Stitch Fix Inc

NASDAQ:SFIX

Earnings Call Transcript 2023-Q2

[Operator]

Good day and thank you for standing by. Welcome to the Second Quarter Fiscal Year 2023 Stitch Fix Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Hayden Blair.

[Hayden Blair, Investor Relations]

Good afternoon and thank you for joining us today to discuss the results for Stitch Fix’s second quarter of fiscal year 2023. Joining me on the call today are Katrina Lake, Interim CEO of Stitch Fix and Dan Jedda, CFO. Also joining us on today’s call is David Aufderhaar. We have posted complete second quarter 2023 financial results in a press release on the quarterly results 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 sections of our annual report on Form 10-K for our fiscal year 2022 previously filed with the SEC and the quarterly report on Form 10-Q for our second quarter of fiscal year 2023, which we expect to be filed tomorrow. Also note that 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 Investor Relations 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 Investor Relations website and a replay of this call will be available on the website shortly.

With that, I will turn the call over to Katrina.

[Katrina Lake, Interim Chief Executive Officer]

Thanks, Hayden. 12 years ago, I was inspired by a very simple human problem to help people look and feel their best. Now as I find myself back as Interim CEO, this simple mission feels more resonant than ever. I am proud of the ways that we have made our mission a reality, but also motivated by the opportunity ahead. We are still in the early days of transforming the industry of apparel and I feel optimistic that Stitch Fix can continue to lead the way in personalization and achieve greater impact in the years to come.

While many companies maybe starting to define an AI strategy, our company was built on data science from day one. We have built technology and systems that leverage the best elements of human stylist combined with machine learning and the billions of proprietary data points that we have around client and product interactions are rich, meaningful datasets that predict outcomes and help us to understand what clients need. At the same time, I realized we haven’t met recent expectations. Driving towards an ambitious vision has resulted in a loss of focus. We must now more than ever deliver on the client experience, bring focus in our marketing efforts and drive results for our shareholders. We have clarity on our path, long-term and short-term.

Long-term, I continue to have great conviction that the market opportunity for a more personalized way to buy apparel is large and growing and that we have a significant advantage rooted in our decade of experience and leveraging data to deliver personalization at scale. Shorter term, we also have clarity. We need to get back to a position of execution and profitability. We have a history of achieving both in the past and I am confident we will get there again. There were two major events in fiscal second quarter intended to help reposition and refocus the company to set ourselves up to optimize for liquidity and profitability in the short-term and maximize our long-term growth potential.

First, we restructured our operating model and made the difficult decisions to reduce our headcount by 20% of salary position and to set our operations in our Salt Lake City warehouse. Late last year, we began analyzing the team and determined to restructure the organization in an effort to create a leaner operating model. This also allows us an opportunity to reorganize and refocus to more nimbly execute. These decisions are never easy, but we know it was the right decision to achieve our goals of liquidity and profitability and for the overall health of the business.

And second, we are conducting a search for a permanent CEO. The Board and I realized that the macroeconomic environment, competitive landscape, and even our own business has changed meaningfully over the past few years. And we are excited to find the right leader for the present and future of Stitch Fix. I am encouraged by the process thus far. And I am confident that we can find an inspiring person to lead the Stitch Fix team and help reestablish the track record of results we were once known for.

In addition, we shared in our press release this afternoon that Dan Jedda will be stepping down as CFO to pursue a new opportunity. The Board and I want to thank Dan for his service to Stitch Fix and wish him well for the future. David Aufderhaar, our SVP of Finance will succeed him as CFO. David joined us 4 years ago with an eye towards CFO’s succession. And working together these many years I have been impressed and inspired by his depth of partnership with the functional leaders at Stitch Fix, his deep commitment to and understanding of our business and our team. He is a thoughtful and trusted leader and I am excited for him to step into the CFO role.

Now on to the financials in the quarter. Fiscal second quarter revenue came in at $412.1 million, which was at the lower end of the provided range. Despite this, we delivered adjusted EBITDA of $3.8 million, which was at the high-end of our guidance range due to effective cost controls and our corporate restructuring. Dan will dive more into the financials later on. But before handing it over, I want to touch on topics in marketing and our products that demonstrate how the company is rallying around bringing focus and clarity to better deliver results for our clients and shareholders.

Consistent with the broader company, our marketing strategy aims to preserve liquidity and achieve profitability while simultaneously attracting long term customers to fuel a return to growth. This will be the case as we continue to refine our traditional paid channels as well as diversify into underpenetrated channels we have yet to scale. We are also continuing to lean into client retention and reengagement strategies in an effort to continue to increase engagement and optimize our CPAs. It’s worth highlighting that our CPAs were down over 40% from a year ago, which shows despite a significant reduction in overall budget, we are gaining traction in more effectively deploying our marketing dollars. Overall, we know these are the right things to focus on. And when combined with our efforts to maximize the client experience and improve retention should maximize ROI in the short-term and set the stage for a return to growth.

Moving on to the client experience. A complicated macroeconomic environment and tighter client wallets make it more critical than ever to reexamine and bring focus to our client experience. The ambitious vision we embrace for the past many months has resulted in a client experience that is less focused on our core areas of differentiation. And we believe that there is opportunity to drive long-term value by being really deliberate and targeted about the role of features and functionalities in the Stitch Fix ecosystem. As an example, we have recently refined our point of view on Fix Preview. Although at the highest level, Fix Preview has demonstrated a positive impact on AOVs. Digging into the data, we see a more nuanced story. There absolutely are clients who significantly benefit from Fix Preview. But there are also clients for whom showing a preview actually increases cancellation.

Acting on this data, we found an opportunity to drive better outcomes and LTV by experimenting with eliminating the preview for some clients, allowing those clients to enjoy the surprise and delight that we know those clients value while allowing other clients to benefit from the agency of Fix Preview. I share this example of letting data drive our decisions and providing more intention and focus in the client experience. I anticipate there are many similar opportunities as we dig into the data and the experience and we believe these strategies will drive LTV enabling us to optimize cash flow and profitability in the short-term while positioning ourselves for an eventual return to growth.

