Earnings Call Transcript
Rent the Runway, Inc. (RENT)
Earnings Call Transcript - RENT Q2 2023
Operator, Operator
Hello, and welcome to Rent the Runway's Second Quarter 2023 Earnings Results Conference Call. As a reminder, this conference is being recorded. I'll now turn the call over to Rent the Runway General Counsel, Cara Schembri. Cara, please go ahead.
Cara Schembri, General Counsel
Good morning, everyone, and thanks for joining us to discuss Rent the Runway's second quarter 2023 results. Joining me today to discuss our results for the quarter ended July 31, 2023, are our CEO and Co-Founder, Jennifer Hyman, and CFO, Sid Thacker. During this call, we will make references to our Q2 '23 earnings presentation which can be found in the Events and Presentations section of our Investor Relations website. Before we begin, we would like to remind you that this call will include forward-looking statements. These statements include our future expectations regarding financial results, guidance and targets, market opportunities, and our growth. These statements are subject to various risks, uncertainties, and assumptions that could cause our actual results to differ materially. These risks, uncertainties, and assumptions are detailed in today's press release as well as our filings with the SEC, including our Form 10-Q that will be filed later today. We undertake no obligation to revise or update any forward-looking statements or information, except as required by law. During this call, we will also reference certain non-GAAP financial information. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Reconciliation of the GAAP to non-GAAP measures can be found in our press release slide presentation posted on our investor website and in our SEC filings. And with that, I'll turn it over to Jen.
Jennifer Hyman, CEO
Thanks, Cara, and thank you, everyone, for joining. I want to start by talking about our progress in Q2, starting with our strong bottom line performance and momentum towards profitability. We're pleased that we exceeded our Q2 profitability guidance by remaining disciplined; adjusted EBITDA margins had a historic high at 10.2% in Q2 driven by fulfillment efficiencies, strong gross margins, and fixed cost control. Notably, today, we announced that we have accelerated our plan to be free cash flow breakeven before cash interest expense for full year '24. For some time now, we've been focused on taking decisive actions aimed at bringing Rent the Runway to profitability. We believe now is the right time to accelerate our efforts. Our growth and improvement story starts with our cash, where we've made immense progress. We've transformed a business that consumed almost $100 million in cash in full year '22 to a business that will consume around $50 million in cash in full year '23 and will break even next year excluding cash interest expense. We believe that a key part of getting to profitability is also making decisive choices that prioritize the medium and long-term health of the business over short-term revenue gains and lower margin customers. Next, Q2 was the fifth consecutive quarter of positive adjusted EBITDA. We've made significant improvements over the past several years, reducing both our fixed and variable cost structure and growing our margins. Cost discipline continues to be firmly embedded in Rent the Runway's culture. Our '22 restructuring was clearly an important step, and we have continued to make progress in optimizing costs during the first half of full year '23. Our teams are continuing to examine our cost structure to assess additional steps we can take to remain agile, flexible, and able to achieve our profitability goals in a range of revenue scenarios. Moving to gross margins, we have continued to improve performance in our fulfillment operations and how we acquire inventory. Even as we changed our subscription programs to offer customers 25% more value in every shipment in Q1, our fulfillment costs have improved primarily by focusing on labor productivity and transportation efficiencies. The strength of our inventory expense reflects the continued impact of product acquisition mix changes towards more efficient channels. Lastly, I want to acknowledge our Q2 miss on revenue. We had a slight revenue miss due to a lower-than-expected active subscriber count primarily driven by lower early term subscriber retention, which we believe is attributed to inventory debt levels that were too low. Reserve, our one-time event rental business, also declined year-over-year which we believe was the result of greater focus on subscription in our marketing efforts and on our site as we discussed last quarter. Our goal is to drive this business to free cash flow profitability, excluding cash interest expense, next year. To do so, we are making deliberate choices that we anticipate will negatively impact short-term revenue and subscriber count. We plan to be less promotional and focus more on rebuilding our high-margin reserve business. We also plan to pull back on marketing spend to prioritize inventory in-stock rate. Above all, we're empowering our leaders to make the right choices to drive profitability. We do not waver from our long-term belief in the enormous market opportunity for rental. As a result, we are focused on creating a sustainable business so that we can control our own destiny and capture as much of the large and growing market as possible over the upcoming years. Before I discuss the positive improvements we've made to the customer experience in the first half, I want to discuss what we believe