FIGS - Q4 2023

Transcript

Operator (participant)

Good afternoon. Thank you for attending today's FIGS' fourth quarter and fiscal 2023 year earnings conference call. My name is Cole, and I'll be the moderator for today's call. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I'd now like to turn the conference over to our host, Jean Fontana. Please go ahead.

Jean Fontana (SVP of Investor Relations)

Thank you. Good afternoon, and thank you for joining today's call to discuss FIGS' fourth quarter and full year 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 the 10-K filed today, which we encourage you to review.

Do not place undue reliance on forward-looking statements, which speak only as of today and 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 their most comparable GAAP measures are included in the stockholder presentation we issued today. Now, I would like to turn the call over to Trina Spear.

Trina Spear (Co-Founder and CEO)

Thank you, Jean. Looking back at 2023, we outperformed our expectations with net revenue growth of 8% and adjusted EBITDA margin of 15.8%. We reduced inventory by 33% and generated strong free cash flow of $85 million. Looking across the business, we grew our active customer base 13% versus last year. Additionally, we achieved 18% net revenue growth in non-scrubs, 42% growth in our international business, and nearly 50% growth in our TEAMS business. We also opened our first permanent retail location, our Community Hub in Los Angeles, with strong early reads in traffic and conversion. Importantly, we continue to lay the groundwork to scale our business with investments in infrastructure and technology. While we are proud of these accomplishments, recent trends have become more challenging, well, which I will speak to in more detail shortly.

But I wanna share right up front my fervent position that we are on the right course. During 2023, we took measures to right-size our inventory levels, which are leading to some after effects. However, the work we have underway to create a more solid foundation from product to marketing to operations will set us up to succeed in the future. We remain the distant leader in healthcare apparel and have the scale and balance sheet to opportunistically invest across numerous growth levers. Now, diving in a bit deeper to provide context on our 2024 net revenue outlook. With respect to the macro environment, we believe there are two factors that are impacting the healthcare apparel industry. First, we continue to see inflation weigh on consumers, including our healthcare community, 2/3 of whom make less than $100,000 a year.

They have less spending power than they did two years ago and are being more intentional about how they spend every dollar. Second, we believe that the sustained fatigue and stress amongst healthcare professionals post-COVID may be impacting behavior. The traumatic experience of COVID, followed by the sustained high demand for healthcare workers, is taking its toll on our community and may be impacting their purchasing decisions. Our Healthcare is Human roundtable discussion this past November shined a light on just how much pressure they're under, and we believe we may be seeing this reflected through lower engagement metrics. We are in the trenches with our community on these challenges and are diligently working to help solve them through our Awesome Humans Bill.

Despite these external challenges, we remain optimistic about the state of the healthcare workforce long term, particularly given that healthcare and social assistant jobs are projected to be the fastest growing of any sector between 2022 and 2032, and are estimated to create about 45% of all projected job gains over that period. This is according to the Bureau of Labor Statistics. In addition, a recent survey by the University of Maryland, Baltimore, showed that 38% of Gen Z plans to pursue a career in healthcare. Outside of these macro factors, we've also taken a step back to assess our own performance. In 2023, one of our top priorities was to reduce inventory levels back to approximately 25 weeks of supply by year-end. We were successful in meeting our goal with only a modest impact on our gross margin.

We did this in part by bringing back a number of products from prior launches. For example, through our iconic FIGS10 campaign, we relaunched 10 of our community's favorite colors in 10 weeks. At times, we also leveraged conversion-driven marketing, including promotional messaging, to move through our inventory. We believe this may have contributed to the lower frequency in active customer trends we're now seeing. Looking back, we think we got away from the cohesive brand building strategy that ties our product launches to powerful storytelling campaigns. Our success has been based on brand excitement that ignites a word-of-mouth flywheel. This flywheel is what makes FIGS fundamentally different, and we're at our best when it's clicking. In 2024, our focus will be leveling up in on innovation and rebuilding our brand momentum through a number of initiatives.

As discussed last quarter, we are evolving our supply chain through best-in-class partners across continents to deliver the most advanced products to healthcare professionals. In addition to innovation in quality and new products, we are enhancing important details like our waistbands, our trims, zippers, fabrications. We have also embarked on an initiative to improve fit consistency across our assortment, which we are excited to roll out over the next year, starting as early as Q2. As we continue to advance our technical capabilities, we also see opportunity to lean further into our layering system by becoming the category-defining brand across scrubwear, outerwear, footwear, underscrubs, compression socks, bags, and so much more for healthcare professionals. Non-scrubs represented 23% of net revenue in the fourth quarter, reflecting strong performance in a number of these categories, and we see meaningful runway ahead of us.

