FIGS, Inc. (NYSE:FIGS) Q3 2023 Earnings Call Transcript

FIGS, Inc. (NYSE:FIGS) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Good afternoon. Thank you for attending today’s FIGS Third Quarter Fiscal 2023 Earnings Conference Call. My name is Cole and I will be the moderator for today’s call. [Operator Instructions] I would now like to pass the conference over to our host, Jean Fontana. Please go ahead.

Jean Fontana: Thank you. Good afternoon and thank you for joining today’s call to discuss FIGS third quarter 2023 results, which we released this afternoon and can be found in our earnings press release and in the stockholder presentation posted to our Investor Relations website at ir.wearfigs.com. Presenting on today’s call are Trina Spear, our Co-Founder and Chief Executive Officer and Daniella Turenshine, our Chief Financial Officer. As a reminder, remarks on this call that do not concern past events are forward-looking statements. These may include predictions, expectations or estimates, including about future financial performance, market opportunity, or business plans. Forward-looking statements involve risks and uncertainties, and actual results could differ materially.

These and other risks are discussed in our SEC filings, including in the 10-Q we filed today, which we encourage you to review. Do not place undue reliance on forward-looking statements, which speak only as of today which we undertake no obligation to update. Finally, we will discuss certain non-GAAP metrics and key performance indicators, which we believe are useful supplemental measures for understanding our business. Definitions and reconciliations of these non-GAAP measures to the most comparable GAAP measures are included in the stockholder presentation issued today. Now, I’d like to turn the call over to Trina Spear, Chief Executive Officer of FIGS.

Trina Spear: Thanks, Jean. Good afternoon, everyone. Thank you for joining us for our third quarter 2023 conference call. We were very pleased to have delivered better-than-expected net revenues and adjusted EBITDA margin for the third quarter. I would like to thank our entire FIGS team for their hard work as well as their devotion to our healthcare community. Touching on some highlights from the quarter. Net revenues grew 11% compared to the prior year period, driven primarily by nearly 20% growth in active customers with another record number of new customers added in the third quarter. Beyond the market share gains we are driving in the United States, we are building demand internationally with record growth of 81%. We are replicating the powerful word of mouth dynamics that we fueled in the U.S. over the last decade.

Within teams, our B2B business, we saw strong performance with a growing number of institutions coming to FIGS to professionalize their organization. We also continue to make meaningful progress in normalizing inventory levels, which declined 15% compared to the third quarter of last year. Looking at profitability, we delivered an adjusted EBITDA margin of 17.2% ahead of our expectations and generated free cash flow of $46 million for the third quarter. Our third quarter performance underscores our ability to deliver on our objectives and as a result, we are raising our full year net revenue and adjusted EBITDA margin guidance, which Daniella will speak to shortly. Turning to our business highlights. As we execute our strategic priorities, we remain committed to our mission of serving those who serve others.

Everything we do is centered around the healthcare community, from the product innovation we bring to bear, to our compelling marketing campaigns to an inspiring ambassadors we partner with, to our work around advocacy. Product innovation for FIGS is above all about solving the real world problems for the healthcare community with premium product that offers supreme functionality, comfort and style. Our customer first approach to product attracts new healthcare professionals to our brand and drives loyalty amongst our existing customers, demonstrated by the fact that repeat customers continue to generate roughly 70% of our net revenues. Our merchandizing strategy is to build a product assortment that not only stands alone but can be match backed to our core scrubs offering to create a complete layering system.

We leverage customer insights to bring new product across our categories. These are limited edition styles that create a flywheel effect that drives both excitement and traffic, whereby customers buy these new styles in addition to replenishing their core. During the third quarter, for example, we introduced our Natal Scrub Tops and Lesage Scrub Jogger with a feminine twist while maintaining maximum movement and utility. We also launched our first wide leg pant, the high-waisted Yendi Cargo Scrub Pant. The success of these limited-edition style drops matched back with our core scrub styles and reflects our ability to deliver a consistent stream of newness that our customers want. Another area of strength is in collaboration. We seek partnerships with brands that are leaders in their industries, have similar values to FIGS and complement our own core capabilities.