are the two biggest challenges we had: lower inventory depth than needed and a softer reserve business. We learned a lot in Q2 about the criticality of inventory depth to the customer experience. We started Q2 with a record number of subscribers and on the heels of our extra item plans launched in April. While we had enough inventory overall to serve our customer base during the quarter, we did not have enough depth in new styles, and as a result, our in-season in-stock rates were down 17% versus Q2 last year. We have data indicating that an inventory depth issue was the primary driver of lower early term subscriber retention and therefore, lower active subscriber count. To take a step back, we fully transitioned from our unlimited swap program to fixed swap plans in 2021, and 2022 was our first year of operating these programs in a more normalized environment where customers were going to offices and out to events again. In 2022, we revamped success metrics for inventory in fixed swap programs, shifted our go-forward strategy away from a breadth strategy to focus on a depth strategy, and established inventory availability as one of our key strategic pillars for 2023. The most important component of this strategy is greater investment in depth of styles and brands. We know she wants to be in stock more of the time. Given the nature of a six-month fashion buying cycle, we were able to implement our learnings from 2022 and impact our Q3 and Q4 2023 buys with higher depth, which is now coming to life in our fall 2023 assortment. As we've shared previously, we expected that the customer impact would begin to be felt on this timeline, which was key in informing our original back half-weighted growth expectations for full year '23. However, we believe that the lag between the time of the buy and going live on-site impacted the customer experience more than we expected in Q2, particularly for new customers, given the high growth we experienced in Q1. In a fashion rental business, availability changes moment to moment, and we have observed that new customers are more likely to be disappointed by lower in-stock rates because they expect to see the items they got excited about while browsing as prospects. Retention of tenured customers continues to be strong because they understand that when they don't see something they've rented one day, they're confident they'll be able to rent it soon. We believe that this issue is temporary in nature. Depths of our 2H 2023 buy are expected to be approximately 1.7x the depth of our 1H '23 buy, which would increase our in-stock rate by 700 basis points to 1,000 basis points. We have acquired even higher depth in our most popular brands and in key items we are confident our customers will want this fall and winter. Functionally, we expect this will be felt by customers throughout the second half of Q3 as they refresh their fall wardrobe and into Q4. We anticipate that this will result in a meaningfully better customer experience and improve retention in the near to midterm. While 2H depth will be a huge improvement over 1H, customer behavior in Q2 illuminated that we should go even further on our depth strategy. To that end, we have further expanded our depth plans for '24. We expect that we will see continued improvement on in-stock in the first half of 2024 as a result of this. The nature of our business model dictates that any significant transition in inventory strategy must be done in multiple phases, given that we monetize inventory over multiple years and it stays in our rental ecosystem for multiple seasons. To be clear, while we have made significant improvements already, we expect the lion's share of the positive impact of our depth strategy and therefore, the positive impact on revenue and subscriber growth to be in 2024 when significantly more of our inventory tranches have appropriate depth. Our data thus far indicates that we should see loyalty gains from all customers with the greatest gains coming from early term customers. For Reserve, we believe we have great opportunities here. Our one-time rental business is what we launched this business with 15 years ago. It's the easiest value proposition for customers to understand as every woman finds herself having to buy outfits every year for events she really wears to. We've made three exciting changes to our reserve business over the past quarter. Last month, we debuted a distinct product experience for Reserve, which separates the reserve funnel from the subscription funnel. This is intended to make it easier for customers to understand the reserve value proposition of locking in a look in advance and getting the second size for free. It also clarifies how the pricing compares to subscription. Second, we started acquiring distinct inventory for the reserve business, mostly on consignment, focused on premier designers who elevate our reserve assortment. Finally, we've shifted our org design to add new leadership focus on reserve, intended to ensure we can grow both this business and subscription side by side. We believe that the appetite for rental at large is big enough that both of these offerings can grow, and we expect this change to the funnel to benefit both reserve and subscription from a conversion standpoint over time. Beyond our inventory depth strategies and focus on improving reserves, the teams have continued their work across our other strategic pillars: the efficient and easy-to-use experience, and best-in-class product discovery, and have been successful in the first half of 2023 at markedly improving