The recent launch of our On-Shift Sherpa Bomber Jacket was one of our biggest to date and is a great example of what we're able to bring to the market outside of core scrubs to address the needs of healthcare professionals on shift and off. Lastly, as we take our product innovation to the next level, we are introducing Extremes. Extremes exemplifies how FIGS can serve even the most extraordinary needs of healthcare professionals. This year, we plan to introduce a series of innovative launches featuring technical products designed to solve problems for some of the most specialized fields within medicine. Last month, we launched our first Extremes collection, supported by an exciting marketing campaign featuring Dr. Luke Bennett, the Medical Performance Director for Hintsa, the medical team supporting Formula One.

Our large-scale storytelling campaigns will be designed to shine a spotlight not only on the extraordinary work that these healthcare professionals do every day, but also on just how extreme all healthcare professionals are. We have a series of exciting partnerships within sports medicine and other areas of healthcare as well, including search and rescue, large animal vets, and EMT. These big brand moments will be augmented with a series of evergreen and smaller product launch campaigns throughout the year, as well as community events and activations that will enable us to engage healthcare professionals in person. The success of our brand has not just been about great product innovation and powerful brand marketing. It's the seamless integration of both that generates excitement, leading healthcare professionals to share their FIGS experience with one another.

We believe that our Extremes initiative is integral in rebuilding the powerful word-of-mouth dynamic that helped us to surpass $500 million in 2022, just 10 years after our inception. To lead our integrated marketing strategy, Bené Eaton has joined FIGS as Chief Marketing Officer, bringing 15 years of experience, most recently at Nike—as Nike's Head of Brand Marketing for New York City. In addition to Nike, her background includes Ralph Lauren and Under Armour. We look forward to having her lead our brand and digital marketing efforts as we work to get back the secret sauce that has driven our success for over the last decade.

While we're excited about our strategic initiatives to drive brand momentum, we know that building new and existing customer engagement in an environment of the headwinds facing our healthcare professionals will take time, which is reflected in our guidance. The healthcare industry is evolving, and we're taking steps to evolve with it while also leveraging our multiple growth levers. Starting with international, net revenue grew 42% in 2023 versus the same prior year period. The strong performance was driven by growth in our more established markets, stemming from localization efforts and targeting initiatives, as well as traction we are gaining in the 10 markets we entered in 2023. Mexico and the Philippines remain our top new markets, and as you may recall, this came with minimal marketing investment. We plan to add new markets in 2024 as we continue to build our brand globally.

We are also excited to share that for the first time in our company's history, FIGS is partnering with the medical team behind sport, starting with Everton Football Club of the English Premier League, which is the most viewed sports league in the world. Our relationship with Everton's medical team demonstrates our commitment to celebrating healthcare professionals who have dedicated their lives to serving others, including athletes. Finally, in support of our growing international business, we plan to open a distribution center in Canada in 2025, which we believe will meaningfully improve our margin and enhance the customer experience with shorter shipping times. Our TEAMS business grew net revenue by 66% as compared to the fourth quarter last year. We successfully launched our TEAMS app open access test, enabling businesses of any size to purchase scrubs through our platform, which contributed to strong growth in the quarter.

We believe that our ability to serve businesses of any size through this platform meaningfully increases our addressable market. In addition to serving these customers with premium products, we also offer personalization, including embroidery. During the holiday season, we created a customized experience for our largest TEAMS customer, a travel nurse agency, to offer a gifting experience to their employees. With healthcare evolving to become more specialized, personalized, and localized, localized, we see tremendous opportunity to grow this business through an expanded assortment and exceptional online digital experience. The U.S. concierge medicine market is expected to double to $13.4 billion by 2030. We see this reflected in record membership growth amongst concierge clinics and in the increased M&A activity within the primary care space. These trends validate our efforts to expand our TEAMS business.