We have talked in the past about our New Balance partnership, where we continue to see tremendous growth in footwear intentionally designed for healthcare professionals. Most recently, we collaborated with Eko, a leading digital health company that is advancing how healthcare professionals detect and monitor heart and lung disease. We launched the co-branded CORE 500 digital stethoscope that was supported by our campaign, innovation you can hear, which exemplified how we create powerful storytelling that captures the attention of our community. Turning to building and deepening engagement with our community, our marketing strategy reflects a combination of engaging campaigns with creative storytelling, segmentation strategies that align our content to our channels, to our audience, and personalized messaging based on our deep understanding of our customers.

The efficiency of our marketing engine enables us to reinvest dollars into top-of-funnel strategies, which help to drive another record number of new customers in the third quarter. As part of our new customer acquisition efforts, we are engaging students who have long purchased cycles as they are just entering their 30 plus year career. We are creating local on-campus experiences with customized products for each school with colors and embroidery. We are also leveraging the team’s platform in order to become the exclusive provider to universities and associations. These efforts led to a new partnership with Veterinary Business Management Association, a student organization spanning 38 universities. We also maintain a strong connection with our community by delivering campaigns that highlight awesome humans, new technical innovation and cultural moments that drive heightened excitement and a call to action.

For Breast Cancer Awareness Month, we teamed up with F cancer on a mission to prevent, detect, and unite. We donated $50,000 to this organization to advance health equity through education, community clinics, and screening. Some of our greatest moments with the healthcare community come through our advocacy beyond the products we deliver. The way we utilize our platform to stand up for their rights and their well-being without hesitation is what generates such intense loyalty to our brand. This quarter, during the largest strike of healthcare workers in U.S. history, we spoke out in support of higher pay, safe working conditions, and sustainable patient loads. All core tenets of our Awesome Humans Bill. Our Instagram post generated some of our highest engagement over the past year, and letters to Congress sent through our Advocacy Hub spiked.

To date, our community has sent almost 3,000 letters to Congress through our Advocacy Hub. Looking at our performance outside the U.S., we are thrilled to see the growing affinity for the FIGS brand across continents. International delivered record net revenue growth of 81%, reflective of strong performance across countries including our longest-standing markets Canada, UK, and Australia. We added seven new countries including Poland, Kuwait, and Singapore during the quarter. And similar to the – to Mexico and the Philippines, our entrants into these new regions arose from strong grassroots demand, signaling the growing recognition of FIGS worldwide. Turning to our B2B business. Teams delivered exceptional net revenue growth year-over-year with orders from best-in-class healthcare organizations, such as the American Student Dental Association, Aya Healthcare, and Veterinary Emergency Group, VEG, a fast-growing emergency care organization with over 60 locations.

Inbound demand is growing as more institutions are looking to FIGS to help them professionalize their staff with premium uniforms. FIGS is best positioned to support these institutions with a best-in-class technology platform and products that help their professionals look good, feel good, and perform at their best. Turning to retail. I am super excited to share that we will officially be opening our first permanent retail store, which we refer to as a community hub on November 3rd, which is tomorrow, in Century City Mall. We are incredibly proud of this achievement, not only because this is our first branded permanent retail location, it’s really the first of its kind, a space that was created and is purely dedicated to healthcare professionals.

In addition to enabling healthcare professionals to feel, try on, and become educated about our products, our community hubs will serve healthcare professionals through purposeful programming and events on topics that they really care about. In closing, while we are proud of what we have accomplished to date, we have so much untapped potential, which I will speak to following Daniella’s review of our financial results.

Daniella Turenshine: Thanks, Trina, and good afternoon, everyone. I will begin my discussion with a review of our third quarter financial performance followed by our revised 2023 outlook. Overall, we are pleased to have exceeded our net revenues and adjusted EBITDA guidance and to be once again raising our full year guidance. We did this while making significant progress toward our strategic priorities, normalizing inventory, and generating strong free cash flow. For the third quarter, net revenues grew 10.7% to $142.4 million, compared to $128.6 million in Q3 last year, primarily due to an increase in orders from existing and new customers, as well as higher AOV. We were pleased to deliver a 19.6% increase in active customers, fueled by ongoing initiatives to drive brand awareness globally and strong reactivation rates among lapsed customers.