Before I turn it over to Dan, I want to thank the entire team at Stitch Fix. We talk internally about celebrating Stitch Fix Grit as one of our core operating tenants. And I have been inspired by the grit I have experienced day in and day out from the team these past few months. I continue to be inspired by the passion I see to deliver value for our clients and our business and to make our company a fantastic place to work. Our continued focus and data-driven decision-making are paving the way for a bright future for Stitch Fix. I believe we are on the right track to get there and I look forward to continuing the journey with you all.

With that, I will turn it over to Dan.

[Dan Jedda, Chief Financial Officer]

Thank you, Katrina and hello to everyone on the call. Before jumping in, I want to thank Katrina and the Stitch Fix board for this opportunity and congratulate David on his new role. David and I have enjoyed a positive and productive working relationship during my tenure and I am confident he is the right person to lead the team. David and I will be working together over the next several weeks to ensure an orderly transition.

On to our Q2 results, Q2 net revenue declined 20% year-over-year to $412.1 million due to the lower net active clients and higher promotional activity in the quarter. Net active clients in the quarter declined 11% year-over-year year over year to approximately $3.6 million. As Katrina mentioned earlier, we have continued to diversify our marketing channel, while ensuring we realized positive near-term ROI on advertising spend. Total advertising spend in the quarter was 5% of net revenue and down 46% year-over-year. We like the trends we are seeing in overall CPA. Even with the lower spend in advertising, we did see positive year-over-year and gross client adds in men’s in Q2. And while women’s and kids gross adds were down year-over-year, our rates are improving in both lines of business. We do continue to see elevated levels of inactive clients and continue to focus on improving this with the right client experience.

We expect advertising to be 6% to 7% of net revenue for the rest of the year. So we will continue to be opportunistic if we experienced the right ROI and lean in where appropriate. Revenue per active client declined 6% year-over-year to $516. While our overall average order value is holding relatively steady year-over-year, similar to Q1, our analysis continues to show that all client cohorts are spending less than in prior years. We expect this trend to continue through the rest of FY ‘23.

Q2 gross margin came in at 41%, down 400 basis points year over year, driven primarily by lower product margins due to increased promotional activity and higher product cost. Total transportation costs were also up year-over-year due to increased carrier rates. Sequentially, gross margin was down approximately 100 basis points from Q1 due mostly to increased promotional activity. We expect gross margins to be around 42% for the remainder of that fiscal year and are actively focused on improving gross margins as we see opportunities to improve product margin, transportation efficiency and inventory efficiency over time.

Q2 adjusted EBITDA came in at $3.8 million, reflecting our ongoing cost control efforts, including a reduction in force and the closure of our Salt Lake City warehouse. The adjusted EBITDA excludes $34.7 million of restructuring and one-time costs. Net inventory ended the quarter at $159 million, down 28% quarter-over-quarter and down 13% year-over-year. Free cash flow for the quarter was positive $15.4 million, our first quarter of positive free cash flow since Q1 of FY ‘22. And we ended the quarter with $224 million in cash, cash equivalents and highly rated securities.

In summary, on our cost structure, with the execution of our restructuring actions and our reduced advertising levels, we have now executed against all the actions needed to realize $135 million of cost reduction targets for FY ‘23. Additionally, we shipped our last fix from the Salt Lake City distribution center at the end of January and we have distributed the inventory across the remaining fulfillment centers in our network. We will begin to see cost savings from the closure in Q4. Our goal remains to achieve positive adjusted EBITDA and free cash flow in the short-term, while continuing to position ourselves for profitable growth in the future. And we believe we are well on our way to achieving these goals.

Now on to our outlook. For the remainder of the fiscal year, we expect to continue to face a challenge and highly promotional operating environment. With that said, we are leaning into our areas of differentiation and focusing on managing the things within our control. We will continue to responsibly manage our cost structure with the goal of staying adjusted EBITDA and free cash flow positive for the remainder of the year. For our fiscal Q3, we anticipate revenue to be between $385 million and $395 million. We expect adjusted EBITDA for the quarter to be between negative $5 million and positive $5 million, largely reflecting increased seasonal advertising spend as we continue into the spring summer season, where our CPAs are generally more efficient.

For the full year, FY ‘23, we now expect revenue to be between $1.625 billion$1.645 billion. We expect adjusted EBITDA for the year to be between breakeven to positive $10 million. Going forward, we remain relentlessly focused on liquidity and profitability. The improvements we have made in our cost structure will allow us to invest in growth as we continue to focus on improving our client experience. And over time, we expect the improved client experience will enable us to grow our net active revenue and free cash flow.

With that, I’ll turn the call over to the operator for Q&A.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Youssef Squali with Truist. You may proceed.

[Youssef Squali, Truist]

Great, thank you very much. Hi, guys. Couple of questions. Good to hear from you, Katrina again. So the first question maybe for Katrina, can you just speak at a high level about how you see, I mean, you talked earlier about you on the one hand, you’ve had a lot of focus on the other, you have clarity on the path forward, when maybe can you just expand a little more about what pinpoint the two or three areas where you felt the Stitch Fix has had lost its focus, and then maybe, kind of what gives you the confidence that that you are back on the path that should ultimately get you to growth? And then maybe can you double click a little bit on your EBITDA margin guide of negative $5 million to positive $5 million and just help us that how you get there, obviously, I think you said gross margin should be around 42%, which really only leaves advertising sales and marketing and G&A as the other components. So maybe just provide a little more color on where you see those for the second half the year. That’d be very helpful. Thank you both.

[Katrina Lake, Interim Chief Executive Officer]

Great. Thanks, Youssef. Good to be back. I’ll answer your first question. And then I will have Dan weigh in on the second around EBITDA margin. On kind of the focus and clarity, I think there’s, there’s innumerable examples that I could bring, I think, just at a very high level, as we thought about expanding the business and very ambitious way, we took a marketing approach that, that probably tried to bring people in to a variety of different customer segments. And very notably, we spent marketing dollars trying to bring people into a freestyle first experience as an example. So that’s a place where not only did we find that that marketing of freestyle first wasn’t as effective as what we had done historically in fixes. But it also actually made it harder for us to be able to be acquiring people into the Fix channel. And so that’s – I think, one example of how that comes to life.