Turning to retail, we are pleased with the early results of our first Community Hub since our opening in early November. We believe that consumers still want that in-person shopping experience, as evidenced by the fact that in 2023, e-commerce comprised only 15.6% of total retail sales in the United States. Our Community Hub is attracting new customers to the brand, while also enabling us to serve existing customers with an additional shopping channel. Since opening in Century City, we've received requests from numerous healthcare professionals to open a store in their market. We are targeting a summer opening for our second Community Hub in Philadelphia. The 4,100 sq ft location will enable us to deliver events and programming that align with our community pillars and advocacy efforts.

The large store format will also enable us to better showcase our broader layering system, presenting an opportunity to drive higher AOV. To exceed $500 million as a digital-only brand is something we're very proud of, and we believe that we can deliver an exceptional shopping experience across multiple channels. Our Community Hub rollout strategy will remain: test, learn, apply, and win. And finally, we are laying the foundation to scale. We are undergoing the transition of our fulfillment operation to a best-in-class tech-enabled facility we will launch later this year that will enable us to scale and provide a better customer experience. In conclusion, we recognize that industry dynamics are creating some near-term pressure, but we have been and will continue to take steps to offset these headwinds and position ourselves for long-term growth.

We are unwavering in our belief that building a brand the right way takes time, but it's the most authentic and valuable way to do it. We are positioning our company to capitalize on the opportunities in front of us while taking important steps to make us a stronger, more resilient company in the future. We remain bullish on our long-term opportunity for several reasons. We are the pinnacle brand in the healthcare apparel space. We've just hit 1 million followers on Instagram, showing how we have the most loved brand in the industry. We have ample market share opportunity across geographies, channels, and professions. We have long-term healthcare industry tailwinds. We have a strong balance sheet with $250 million in cash and short-term investments. We have no debt, and we continue to be a cash flow generative business.

I remain confident that the strategies we have underway will lead to healthy, long-term, sustainable growth. Now, I want to take a moment to acknowledge the announcement related to Daniella Turenshine's decision to leave FIGS to assume a CFO role at another company. I am so grateful for her contributions over the last five and a half years as she helped us build the brand that serves those who serve others. Daniella has had the backs of our healthcare community, and she has been an incredible leader and thought partner to me and the whole FIGS family. She has also built out the best of the best finance team, leading us to over $500 million in net revenue while also being profitable. We are fortunate to have Daniella with us through mid-April to ensure a smooth transition.

Kevin Fosty, our Corporate Controller, has been part of the FIGS family for the last three years, and we have every confidence in his ability to serve as our Interim CFO. With that, I will turn the call over to Daniella to provide details on our fourth quarter and full-year results and our outlook for 2024.

Daniella Turenshine (CFO)

Thank you, Trina. My time at FIGS has been an incredible experience, and I'm so grateful to have been part of this growth journey. I am so proud of what we have accomplished over the last several years, and I truly believe that there is so much opportunity ahead. Our finance team is comprised of some of the best and the brightest, and I have every confidence that we will have a seamless transition under Kevin's leadership. I will now turn my discussion to a review of our fourth quarter financial results, followed by our outlook for the first quarter and full year 2024. We were pleased to have exceeded our adjusted EBITDA margin expectations for 2023.

As we consider our 2024 outlook, we are mindful of the current macro challenges and remain focused on leaning into our brand DNA to drive improved and more consistent performance in the future. Importantly, we have a strong balance sheet to make sound investments in our business to drive long-term sustainable growth. As noted in our press release, our fourth quarter reflects a $4.7 million net revenue reclassification from selling expense to a contra revenue account. This was associated with an accounting change for duty subsidies that we have been paying on behalf of our Canadian customers. Now turning to our results. Beginning with the top line, for the fourth quarter, net revenues were $144.9 million, flat to Q4 last year. The aforementioned duty reclassification negatively impacted net revenues by $4.7 million.

This reclassification was not reflected in our Q4 net revenue guidance of low single-digit growth. Active customers for the twelve-month period increased 13% compared to a record quarter of new customer growth in last year's Q4. As a reminder, we anticipated that the strong performance of our sample sale would pull forward some demand into the third quarter. AOV increased 4.5% to $117 in the fourth quarter due to higher average unit retail, or AUR, driven by product mix. Trailing twelve months net revenues per active customer decreased 5% to $210. Gross margin for Q4 was 67.5%, compared to 68.2% in Q4 2022. The net revenues impact of the reclassification negatively impacted gross margin by 100 basis points.

