STITCH FIX, INC. You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and related notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K, or Annual Report. We use a 52- or 53-week fiscal year, with our fiscal year ending on the Saturday that is closest toJuly 31 of that year. Each fiscal year generally consists of four 13-week fiscal quarters, with each fiscal quarter ending on the Saturday that is closest to the last day of the last month of the quarter. The fiscal years endedJuly 30, 2022 ("2022") andJuly 31, 2021 ("2021") consisted of 52 weeks. The fiscal year endedAugust 1, 2020 ("2020") consisted of 53 weeks. Throughout this Annual Report, all references to quarters and years are to our fiscal quarters and fiscal years unless otherwise noted. In addition, this discussion contains forward-looking statements that reflect our plans, estimates, and beliefs, and involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in or implied by these forward-looking statements as a result of several factors, including those discussed in the section titled "Risk Factors" included under Part I, Item 1A and elsewhere in this Annual Report. See "Special Note Regarding Forward-Looking Statements" in this Annual Report. A discussion regarding our financial condition and results of operation for the fiscal year endedJuly 30, 2022 , compared to the fiscal year endedJuly 31, 2021 , is presented below. A discussion regarding our financial condition and results of operations for fiscal year endedJuly 31, 2021 , compared to the fiscal year endedAugust 1, 2020 , can be found under Item 7 in our Annual Report on Form 10-K for the fiscal year endedJuly 31, 2021 , filed with theSEC onSeptember 27, 2021 , which is available on theSEC's website at www.sec.gov and on the SEC Filings section of the Investor Relations section of our website at: https://investors.stitchfix.com.
Overview
Since our founding in 2011, we have helped millions of women, men, and kids discover and buy what they love through personalized shipments of apparel, shoes, and accessories. Currently, clients can engage with us in one of two ways that, combined, form an ecosystem of personalized experiences across styling, shopping, and inspiration: (1) by receiving a personalized shipment of items informed by our algorithms and sent by aStitch Fix stylist (a "Fix"); or (2) by purchasing directly from our website or mobile app based on a personalized assortment of outfit and item recommendations ("Freestyle"). For a Fix, clients can choose to schedule automatic shipments or order on demand after they fill out a style profile on our website or mobile app. After receiving a Fix, our clients purchase the items they want to keep and return the other items, if any. Freestyle utilizes our algorithms to recommend a personalized assortment of outfit and item recommendations that will update throughout the day and will continue to evolve as we learn more about the client.
For the fiscal year ended
During the first half of fiscal 2022, our year-over-year net revenue growth rate was lower than it had historically been, and during the third and fourth quarters of fiscal 2022, we experienced a decline in net revenue year-over-year. This revenue trend is primarily due to our challenges in acquiring new clients during fiscal 2022, which has had and will continue to have a negative compounding effect on net revenue in fiscal 2023. We are continuing to navigate the uncertainties presented by the current macroeconomic environment and remain focused on improving the conversion of new clients and our overall client experience.
Net loss for the fiscal year ended
In light of our recent business momentum and an uncertain macroeconomic environment, we announced a restructuring plan onJune 9, 2022 , that reduces our future fixed and variable operating costs and allows us to centralize key capabilities, strengthen decision-making to drive efficiencies, and ensure we are allocating resources to our most critical priorities. This restructuring plan reduced our workforce by approximately 15% of salaried positions and represented approximately 4% of our roles in total. We are continuing to evaluate other fixed and variable operating costs, including rationalizing our real estate footprint, to position ourselves for profitable growth in the future. However, our future results of operations will depend on our ability to successfully navigate current business challenges and the overall macroeconomic environment. Notwithstanding this restructuring plan, we will continue to invest strategically in both product and technology, while remaining financially disciplined. In connection with the restructuring plan, we incurred$10.9 million in cash expenses related to termination benefits,$6.2 million in non-cash asset impairment charges, and$0.7 million of other non-cash costs which were recognized in the fourth quarter of fiscal 2022. We also incurred other one-time cash charges of$8.5 million related to retention bonuses for continuing employees which was recognized in the fourth quarter of fiscal 2022.
For more information on the components of net loss, refer to the section titled "Results of Operations" below.