Another one is around inventory. We definitely built up an inventory in anticipation of a freestyle customer that, was a different set of inventory than fixes and also more unknown, it was a customer we hadn’t served before. It was a channel we hadn’t served before. And so, there was more risk in the inventory and going forward, we can use our 10 years plus of historical data to really be able to buy with confidence on the inventory side and that’s another good example of focus. And the customer experience as well I mentioned, I mentioned, us to looking at preview as an example. And I think there’s still other places where we can really kind of clean up the customer experience so that we’re really maximizing value for the client and value for the shareholder at the same time.

In terms of confidence back to growth, I think, there’s a lot of places where, yes, I think all of those places are areas where, the inventory front, I think we can feel confident looking at what we’re doing going ahead for now. And on the marketing front, I think we have near-term results that show that things are working when Dan referenced that we saw customer acquisition cost down by 40%, compared to last year. And to me, that’s a great example of how focus is kind of creating value in the business today. And I think we feel really confident that it’s creating value in the business long-term. Dan, you want to talk about EBITDA?

[Dan Jedda, Chief Financial Officer]

Yes. Hi, Youssef. On the on the EBITDA guide the negative $5 million to positive $5 million. Again, I think we’ve provided obviously revenue and gross margin. And we also provided that 6% to 7% advertising number for Q3, we’re going to be on the higher end of that 6% to 7%, simply because as we enter our spring summer season, it’s a very efficient quarter for us. We talked – Katrina talked about it. And we’re very focused on the efficiencies within our marketing channel. And we just feel as we exited to Q2 and go into Q3, we’re like what we’re seeing. And so think of the Q3 as the higher end of that 6% to 7%. That leads us of course, with SG&A, excluding advertising on a run rate basis, after our restructuring, that gets you to that negative $5 million to positive $5 million, if, of course, if we’re not seeing the efficiencies, we won’t spend the advertising dollars. So we feel pretty good about the guidance. And of course, the level of spend that we’re now targeting for advertising.

[Youssef Squali, Truist]

And just to be clear, that $34 million that I think you mentioned in one-time restructuring costs and other that hit the S&A and expense line of 187 in Q2.

[Dan Jedda, Chief Financial Officer]

It did.

[Youssef Squali, Truist]

Okay. Alright. That makes sense now, thank you very much.

[Operator]

Thank you. Our next question comes from Simeon Siegel with BMO Capital Markets. You may proceed.

[Unidentified Analyst]

Hi, this is [indiscernible] on for Simeon. Thanks for taking our question today. Just noticing in the press release, you guys noticed, going back to more of a stylus focused approach is that kind of a de-emphasis maybe a little bit for kind of freestyle. And Katrina, you just mentioned getting inventories right from within the freestyle versus a Fix business, understanding how those are different. I’m just curious how you guys are thinking about that business going forward? And how you’re planning – kind of how to work around some of some of the challenges maybe you’ve had there?

[Katrina Lake, Interim Chief Executive Officer]

Yes, thanks, Derek. It’s a good question. I think what we’re – there’s no question that freestyle adds value in ways that fixes didn’t and go, I think the most clear way that we think about that is looking at the assortment data. And we’ve shared in call historically that we’re seeing a different assortment being bought and freestyle than fixes. We’re seeing more outerwear, shoes, accessories. And so that says to us that this is helping to fill a different need for our clients. That being said, as I mentioned in the last question, I think, the using freestyle is a customer acquisition vehicle as an example that was less effective. And so, what we’re really trying to do is to say, where are areas of differentiation and personalization, styling are really at the core of that, especially if you think about our kind of competitive positioning relative to others. Those are spaces that we really uniquely own. And so as we think about what is the customer experience that best delivers, again, personalization, again styling, I think freestyle can be a component of that but we’re probably thinking of it more as one ecosystem that has a more clear customer journey, rather than thinking of as kind of separate business units.

[Unidentified Analyst]

Great. Appreciate that. And just as a quick follow-up, I’m just looking at the 42% guidance for gross margin for the remainder of the year. And then your comments on how the difference from 1Q to 2Q is about 100 bps of markdown pressure, are you guys seeing kind of a return to markdown levels where you were going back a few quarters, I’m just curious how you’re planning about markdown pressure for kind of the back half of the year and kind of what you’re seeing more broadly within your customers and their ability in their willingness to shop on kind of more of a full price level compared to kind of a discounted one?

[Dan Jedda, Chief Financial Officer]

Yes, the way we approach we talked about this in the past and thanks for the question, the way we’ve approached markdown is really focused on where we think we have access or the wrong inventory and using our freestyle channel to that inventory. And we’ve seen success in that, as opposed to the option of selling it out to a third-party liquidator. And so we’ve seen success in that. And we will continue to utilize that. Although, as you can see from our inventory levels, now we’ve come down considerably, and we feel we’ve right sized our inventory, we feel very good about the inventory position that we’re in now in terms of total dollars, and we still have some buckets to work through. And so we are using the freestyle channel for that. And in the Fix channel, we are not discounting a lot, we simply aren’t doing that clients love with the styling service that we give them. And we have not seen the need to discount in the Fix business. And we don’t anticipate doing that going forward.

[Unidentified Analyst]

Great. Thank you, both.

[Operator]

Thank you. Our next question comes from Mark Altschwager with Baird. You may proceed.

[Amy Teske, Baird]

Hi, this is Amy Teske on the Mark. Thanks for taking our question. On the inventory point, as you’ve worked down inventory and pulled back on your receipts, what is your level of comfort that you now have the right type of inventory? So how do you think about the composition of your inventory between casual and dressing styles and product categories? Thank you.

