Operator: Good afternoon ladies and gentlemen. Thank you for joining the FIGS’ Second Quarter Fiscal 2023 Earnings Conference Call. My name is Kate, and I will be the moderator for today’s call. [Operator Instructions] I would now like to pass the call over to our host, Jean Fontana.
Jean Fontana: Good afternoon. Thank you for joining today’s call to discuss FIGS’ second quarter 2023 results, which we released this afternoon, can be found in our earnings press release and in the stockholder presentation posted in our Investor Relations website at ir.wearfigs.com. Presenting on today’s call are Trina Spear, Chief Executive Officer and Co-Founder 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.
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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 cycle of slide deck issued today. Now, I would like to turn the call over to Trina Spear, Chief Executive Officer of FIGS.
Trina Spear: Thanks Jean. Welcome to our second quarter 2023 earnings call. Our strong second quarter results demonstrate the resilience of our business, outstanding execution against our strategic priorities, and operational excellence. We delivered 13% net revenue growth as compared to the second quarter last year, primarily due to the 21% increase in our active customer base, as we continue to widen our market leadership position within the healthcare apparel industry. We generated strong profitability with Q2 adjustment of its own margin of 13.7%, ahead of our 9% to 10% margin expectation, and we delivered free cash flow of 29 million in the second quarter. In addition, inventory is down from peak levels, and we are on track to reach our year-end target of approximately 25 weeks of supply.
The fundamentals of our business remain strong. We operate in a resilient and growing industry. We have the powerful combination of unmatched product innovation and brand authenticity, and our business model yields strong positive cash flow due to the non-seasonal replenishment nature of healthcare uniforms. Looking ahead, we believe that we are well positioned to deliver long-term profitable growth. First, we have ample room to further build our community and grow share wallet within the U.S. Second, we are highly encouraged by the opportunities we see in our international and teams businesses, and third, we are just getting started in retail. Now, I’ll dive into our strategic growth pillars, beginning with our solutions-based product innovation.
We believe that product innovation is one of the largest modes around our business. We have deep knowledge of the healthcare community. We have the design and technical capabilities to deliver best-in-class products, and we have the trust of the healthcare community to bring innovation that helps them do their jobs better each and every day. Our scrubs business drove over 80% of our net revenues in the second quarter, supported by the newness we continuously bring to market. In non-scrubs, the diversification of our product assortment across our layering system contributed to net revenue growth of 25%. Nearly 40% of our active customers purchased at least one non-scrub item, illustrating that our layering system resonates with our community.
Our collaboration with New Balance and Footwear is a prime example of how we can serve this community in a way they’ve never experienced before. Our [indiscernible] shoe launched in the quarter is engineered for 24-7 protection, support, and comfort for your feet. We also gave the New Balance 70s-inspired 327 shoe an upgrade, featuring materials and functionality designed specifically for healthcare professionals. Both launches drove high sell-through rates and sold out in multiple colorways. Most recently, we made a bold entry into under-under scrubs with underwear for overachievers, making them available in all of our classic scrubs’ colors. Featuring smooth lines and no bunching or riding, they are not only comfortable but also invisible under our scrubs.
We have a strong pipeline of innovation across fabrications, categories, and styles that we believe will attract new customers and drive net revenue per active customer as we expand our TAM over the long term. Next, I will spend a few minutes on how we’re building and connecting with the healthcare community. First, I’m happy to report that we delivered another incredible Nurses Week campaign. I am a nurse, putting the spotlight on how nurses are the backbone of our society. We call our Nurses Week our Super Bowl, as we love to celebrate our awesome community. We also launched our Innovate Beyond Your Imagination campaign in early Q2 to highlight product innovation across FIGS Pro, our FREEx fabrication, our own Brace Scrub jumpsuit, which is our first print offering, and our New Balance collaborations, including our robe and our 327 shoes.
These campaigns reflect storytelling, including our innovation lab concept, which showcase how product comes to life, both on shift and off, in a fun and unique way. These campaigns rallied our community, as we’ve never seen before, with over 2 million views on our own brace FREEx video alone. The strong response to our marketing is evidenced by the 21% growth we saw in our active customer base in the second quarter compared to Q2 of last year. We acquired the third highest number of new customers in our company’s history, leaning into creative optimization strategies. This is a strong positive indicator for the future growth of our business. Our highly efficient marketing engine combined with our discipline around first order profitability enables us to maintain marketing spend at 15% of net revenues on an annual basis.
As we discussed in the past, we are making advances in elevating personalization capabilities in marketing, as well as our online shopping experience and our mobile app. We expect these initiatives to drive traffic more efficiently and increase conversion, turning to advocacy, which truly sets our brand apart. We further our commitment to the healthcare community with the launch of our first of its kind, FIGS Advocacy Hub, an online experience for our community to learn about the most important policy developments affecting them and where they can advocate for real change through FIGS. The launch of our Advocacy Hub was supported by a multi-page ad in the New York Times, highlighting the challenges being experienced by healthcare workers and how our awesome humans bill would help solve them.