Gross margin benefited from lower air freight utilization, improved ocean freight costs, and a more favorable promotional mix, partially offset by product mix. Selling expense for Q4 was $28.1 million, representing 19.4% of net revenues, compared to 26% in Q4 2022. The 660 basis point-decrease was primarily due to lower warehouse storage and associated labor costs within fulfillment, as well as improved domestic shipping fees. As a reminder, selling expense no longer includes the $4.7 million in duty subsidies we've reclassified. Marketing expense for Q4 was $20.1 million, representing 13.9% of net revenues, compared to 14.8% in Q4 2022. The decline in marketing expense as a percentage of sales is largely due to lower brand marketing, including out-of-home.

We continue to drive marketing efficiencies and spend on both new customer acquisition and retention, maintaining first-order profitability. G&A expense for Q4 was $35.4 million, representing 24.5% of net revenues, compared to 25.2% in Q4 2022. The decrease in G&A as a percentage of sales was largely due to lower legal fees and insurance costs, partially offset by investments in people. Our fourth quarter net income was $10 million, or diluted EPS of $0.05, as compared to net income of $3.4 million, or $0.02 in diluted EPS in last year's fourth quarter. Finally, our adjusted EBITDA for Q4 remained strong at $26.6 million, for an adjusted EBITDA margin of 18.4%, compared to 13.6% in Q4 2022. Briefly touching on the full year.

Net revenues were $545.6 million, an increase of 7.9% year-over-year. Gross margin was 69.1%, a decrease of 100 basis points year-over-year due to product mix shift and, to a lesser extent, higher duties and a higher mix of promotional sales, partially offset by lower air freight utilization and ocean freight rates. As a percentage of net revenues, operating expenses slightly increased to 62.8% from 62.6% in the prior year, primarily due to higher general and administrative expenses, offset by lower marketing and selling expense. Adjusted EBITDA margin was 15.8%, as compared to 17.2% in the same period last year.

Touching on our balance sheet, we finished the quarter with cash and cash equivalents and short-term investments of $246.7 million. Inventory decreased 33% to $119 million at the end of the fourth quarter, reaching our target of approximately 25 weeks of supply for year-end. Overall, we are comfortable with the balance of core and limited edition inventory levels and believe we will be back to normalized weeks of supply in 2024. CapEx for the year totaled $16.3 million, of which $12.2 million is associated with the fulfillment enhancement project. Before turning to our guidance, I want to reiterate some of the comments Trina discussed in regards to factors impacting our business. First, we believe macro challenges, such as inflation, will continue to pressure healthcare professionals in the near term.

We believe this could be exacerbated by the rising fatigue and stress among some workers in the industry. Looking at our own business, during 2023, as we focused on getting down inventory to more normalized levels, we believe we may have shifted a bit too far away from our approach of tying product launches to brand storytelling campaigns. We believe that the strategic actions we are taking in product and marketing will ultimately drive improved performance, though we recognize that this will take time, which is reflected in our outlook. Looking at profitability, we expect selling expense pressure associated with our fulfillment enhancement project and deleverage on G&A to pressure-adjusted EBITDA margin in 2024.

We are confident in the steps we are taking to drive improved performance, and therefore, we plan to continue to leverage our strong balance sheet and cash flow dynamics to make strategic investments that will position us to scale our business for future growth. Now moving to guidance for the full year 2024. As a result of the aforementioned factors, we expect net revenues to be flat to down mid-single digits as compared to the full year 2023, reflecting pressure and frequency trends and active customer growth. Looking at cadence, we expect the third quarter to be the most challenged of the year as we anniversary the strong volume generated by last year's sample sale as we continued to work down inventory levels.

Turning to gross margin for the year, we expect to be roughly in line with our 2023 rate as we elevate products with new fabrications and trends and continue to see product mix shift. We expect this to be offset by a duty cost benefit later in 2024. Turning to selling expense. Transitory costs associated with our fulfillment enhancement project are estimated to be approximately $14 million or about 250 basis points in 2024. In terms of ongoing fulfillment-related costs, we expect that the costs associated with the new facility will offset the savings we gained on storage count costs to house excess inventory last year. Therefore, 2023 represents a good baseline for what we expect selling expense to be as a percentage of sales following the completion of our transition to our new fulfillment center.