[Dan Jedda, Chief Financial Officer]

Yes, I’ll take that one. That’s a great question, Amy. And thanks for asking it. First of all, we talked about inventory in our Q4 again in our Q1 results and how we had a lot of inventory. And we simply needed to work it down. And we’ve done that. And a lot of that, of course was getting rid of excess inventory and or the wrong styles or brands of inventory, we’re in a much better position. Now as I mentioned, we still have a little bit of work to do on the inventory that is going to be short-term. And that’s included in our guidance going forward. But we feel really good about the brands that we’re targeting and with a big focus on our on our exclusive brands, which are trending very well for us. And in fact, I’ll just share that we did notice in January, where we were soft on some of our exclusive brands on our customers told us they wanted that and we quickly pivoted and where we were short on inventory, we chased back into it. And that’s a great sign for us that our customers love our exclusive and our Stitch Fix only brands that we are selling and so we are going to continue to focus on that in the very near-term as we get into spring, summer and then as we get back into fall winter, a year from now.

[Operator]

Thank you. Our next question comes from Ed Yruma with Piper Sandler. You may proceed.

[Ed Yruma, Piper Sandler]

Hey, thanks very much for taking my question and welcome back, Kat. I guess just the bigger picture question you guys are really known for personalization. You have talked about this a lot today, can you talk about competitive gap, you think that your competitors have gotten better? And since the inception of your business and maybe Kat, do you have any observations of things that have changed adversely since the last one and I will come back there looking to rectify quickly? We would appreciate that. Thank you.

[Katrina Lake, Interim Chief Executive Officer]

Thank you, Ed. I think I got your question here. So in terms of just more of the competitive gap, honestly, I feel really strong about our capabilities. And we’ve been able to be in this business for 10 years plus with a history of profitability with a history of being able to deliver cash flows. And there’s not a lot in the competitive set that are able to claim the same thing. And so, the focus that we’ve had around data science, the focus that we’ve had around personalization, I strongly believe that we continue to lead on that front. And I feel just as good, if not better about that coming back into the role. In terms of things that I think your question was more of just like what has adversely changed? I think I spoke to it on the call, but I really do think it’s focused, I do think hindsight is 2020. And I think we had some really ambitious visions that we were chasing after and with kind of chasing an ambitious big vision came a kind of reduction of focus on what I would consider our core differentiators, which are really around personalization and the styling. And so, I think a lot of what we’ve been talking about internally is just how can we make sure that everything that we are doing with our valuable resources and time are really focusing again, delivering that for our clients and ultimately our shareholders and being able to deliver an experience that feels personalized for all of our clients and making sure that everything that we invest in achieves that goal.

[Ed Yruma, Piper Sandler]

Thank you.

[Katrina Lake, Interim Chief Executive Officer]

Thanks, Ed.

[Operator]

Thank you. Our next question comes from Trevor Young with Barclays. You can proceed.

[Trevor Young, Barclays]

Great, thanks. First one Katrina just on the testing of discontinuing the Fix Preview, are you getting any sort of signal that keep rates are eroding in those circumstances? And then more broadly big picture, do you feel like the cost space is in a good place now, to set the stage for recovery in some future quarter after we go through kind of the reset on core fixes here or is there some work to be done and maybe even some reinvestment to be done on the tech side to get that into a better place? Just any thoughts on that would be appreciated?

[Katrina Lake, Interim Chief Executive Officer]

Great. Thanks for the questions, Trevor, I’ll take the first one and have Dan talk more about the cost basis. On this preview, I mean, one way to really think about it is to try to maximize the ROI and LTV is a given cohort. And so as we do some segmentation, we can see at a high level that overall, we saw AOV go up with the ability to have access to Fix Preview, but once you dig in, there’s going to be some cohorts where we see people more likely to cancel when they see a Fix Preview. And so what we’re really trying to optimize for are those LTVs. And so we – I think we’re able to do is to fine tune, I guess a little bit more at a more personalized level of where we’re going to be deploying Fix Preview to be able to maintain that benefit that you mentioned, to keep rate an AOV for the populations for whom we know that that will occur, while at the same time reducing cancellations and making sure that we are retaining and engaging clients that in all of our cohorts by eliminating Fix Preview from those who we don’t think will benefit from it. And I would say also, from a customer survey perspective, like one of the things that we hear is that one of the real benefits of Stitch Fix is surprise and delight. And so to be able to – for some clients, you can think of it as a lack of agency, but you can also think of it as actually allowing people to have that surprise and delight. Somebody said to me with I love this quote of like, as an adult, you just don’t get a whole lot of good surprises in your life. And Stitch Fix can be one of those. And so we know there are clients who really, really value that and actually being able to continue to maintain that for those clients is valuable and LTV positive for those clients. Dan, you want to answer the question on the cost basis?

[Dan Jedda, Chief Financial Officer]

Yes. On the total cost, when you look at where we ended Q2 and adjusted for restructuring, we’re back to fiscal 2019 SG&A excluding SPC. And we feel very good about that. And going forward, and there’s still more efficiency to have in my prepared remarks. You heard us talk about gross margin and the opportunities that we see there. There’s also this further opportunity on our footprint to better monetize that as we reduce our corporate office space. We have variable efficiency projects that are ongoing. So yes, I feel the cost structure is in very good space – in a very good place. And I think there’s tremendous opportunity to improve it going forward. So we’re in a good place from a cost standpoint and a liquidity standpoint.

[Trevor Young, Barclays]

Great, thank you both and best of luck, Dan.

[Dan Jedda, Chief Financial Officer]

Thank you.

[Operator]

Thank you. Our next question comes from David Bellinger with ROTH MKM. You may proceed.

[David Bellinger, ROTH MKM]

Hey, everyone. Thanks for the question. On the cost per acquisition being down 40% in the quarter, how much of that is internally driven through some type of channel mix shift and the ROI your where that’s getting better versus some of call it the external factors that play within the broader apparel category?

[Katrina Lake, Interim Chief Executive Officer]

Yes, thanks for the question, David. I can start and might benefit from some of Dan’s weighing in here. But I think honestly a lot of that is really more from a perspective of focus. And so if you think about where we were last year, we were doing more freestyle first marketing, we were driving people to an immediate purchase experience instead of driving people into a styling experience through fixes. And just very simply put that freestyle first marketing was not as efficient as our core Fixed experience. And so I think just to be able to have the marketing messages be more clear around the benefits of personalization and styling and to be really focused on driving people through one channels and conversion has been driving that efficiency. We definitely are always looking at diversifying our channels and so we have our tried and true channels that we know perform. And those have performed well as you’ve kind of heard in the numbers. And at the same time, we’re always experimenting to make sure that we’re getting all the emerging channels and to make sure that we’re kind of exercising that muscle of acquiring and converting clients in all the new places that we see our clients kind of spending time. I don’t know, Dan, if you have anything to add to that.