Our Advocacy Hub is truly unique and enables us to leverage our two and a half million active customers to create one of the largest bases of grassroots advocates that we know of. We could not be prouder to be leading this effort. Turning to international. International net revenue increased 52% compared to the second quarter last year, demonstrating our ability to build our brand outside of the U.S. We are encouraged by the success of our localization strategies, such as our Canadian ambassador event. As we deepen our presence in the 13 international markets we’ve previously entered, we also recognize that there’s a growing demand for FIGS across a number of other countries that we don’t serve today. In response to the strong organic traffic trends we saw in our site, we made FIGS available in Mexico, the Philippines, and Saudi Arabia during the second quarter.
Results have far exceeded our expectations even before investing any marketing dollars to support these countries. We are excited to advocate our marketing engine to fuel further growth in these markets. We will also leverage our demand insights to determine additional countries that may provide meaningful growth opportunities for our brand. We have only scratched the surface on building our international presence and plans to strike the appropriate balance of top-line growth and profitability as we do so. Moving on to our team’s business, which is where we sell directly to hospitals and healthcare institutions. Teams is growing fast and tracking to approximately a mid-single digit percentage of net revenues. Notably, this growth has come almost entirely from inbound requests.
Our team’s business continues to see demand across universities, private practices, staffing agencies, and hospital departments, as well as concierge clinics, which is an area of focus for us that I’ll briefly touch on. People no longer want a one-size-fits-all approach to their health. They want the kinds of smaller, more individualized concepts that are popping up across all areas of healthcare that focus on prevention and proactive measures. Whether it’s veterinary care or dental or physical therapy or aesthetics, people are demanding more accessible, regular, and specialized care, and it’s changing the landscape of healthcare. Just as healthcare is branching out, becoming more specialized, localized, and consumerized, so too is the experience of the healthcare professional.
Just like laypeople are demanding more from their providers, providers are demanding more from their partners. FIGS is their ultimate partner in helping make them look good, feel good, and perform at their best. At branding their businesses, our logo is a symbol of professionalism, style, and technology, and at supporting their endeavors to pave the future of healthcare. To that end, we are on track to launch an updated version of our team’s technology platform later this year that will support the growth of this business. The platform enhancements are focused on expanding our product store into our team’s customers and proving the administrator experience and expanding payment capabilities. Given the significant tailwinds created by the evolution of healthcare, we are developing a more robust strategic plan to accelerate growth in teams.
Next, I will provide an update on our retail strategy. Along with continued progress towards opening our first permanent store in Century City this fall, we have also signed a store lease for 4,000 square foot location on Walnut Street in Philadelphia, which we plan to open in the first half of next year. The store located within two miles of five healthcare institutions will have a dedicated space to host events for our healthcare community. Philadelphia is an ideal choice for a second location as a leading market for healthcare education, where one in every six doctors in the U.S. has been trained. It is the fourth highest number of healthcare professionals in the U.S. and is one of our most under-penetrated markets. We are excited to be meeting our community where they are and delivering a meaningful experience and environment like they’ve never seen before.
In conclusion, we are pleased with our second quarter results and how we continue to build our FIGS community of healthcare professionals. We have assembled a best in class executive team that has a proven ability to not only advance our strategic priorities, but also to remain nimble as we continue to navigate an uncertain environment. We believe that our sustained competitive advantages of unmatched product innovation, brand authenticity and scale, position us well to meet our long-term objectives. With that, I’ll turn the call over to Danielle to discuss our financials and our outlook.
Daniella Turenshine: Good afternoon, everyone. We delivered second quarter results above expectations. Strong net revenues growth flowed down to profitability and we generated healthy free cash flow. In addition, we made progress toward our goal of normalizing inventory back to prior year levels. Overall, we are encouraged by the resilience of our business given the macro headwinds. We remain focused on what we can control by executing on our long-term strategies while maintaining disciplined expense management. I will begin with a detailed discussion of our second quarter financial results, followed by our updated outlook. Beginning with the second quarter net revenues, we grew 13% to 138.1 million compared to 122.2 million in Q2 last year, reflecting an increase in orders and higher AOV.
We delivered active customer growth of 21%, reflecting our third highest quarter of new customer additions driven by both the U.S. and international markets. We have also seen success in our initiatives to drive reactivation rates with an increasing number of customers returning to the brand after month 12. AOV increased 5.5% to $115 compared to $109 in Q2-22. AOV was led by an increase in AURs attributable to product mix and growth in UPTs, which continue to benefit from the expansion of our layering system. AOV growth also reflects a higher mix of team sales. Gross margin for Q2 was above our expectation at 69.5% compared to 70.6% in Q2-22. The 110 basis point decrease compared to Q2 last year was primarily due to product mix and to a lesser extent, higher duties and a higher mix of promotional sales.
