in them and we’ll continue to run those programs as well, but again on a programmatic basis in a thoughtful way.

Elizabeth Spaulding — Chief Executive Officer

Yeah. And Katie, maybe the one thing I would add is with opening up Freestyle, I think there are more opportunities for us to play into consumers’ sentiment at different time periods. One thing that has always been a great value to our clients is our buy discount with Fixes and now with Freestyle there are moments like end of season or even special offers for clients within their own personalized store. So we see a lot of opportunity to be both differentiating on these areas a bit, discovery and relationships, as well as providing great value to our clients in ways that are opening up to us through Freestyle that were harder to do via Fixes.

Katie — J.P. Morgan — Analyst

Great, thanks.

Operator

Thank you. We’ll take our next question from Ike Boruchow with Wells Fargo.

Ike Boruchow — Wells Fargo — Analyst

Hey, guys. Two questions, quick one for Dan. Then just, I think you gave a lot of color, but can I just ask you explicitly, are you guys expecting the adjusted EBITDA margin in Q4 to be negative? And just further color would be helpful. And then, Elizabeth, more higher level for you. I guess my question is there are some issues in growth, you can see, and it sounds like you guys are ready to re-ramp up growth opex and marketing when you figure some things out. I guess my question is what does it — what would it take for you to take a bigger step back and maybe look to cut subs and focus more on a smaller sub base. I mean, you guys had your biggest — your largest operating margin when I think you operated a little over 1 million active customers. I’m not saying that’s where you need to go, but what would it take for you to reassess the customer base and try to run maybe a smaller but a more profitable business? I’m just curious your thoughts at a higher level there.

Elizabeth Spaulding — Chief Executive Officer

Yeah. Why don’t Dan start with the EBITDA and maybe he can give his initial thoughts on the second one. And I can add on.

Dan Jedda — Chief Financial Officer

Yeah. On the EBITDA again because as we acquire active, it does take time for them to spend in our ecosystem. So one of the reasons why we didn’t give guidance is because we want to understand what our marketing spend is in Q3 and how efficient is as well as we continue to see progress in conversion. So I would expect EBITDA to be negative in Q4, but again, we’re not giving specific guidance at this time.

Elizabeth Spaulding — Chief Executive Officer

And on your second question, I just want to make sure to clarify, Ike, of what you’re asking on the growth question is what you’re asking, would we rather have fewer higher quality customers? I wasn’t quite sure what you’re asking in that second question.

Ike Boruchow — Wells Fargo — Analyst

Yeah. And it’s a high-level question. It’s just basically looking at the — as your active customers have gone up, the margins have come down and I’m looking over a multi-year period and then when we’re talking about re-accelerating growth opex and trying to acquire new customers again, it’s more — it’s very high level just to think about do you ever think about maybe this business would be more profitable, more successful, whatever the word is if you focused on maybe a smaller subgroup of the active sub that are loyal and spend more and have a better margin and a lower CAC, just trying to understand how you think about that and maybe what would cause you to think about that in lieu of growth?

Elizabeth Spaulding — Chief Executive Officer

Got it. I think we feel really good about the kind of customers we’ve been acquiring and actually on a profitability basis our customers are staying longer, spending more with us this year than last year or the year before. So we’re actually improving customer value by enhancing the experience for things like Fix Preview, other things we intend to do through the Fix model and styling services we think can add value there over time together with Freestyle. So we think we’re finding more ways to drive value with each client. We also really like what we see on — to Dan’s point, the unit economics both with Fixes and even better with Freestyle. And so part of the profitability question I think is a marketing question and part of it is a fixed cost structure.

And so Dan alluded to some improvements that we anticipate making on that side, but as we continue to scale the business, we believe that this can be a very profitable business over time. We are just still in the business model evolution as well as the scaling phase. And then on the marketing front, our belief that in expanding into things like Freestyle, participating in things like SEO, participating in a lot of other marketing channels like affiliate marketing, influencer marketing, I would argue that some of the channels that we have been reasonably relying on the past got more and more expensive over time and we are going to be participating in a much wider portfolio in the future and even things like top of funnel that drive efficiency and lower funnel that really has been somewhat untapped for Stitch Fix. So I think we believe actually a bigger business presents more opportunity rather than narrowing the customer base. I don’t know, Dan, if you want to add any…

Dan Jedda — Chief Financial Officer

No, I think — again, I just want to reiterate, I think the comment was made in terms of total margin on — again on the contribution margin side which excludes marketing. I do think that we have maintained and gotten slightly better. And as we mix out, we hope to get — we expect to get even better soon. So the question, to Elizabeth’s point, it’s really about marketing while the performance based channels have seen some — we’ve seen some challenges in those, we do feel like there are many other channels that we know will generate new actives, whether it’s in the Fix — into Fix plus Freestyle or in the Freestyle. And hopefully into Fix and Freestyle, I mean that’s really our goal here. So I think the margins that we have will provide leverage over time. I said that earlier on, we still believe that. And on the fixed cost side, we will see improvement as we go forward and leverage as we turn the corner and start growing active again.