our overall customer experience. We believe we'll see more of the full retentive impact of these changes to customer experience and discovery when the in-stock rates are higher. Let me share a few of those initiatives here. Related to our pillar on efficient and easy-to-use experience, we've seen early success with our SMS-based concierge program that is leading to improvements in loyalty among those who sign up. Concierge has already accelerated our learnings from early term customers and priority areas to improve their experience. Given its success, we plan to continue to invest in concierge in full year '23 through expanding this program to more customers across more terms. Yesterday, we launched a new subscriber onboarding experience based on our learnings from concierge to help lead them to inventory they love quickly and pick their first shipment. This also includes the creation of an interactive customer filing profile and encourages sign-up into our concierge program to aid with live one-on-one assistance. Finally, we continue to drive major improvements in site performance and reliability, improving Lighthouse scores of key acquisition pages by 50% year-over-year. A Lighthouse score is the rating Google gives to websites based on a combination of criteria, including performance, accessibility, SEO, and other best practices. Related to best-in-class product discovery, we introduced multiple improvements during the quarter, which have driven reductions in time to select shipments for our customers. We achieved this by one, launching a fully redesigned app product detail page experience that features more detailed larger product images, clearly displayed fitted advice, and makes the availability of that item more obvious to the customer. Two, we're elevating the look and feel of our brand in sight across all touch points from photography to design and creative, which is intended to ensure that our premium positioning is clear to our customers and brand partners. Three, we created more visibility for editorial durations throughout our site and accelerated our schedules for refreshing them. We've seen high engagement with our editorial suggestions. Four, we improved filters, making it easier for customers to search with specificity. And finally, we rolled out our AI search beta to 20% of our customer base. We are using this data to gather user feedback and iterate on the best and quickest way to search our catalog. I firmly believe that we are making the right decisions for customers and that our customers will reward our product improvements, additional items, and improved experience with inventory. I'm excited about our plans for the remainder of full year '23 and into full year '24. Most importantly, we are excited to drive this business to free cash flow profitability, excluding cash interest. With that, I'll hand it over to Sid.
Sid Thacker, CFO
Thanks, Jen, and thanks again, everyone, for joining us. Prior to reviewing second quarter results, I would like to provide some perspectives on the significant acceleration in our timelines of free cash flow breakeven before cash interest expense. While the inventory debt issue that Jen just described is expected to affect revenue growth negatively this year, we continue on our steady path to providing more value and a better experience for our customers. We're confident that with a favorable market backdrop, these improvements will translate to stronger revenue growth. Importantly, slower revenue growth will not mean slower progress on profitability for Rent the Runway. In fact, as Jen outlined earlier, one reason for our reduction in revenue guidance for fiscal '23 is our decision to prioritize more rapid progress on profitability by reducing promotions and therefore, subscriber acquisition. Over the past few quarters, we have made significant changes to our fixed cost structure, improved our variable cost structure by finding efficiencies across fulfillment and product costs, and fundamentally changed how we approach promotions and customer acquisitions. On account of these changes, we now expect to be free cash flow breakeven before cash interest expense for fiscal year 2024. This relies on only modest levels of subscriber growth in fiscal '24. We plan to provide more details later this fiscal year, but we expect these results at subscriber levels that are much lower than our previously communicated level of 185,000 subscribers. Free cash flow breakeven before cash interest expense is an important milestone for Rent the Runway and one that we think will demonstrate the attractive underlying economics of the business, our focus on profitability, and the progress our teams have made on improving efficiency throughout our business. Let me now provide commentary on second quarter results and guidance for 2023. We ended Q2 with 137,566 ending active subscribers, up 10.8% year-over-year. Average active subscribers during the quarter were 141,393 versus 129,565 subscribers in the prior year, an increase of 9.1%. The ending active subscribers declined from 145,220 subscribers at the end of Q1 2023, which we believe is primarily due to inventory depth. Active subscriber levels were also affected by promotional experiments during the quarter. Total revenue for the quarter was $75.7 million, down 1% year-over-year. The shortfall versus guidance was primarily driven by lower-than-expected subscriber growth. Subscription and reserve rental revenue was $68 million versus $70 million last year, a decrease of 2.9%. This revenue was negatively impacted by a decline in our