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--------------------------------------------------------------------------------Key Financial and Operating Metrics
Non-GAAP Financial Measures
We report our financial results in accordance with generally accepted accounting principles inthe United States ("GAAP"). However, management believes that certain non-GAAP financial measures provide users of our financial information with additional useful information in evaluating our performance. We believe that adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, and that this supplemental measure facilitates comparisons between companies. We believe free cash flow is an important metric because it represents a measure of how much cash from operations we have available for discretionary and non-discretionary items after the deduction of capital expenditures. These non-GAAP financial measures may be different than similarly titled measures used by other companies.
Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are several limitations related to the use of our non-GAAP financial measures as compared to the closest comparable GAAP measures. Some of these limitations include:
•adjusted EBITDA excludes interest income and other expense, net, as these items are not components of our core business;
•adjusted EBITDA does not reflect our income tax provision (benefit), which may increase or decrease cash available to us;
•adjusted EBITDA excludes the recurring, non-cash expenses of depreciation and amortization of property and equipment and, although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future; •adjusted EBITDA excludes the non-cash expense of stock-based compensation, which has been, and will continue to be for the foreseeable future, an important part of how we attract and retain our employees and a significant recurring expense in our business; and •adjusted EBITDA excludes costs incurred related to discrete restructuring plans and other one-time costs that are fundamentally different in strategic nature and frequency from ongoing initiatives. We believe exclusion of these items facilitates a more consistent comparison of operating performance over time, however these costs do include cash outflows;
•free cash flow does not represent the total residual cash flow available for discretionary purposes and does not reflect our future contractual commitments.
Adjusted EBITDA
We define adjusted EBITDA as net loss excluding interest income, other expense,
net, income tax provision (benefit), depreciation and amortization, stock-based
compensation expense, and restructuring and other one-time costs. The following
table presents a reconciliation of net loss, the most comparable GAAP financial
measure, to adjusted EBITDA for each of the periods presented:
For the Fiscal Year Ended
(in thousands) July 30, 2022 July 31, 2021 August 1, 2020
Adjusted EBITDA:
Net loss $ (207,121) $ (8,876) $ (67,117)
Add (deduct):
Interest income (930) (2,610) (5,535)
Other expense, net 2,355 366 1,593
Income tax provision (benefit) (2,349) (52,241) 19,395
Depreciation and amortization 35,011 27,610 22,562
Stock-based compensation expense(1) 127,373 100,696 67,530
Restructuring and other one-time costs(2) 26,206 - -
Adjusted EBITDA $ (19,455) $ 64,945 $ 38,428 (1)Excludes
(2)Restructuring charges consist of$17.7 million in cash and noncash charges primarily related to termination benefits and asset impairment charges in connection with ourJune 9, 2022 , restructuring plan. Other one-time costs primarily consists of$8.5 million in retention bonuses for continuing employees and we expect to incur an additional$5.4 million in retention bonuses during the first quarter of fiscal 2023 in connection with our one-time retention program. 36 --------------------------------------------------------------------------------
Free Cash Flow
We define free cash flow as cash flows from operating activities reduced by purchases of property and equipment that are included in cash flows from investing activities. The following table presents a reconciliation of cash flows provided by (used in) operating activities, the most comparable GAAP financial measure, to free cash flow for each of the periods presented:
For the Fiscal Year Ended
(in thousands) July 30, 2022 July 31, 2021 August 1, 2020
Free cash flow reconciliation:
Cash flows provided by (used in) operating activities $ 55,395 $ (15,675) $ 42,877
Deduct:
Purchases of property and equipment (46,351) (35,256) (30,207)
Free cash flow $
9,044
Operating Metrics
July 30, 2022 July 31, 2021 August 1, 2020
Active clients (in thousands) 3,795 4,165 3,522
Active Clients
We believe that the number of active clients is a key indicator of our growth
and the overall health of our business. We define an active client as a client
who checked out a Fix or was shipped an item via Freestyle in the preceding 52
weeks, measured as of the last day of that period. A client checks out a Fix
when she indicates what items she is keeping through our mobile application or
on our website. We consider each Women's, Men's, or Kids account as a client,
even if they share the same household. We had 3,795,000 and 4,165,000 active
clients as of July 30, 2022 , and July 31, 2021 , respectively, representing a
year-over-year decline of 8.9%. The decline in active clients was driven by
client conversion challenges, lower site traffic, and the lapping of our
high-dollar value referral program which ended in fiscal 2021.