As Trina stated, we reached another third quarter record in new customers. AOV increased nearly 2% versus last year’s Q3, led by higher units per transaction, or UPT, and to a lesser degree, by an increase in average unit retail, or AUR. AOV continues to benefit from the product mix shift, driven largely by the strength in footwear and outerwear. This was partially offset by a higher mix of sales occurring during our planned sample sale in September. Gross margin for Q3 was 68.4%, compared to 70.6% in Q3 2022. The 220-basis-point decline compared to Q3 last year was primarily due to product mix shift. We saw strong growth in non-scrub wear categories including footwear, as well as in certain limited-edition styles. Non-scrub wear grew 26.4% to 19.3% of net revenues in the third quarter versus 16.9% in the same period last year.

To a lesser degree, gross margin was impacted by a higher mix of promotions, as well as higher duties. This was partially offset by lower airfreight utilization and better freight costs. Moving to operating expenses. Selling expense for Q3 was $32.2 million, representing 22.6% of net revenues, compared to 24.8% in Q3 2022. The 220-basis-point decline was a result of lower fulfillment expenses as we lost elevated storage costs last year and, to a lesser extent, leverage within shipping expense due to higher AOV. This was partially offset by higher duties related to the increased mix of international sales and a higher mix of promotional sales. Marketing expense for Q3 was $19 million, representing 13.4% of net revenues, compared to 15.6% in Q3 2022, reflecting digital marketing efficiencies.

We continue to flex our marketing spend to optimize our return and maintain a disciplined approach to balancing investments and top-of-funnel marketing and maintaining first order profitability. G&A expense for Q3 was $36.2 million, representing 25.5% of net revenues compared to 21.5% in Q3 2022. The increase in G&A as a percentage of sales was due to higher investment in people including salaries, bonus, payroll tax, and stock-based compensation expense partially offset by lower professional fees. In addition, as you may recall, last year, we saw a 190 basis point benefit due to a change in our accrual methodology for charitable donations. Taking this to the bottom line. Our net income was $6.1 million or $0.03 in diluted EPS for the quarter.

This compares to net income of $4 million and diluted EPS of $0.02 per share in Q3 2022. Adjusted net income was $6.3 million and diluted EPS as adjusted was $0.03 in Q3 2023 as compared to adjusted net income of $4.1 million and diluted EPS of $0.02 in Q3 2022. Finally, our adjusted EBITDA for Q3 was $24.4 million for an adjusted EBITDA margin of $17.2% compared to 16.4% in Q3 2022. Turning to our balance sheet, we finished the quarter with cash, cash equivalents, and short-term investments of $232 million. Inventory declined 15% to $143 million at the end of the third quarter compared to $168 million in the third quarter last year. We made significant progress moving toward more normalized levels and expect inventory to decline again in Q4.

Lastly, free cash flow was $46 million in the quarter. Moving to our outlook, starting with the top line. We expect fourth quarter net revenue growth to be up low single digits, reflecting ongoing macro uncertainty and recognizing that there may have been some pull forward of demand, given the outperformance of the third quarter. We expect the macro environment to continue to weigh on the consumer at least into the first half of next year. Moving to gross margin for the fourth quarter, we expect better freight costing to be offset by a shift in product and promotional mix. Looking at selling expense. We expect to incur approximately $2 million in initial start-up costs for our fulfillment enhancement project. These elevated costs are expected to extend into the first three quarters of 2024.

In addition, we expect selling expense to be impacted by higher relative growth in our international business, which carries both duties, as well as higher shipping expense given that we currently distribute all products from our California facility. As a result of these factors, we expect fourth quarter adjusted EBITDA margin of between 11% and 12%. Based on our better-than-expected third quarter performance and outlook for Q4, we now expect 2023 net revenue growth of approximately 8.5% and adjusted EBITDA of approximately 14%. This is up from our previous expectation of 5.5% to 7.5% net revenues growth, and 12.5% to 13.5% adjusted EBITDA margin. Overall, we are really proud of what we have delivered in this uncertain macro environment, and we remain excited about the long-term growth potential of our business as we continue to advance our leadership position within the healthcare apparel industry.