reserve business versus last year. Revenue per average subscriber for the quarter was negatively impacted by lower add-on rates, changes in subscriber program mix, and promotional testing. During the quarter, we tested the effects of both increasing and reducing promotions. Our learnings from these tests have informed our go-forward promotional strategy and revenue guidance for the remainder of the year. Other revenue was $7.7 million, an increase of 18.5% versus $6.5 million last year. Other revenue represented 10.2% of revenue during the quarter versus 8.5% of revenue last year. Fulfillment costs were $22.5 million in Q2 '23 versus $23.4 million in Q2 '22. Fulfillment costs as a percentage of revenue improved to 29.7% in Q2 '23 from 30.6% in Q2 '22. Fulfillment costs as a percentage of sales benefited from continued processing and transportation cost efficiencies. In August, we entered into a new transportation agreement with UPS to lock in competitive rates and consolidate the vast majority of our shipping needs while continuing to serve our customers with premium delivery and return service. Gross margins were 43.9% in Q2 '23 versus 42.4% in Q2 '22. Q2 '23 gross margins reflect both the aforementioned fulfillment cost improvements and lower rental product depreciation due to our ongoing progress in procuring more consignments and exclusive design inventory. As expected, gross margin improved sequentially due to seasonally lower product acquisition costs compared to Q1 '23. Operating expenses were about 12% lower year-over-year, primarily due to the favorable impact of our 2022 restructuring plan. Total operating expenses, including technology, marketing, G&A, and stock-based compensation were about 62% of revenue versus approximately 70% of revenue last year. Adjusted EBITDA for the quarter was $7.7 million or 10.2% of revenue versus $1.8 million and 2.4% of revenue in the prior year. Adjusted EBITDA margins reflect improved operating and fixed cost efficiencies along with lower promotions. Free cash flow for the six months ended July 31, 2023, was negative $30 million versus negative $54 million for the same period in fiscal '22. Let me now turn to Q3 and 2023 guidance. We are reducing revenue guidance for 2023 and now expect that 2023 revenue will be at least $296.4 million, down from our fiscal 2022 revenue. We expect Q3 revenue to be between $72 million and $74 million. We are not providing specific active subscriber guidance for Q3 or fiscal year '23 as our general expectations are reflected within our revenue guidance. We no longer expect ending active subscriber growth of more than 25% for fiscal '23. Let me outline the rationale and underlying assumptions behind our lower fiscal '23 revenue guidance. First, after our experimentation with promotions in Q2, we expect to be significantly less promotional for the remainder of the year. While we believe a lower level of promotions will improve customer experience, retention, and profitability over time, we expect lower subscriber acquisitions in the near term. Second, revenue guidance reflects the timing of inventory in-stock improvements that we believe will impact customer experience toward the end of Q3 and into fiscal '24. Third, we are not reflecting all potential improvements from our strategic pillar initiatives to improve customer experience or from an increased focus on new leadership and more optimal inventory for our reserve business. As we saw in Q2, inventory in-stock rates have to improve before we see the positive impacts from these initiatives. Finally, we ended Q2 with lower-than-expected active subscribers. We believe our second half plan, despite the expected negative impact on short-term subscriber growth, is a key pillar to our path to positive free cash flow and strengthen the health of the business. Our guidance also provides business leaders with the flexibility needed to make the right decisions for the long-term health of our business. Despite lower revenue, we expect to maintain our adjusted EBITDA margin guidance of between 7% to 8% of revenue for fiscal 2023. Note that due to significantly higher seasonal inventory acquisition costs in Q3, we expect higher adjusted EBITDA margins in Q4 versus Q3. We expect Q3 adjusted EBITDA margins to be between 3% and 4%, primarily as a result of approximately 300 basis points of sales in higher revenue share payments in Q3 versus Q4. We expect continued operational and fixed cost efficiencies along with lower promotions in the back half of 2023. Note that our expectations for adjusted EBITDA margins reflect lower gross margins in the second half of 2023 compared to fiscal 2022 on account of higher rental product depreciation and revenue share costs as a percentage of sales. We now expect fiscal year '23 rental product purchases to be between $74 million and $77 million as we expect to shift dollars between marketing and rental product acquisition to further improve in-stock levels. As a result, we expect cash consumption for the year to be approximately $2 million to $3 million higher in the range of $50 million to $53 million. While Q2 was challenging, we have transformed—we are confident we continue to make the right decisions for our customers. Financially, we have transformed a business that consumes almost $100 million in cash in fiscal '22 to a business that we expect will be free cash flow breakeven before cash interest expense in fiscal year '24. We will now take your questions.
Operator, Operator
Our first question today is from Rick Patel at Raymond James. Your line is now live.