Net Revenue per Active Client
We believe that net revenue per active client is an indicator of client engagement and satisfaction. We calculate net revenue per active client based on net revenue over the preceding four fiscal quarters divided by the number of active clients, measured as of the last day of the period. Net revenue per active client was$546 and$505 as ofJuly 30, 2022 , andJuly 31, 2021 , respectively, representing a year-over-year increase of 8.1%.
Factors Affecting Our Performance
Inventory Management
We leverage our data science to buy and manage our inventory, including merchandise assortment and fulfillment center optimization. Because our merchandise assortment directly correlates to client success, we may at times optimize our inventory to prioritize long-term client success over short-term gross margin impact. To ensure sufficient availability of merchandise, we generally enter into purchase orders well in advance and frequently before apparel trends are confirmed by client purchases. As a result, we are vulnerable to demand and pricing shifts and availability of merchandise at time of purchase. We incur inventory write-offs and changes in inventory reserves that impact our gross margins. Moreover, our inventory investments will fluctuate with the needs of our business. For example, entering new locations, expanding to new categories, offering new functionalities such as Freestyle, or adding new fulfillment centers will all require additional investments in inventory. During the first six months of fiscal 2022, we experienced lower than expected inventory receipts largely due to global supply chain delays. We worked to mitigate these delays by ordering product in advance of our typical timelines. During the second half of fiscal 2022, we experienced slight easing of these supply chain delays, and coupled with our mitigating strategies, inventory receipts were less severely impacted, a trend we expect to continue in fiscal 2023. We will continue to actively manage global supply chain delays and plan to mitigate the impact of any anticipated delays on future inventory receipts.
Client Acquisition and Engagement
To grow our business, we must continue to acquire clients and successfully engage them. We believe that implementing broad-based marketing strategies that increase our brand awareness has the potential to strengthenStitch Fix as a national consumer brand, help us acquire new clients, and drive revenue growth. We currently utilize both digital and offline channels to attract new visitors to our website or mobile app and subsequently convert them into clients. Our current marketing efforts include client referrals, affiliate programs, partnerships, campaigns with celebrities and influencers, display advertising, television, print, radio, video, content, direct 37 -------------------------------------------------------------------------------- mail, social media, email, mobile "push" communications, search engine optimization, and keyword search campaigns. The launch of Freestyle to new-to-Stitch Fix clients has opened up new marketing opportunities and channels with which we have less experience. Our marketing expenses have varied from period to period, and we expect this trend to continue as we test new channels and refine our marketing strategies.
The largest component of our marketing spend is advertising, which was
We must also continue to improve the diversity of our offerings to successfully acquire clients and increase engagement. These efforts may include broadening our brand partnerships and expanding into new categories, product types, price points, and geographies.
Investment in our Operations and Infrastructure
To grow our client base and enhance our offering, we will incur additional expenses. We intend to leverage our data science and deep understanding of our clients' needs to make targeted investments in technology and product.
Merchandise Mix
We offer apparel, shoes, and accessories across categories, brands, product types, and price points. We currently serve our clients in the following categories: Women's, Petite, Maternity, Men's, Plus, and Kids. We carry a mix of third-party branded merchandise, including premium brands, and our own Exclusive Brands. We also offer a wide variety of product types, including denim, dresses, blouses, skirts, shoes, jewelry, and handbags. We sell merchandise across a broad range of price points and may further broaden our price point offerings in the future. Generally, changes in our merchandise mix have not caused significant fluctuations in our gross margin to date; however, categories, brands, product types, and price points do have a range of margin profiles. For example, our Exclusive Brands have generally contributed higher margins than our third-party brands, which have generally contributed lower margins. We continue to analyze and evolve our merchandise mix and may increase or add third-party brands to improve the client experience and attract new active clients. Shifts in merchandise mix, particularly if we increase the number of third-party brands we offer, may affect or result in fluctuations in our gross margin from period to period.