Longer term, we expect to gain leverage as we scale. In terms of cadence, we expect the majority of these transitory costs will be spread within the first three quarters, with the second quarter carrying the highest expense. The bulk of the project involves moving our fulfillment to a new facility in 2024, while simultaneously continuing operations in our current facility to ensure a smooth transition. The projected $14 million in transitory costs are largely associated with temporarily running the two concurrently. The new facility will operate with state-of-the-art robotics and new technology that we expect to increase reliability, flexibility, and efficiency, as well as improve order delivery times. In addition, we expect this new facility to have the capacity to support $1 billion in net revenues as we continue to scale our business. G&A is expected to deleverage based on our net revenue outlook.

We are taking a close look at our cost structure to identify savings opportunities, but will continue to invest in the areas of our business that drive growth. We expect G&A to increase commensurate with the increase in CapEx. As a result of these factors, adjusted EBITDA margin for full year 2024 is expected to be between 11% and 12%. This reflects approximately 250 basis points of cost headwind from the transitory portion of our fulfillment project. In terms of our Q1 2024 outlook, we expect net revenues to decline in the low single digits, reflecting pressure and active customer growth and continuation of slower frequency trends. We expect gross margin to be down versus Q1 last year due to investments in innovation and product mix shift. Looking at operating expenses.

For selling expense, we expect the transitory fulfillment project cost to impact Q1 by approximately 370 basis points. Offsetting this will be the benefit of the cost savings from non-recurring storage fees from last year, as well as the duty reclassification. Net-net, we expect selling expense to deleverage by approximately 70 basis points, which also takes into account higher ongoing fulfillment costs. As a result, we expect first-quarter adjusted EBITDA margin to be approximately 7.5%. CapEx for 2024 are expected to be between $18 million and $19 million, including $13 million-$14 million in fulfillment enhancement-related costs. In conclusion, we believe we have identified areas of opportunity to reignite demand in our business, but also recognize that this will take time and we are still facing macro headwinds. We remain excited about the long-term prospects for our business.

We are the distinct leader in healthcare apparel, with distinct competitive advantages in product innovation and brand love, coupled with the scale and balance sheet to invest in future growth. With that, I will turn it over to the operator to kick off our Q&A session. Operator?

Operator (participant)

Thank you. If you'd like to queue for a question, please press star, followed by one on your telephone keypad. If for any reason you'd like to remove your question, you can press star two. Again, to queue for a question, please press star one. We will pause here briefly as questions are registered. Our first question is from Brian Nagel with Oppenheimer. Your line is now open.

Brian Nagel (Managing Director and Senior Analyst, Consumer Growth & eCommerce)

Hi, good afternoon. Thanks for taking my questions. So, Daniella, I guess the first question I have, just to make sure that we're clear on this. So the EBITDA guidance, EBITDA margin guidance for 2024 is 11%-12%. You said there's—the 250 basis points reflects the transitory cost. Is that all that's abnormal in 2024, or are there other factors that are temporarily suppressing EBITDA margins next year or this year?

Daniella Turenshine (CFO)

Thanks for the question, Brian. So our 2024 EBITDA outlook of 11%-12%, once you adjust, you know, for the 250 basis points of transitory selling expenses, gets you to 13.5%-14.5%. I think the other thing that is, you know, impacting the outlook is the revenue guidance. So we are expecting to see some short-term deleverage in G&A expenses. I think looking into the future, you know, we believe that a high teens adjusted EBITDA margin is still a really good target for our business. And I think we showed in 2023, at almost 16%, that we're, you know, we're pretty close to that target as well. And so, yeah, super proud of the performance we delivered.

Brian Nagel (Managing Director and Senior Analyst, Consumer Growth & eCommerce)

Got it. Okay, then my second question, you know, just with respect to, I guess, the revenue guidance or what you're seeing with the consumer. So if the more challenged backdrop that you and Trina articulate as well, is that- is it something you're seeing here in—have you seen that more here in, as we started to progress into 2024? And then the second question I have with that is, you know, recognizing that you are the leader out there in a very fragmented space, but are you seeing any indications at all that, you know, for one reason or another, your target consumers are trading away from FIGS to something else? Or is it simply just weaker activity on the part of your core consumers?

Daniella Turenshine (CFO)

Well, I'll take the first part in terms of what we're seeing in 2024. So I think, like we've said in the past, year-over-year, we have a different schedule for events, for launches, and so it's very hard for us to compare apples to apples. However, the trends that we're speaking to in our outlook in terms of continued pressure on frequency rates, but also pressure on active customer growth, we are, you know, we're utilizing the information that we have year to date to inform our outlook. And so that's how we're encompassing that information. And I'll pass it over to Trina to talk about your second question.