This was partially offset by the benefit of lower air freight utilization and reduced ocean freight rates. Moving to operating expenses. Selling expense for Q2 was 33.7 million, representing 24.4% of net revenues compared to 21.9% in Q2-22. This 250 basis point increase was largely due to higher costs within fulfillment, including a 210 basis point impact from incremental warehouse storage. To a lesser degree, the increase in selling expense reflects international duty subsidies that we put in place in the middle of the third quarter last year. Marketing expense for Q2 was 20.9 million, representing 15.1% of net revenues compared to 17% in Q2-22. The decrease in marketing expense as a percentage of net revenues reflects the shift to multiple smaller ambassador events in 2023, versus a large single retreat we held in Q2-22.
Our shift to numerous smaller events allows us to connect with the community in a more meaningful way, better enables us to engage with both existing new and potential ambassadors, and creates continuity as we flow these events throughout the year. Another reason for the decrease in marketing investment as a percentage of net revenues is that brand marketing investments were more concentrated in Q2 last year versus this year. Our focus on driving digital marketing efficiencies enables us to maintain a healthy return on ad spend while driving strong new customer acquisition. G&A expense for Q2 is 34.8 million, representing 25.2% of net revenues compared to 23.9% in Q2-22. The increase was due to higher salaries, bonuses, and stock-based compensation as we continue to invest in people.
Our net income was 4.6 million or $0.02 in diluted EPS for the second quarter. Net income was 4.9 million and diluted EPS was $0.03 in Q2-22. For comparison purposes, adjusted net income for Q2-22 was 6.3 million and adjusted diluted EPS was $0.03. Finally, our adjusted EBITDA for Q2 was 18.9 million for an adjusted EBITDA margin of 13.7% compared to 17.6% in Q2-22. Turning to our balance sheet, at the end of Q2, cash equivalents and short-term investments totaled 185.3 million compared to 170 million in the second quarter of last year. Inventory totals 167.8 million at the end of the second quarter, reflecting progress and getting inventory back to normalized levels while maintaining discipline around promotional activity to protect the long-term health of our brand.
Consistent with past quarters, roughly 50% of inventory on hand was core. Of the remaining inventory, we are seeing a smaller mix from future product launches as planned due to lower receipts. As such, we expect inventory to decrease more meaningfully in the third quarter than we saw in Q2. Lastly, we delivered positive cash flow from operations of 29.4 million for the second quarter and continue to expect cash flow to be positive for the remainder of the year. Turning next to our outlook, we are maintaining our net revenue outlook and are raising our adjusted EBITDA margin expectations for the full year 2023. Overall, we remain pleased with the performance of our business, which reflects better than expected results in the first half of the year.
Consistent with the factors we discussed last quarter, our guidance assumes a challenging macro environment in the back half of the year, as well as tougher compares and new customer growth. As we manage through the challenging environment, we remain focused on driving profitability and strong free cash flow while continuing to make investments in our business to drive long-term growth. Starting with our outlook for the third quarter, as we stated on our prior earnings call, we expect this to be the most pressured quarter of the year in terms of year-over-year net revenue growth due to the timing shift in our product launch and marketing failures into Q3 last year associated with supply chain challenges. Our product launches and marketing campaigns are back to our more typical cadence in 2023.
In addition, we plan to maintain discipline around our promotional cadence as we prioritize delivering healthy sales growth. As a result of these factors, we expect sales to be flat to up low single digits following 25% growth in the third quarter of last year. We expect Q3 gross margin to be approximately 69%. This is slightly below our long-term expectation of 70% plus. While we are seeing lower freight rates versus Q3 last year, we continue to sell through product purchase at higher ocean freight rates in the prior year. Looking at operating expenses, we expect to leverage selling expense in Q3, primarily as a result of lower storage fees as compared to last year as we move through excess inventory. For G&A, we continue to expect to leverage year-over-year due to higher stock-based compensation, salaries, and bonuses as we continue to invest in people.
In addition, our G&A for Q3 last year reflected a 190 basis point benefit due to a change in our accrual methodology for charitable donations. As such, we expect G&A dollar expense to be similar to that of Q2. As a result of these factors, we expect third quarter adjusted EBITDA margin to be between 13% and 14%. Turning to full-year guidance. For the full year, we continue to expect net revenues to grow between 5.5% and 7.5%. We believe this reflects resilience in our brand given we are lacking 21% growth in 2022 and 60% growth in 2021. Turning to gross margin. We are passing through the better than expected Q2 performance and now expect the gross margin rate to be above 69% for the year. In regard to selling expense. In Q4, we expect to leverage due to the initial implementation costs of approximately 2 million for our fulfillment project.