Components of Results of Operations
Revenue
We generate revenue from the sale of merchandise, either through our Fix or Freestyle offerings. With our Fix offering, we charge a nonrefundable upfront fee, referred to as a "styling fee," that is credited towards any merchandise purchased. We offerStyle Pass to provide selectU.S. clients with an alternative to paying a styling fee per Fix.Style Pass clients pay a nonrefundable annual fee for unlimited styling that is credited towards merchandise purchases. We deduct discounts, sales tax, and estimated refunds to arrive at net revenue, which we refer to as revenue throughout this Annual Report. We also recognize revenue resulting from estimated breakage income on gift cards. Cost of Goods Sold Cost of goods sold consists of the costs of merchandise, expenses for inbound freight and shipping to and from clients, inventory write-offs and changes in our inventory reserve, payment processing fees, and packaging materials costs, offset by the recoverable cost of merchandise estimated to be returned. We expect our cost of goods sold to fluctuate as a percentage of revenue primarily due to how we manage our inventory and merchandise mix. Our classification of cost of goods sold may vary from other companies in our industry and may not be comparable.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses ("SG&A") consist primarily of
compensation and benefits costs, including stock-based compensation expense, for
our employees including our stylists, fulfillment center operations, data
analytics, merchandising, engineering, marketing, client experience, and
corporate personnel. Selling, general, and administrative expenses also include
marketing and advertising costs, third-party logistics costs, facility costs for
our fulfillment centers and offices, professional service fees, information
technology costs, and depreciation and amortization expense. As a result of our
restructuring and cost reduction actions, we expect SG&A in fiscal 2023 to
decrease year over year. Our classification of selling, general, and
administrative expenses may vary from other companies in our industry and may
not be comparable.
Interest Income
Interest income is generated from our cash equivalents and investments in available-for-sale securities.
Income Tax Provision (Benefit)
Our income tax provision (benefit) consists of an estimate of federal, state,
and international income taxes based on enacted federal, state, and
international tax rates, as adjusted for allowable credits, deductions,
uncertain tax positions, and changes in the valuation of our net federal and
state deferred tax assets.
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Results of Operations
Comparison of the Fiscal Years Ended
The following table sets forth our results of operations for the periods
indicated:
For the Fiscal Year Ended 2022 vs. 2021 2021 vs. 2020
(in thousands) July 30, 2022 July 31, 2021 August 1, 2020 % Change % Change
Revenue, net $ 2,072,812 $ 2,101,258 $ 1,711,733 (1.4) % 22.8 %
Cost of goods sold 1,164,338 1,153,622 957,523 0.9 % 20.5 %
Gross profit 908,474 947,636 754,210 (4.1) % 25.6 %
Selling, general, and
administrative expenses 1,116,519 1,010,997 805,874 10.4 % 25.5 %
Operating loss (208,045) (63,361) (51,664) 228.3 % 22.6 %
Interest income 930 2,610 5,535 (64.4) % (52.8) %
Other expense, net (2,355) (366) (1,593) 543.4 % (77.0) %
Loss before income taxes (209,470) (61,117) (47,722) 242.7 % 28.1 %
Income tax provision (benefit) (2,349) $ (52,241) $ 19,395 (95.5) % (369.4) %
Net loss $ (207,121) $ (8,876) $ (67,117) * (86.8) %
* Not meaningful
The following table sets forth the components of our results of operations as a percentage of revenue:
For the Fiscal Year Ended
July 30, 2022 July 31, 2021 August 1, 2020
Revenue, net 100.0 % 100.0 % 100.0 %
Cost of goods sold 56.2 % 54.9 % 55.9 %
Gross margin 43.8 % 45.1 % 44.1 %
Selling, general, and administrative expenses 53.9 % 48.1 % 47.1 %
Operating loss (10.0) % (3.0) % (3.0) %
Interest income - % 0.1 % 0.3 %
Other expense, net (0.1) % - % (0.1) %
Loss before income taxes (10.1) % (2.9) % (2.8) %
Income tax provision (benefit) (0.1) % (2.5) % 1.1 %
Net loss (10.0) % (0.4) % (3.9) %
Note: Due to rounding, percentages in this table may not sum to totals.