[Dan Jedda, Chief Financial Officer]

Yes, the only – I presume – I 100% agree with what Katrina said. And I think I would simply add that part of the experiences where we really hardened the funnel really helped with conversion of traffic, and therefore the efficiency of the marketing spend. In addition to just being very focused on the next dollar spent within the channels. And is that an efficient spend. And I think the marketing team has done a tremendously good job of diversifying the channels, but then focusing on the efficiency and making sure we’re bringing in the right clients, which we feel very good about. And I think we’ve talked about that in the earlier remarks.

[David Bellinger, ROTH MKM]

Great, thanks for that. And just one other follow-up, I think you mentioned some type of chasing inventory. It sounds like you’re more comfortable with the assortment. So what’s the next step, if we think bigger picture here and getting your core customer back and spending again? Is there some type of refresh needed on top of that on the inventory side or is there more of a technology connectivity issue you need with your core customers to get them back again?

[Katrina Lake, Interim Chief Executive Officer]

Yes, I mean, I can take that. And I think to be clear, like we’re seeing that customer perform in a pretty healthy way. I mean, we’re seeing our AOV be pretty consistent on the inventory side. It’s of course been gradual over the last few months of kind of evolving into the inventory next that we want, but we feel really good about where we are in the inventory perspective. That being said like, there’s definitely opportunity, I think, we see, Dan mentioned, we’re seeing some cohort weakness. There is no question. There’s some macro headwind, but I’m not willing to accept that it’s all macro, I think there are still opportunities for us to improve the customer journey for us to improve the ways that we’re serving our clients so that they can have the best possible experience that then leads to LTV, it leads to shareholder value. And so I definitely still think that there’s a lot of opportunity. But as we kind of dig in and look at how our Fix is doing, how are people feeling in their actual transactions, we’re actually seeing goodness there. And I think, it’s on us now to be able to deliver more goodness to the rest of the customer experience.

[David Bellinger, ROTH MKM]

Great, thank you.

[Operator]

Thank you. Our next question comes from Ike Boruchow with Wells Fargo. You may proceed.

[Jesse Sobelson, Wells Fargo]

Hi, everyone, this is Jesse Sobelson for Ike. It looks like taking down inventory was a major source of cash this quarter. So on the liquidity front, I’m just curious, how much cash do you guys need to run the business? And what should investors expect regarding cash flow generation throughout the rest of the year?

[Dan Jedd]

Yes, thanks for the question. And so yes, we did have a source of cash come from our inventory position, which we implied was going to happen last quarter as we brought our inventory down, and on a go forward how much cash do we need to run the position that from a liquidity standpoint, we’re in a very good position, we have $323 million, $223 million of cash equivalents. And we have a credit facility which we don’t plan to use. And so going forward, as we guided to a positive H2 adjusted EBITDA, we talked about EBITDA is a great proxy for cash flow for us, simply because we do not have a lot of CapEx, and we do not anticipate a lot of CapEx spend over the next several quarters. And so we feel that both our EBITDA and cash flow are trending positive for H2. And we will get more guidance on FY ‘24 at a later date. But overall, we feel very good about the liquidity position that we’re in and the cash flow that we’ve generated in both Q2 and for H2, as we go forward.

[Jesse Sobelson, Wells Fargo]

Great. Thank you.

[Operator]

Thank you. Our next question comes from Blake Anderson with Jefferies. You may proceed.

[Blake Anderson, Jefferies]

Hi, thanks for taking our question. Wanted to revisit the freestyle topic and how the tone has seemed to maybe change a little bit on that. This is more of a philosophical one. But should we expect any strategic changes to that business before a new CEO is announced? Just wondering Katrina, how much influence we could have on that business in the short-term? Thank you.

[Katrina Lake, Interim Chief Executive Officer]

Yes, thanks, Blake for the question. I mean, we’re always evolving to experience and so at a very high level like I really don’t see a big foundational shift in the strategy I think the strategy of focusing on personalization and focusing on styling and focusing on the areas that we know are valuable areas of differentiation for our client, I think it’s hard to imagine that we would deviate from that. That being said, like, we are always doing experiments, we are always doing AB test to better understand what are we doing that to what can we be doing differently or better in order to optimize that client journey to drive LTV, to drive value for our clients, to drive profitability and long-term growth. And so we are always making changes. And so hopefully, what I can say is like, you can probably expect to see some small changes in terms of the way that that the customer journey evolves over time. But I honestly, I wouldn’t see them as like fundamental big changes, I think we know that freestyle adds value. We know that there – we know which ways in which it adds value. And so really, it’s about how do we make sure to tailor and target the right customer experience so that clients are getting the most value out of their experience with Stitch Fix and thus, we are getting the most value out of clients that we acquire.

[Blake Anderson, Jefferies]

That’s helpful. Thank you. And maybe I missed it, but did you talk about kind of trends by month throughout the quarter and any commentary you guys can provide on the quarter-to-date, especially how that – how the budget shopper is holding up? Thanks so much.

[Dan Jedda, Chief Financial Officer]

Yes, I can take that. So, we did not provide trends by quarter for our Q2. I will say that, February has largely been as expected for us. We are – again the guidance that we gave of course, takes into account 5 weeks of February and we are not seeing anything that is out of the ordinary where we have seen a change in trajectory to the negative. So, we continue to see our keep rates trending positively. There might be some frequency with the cohorts analysis that we talked about for Q2 to see that trend continue. We haven’t looked at that yet for Q3, but we will, but no real trend update beyond what we have provided in the – for the guidance for Q3 and the commentary we gave on Q2.

[Blake Anderson, Jefferies]

Great, thank you. Best of luck.

[Katrina Lake, Interim Chief Executive Officer]

Thank you.

[Operator]

Thank you. Our next question comes from Tom Nikic with Wedbush Securities. You may proceed.