Rick Patel, Analyst
Thank you. Good morning, everyone. Can you talk about the assumptions underpinning the third quarter revenue guidance as you reduce promotions and marketing? What's the right way to think about the driver count in the quarter? I know you're planning for it to be lower, but just any guardrails there as we think about modeling? And if you can—rate trends, that would be great.
Sid Thacker, CFO
Sure. So if you look at our subscriber guidance, we're obviously not providing specific subscriber guidance for Q3. But if you look at our $72 million to $74 million revenue guidance, that is obviously down from Q2 levels. You can run your math, but that will imply a subscriber count that you can determine. Now what I want to do is try and give you a sense of the changes we're making and why we're issuing the guidance that we are. We're making a lot of changes to promotions for the year. And just to give you a sense of the magnitude of what we have decided to do. Historically, our promotions have been two months long; the current level of promotions that we're running is essentially only one month. So we have made very significant changes in promotions. And importantly, these promotional changes form a very key part of our progress to profitability in fiscal '24. We're changing a significant amount related to the reserve funnel, so our guidance encompasses a whole range of scenarios. We want to be prudent and not factor in all the benefits of improved in-stock, the reserve funnel. That's the underlying premise behind the guidance: we want to be prudent and ensure that we factor in all possible scenarios, and we want to be mindful that it's going to take a little while for in-stock levels to improve and to be felt by our customers. Some of the initiatives that we have may not be quite felt until in-stock improves.
Rick Patel, Analyst
Can you also touch on marketing? I believe you talked about pulling back a little bit on the near term, but then you also talked about shifting some of that focus to reserve revenue. Just some additional color there would be great.
Jennifer Hyman, CEO
Yes. We really learned in Q2 just the criticality of inventory depth to the customer experience, especially among early term customers. Because we learned that while depth is up in the second half, 1.7x what the depth was in the first half, we should have gone even further than 1.7x. We felt it was wise to take some dollars away from marketing and put it towards reorders in the back half of this year that could further accelerate in-stock rate. Another way to think about this is we don't want to market or promotionalize into an experience with inappropriate levels of in-stock rates because early term subscribers are the ones affected most by not seeing the inventory that they wanted when they were prospects. This is really in favor of the top priority, which is getting the in-stock rates higher, which we know positively affects the retention of early-term subscribers.
Rick Patel, Analyst
Thanks very much.
Operator, Operator
Thank you. Next question is coming from Ike Burochow from Wells Fargo. Your line is now live.
Ike Burochow, Analyst
Hi. Good morning. So a couple of questions around the longer-term commentary you provided. So the free cash flow breakeven before interest expense in fiscal '24, can you just give a reminder of what is the expectation for cash interest expense? What is that going to be in fiscal '24? And then is there any help you can give us around what is the revenue number that is associated with that assumption that you guys have next year? Thanks.
Sid Thacker, CFO
Sure. So let me answer the first part of your question, which is about $12 million in cash interest expense in fiscal '24. But let me address what gives us confidence that we'll get the free cash flow breakeven in fiscal '24. There are a few key pillars here. First, we expect both efficiencies versus fiscal '23. Secondly, we expect lower fixed costs versus fiscal '23 in fiscal '24. Third, and this is where the promotions and all of the customer acquisition work we're doing plays in, we expect rental product spending in fiscal '24 to benefit from provisioning for much more modest levels of revenue growth as well as continued increases in mix towards more non-wholesale channels. It's important to realize that when we promote and acquire customers, not only do we acquire a bunch of customers that stay with us for a shorter period of time because they're less qualified, but we also go out and provision inventory for those customers. So in some ways, as we attract and focus on higher qualified customers, we accelerate our progress towards free cash flow, which will be reflected in rental product spending in fiscal '24 versus '23. Fourth, the promotional changes do result in improved profitability per subscriber. Finally, we expect the modest subscriber and revenue growth that we expect in fiscal '24 to contribute to profitability and cash flow. A substantial portion of the improvement, if you think about lower fixed costs, fulfillment cost efficiencies, and the plans we have on rental products, are decisions that we have made and improvements we have already implemented, giving us high confidence in our projections.
Ike Burochow, Analyst
Great. Thanks a lot.
Operator, Operator
Thank you. The next question is coming from Andrew Boone from JMP Securities. Your line is now live.