Trina Spear (Co-Founder and CEO)

Yeah. Thanks, Brian. So I think what we're seeing with the consumer more broadly is that the economic landscape has felt uncertain for the majority of our customer base since 2021, when, you know, COVID-19 was, you know, has really slowed since then. So inflation has really been impacting our base. Two-thirds of our customers make less than $100,000 a year, and they have less spending power than they did two years ago and are being more intentional about how they spend every dollar. The second impact that we've seen has more. It's more related to the healthcare community, and the sustained high demand that is being really put on this community and taking a toll on them.

There is a supply and demand imbalance, a staffing shortage, where healthcare professionals are being asked to do much more than they have had to do in the past. You know, long term, healthcare is an incredibly strong segment, and it's going to continue to grow, but that's what we're seeing. To your question around, are they trading down, you know, we really are not seeing that. A very large player in the less premium part of the healthcare apparel industry by the name of SPI just filed for bankruptcy. So we really—you know, this isn't really specific.

We don't. We think this is being felt by the overall industry, and I do think that, you know, staying true to who we are, staying true to our authenticity, our product innovation, our brand storytelling and advocacy is what will help us win long term.

Brian Nagel (Managing Director and Senior Analyst, Consumer Growth & eCommerce)

That's very helpful. So before I hand it over to Daniella, best of luck in your new next endeavor. It's been a pleasure working with you.

Daniella Turenshine (CFO)

Thanks so much, Brian.

Operator (participant)

Our next question is from Edward Yruma with Piper Sandler. Your line is now open.

Edward Yruma (Managing Director and Senior Research Analyst, Global Lifestyle Brands)

Hey, good afternoon, guys. Thanks for taking the questions. I guess first, I know you listed a number of different use cases for some of your more specialized medical wear, but kind of curious to link back to the comments on, you know, pockets of incremental demand that you see. So is it these kind of more niche applications? Is it the layering system? I guess kind of what gives you comfort in that medium-term view based on what you see in the product offering today. And then second, would just love to kind of think through the promotional calendar now that you've gotten inventory more aligned, is the expectation that promotions should be broadly lower than they were in 2023? Thank you.

Trina Spear (Co-Founder and CEO)

Sure. Thanks, Ed. So I think from a product perspective, in 2023, we had, had—you know, we had a number of launches, but we were also bringing back a number of different styles and colors from the past. And so if you look at the cadence of the year, net-net, there was less newness, there was less innovation in terms of where we are now. And we're very proud of the ability of what we did in terms of bringing down our inventory from a peak of $190 million to $119 million in Q4. And so where are we now on products? We have a very healthy weeks of supply.

We feel really good about our ability to introduce innovation across new fabrications, products, features, and functionality in both scrubs and in non-scrubs. This includes our outerwear business, footwear, underscrubs, lab coats, compression socks, really stepping up and leveling up on all of these categories, all with the needs of the healthcare professional in mind. You know, a good example of this, and I mentioned it, is our On-Shift Sherpa Bomber Jacket. It was one of our best outerwear launches since 2022. Our ScrubLegging launch was a huge success.

So we're energized by what we've seen in Q1, but we know that building the level of engagement that we had will take time, but we are going to continue to bring healthcare professionals new innovation that not only drives them to try to, you know, really engage with any particular launch, but also drives the core. And that's the flywheel that has made us so successful. In terms of the promotional calendar, Daniella, do you want to take that one?

Daniella Turenshine (CFO)

Yeah. So in terms of promotional cadence for 2024, you know, I think it's important to note that in 2023, despite having an elevated inventory balance, we maintained discipline around our promotional events, and I think that's really apparent in the really strong gross margin rate that we delivered for the full year. And so looking into the, you know, next year, our guidance assumes that we continue to maintain that same discipline around our promotional events. You know, as you know, we don't do like-for-like events every quarter, and so we think that's really important to ensure that our customer isn't waiting for the next event. I think we're going to continue to be really focused on protecting our brand, but we're also really mindful of the fact that we're in a challenging macro environment where, as Trina discussed, you know, the consumer is under pressure.