[Tom Nikic, Wedbush Securities]

Hi, thanks for taking my question. Dan, quick one for you. Sorry, if I missed this, did you actually say what the marketing expense was in Q2 as either in dollars or as a percentage of revenue?

[Dan Jedda, Chief Financial Officer]

We did 5%.

[Tom Nikic, Wedbush Securities]

Got it. Okay. Thanks. And Kat, welcome back to the CEO role in an interim basis, but when we think about the permanent CEO role or the successor, what are you looking for like what skill sets – are you looking for like what optimally who is – what attributes would your ideal candidate have for the permanent CEO seat? Thanks.

[Katrina Lake, Interim Chief Executive Officer]

Yes, thanks, Tom. Yes, so we have kicked off a search. We have engaged with the search firm and we have been having conversations with candidates quite a few conversations with candidates. And overall I feel excited and optimistic about kind of the quality of people that we are meeting. And at the highest level, like, are very simply like, I really do think it’s having a history of delivering results and executing a business that our business is fairly complex. And so, I think somebody who has had experience in a business that has similar complexity to ours and have a kind of history of delivering results is, of course, first and foremost, important. And then relatedly, we have a large company that has a lot of people in different types of roles. And so that leadership and someone who has a natural leadership and somebody who is going to be able to be successful and leading a diverse organization is really important. And so at the highest level, I think those are two things that that we’re really looking for. But we’ve kind of talked and as we have had a lot of conversations, we have had a lot of candidates who have first hand experience with Stitch Fix who know the business well and feel really connected to the business and the customer. And I think we are excited about the people we are meeting, so optimistic.

[Tom Nikic, Wedbush Securities]

Sounds good. Thanks, Kat. Best for luck in the CEO search and with the business for the rest of the fiscal year.

[Katrina Lake, Interim Chief Executive Officer]

Thank you.

[Operator]

Thank you. Our next question comes from Kunal Madhukar was UBS. You may proceed.

[Kunal Madhukar]

Hi, thanks for taking the question. One more housekeeping and then one more longer term. So on the housekeeping side, can you help us understand the LTM active clients has been declining for the past five quarters now? How should we kind of think of the trend for LTM active clients going forward? And then Katrina, you talked about the eventual return to growth and you also talked about having a lot more visibility on the business. So can you help us understand in your mind how you are thinking of growth going into 2024 and maybe into 2025, when are we going to get to growth? And part of the reason is, in fiscal 4Q of this year, that is going to be a 14-week period rather than a 13. So, the guide does not inspire a lot of confidence. Thank you.

[Dan Jedda, Chief Financial Officer]

So I’ll take the RPAC question. RPAC is a trailing metric. It’s trailing 12-month metric on actives. And so there is a lot of math that goes into the mix of RPAC. And so – and I know your models take into account RPAC, but I think the best way we can say that is well, we are seeing some cohort degradation in terms of spend, which will impact RPAC. Mix is a bigger impact of RPAC – mix of the tenure of our clients. We have mentioned in the past that our older clients spend less our new clients spend more as their closets get filled up. And so we will continue to talk about RPAC from an actual basis, but we are not guiding the future RPAC. That being said, I think it’s safe to say that, where we might see some cohort degradation on spend and some mix, we are not expecting big reductions in RPAC on a go forward basis. So we will probably see some of that because of the spend in cohort on a year-over-year, but we don’t think it’s going to be material. Our clients do continue to spend with us. They do continue to stay with us. The newer clients that we are bringing in as we look at them are cash flow positive clients that we talked about the near-term ROI, all that will have the effect eventually of stabilizing that RPAC and ultimately bringing it up, but that’s going to happen over time.

[Kunal Madhukar]

Thank you.

[Dan Jedda, Chief Financial Officer]

Sorry, I think we want to get to the second.

[Katrina Lake, Interim Chief Executive Officer]

So, the part two is more around like how am I thinking about the eventual return to growth, is that? Okay, I think I mean, Dan mentioned, I think – I totally agree with everything that Dan mentioned. And I would just add also that in our business, so much of our business is serving clients that are returning, and that’s a great part of our business. We generate a lot of revenue from our existing customer base. And so all of the benefits that we – all the things that we are able to do to be able to make that client more valuable. And so all of the ways in which we can reengage that client, all the ways in which we can offer those clients reasons to come back also add and so we are always thinking about new clients, we are also thinking about how do we make sure that our existing base is healthy. And I think we have seen some positive signals that we have been excited about and feel really confident that we are doing the right things and the things we need to be doing right now.

[Operator]

Thank you. Our next question comes from Janet Joseph Kloppenburg with JJK Research Associates. You may proceed.

[Janet Kloppenburg, JJK Research Associates]

Hi, Katrina. Hi, Dan. I just wanted to follow-up on that question is, it seems to me that and please correct me when I am wrong that you are going to be spending your investment, will spending will shift to a higher degree of investing in fix and low degree in freestyle and that should drive up your active customer participation and your sales. But I think that’s what you are saying and that you will use freestyle as to some extent as a liquidation channel for fix, but that your investment spending will go back towards the personalization fix business and that, that should help to improve the EBITDA performance of the company as well? And does it mean that maybe the advertising rates can stay below 7%, 8% as we go forward or is that something that needs to be tested and refined? Thank you.

[Katrina Lake, Interim Chief Executive Officer]

Sure. I can answer at a high level and then Dan can kind of weigh in on more of the specifics. But I mean I think at a high level, the way to think about it is, that we are really focusing the business around personalization and styling. And yes, Fix is a very big part of that. And having a more focused messaging from a marketing perspective helps us to drive marketing efficiency, having a more focused point of view around who the client is. I think one of the challenges with acquirer, trying to acquire freestyle for the clients was that, we were definitely deviating from our historical client and trying to kind of – trying to have many different messages, and to actually have an assortment that back that. And so simplifying on the inventory side also delivers efficiency. And freestyle definitely still has a role to play in order to be able to help our client to fill in their closet, to be able to engage in between fixes. And so we definitely are going to continue to have to be thinking about how to freestyle add value to that client experience. But I would say that the investing is more around thinking more holistically around, what is the Fix – what is the Stitch Fix ecosystem and how do all these pieces fill in together in order to drive the best LTV and experience for our clients, but then also, of course delivering results for our shareholders. So, maybe I will – and Dan will you talk a little bit about the marketing side?