Andrew Boone, Analyst
Good morning. And thanks for taking my questions. Jen, you guys made a number of improvements to products. Can you just talk about getting customers past that 90-day threshold? Are you seeing any improvement there? How do we think about new customers' ability to turn them into long-term customers?
Jennifer Hyman, CEO
Yes. In Q2, fundamentally, we saw that the improvements we were making to the customer experience were not going to be felt deeply until the in-stock rates were higher. For early term subscribers, they come in expecting to see the inventory they signed up for. If they don't see that inventory, they have a much higher probability of churn. The retention of longer-term customers remains strong. They responded very well to the customer experience improvements we were making; however, we found that in-stock has to improve and be at a better level before these improvements will start to impact those early term customers. We still have a lot of confidence that we're making the right changes for early term customers. For example, we mentioned that those who sign up for our concierge program exhibit higher loyalty rates than those who don't sign up, and those are T-0 customers. The in-stock rates are being improved to raise retention rates significantly, resulting in a positive increase in customer experience.
Andrew Boone, Analyst
And then as we get further away from the launch of the era of Extra, can you talk about just top-of-funnel trends? What are you guys seeing now versus, say, last year? How does top of funnel relate? And how are you thinking about top funnel now that you're pulling that marketing for the back half of this year and potentially into '24? Thanks so much.
Jennifer Hyman, CEO
Yes. Top of funnel continues to be strong. We continue to see very high interest for subscription and our reserve offering; we feel that the market is growing. That's why it's so critical for us to offer an experience that continues to improve. Over 80% of our acquisitions come in through word-of-mouth, so improving the in-stock rate is vital for enhancing the experience of early-term customers, which we believe will aid in organic growth. By removing some marketing dollars, we also prevent marketing into an experience where the in-stock rate isn't satisfactory. So we feel good about top of funnel, and we believe the market continues to grow, making the necessary changes for the medium and long-term health of this business to drive profitability.
Sid Thacker, CFO
Yes. It's useful to provide context. We're changing our promotional strategy, and it's helpful to reiterate how we're thinking about this business. One way to grow is by acquiring tons of customers—that would result in high subscriber growth and revenue growth, but we have to provision significant amounts of inventory for these customers, which is less efficient. We're focusing on ensuring we improve the quality of acquisitions coming in, making the product acquisition more efficient for those qualified customers, and delivering the best experience possible. If we do all of these things right, the feedback loop given that 80% of our customers come to us organically will drive additional organic acquisitions in a more efficient way. Companies that reconsider their growth strategies and focus on improving business fundamentals often emerge stronger.
Jennifer Hyman, CEO
I want to add to what Sid said, which is that we have one pool of inventory. If we promotionalize lower-margin customers, not only do we provision extra inventory for them, but they may very well take the best inventory away from our more loyal, higher-margin customers. So we are prioritizing our higher-margin customers, our overall customer experience, and we do not want to market into lower-margin customers who grab prime inventory.
Andrew Boone, Analyst
Thank you.
Operator, Operator
Thank you. Next question today is coming from Ross Sandler from Barclays. Your line is now live.
Ross Sandler, Analyst
Just one for Jen and one for Sid. Jen, so on this new customer retention, is there precedent looking back at different times in the past when you had better depth of inventory for in-season? How far off is the retention rate today versus back then? Is it a matter of a couple of quarters? Or is it going to take longer than that? And then, Sid, you talked about reducing fixed costs and also some variable costs in fulfillment. Can you just elaborate on both of those? Is it the UPS deal that's allowing better fulfillment leverage or walk us through those assumptions for '24? Thanks a lot.
Sid Thacker, CFO
So let's start with focus and expenses. It's twofold, right? First, there is an impact from the UPS contract that will be felt in the back half of this year and into next year. The second thing is if you look at what we have historically done, we've continually improved our ability to process units with the same labor pool. We expect to continue progress on efficiencies, and we have specific initiatives that we're working on to impact fiscal '24. In terms of fixed costs, our teams have reviewed—we're reviewing our cost structure to ensure that we achieve free cash flow breakeven in fiscal '24 under various sales scenarios and will take the right actions to ensure that happens.
Jennifer Hyman, CEO
Regarding the in-stock rate, I want to clarify that it is already improving, between 700 and 1,000 basis points in the second half of the year. When will customers notice that? We believe the impact will be felt towards the end of Q3 and into Q4 when all that inventory is operational and circulating among our customers. We're also making further improvements for '24 to significantly increase the in-stock rate. Across all of our categories, we will have less breadth and more depth, focusing on vital brands and categories that provide significant value to our customers.