Revenue and Gross Margin
Revenue in the fiscal year endedJuly 30, 2022 decreased by$28.4 million , or 1.4%, from revenue in the fiscal year endedJuly 31, 2021 . The decline in revenue was primarily attributable to a 8.9% decline in active clients fromJuly 31, 2021 toJuly 30, 2022 , and what we believe was a slowdown in consumer discretionary spending during our fourth quarter of fiscal 2022. The decline in active clients was primarily driven by client conversion challenges and lower site traffic, as we experienced weaker-than-expected conversion of new clients due to onboarding friction, and we experienced traffic-related challenges due in part to the ongoing effects of Apple's iOS privacy changes. The decline in active clients was also attributable to higher attrition of clients obtained through our high-dollar value referral program that ended in fiscal 2021. Gross margin for the fiscal year endedJuly 30, 2022 , decreased by 130 basis points compared with the fiscal year endedJuly 31, 2021 . The decrease was primarily attributable to an increase in inventory charges for excess spring and summer inventory in the current year.
Selling, General, and Administrative Expenses
SG&A expenses in the fiscal year endedJuly 30, 2022 , increased by$105.5 million , compared with the fiscal year endedJuly 31, 2021 . As a percentage of revenue, SG&A expenses increased to 53.9% for the fiscal year endedJuly 30, 2022 , compared with 48.1% for the fiscal year endedJuly 31, 2021 . The increase was primarily related to higher compensation and benefits expenses, including an increase in stock-based compensation of$27.8 million in fiscal 2022, primarily due to investments in technology talent. The increase was also related to restructuring and other one-time costs of$26.2 million recorded in the fourth quarter of fiscal 2022. 39
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Income Tax Provision (Benefit)
The following table summarizes our effective tax rate for the periods presented:
For the Fiscal Year Ended
(in thousands) July 30, 2022 July 31, 2021 August 1, 2020
Loss before income taxes $ (209,470) $ (61,117) $ (47,722)
Income tax provision (benefit) (2,349) (52,241) 19,395
Effective tax rate 1.1 % 85.5 % (40.6) %
We are subject to income taxes in the United States and the UK . Our effective
tax rate and benefit for income taxes decreased from the fiscal year ended
July 31, 2021 , to the fiscal year ended July 30, 2022 , primarily due to the
reversal of stock-based compensation expenses and the absence of the prior year
net operating loss carryback provisions of the CARES Act that were not in effect
for the current year.
Liquidity and Capital Resources
Sources of Liquidity
Our principal source of liquidity is our cash flow from operations.
As of
We are party to a$100.0 million amended and restated credit agreement, entered intoJune 2, 2021 and amended onJuly 29, 2022 (the "Amended Credit Agreement") withSilicon Valley Bank and other lenders. The Amended Credit Agreement includes a letter of credit sub-facility of$30.0 million and a swingline sub-facility of up to$40.0 million . As ofJuly 30, 2022 , we did not have any borrowings outstanding under the Credit Agreement. Our obligations under the Amended Credit Agreement and any hedging or cash management agreements entered into with any lender thereunder are secured by substantially all of our current and future property, rights, and assets, including, but not limited to, cash, goods, equipment, contractual rights, financial assets, and intangible assets. The Amended Credit Agreement contains covenants limiting the ability to, among other things, dispose of assets, undergo a change in control, merge or consolidate, make acquisitions, incur debt, incur liens, pay dividends, repurchase stock, and make investments, in each case subject to certain exceptions. The Amended Credit Agreement also contains financial covenants requiring us to maintain minimum free cash flow and an adjusted current ratio above specified levels, measured in each case at the end of each fiscal quarter. The Amended Credit Agreement contains events of default that include, among others, non-payment of principal, interest, or fees, breach of covenants, inaccuracy of representations and warranties, cross defaults to certain other indebtedness, bankruptcy and insolvency events, and material judgments. For information on the terms of the Amended Credit Agreement, please see "Credit Agreement" in Note 7 to the Consolidated Financial Statements included in this Annual Report. Uses of Cash Our primary use of cash includes operating costs such as merchandise purchases, lease obligations, compensation and benefits, marketing, and other expenditures necessary to support our business. We may also use cash to repurchase shares of our common stock.
We believe our existing cash, cash equivalents, investment balances, and the borrowing available under our Amended Credit Agreement, if needed, will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months and beyond.