We have an incredibly healthy balance sheet with ample cash and no debt, and our business model generates strong cash flow. We are making the investments today that we believe will drive accelerated future performance as we move past near-term macro challenges. I will turn it back to Trina to discuss where we are investing in our business for the long-term.

Trina Spear: Thanks, Daniella. We believe that the growth and the evolution of the healthcare industry combined with our leadership position in healthcare apparel and strong balance sheet creates significant, long-term opportunity for FIGS. As Daniella stated, we will leverage our strong cash flow conversion dynamics and scale to lay the groundwork for multiyear growth. These investments span across several areas of our business. I’ll begin with product, the lifeblood of FIGS. We are evolving our sourcing strategy to deliver the most innovative and high-quality products healthcare professionals have ever experienced. We are refining our supplier base with best-in-class partners. We are working to optimize lead times to bring more flexibility to our supply chain.

And finally, we are diversifying geographically to mitigate risk. We are confident that this is the right direction for our company as we widen the moat around our business and advance our leadership position. Second, we will continue to invest in driving international growth to become the global leader in healthcare apparel. We are building our localization capabilities, expanding our ambassador network, and deploying brand initiatives in existing and in new markets. Third, we are building our go-to-market strategy for our teams business to capture the growing trend in more specialized and consumerized medicine. We see a huge opportunity to capture share in an area of the healthcare industry where innovation is lacking. To capture this opportunity, we are upgrading the technology behind our team’s platform to create a seamless experience for administrators, saving them time and resources when procuring the uniforms of their staff.

Their staffs need to do their jobs. The next generation of this platform is on track, and we’ll launch later this year. Finally, we are just one community hub in on our retail strategy. We are going to learn from our early experience and ensure we have the right talent in place to successfully and profitably build out our retail presence. As we build for the future, we are setting the foundation for a global distribution network. Our fulfillment enhancement project is on track for 2024, and we plan to open a Canadian DC in 2025. In conclusion, we see tremendous opportunity to leverage our authenticity, industry leading product innovation, strong balance sheet, and scale to capitalize on the tailwinds in the growing healthcare industry. Healthcare professionals are at the heart of everything we do and serving them is what guides our company from how we approach product innovation, how we engage with our community, and how we show up through our advocacy.

These are the values that will keep our company on track to serve healthcare professionals like no other brand and to deliver long-term profitable growth for our community, our employees, and our shareholders. With that, I will turn it over to the operator to take your questions.

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Q&A Session

Operator: Thank you. We will now begin the Q&A session. [Operator instructions] Our first question is from Edward Yruma with Piper Sandler. Your line is now open.

Ed Yruma: Hi, good afternoon. Thanks for taking the question. Congrats on the results. I guess, first, I would love to click down a little bit more on the driver of gross margin. I know you talked a little bit about mix shift to non-scrub. We’d like to maybe go a little further there. Can you talk about the performance of some of your newer products like the under-under scrubs, lab coats, things that are more evergreen in the assortment versus something like footwear? And then as a follow-up, we’ve gotten a lot of questions on the distribution center investment cadence. So, if you wouldn’t just mind maybe giving us a quick update on how we should think about that over the coming quarters. Thank you.

Daniella Turenshine: Sure, I can start talking about the drivers of gross margin. So, the biggest driver year-over-year was product mix shift both into non-scrub wear as we saw big acceleration in footwear but also into our limited-edition scrub wear. To a smaller extent, it was mix shift, promotional mix. We did see some outperformance in our sample sale and also higher duties and again that was offset by better than expected by better freight both ocean and air freight.