Nathan Feather, Analyst
Hi, good morning, everyone. This is Nathan Feather on for Lauren. So first off, just thinking about increasing depth in the platform, to what extent does that impact your ability to shift away from wholesale there, either faster or slower?
Jennifer Hyman, CEO
Increasing depth is fantastic for us from an inventory acquisition standpoint, whether it's via wholesale, consignment, or exclusive design. When you buy items at higher depth, you receive higher discounts, whether manufacturing, buying from a brand, or acquiring them on consignment. A depth strategy is financially beneficial, so we see no difficulties in getting there. The challenge lies in monetizing inventory over multiple years; thus, making changes for inventory strategies is a gradual process, explaining why we expect to see more significant impacts in 2024.
Nathan Feather, Analyst
Okay, great. That's helpful. Then for the changes in marketing, is that just a temporary pullback until in-stock rates improve? Or should we expect lower marketing over the medium term? And how to think about those updates to the long-term strategy on the marketing side? Thanks.
Sid Thacker, CFO
At this moment, we're focused only on the decisions we've announced for the back half of fiscal '23. We haven't made any specific plans or sharing plans for fiscal '24. I want to emphasize that we haven't seen any changes in the effectiveness or efficiency of our marketing. We believe our marketing is strong, showing high LTV to CAC ratios. We can grow our business in two ways: acquiring more customers or improving the experience for our customers, positively affecting retention.
Operator, Operator
Thank you. Next question is coming from Edward Yruma from Piper Sandler. Your line is now live.
Edward Yruma, Analyst
Hi, guys. Thanks for taking the questions today. I guess, first, just given the materiality of the shortfall, just maybe get a little more comfortable on why exactly you think it was inventory depth that was the primary culprit and why this isn't just a macro issue? And then maybe more of a follow-up on Ross' question. So like—and maybe this isn't a great analog, but when someone churns off because of inventory availability, what do you have to do to get them to turn back on again? What's your experience been there? And when would we expect you to run that play as those inventory levels normalize? Thank you.
Jennifer Hyman, CEO
When we analyzed what happened in Q2, we observed very different outcomes among early-term subscribers and among subscribers who had been with us for over 90 days. The impact of in-stock rate fundamentally varied. We found strong retention amongst tenured customers, while we observed that the decline in the in-stock rate adversely affected churn rates among early-term subscribers, which increased year-over-year. If it were an overall macro issue, all customer cohorts would experience a decline. Since we isolated our issue in Q2 specifically to early term churn, that tells us it's primarily inventory depth-driven.
Sid Thacker, CFO
We acquire new customers every month, and those customers will choose to stay based on whether they have a great experience, can find the inventory they love, and whether that inventory is in stock. The way we can positively affect this is by providing those customers who stay with us with a much better experience. Improving this experience then drives organic growth as customers spread the word. We have a good track record of reacquiring former customers, which we find rewarding as they see our continuing improvements.
Jennifer Hyman, CEO
Historically, our retention has been strong among reactivated customers. The primary reason for this is that customers see our experience is continuously improving. Additionally, we benefit greatly from word of mouth. As we initiate positive changes, those who churned will perceive these improvements, enhancing their inclination to return. We're confident that our actions to improve in-stock depth will lead to a significant uptick in rejoin rates and that we will see a positive response from customers based on our brand reputation and service.
Edward Yruma, Analyst
Great. Thank you.
Operator, Operator
Thank you. Next question is coming from Ashley Helgans from Jefferies. Your line is now live.
Unidentified Analyst, Analyst
Hi, good morning. It's Blake on for Ashley. Several questions have been answered. I wanted to ask on just a couple of clarifying questions. On the lower expectations this year versus prior, it seems like the two big buckets are the lower promos you discussed? And then lower inventory availability. Just wanted to make sure those are kind of the two big items. We're not missing any others. And then could you rank or just discuss the magnitude of each of those impacts?
Sid Thacker, CFO
Yes, you have the two big items here. We're not disclosing the exact magnitude of these impacts, but both are really important. We expect to make significant progress on the inventory in-stock rate into Q3 and Q4 and into 2024. Our guidance and subscriber expectations reflect the possibility that these improvements may take some time to build, and we're being prudent about that.