Share Repurchases
InJanuary 2022 , our Board of Directors authorized a share repurchase program to repurchase up to$150.0 million of our outstanding Class A common stock, with no expiration date (the "2022 Repurchase Program"). We may repurchase shares from time to time through open market repurchases, privately negotiated transactions, or other means, including through Rule 10b5-1 trading plans. The actual timing, number and value of shares repurchased in the future will be determined by the Company in its discretion and will depend on a number of factors, including price, trading volume, market conditions, and other general business conditions. Repurchases will be funded from the Company's existing cash and cash equivalents or future cash flow. The repurchase program may be modified, suspended, or terminated at any time. During the three months endedJuly 30, 2022 , the Company made no repurchases of Class A common stock. As ofJuly 30, 2022 , the Company has repurchased 2,302,141 shares of Class A common stock for approximately$30.0 million under the 2022 Repurchase Program. We had$120.0 million remaining in share repurchase capacity as ofJuly 30, 2022 . 40 --------------------------------------------------------------------------------
Cash Flows
The following table summarizes our cash flows for the periods indicated (in thousands):
For the Fiscal Year Ended
(in thousands) July 30, 2022 July 31, 2021 August 1, 2020
Net cash provided by (used in) operating activities
$ (15,675) $ 42,877 Net cash provided by (used in) investing activities 10,233 39,093 (70,461) Net cash used in financing activities (60,250) (38,885) (1,435) Effect of exchange rate changes on cash and cash equivalents (4,228) 1,797 1,542
Net increase (decrease) in cash and cash equivalents
Cash provided (used in) by operating activities
During the fiscal year endedJuly 30, 2022 , cash provided by operating activities was$55.4 million , which consisted of a net loss of$207.1 million , adjusted by non-cash charges of$188.1 million and a change of$74.4 million in our net operating assets and liabilities. The non-cash charges were largely driven by$128.5 million of stock-based compensation expense,$37.2 million of depreciation, amortization, and accretion,$16.6 million in inventory reserves, and$6.2 million in asset impairment charges. The change in our net operating assets and liabilities was primarily due to an increase of$71.3 million in our accounts payable balance due to timing of inventory receipts and payments, as well as increased efficiency in the management of our working capital. During the fiscal year endedJuly 31, 2021 , cash used in operating activities was$15.7 million , which consisted of a net loss of$8.9 million , adjusted by non-cash charges of$135.9 million and a change of$142.7 million in our net operating assets and liabilities. The non-cash charges were largely driven by$100.7 million of stock-based compensation expense, and$29.9 million of depreciation, amortization, and accretion. The change in our net operating assets and liabilities was primarily due to an increase of$96.1 million in our inventory balance due to increased inventory purchases to support growth and selection, and a change of$31.7 million in income tax receivables primarily due to the net operating loss carryback provisions of the CARES Act.
Cash provided by (used in) investing activities
During the fiscal year ended
During the fiscal year ended
Cash used in financing activities
During the fiscal year endedJuly 30, 2022 , cash used in financing activities was$60.3 million , which was primarily due to payments for tax withholding related to vesting of restricted stock units of$31.7 million and repurchases of common stock of$30.0 million , partially offset by proceeds from the exercise of stock options of$1.5 million . During the fiscal year endedJuly 31, 2021 , cash used in financing activities was$38.9 million , which was primarily due to payments for tax withholding related to vesting of restricted stock units of$64.3 million , partially offset by proceeds from the exercise of stock options of$25.9 million .
Effect of exchange rate changes on cash and cash equivalents
Foreign currency exchange rates for the fiscal year endedJuly 30, 2022 , had a negative impact of$4.2 million on cash and cash equivalents. The negative impact on cash and cash equivalents was primarily due to the unfavorable impact of fluctuations in the exchange rate of the British pound sterling to theU.S. dollar.