[Dan Jedda, Chief Financial Officer]

Yes. On the marketing side, again, Katrina mentioned, we are not marketing a freestyle first experience, which we had done in the past. And that along with a lot of the product, the client experience improvements we have made. It just has allowed us to focus on that fixed first client in a very efficient way. And so well, the advertising drop year-over-year seems large. When you look at the clients that we are bringing in, we are seeing very efficient spend. And that was the point, when we talked about men’s actually being up on a gross adds basis, and women’s and kids improving, while still down year-over-year improving from current trends. That’s with that 46% reduction in marketing, in advertising. So, we do anticipate to stay on this trend of lower advertising spend, but focusing on the right client, the fixed first client. And then having freestyle be a very important incremental opportunity, once the client is in the door and engaged in the Fix business. It still is a material part of our business and will continue to be freestyle, that is.

[Janet Kloppenburg, JJK Research Associates]

Thank you both so much.

[Operator]

Thank you. Our next question comes from Dana Telsey with Telsey Advisory Group. You may proceed.

[Dana Telsey, Telsey Advisory Group]

Hi, good afternoon everyone. Kat, welcome back for the interim period. As you think about the near-term and the long-term, on the near-term, how are you thinking about the core customer, what they are spending on pricing, how you are thinking of brands? And how do you think about the differentiation between the freestyle and the fix in terms of whether it’s AUR or captivating the customer? And then on the long-term, obviously new processes, it sounds like are being put in place right now. What do you see is the most incremental driver to return to growth under the hood in terms of operations or logistics or processes? Thank you.

[Katrina Lake, Interim Chief Executive Officer]

Thanks Dana. Let’s see. So, on the first part, as we think about like, kind of what are we seeing on the customer side, we actually are seeing – we are seeing AOVs hold pretty strong. We are seeing AURs hold pretty strong. And I think in terms of what the customer is looking for, I think that’s really differentiated about our channel relative to others, it’s not necessarily price. It’s not necessarily, kind of finding the brand that you love. It is actually around fit. It’s about fit. It’s about style. It’s about finding things that you love. And in some cases, find things that you love that are surprising to you. And that’s something that really only our channel can deliver on. And that’s kind of how we are thinking about who the core customer is. And the good news is, I think there is a lot of that core customer. There is some data that we had that, like that men, most men and even half of women would characterize themselves as you know, not loving to shop. And there is not a lot of other retailers that are focusing on that customer. And Stitch Fix is one that really makes shopping more tenable and makes it easier. It helps people to look their best without spending a lot of effort to do it. And those are really differentiating qualities in our customer that we can build the right assortment to be able to deliver on. In terms of what’s most influential under the hood, I mean that’s a good question. But I mean really for me, I think the broad umbrella that really is focused. And it really is around focusing those marketing messages, focusing that conversion funnels, focusing on the inventory side. I think just really being able to focus on the things that we already know that we are able to deliver on that we have a business that’s 10-plus-years-old, that has a history of profitability delivering on this business to be able to focus back on the things that we know and know that we can deliver is kind of the core thesis. And I would say, there is rather than having one big thing. It’s probably a lot of little things like the ones that I mentioned around marketing and inventory. And I shouldn’t call them little things are really meaningful. And I think you could see that in the marketing numbers that we shared. But I feel optimistic by kind of what we have been able to see as we dig into the business and excited to be able to deliver more in the quarters to come.

[Dana Telsey, Telsey Advisory Group]

Thank you.

[Operator]

Thank you. Our next question comes from Mark Mahaney with Evercore ISI. You may proceed.

[Mark Mahaney, Evercore ISI]

Okay. Thanks. Two questions please. Katrina, you talked about marketing diversification into newer channels that have yet to scale. Can you provide more color on what those newer channels could be? And then secondly, I was wondering if I could just get to the comment on sort of macro trends. And I realized there is a lot of other factors going on here. You have got year-over-year revenue declines pretty consistent in Q1, Q2, Q3, and Q4. So, my sense is that maybe overall macro trends are soft, but kind of consistently soft. They are kind of lagging along at the bottom. But can you just comment on whether you think macro trends in the consumer macro – consumer demand trends, are the margins further softening, stabilizing or possibly recovering? And I know there is a lot of other factors going on, but I am wondering if you would just address that question. Thank you.

[Katrina Lake, Interim Chief Executive Officer]

Great. Thanks Mark. So, first on marketing diversification, I think it’s probably some of the obvious. But we have done some experimenting with TikTok that I think had some promise. We have done some experimenting in YouTube and trying to think about how does YouTube get into kind of our overall conversion funnel. And then actually returned to our organic is definitely a big place to. I think we have seen being able to use influencers, both I think well-known influencers, but also more of what you would call, like micro influencers be effective. And that’s definitely been a part of the history of Stitch Fix is, some of the very early years of growth of Stitch Fix were driven by that, by that kind of at the time was more bloggers, but more of those micro influencer categories. And so that’s another place that we are making sure we rebuild the muscle in. And in terms of macro, I mean I wish I had a crystal ball, and that I could tell you what’s happening from – what’s happening in our business, we see AUR and AOV actually be pretty stable. And so I think the places where we would expect to see macro headwinds would be probably around more conversion and customer acquisition. We have seen some successor as we shared in this last quarter. But I think that’s the place that you could anticipate that we – that there could be some headwinds. And then I think – and the other place is probably around just longer term, like fixed frequency or purchase frequency. And I think Dan shared that we have seen some softer cohorts. And I think we do believe that some of that is macro. But as I have said, I do – I am not willing to accept that it’s all macro, I do think that there are things that we can be doing better to be able to deliver on a better client experience that delivers more LTV. And so I don’t know, Dan, if you have any quantification to add, but I wish I could give you a solid answer on what to expect.

[Dan Jedda, Chief Financial Officer]

I don’t have anything to add. I completely agree with all of that. Specifically, on some of the macro, we talked about how we liked the trends we are seeing on gross adds, on the improvement, I think that’s a positive. But we are still seeing some elevated in actives. And that’s something that we are very focused on fixing with improvements in the client experience. And we do believe a lot of that of course, is macro related.