Unidentified Analyst, Analyst
Got it. And then in terms of the impact to subs from lower promotions, I would guess that's mainly impacting the acquisition of new customers. Wondering about that impact to acquiring new customers versus churn from existing?
Jennifer Hyman, CEO
I mean, promotions don't really have an impact at all on churn from existing customers because promotions are given to new customers to join.
Sid Thacker, CFO
We believe that attracting more qualified customers will lead to improved churn rates for our subscribers. Acquiring customers effectively reduces the churn, so we should see long-term retention benefits overall.
Unidentified Analyst, Analyst
Okay. So maybe when a customer renews, you're not seeing them—the impact from a renewal isn't as big right now if they're renewing at a lower promotion rate. Would that impact like a renewal customer?
Sid Thacker, CFO
We acquire all our customers, whether new customers or rejoining customers, through a very similar set of promotions. It's affecting all aspects of our subscriber acquisition.
Unidentified Analyst, Analyst
Okay. That makes sense. Thanks so much.
Operator, Operator
Thank you. Next question today is coming from Dana Telsey from Telsey Advisory Group. Your line is now live.
Dana Telsey, Analyst
Hi. Good morning, everyone. Given the in-stock position and the improvement that’s expected in the back half of the year, particularly in the fourth quarter, what are you seeing from your existing customers, the cohort of your best customers? And how are they impacted by this? And have you seen any update on churn? And lastly, as you think about the categories, what categories are performing? And is the in-stock shortage across all categories? Thank you.
Jennifer Hyman, CEO
We continue to see strong loyalty rates amongst our tenured subscribers. Across the board, we don't believe the depths were high enough in any category. We're being smart about how we increase our depth strategy where it's not a one-size-fits-all approach. We do think across the board, we should have less breadth and more depth, but we're taking into account the most important brands that provide significant value to our customers, and the categories that provide the most value to our customers are being elevated. In terms of something that we are excited about, we are seeing an increase in return to work. Workwear is currently as strong as it was in 2019, which is great for the business since it's something people do five days a week.
Dana Telsey, Analyst
And then just following up with the in-stock position, was it more a macro situation with the brand? Was it more your planning? What led to the shortage of the in-stock position?
Jennifer Hyman, CEO
I think that 2022 was the first year we had these fixed swap programs in a more normalized environment, as people started going back to work and events. That's when we really started using new investment inventory metrics. In-stock became critically important, leading us to place inventory availability as one of our top strategic pillars for this year. Even before '23, we knew in-stock levels were critical. By increasing depth 1.7x in the latter half of the year against the first half, we're building a robust framework. We knew these would be vital to our success in the second half this year. However, we learned in Q2 that we could have gone further than this to achieve our planned levels.
Dana Telsey, Analyst
Thank you.
Operator, Operator
Thank you. Next question is coming from Eric Sheridan from Goldman Sachs. Your line is now live.
Eric Sheridan, Analyst
Thanks. Maybe just one. As you move from this inventory strategy from breadth to depth, how should we think about product segmentation or product messaging to ensure that the idea of inventory depth results in the subscriber acquisition you're looking for on the other side of the inventory issue? Could this lead to new product iteration, product segmentation? Or is it more about executing on the inventory depth and then turning on the subscriber acquisition dynamic again to get back to more normalized growth? Thanks so much.
Jennifer Hyman, CEO
Having styles with greater depth impacts retention rather than acquiring new customers. When a customer browses our entire catalog as a prospect, they sign up and see the available inventory, where the in-stock changes daily. The higher our depths, the more likely those desired styles will be available. We have data showing that this positively impacts early-term subscriber retention. We must prioritize enhancing in-stock levels and aligning our growth strategies, trusting the improvements will boost retention rates in the long run.
Sid Thacker, CFO
I want to reiterate that the most crucial aspect is to improve the customer experience, as 80% of our customers come organically. Improving experience drives advocacy, which should result in new customer growth. The results from improved in-stock will enhance organic customer acquisition, and we believe this will lead to significant awareness of the better experience we provide to attract new subscribers.
Eric Sheridan, Analyst
Thank you.
Operator, Operator
Thank you. We reach the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.
Jennifer Hyman, CEO
Thanks for joining us today, and I look forward to chatting more in the weeks to come.
Sid Thacker, CFO
Thank you.
Operator, Operator
Thank you. That concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.