Trina Spear: And in terms of product innovation, we continue to see our layering system resonate with our community. And so, we saw that with our underwear, which we launched in the quarter with our outerwear. Our Sherpas are doing really well, our footwear collaboration with New Balance and so, non-scrubs as a percent of total is almost 20% of our business. And as we continue to build out these categories, we’ll get leverage from a costing perspective, but, they need to grow – build out and that’s what we’re really focused on. And you see – we talked a little bit about how these scrubs, whether it’s within scrubs or outside of scrubs, across our under scrubs, across our outerwear and our footwear, how we’re able to match that back to the core. And really, we’re seeing our healthcare professionals engage with these new styles, as well as the core and kind of replenishing our core. And those two things are working really well together.

Daniella Turenshine: And on your last question on investments for our fulfillment enhancement project, so we’re expecting about $2 million of start-up costs in the fourth quarter. Looking into 2024, we’re still expecting total project costs to be $16 million to $18 million. So, $14 million to $16 million of that taking place in 2024 as a result of that, we are expecting some pressure in selling as a result of this fulfillment enhancement initiative, but do believe that it’s going to enable us to drive better efficiency, better reliability, a better customer experience over the long-term and we are still expecting about $20 million of capital expenses in 2023 with the majority of that taking place in the fourth quarter.

Ed Yruma: Thanks so much.

Operator: Our next question is from Brooke Roach with Goldman. Your line is now open.

Brooke Roach: Good afternoon and thank you for taking our question. Trina, I was hoping you could elaborate on any changes or trends you’re seeing and consumer behavior that you’ve seen as you move through the third quarter and into fourth quarter to date. Have you seen any changes in price elasticity of demand or any trends or changes in how consumers are engaging with the brand as student loan repayments resume and as we see some changes in the macro in aggregate?

Trina Spear: Thanks, Brooke. Yes, I think we’re seeing kind of two dynamics going on. The first one is there was a lot of stocking up during the pandemic and there was obviously a heightened need for scrubs during that time. There was stimulus. Interest rates were super low and, we are experiencing the hangover effect of that. And we see that mainly in our frequency rates. And so, we do believe that we, at this point, have abnormally low repeat frequency. And we believe we will see that normalize over time, and we will see going into next year and beyond what a more normalized cadence will look like from our healthcare professionals. But as you know, healthcare professionals, they are buying about, pre-pandemic 4 to 6 sets a year.

They are spending about $550 a year. And so, with us, they are buying more like 2 to 3 sets a year and spending about $212. So, this is a huge opportunity going forward. The second piece that we think is happening is the macro environment, there is still a lot of uncertainty. And as you mentioned with student loans and other dynamics, that we think will be a short-term headwind, but we do believe we’re able to offset some of this repeat frequency with new customer ads and you’ve seen that in the last quarter.

Brooke Roach: Very clear, thank you so much for that. Daniella, can you comment on inventory rationalization? Are you still targeting 25 weeks of supply by the end of the year? And how should we be thinking about further cadence of inventory drawdown over the next few quarters?

Daniella Turenshine: So, we’re still on track to deliver approximately 25 weeks of supply at year-end. As a reminder, this is slightly above our normalized level of 16 to 20 weeks, which we expect to be able to get back to in 2024. Important to note, still about 50% of our inventory is in core styles and classic colors, so sell all year round. Never goes out of stock, never goes out of style. And as you saw, we made progress in the second quarter and the third quarter on moving inventory receipts lower. And we’re going to expect to make further progress there in the fourth quarter with minimal planned receipts. And I think we continue to be really focused on maintaining the integrity of our brand with a really disciplined promotional strategy with so much growth ahead of us.

And we’re going to continue to work through our inventory at the right rate and pace for our business. Looking into 2024, when we’re back at that kind of 16 to 20 weeks of supply, we would expect to grow inventory in line with sales going forward.

Brooke Roach: Thank you so much. I’ll pass it on.

Operator: Our next question is from Dana Telsey with Telsey Advisory Group. Your line is now open.

Dana Telsey: Hi, everyone. Congratulations and nice to see the progress. Trina, you mentioned the sourcing diversification opportunity. What are you doing exactly, where are you going, and what do you see as the opportunity and lead times, as I would think that could also be a gross margin driver? And then just secondly on the more efficient marketing spend in digital marketing, how do you planning marketing going forward? Thank you.