Ike Boruchow — Wells Fargo — Analyst

Got it. Thank you.

Operator

Thank you. We’ll take our next question from Roxanne Meyer with MKM Partners.

Roxanne Meyer — MKM Partners — Analyst

Great. Good afternoon. Thanks for taking my question. I actually have a few. My first question is on pricing. The industry obviously is in a more inflationary environment with many across the industry raising prices. So I guess I was curious with your AOV up for Fixes in the quarter, up 5%. How much was due to pricing that you took versus units and what’s your thoughts on pricing going forward?

Dan Jedda — Chief Financial Officer

Yeah, I’ll take that one. Hi, Roxanne. None of it was due to pricing. We have not significantly raised prices. It was primarily due to keep rate within Fixes. We’re lapping the full cycle of our algorithms, we generated previews which has had a positive impact, plus the experience went through in our ecosystem is very positive. And then on the RPAC side, you have the mix of Fix plus Freestyle contributing favorably. So it wasn’t — any of it wasn’t on pricing and going forward, we’ll continue to look at the cost of our product and suspect like we may tweak pricing. I don’t think it’s going to be significant in terms of increases. We think we’re pretty analytical and methodical about looking at our pricing, especially with our EV brand. And then on our national brands, we’re taking a hard look at pricing. And I do not expect that to go up and in fact, could possibly come down. This as we see what’s going on in the market.

Roxanne Meyer — MKM Partners — Analyst

Okay, great. And then just trying to reconcile your revised guidance for the full year. When you take into account your expectations for flat active customer growth, it assumes that your revenue per client fall sequentially in the next two quarters. And you know that comes on the back of an 18% healthy increase this past quarter. So just trying to understand the dynamics and what’s going on with your expectations for revenue per client?

Dan Jedda — Chief Financial Officer

Yeah, I’ll take that one. And that’s a good question. And part of that is just a function of the lower net adds in H1. That the newer clients just spend more relative to tenured based clients. So it really is a mix impact. A lot of — when we look at a cohort impact, of course, as we mentioned, we see positive in year-over-year growth when we look at it and we do it on a 30-day and 90-day cohort like-for-like basis. So that is positive, but we might see a drop. You’re right on the revenue and active guidance that we gave simply because we’re mixing out to improve new active. Now as we improve conversion and add actives that will reverse itself as we go forward.

Roxanne Meyer — MKM Partners — Analyst

Okay, thanks for that color. And then just last trying to think about the average spend in Freestyle for a Fix customer versus a pure Freestyle customer. And then just wondering about how do you think about your ability so far to match client preferences as dictated by the questions that you had out there and your algorithm with the offering she’s actually presented. And I guess that would manifest itself by that active spend. Thanks a lot.

Elizabeth Spaulding — Chief Executive Officer

Yeah, I can start on that, Roxanne, and Dan, can add. I mean the majority of the clients in Freestyle are — still are Fix first clients just given by nature of the fact that we very recently opened that up. We like what we’re seeing with these early new cohorts. But it’s admittedly small still. And so I think to Dan’s point, there was an earlier question on this related to RPAC. As we have more data and more longitudinal data, we’ll feel more comfortable sharing what we’re seeing. We have seen those Freestyle customers coming back. We have been am opting into Fixes to some extent, but I think we have more data to gather to understand that.

And then I think on your question of relevance, we actually feel really good on a cold start basis to be able to show relevant style-based inventory. It is a very new kind of shopping experience. We think of it as styling on demand. To Dan’s point, 40% of the sales are through output. So some of these baseline features that make it easier for customers to have a reference point or otherwise they shop or some of what we need to add and that’s a lot of the work we have in front of us in addition to making it highly differentiated. I don’t know, Dan, if you would add anything on average spend in Freestyle. Anything else you can share.

Dan Jedda — Chief Financial Officer

No, I do — I think I completely agree, of course, with everything Elizabeth said. I will just add that when Fix customers do engage in Freestyle, we do see both their Fix and their Freestyle go up. And so that’s just really back to the point of how the two really work in tandem together, from an overall client experience standpoint and Elizabeth is right, like we are gathering the data on Freestyle for those to come in and whose first intent and first purchase is a Freestyle only and eventually we’ll share data on that but we just need to collectively have more time to gather what that looks like over time.

Roxanne Meyer — MKM Partners — Analyst

Okay, thanks. That’s helpful. Thank you so much.

Elizabeth Spaulding — Chief Executive Officer

Thank you all for joining us today. We look forward to updating you on our progress next quarter.

Operator

Thank you. [Operator Closing Remarks]