[Mark Mahaney, Evercore ISI]

Okay. Thanks Katrina. Thanks Dan.

[Dan Jedda, Chief Financial Officer]

Thanks Mark.

[Operator]

Thank you. Our next question comes from Aneesha Sherman with Bernstein. You may proceed.

[Aneesha Sherman, Bernstein]

Yes. Thank you for taking my question. So, continuing on the theme of the macro and the consumer demand behavior trend. Last quarter, you talked about the consumer being more judicious with their spending and frequency declines? It sounds like you have seen that again. Is the mix shift or higher demand for own brands over national brands? Do you think that is part of it? Do you think that’s – are you seeing the consumer sort of trade down a little bit to lower price points, rather than the national brands? And if so does that – how does that or does that change your national brand strategy that you have been talking about for the last few quarters on increasing your mix of national brands? And can you also talk about how that impacts gross margins, because I understand that your own brands are more profitable. Does that change your margin mix kind of looking into next year? Thanks.

[Katrina Lake, Interim Chief Executive Officer]

Great. That’s a great question Aneesha. I will answer the first part. And I know Dan is chomping at the bit to answer the gross margin part. But yes, I mean it’s, I don’t know if I would say that it’s necessarily mix shift that’s driven by macro. But I would say like, historically, it’s very interesting in our channel. Historically, national brands do not perform very well in fixes. And I do think fixes are a place where the apparel is kind of the most stripped down version of itself. And people are really looking at those fixes to say, does – is this my style, does this fit me well, and brand is like a very tertiary, kind of consideration beyond those. And so historically, we have actually not seen national brands performed very well in fixes. And so a lot of the intention around bringing national brands into the portfolio recently has been to support a better freestyle experience. And so as we have and I think candidly, like those brands haven’t performed as well, and the freestyle experience, although better than in the fixed experience. But I think longer term, the national brands will probably be a smaller part of our portfolio going forward is the way that they were historically respected. And I would actually really position that as a positive of being really a testament to our personalization. And at the end of the day, like even if it’s not a brand that somebody recognizes, if you are delivering jeans that fit someone, someone is going to buy them. So Dan, can speak more about on the gross margins side.

[Dan Jedda, Chief Financial Officer]

Yes. Just to follow-on to your second point on that question, what Kat is saying this idea that we really focus more on our exclusive brands and be tighter with national brands having less of that, that level of course, we think it’s the right client experience. And also what that does is, of course lead to higher margins simply because the private label and exclusive brands have higher product margins. When I mentioned earlier in the call that we see opportunity in gross margin, the first comment I made was in product margins. That is the big driver of product margins. So, as we get tighter with that, we do expect margins, it to positively impact margins. We do have some national brands that were so – inventory that we are still working through, although it’s not a huge number. And we will get through that and we feel very good of the impact. Our focus will be on product margins. It will also have the impact of making inventory more efficient, which is a huge positive to cashflow. So, we feel good about that strategy and how it will impact financials.

[Operator]

Thank you. Our next question comes from Noah Zatzkin with KeyBanc Capital Markets. You may proceed.

[Noah Zatzkin, KeyBanc Capital Markets]

Hi. Thanks for taking my question. It’s kind of along the lines of the macro questions. And maybe I will ask it slightly differently. With Stitch Fix traditionally being full price business, how would you kind of frame or how do you kind of think about parsing out the impact of the broader promotional environment in apparel and what that had on Stitch Fix over the last couple of quarters? And with others in the space, talking about inventory beginning to be right sized, or at least having line of sight, to more right sized inventory positioned, how are you thinking about potential upside in the model? Should the promotional environment begin to normalize over the next couple quarters? Thanks.

[Katrina Lake, Interim Chief Executive Officer]

Thanks Noah. Yes. That’s a good question. I mean Stitch Fix has been, I would say kind of oddly resilient to promotional periods. And I think we see some marginal impact, but not really as much as you would expect. And what we see is like, in the fixed experience, like first of all, I don’t think people are coming to Stitch Fix in order to find a deal. That’s not the primary intention. Of course, we need to do right price all the time. There is no question about that. But I would say that like people aren’t coming to our channel in order to get a deal. And so what that means is people are actually coming to our channel, because they want clothes that fit them, because they want to refresh their wardrobe, because they want things that are their style. And so as a result, I would say that, we see like AOVs and AURs are kind of held pretty strong. And so I would say that we see maybe less of what you would expect, in terms of like the highly promotional environment right now. But I would say my hypothesis is that it probably impacts conversion more where that there are probably going to be fewer people that as they are looking at their budgets and as they are looking at where they are going to spend fewer dollars that they might have in a bank account that like refreshing a wardrobe might not be as high priority as it might have been 10 months ago. And so I would say our hypothesis is that our existing clients that are in this ecosystem are relatively stable, like I think they are probably the headwinds a little bit on the customer acquisition side that hopefully, if things led-up, and as we see things turn up the other way that will alleviate and make things easier for us. But I would say that it’s a little bit of a unique proposition within Stitch Fix. That’s not a perfect analogy to the promotional environment that you see outside of our ecosystem.

[Dan Jedda, Chief Financial Officer]

I will pick the second part of that question, which I believe was a question on inventory. And I hope I am answering – I hope I am interpreting that correctly. But from the standpoint of where we see inventory going forward, related to the macro, and what we are seeing in our focus on our exclusive brands is, we do expect our inventory to be more efficient. When you look at our, the way we record turns externally, we have been as high as Fix turns in the past. And while that was pre-freestyle, we do believe that we are going to see improved efficiency in the back half of this year simply because we have taken our inventory down as we ended Q2 and we do not expect significant changes for it to increase, it may ebb and flow a little bit quarter-to-quarter. But we feel very good about the inventory efficiency and we expect on a net inventory basis to be back about four in each two.

[Noah Zatzkin, KeyBanc Capital Markets]

Thank you.

[Operator]

Thank you. And this concludes today’s conference call. Thank you for participating. You may now disconnect.