I think we're going to balance all of those things and expect to, you know, have a relatively similar promotional cadence in 2024.

Operator (participant)

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

Brooke Roach (VP of Equity Research)

Good afternoon, and thank you for taking the question. I was hoping we could talk a bit more about your marketing plans for the year. It looks like you've had some efficiencies in the fourth quarter, but revenues are under pressure and the customer is engaging a little bit differently. Can you talk about what's changing in your advertising and marketing spends in 2024 on customer acquisition costs and the absolute percent of planned marketing costs as a percent of sales this year?

Trina Spear (Co-Founder and CEO)

Sure. Thanks, Brooke. So first off, we're, you know, I want to reiterate how excited we are about Bené Eaton joining us as our new CMO. I think, you know, we're currently making a shift to really tie our product, our merchandising, and our marketing together with very intentional and cohesive brand campaigns, and engaging our community at the top of the funnel. It is why our community loves FIGS. It is what has driven our success, and having, you know, having that lens is going to be super important over the long run. And so that is, you know, how we think about it.

And I think, the strategy around launching new products, engaging our community, you know, they're waiting up until midnight, seeing what we launched, they're engaging with that product, and then replenishing the core, none of that is changing. That continues to be, how we think about, the merchandising behind that marketing. In terms of the spend and CAC, we've been, as you know, incredibly efficient. It's been around 15%. Marketing as a percent of net revenue has been around 15%, and that's been stable quarter-after-quarter-after-quarter.

We look to remain and be disciplined, but are also evaluating certain parts of the business and opportunities where we can potentially push that more as we see across channels, across international, across TEAMS, ways in which we can drive that long-term LTV and long-term return on that investment, and that is where we're focused.

Brooke Roach (VP of Equity Research)

Great, thanks. And then just one quick follow-up for Daniella. Can you provide thoughts around what level of U.S. versus international growth you're contemplating in the flat to down 5% revenue outlook for the year? Thank you.

Daniella Turenshine (CFO)

Not breaking out in the specific buckets. I think similar to what we've seen in the past, you know, international is in earlier stages, and we are expecting the growth trajectory to be stronger than the U.S. But I think we're really focused on, you know, as Trina mentioned, driving intentional product innovation and combining that with cohesive storytelling and brand campaigns across our portfolio, and that's going to ultimately, you know, drive both the U.S. and the international business over time.

Operator (participant)

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

Dana Telsey (CEO and Chief Research Officer)

Hi. Hi, Trina, and best of luck, Daniella. As you mentioned about product launches to better enhance to focus more on the storytelling campaign part of it, too, as we go through 2024 with the new people also that you've brought in, Trina, how do you see the product telling story? What should we be looking for on the product cadence to drive excitement, given more consumer challenges now? How do you think about the product offering, both in scrubs and in non-scrubwear? Thank you.

Trina Spear (Co-Founder and CEO)

Thank you, Dana. You know, it's really exciting to be able to bring different stories around, what healthcare professionals are doing in extreme environments. And so our big campaign for the year is Extremes, and we feel as though, showcasing, you know, even someone like Dr. Luke Bennett, who's the Medical Director behind Hintsa, which is basically leading the medical teams for Formula One, race car driving, which is super cool. And so telling that story, tying that to the racing suit that we launched, tying that to the entire collection that brought in different elements of, that profession, bringing different elements and different innovation across, you know, across scrubs, but also across outerwear. We've had a number of launches this quarter with an outerwear that ties to, to the Extremes campaign.

And so this is a really exciting direction for us, in launching pinnacle products that not just drive excitement in and of themselves, but also drive our community to the core. And so, that's what we're going to continue to do. There's a lot of opportunity within fabrication. We're right now developing two new fabrications within scrubwear, that, you know, we believe are going to change the game.

And then outside of scrubwear, outerwear is a massive category. Healthcare professionals are still wearing jackets that are made to, you know, go hiking and rock climbing. And so there's a lot of runway, I would say, in outerwear, as is kind of the second behind scrubs, and then across the layering system for sure. But, tying these two pieces, and really three, it's, it's product, it's merchandising and marketing, tying these three pieces together in a really intentional way, is the direction and is where we're headed.

Operator (participant)

Our next question is from John Kernan with TD Cowen. Your line is now open.