As a reminder, we estimate costs associated with the implementation and execution of this project to be between 16 million and 18 million. We expect to incur the bulk of these non-recurring costs in 2024. Based on the outperformance in the second quarter, we now expect adjusted EBITDA margin for the full year 2023 to be between 12.5% and 13.5%. We expect capital expenditures of between 24 million and 26 million for the full year 2023. This reflects approximately 20 million in fulfillment costs, but the remainder being related to software investments and our retail store build out. In conclusion, the progress we are making across our strategic priorities and our strong market share position within the healthcare apparel industry positions us to capitalize on the significant growth opportunities that are still ahead.
As such, we will continue to invest in these long-term strategies, leveraging our strong balance sheet and healthy free cash flow. Furthermore, we remain confident in our ability to return to a high teens plus adjusted EBITDA margin as we move beyond fulfillment investments and transitory costs. With that, I will turn it over to the operator to kick off our Q&A session. Operator?
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Q&A Session
Operator: Thank you. We will now begin the question and answer session. [Operator Instructions] The first question will be from the line of Ed Yruma with Piper Sandler. Your line is now open.
Ed Yruma: Hey, good afternoon. Thanks for taking the question. I guess first, just on some of the innovation, I know you mentioned a couple of things you launched. You mentioned to sell out of the rollout. I’m curious if you can give us some insight into how the under-underscripts performed, made some new lab coats. And then second, I would see some nice gross margin performance there. Maybe just help us unpack a little bit how the impact of lower freight rates will kind of flow through the gross margin line over time. And how we should think about promo is really for the back half of the year. Thank you.
Trina Spear: Thanks, Ed. Great to have you on. Yes, we saw a lot of great product innovation in the quarter. As you know, FIGS Pro is an area that we’re really focused on. It’s becoming even more important as we see the evolution of the healthcare industry. As we discussed on the call, concierge medicine is a meaningful opportunity for us to expand our presence as we believe clinics are going to enable individuals to play a greater role in their healthcare. Healthcare is everywhere and people are owning their healthcare more and more. So we’re going to continue to invest in FIGS Pro. And you saw that with our high-collar lab coat, our high-waisted, wide-legged scrub trouser, which both received excellent response. But in addition to our existing categories, we’re also building new ones.
And so, in our goal to completely redefine the experience of being a healthcare professional, we are adding new categories that have never existed. And so you saw that with our launch of our under-under scrubs, underwear for overachievers. So we’re pleased with the early read, early feedback on our under-under scrubs. But it’s another example of where we are increasing our share of wallet by addressing all the needs of our healthcare professionals from head to toe with our complete layering system.
Daniella Turenshine: And to your question on the gross margin outperformance, we’re really pleased with the results that we saw in the quarter. We delivered better than expected gross margin due to ocean freight, as you mentioned, but also product mix and also lower air freight utilization than we anticipated. We are expecting that ocean freight benefit to have less of an impact in the second half as we’re materially bringing down the number of receipts that we’re bringing in. But we do expect to see that opportunity in ocean freight looking into 2024 and beyond with the lower rates that we’re getting today. In respect to your question on promotional cadence, we’re planning to keep a similar promotional cadence year over year in the back half.
Given our inventory composition is 50% core classic, always on our site, always in stock year round. And the remaining balance is also a uniform that’s seasonless and never goes out of style. We don’t feel that we need to, change our promotional cadence to move through our inventory balance. And so we’re really focused on protecting the brand over the long term, and that’s what we’re going to continue to do. So we’re not anticipating any changes to our promotional cadence in the back half of the year.
Ed Yruma: Great. Thank you.
Operator: Thank you. The next question will be from the line of Dana Telsey with Telsey Group. Your line is now open.
Dana Telsey: Hi. Good afternoon, everyone. The inventory increase was down more than expected. It’s nice to see the reduction progress. Can you expand on what you’re looking for in this third and fourth quarter as we move on? And I have one follow-up to that. Thank you.
Trina Spear: Thanks, Dana. So getting our inventory into a more normalized position is a big priority for us. And as you saw in the second quarter, like we said, we did bring that down. The first quarter really represented a peak, and we’re going to expect to see it sequentially decline from here. So we are going to see even a bigger reduction in the third quarter as we really bring down our receipts in the back half of the year. I think it’s important to note that we’re still going to be delivering a lot of newness to the customer. We’re still bringing new products and innovation. It’s just going to be in shallower buys. And because of that, we feel really confident in our ability to get to 25 weeks of supply by year end and bring that inventory down to a much more normalized place.