Contractual Obligations and Other Commitments
Our most significant contractual obligations relate to purchase commitments of inventory and operating lease obligations on our fulfillment centers and corporate offices. As ofJuly 30, 2022 , we had$235.0 million of enforceable and legally binding inventory purchase commitments predominantly due within one year. For information on our contractual obligations for operating leases, please see "Leases" in Note 4 of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" to this Annual Report on Form 10-K. 41
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Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP. The preparation of our financial statements requires us to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and the related disclosures. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. The critical accounting policies, estimates, and judgments that we believe to have the most significant impacts to our consolidated financial statements are described below. Inventory, net Inventory, net consists of finished goods which are recorded at the lower of cost or net realizable value using the first-in-first-out (FIFO) method. We establish a reserve for excess and slow-moving inventory we expect to write off based on historical trends, which consider factors such as the age of the inventory and sell through rate for a particular item. In addition, we estimate and accrue shrinkage as a percentage of inventory out to the client and damaged items at 100% of cost. Inventory shrinkage and damage estimates are made to reduce the inventory value for lost, stolen, or damaged items. If actual experience differs significantly from our estimates due to changes in client merchandise preferences, client demand, or economic conditions, additional merchandise inventory write-downs may be required which could adversely affect our operating results. A 10% change in our inventory reserves estimate as ofJuly 30, 2022 , would result in a change in reserves of approximately$6.0 million . In fiscal 2022, we recorded additional reserves related to excess spring and summer inventory. Aside from these specific reserves, we have not made any material changes to our assumptions included in the calculations of the lower of cost or net realizable value reserves during the fiscal year endedJuly 30, 2022 .
Stock-Based Compensation
We grant stock options and restricted stock units ("RSUs") to our employees and
members of our Board of Directors, and recognize stock-based compensation
expense based on the fair value of such awards at grant date. We estimate the
fair value of stock options using the Black-Scholes option-pricing model. This
model requires us to use certain estimates and assumptions such as:
•Expected volatility of our common stock-based on an even blend of historical and implied volatility;
•Expected term of our stock options-the period that our stock options are expected to be outstanding based on historical averages.
•Expected dividend yield-as we have not paid and do not anticipate paying dividends on our common stock, our expected dividend yield is 0%; and
•Risk-free interest rates-based on theU.S. Treasury zero coupon notes in effect at the grant date with maturities equal to the expected terms of the options granted. We record stock-based compensation expense net of estimated forfeitures so that expense is recorded for only the stock options and RSUs that we expect to vest. We estimate forfeitures based on our historical forfeiture of stock options and RSUs adjusted to reflect future changes in facts and circumstances, if any. We will revise our estimated forfeiture rate if actual forfeitures differ from our initial estimates. We will continue to use judgment in evaluating assumptions related to our stock-based compensation expense. As we continue to accumulate data related to our common stock, we may have refinements to our estimates and assumptions which could impact our future stock-based compensation expense. During fiscal 2022, we updated our volatility and expected term assumptions to move away from using peer based volatility and the simplified method, respectively, and began using our own historical data for these assumptions.
Income Taxes
We are subject to income taxes inthe United States and theUK . We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the amount that is more likely than not to be realized. We consider many factors when assessing the likelihood of future realization, including our recent cumulative loss, earnings expectations in earlier future years, and other relevant factors. Significant judgment is required in determining our uncertain tax positions. We continuously review issues raised in connection with all ongoing examinations and open tax years to evaluate the adequacy of our tax liabilities. We evaluate uncertain tax positions under a two-step approach. The first step is to evaluate the uncertain tax position for recognition by determining if the weight of available 42
-------------------------------------------------------------------------------- evidence indicates that it is more likely than not that the position will be sustained upon examination based on its technical merits. The second step is, for those positions that meet the recognition criteria, to measure the tax benefit as the largest amount that is more than 50% likely of being realized. We believe our recorded tax liabilities are adequate to cover all open tax years based on our assessment. This assessment relies on estimates and assumptions and involves significant judgments about future events. To the extent that our view as to the outcome of these matters changes, we will adjust income tax expense in the period in which such determination is made. We classify interest and penalties related to income taxes as income tax expense.
Revenue Recognition
Revenue is recognized net of sales taxes, discounts, and estimated refunds. We record a refund reserve based on our historical refund patterns. The impact of our refund reserve on our operating results may fluctuate based on changes in client refund activity over time. We also sell gift cards to clients and establish a liability based on the face value of such gift cards. If a gift card is not used, we will recognize estimated gift card breakage revenue proportionately to customer usage of gift cards over the expected gift card usage period, subject to requirements to remit balances to governmental agencies.
We have not made any material changes to our revenue recognition accounting
policies during the fiscal year ended
Recent Accounting Pronouncements
For recent accounting pronouncements, please see "Significant Accounting Policies" in Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report.
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