John Kernan (Managing Director)

Hey, thanks for taking my question. Just wanted to, you know, take a look at, you know, the selling expenses and the outlook for selling beyond fiscal 2024, Daniella. You know, as, you know, top-line growth returns, what do you think a normalized selling margin is for the business? And you know, what type of top-line growth will you need to see that rate decline as a percent of sales?

Daniella Turenshine (CFO)

Thanks for the question, John. So as we discussed, just to reiterate, we have about $14 million in non-recurring selling costs associated with our fulfillment enhancement project through the third quarter of 2024. This compares to kind of the original $16 million-$18 million that we cited previously. That is transitory, so looking beyond this transition year, those will roll off. There are also gonna be higher costs associated with the facility, but these are investments to drive better efficiency, flexibility, speed, and accuracy, really, to enable us to better serve our customers, and really setting the foundation for us to expand our distribution network in the future.

Looking at ongoing costs, you know, as we said in the script, we do believe that, 2023 is a pretty good baseline level to use going forward as, you know, these higher costs do offset the savings that we would have gained by no longer using the excess storage facilities to house inventory. Over time, you know, there's a lot of opportunity to leverage this line item as we scale, and also as we expand our distribution network and, you know, are serving our international customers, you know, closer to them, lower shipping fees and the like. And so I think as we mentioned, we do plan to open a Canada DC in early 2025. So that's gonna be a really important driver of revenue and profitability on the horizon.

John Kernan (Managing Director)

That's helpful. Thanks. And then when we look at the adjusted EBITDA margin, you've been in the mid- to high-teens recently, with gross margin hovering around 69%-70%, what is the long-term path? How does it look back to that higher levels of adjusted EBITDA margin you've been in the past, and how should we think about the underlying drivers of that?

Daniella Turenshine (CFO)

Yeah, I think, well, dependent on our sales growth, we do believe that we can return to high teens EBITDA margin fairly quickly. You know, super proud to have delivered almost 16% adjusted EBITDA margin in the past year. I think looking at the P&L buckets, you spoke about gross margin. We're continuing to maintain a really healthy rate there, while also driving, you know, more innovation, investments in quality and consistency. And I think into the future, we have the opportunity to really optimize in our supplier base and continue to drive better costing as we scale our core business, and then continuing to invest some of those gains, you know, back into growth. Selling expense, we just chatted through kind of the puts and takes there.

I think, you know, as Trina's discussed, we're gonna continue to remain efficient in marketing spend, but also have the ability to flex up or down, depending on what we're seeing in the environment. And over time, right, as we return to growth, we believe we can leverage G&A, but we're not gonna make short-term sacrifices. We're gonna, you know, continue to invest in growth in the near term. I think 2023 shows that our core business, you know, it's high margin, it's replenishment driven, it's highly profitable. I think there's some short-term impacts that are creating some pressure in 2024, but fundamentals of our business remain really strong.

Operator (participant)

Our next question is from Rick Patel with Raymond James. Your line is now open.

Josh Reiss (Equity Research Senior Associate)

Hey, this is Josh Reiss, filling in for Rick here. I was hoping you could dig a bit deeper on the active customer growth in Q4. Any context on how much of that growth came from the U.S. versus international markets, and how should we think about new customer potential in 2024 compared to what you achieved in 2023?

Daniella Turenshine (CFO)

We don't provide more, you know, breakout on active customer mix between the U.S. and international. I think similar to the growth rates that we're seeing between the two, you know, international is a stronger driver of growth, but I think in both cases, you know, we are under-penetrated, and we have a lot of opportunity to continue to add more customers into the FIGS family. Looking into 2024, you know, as we've been speaking about, we are comping a really strong period of growth customer adds in 2023. You know, as a reminder, over the last several years, we've actually doubled our active customer base, and so we're comping some really big numbers here. And I think over time, as Trina was speaking to, we have an opportunity to really marry this intentional product innovation with our brand storytelling.

I think the top-of-funnel marketing that we're doing is going to be a large customer acquisition driver, but these strategies will take time. And as a result, you know, we are speaking to some pressure and active customer growth looking into 2024.

Operator (participant)

Our next question is from Matt Koranda with ROTH MKM. Your line is now open.

Matthew Koranda (Managing Director and Senior Research Analyst)

Hey, everyone. Just wanted to clarify what you said in terms of the quarter that should be sort of the lowest growth quarter in 2024, and then maybe just if you could talk about the phasing of growth across the year, just given the overall sort of low single-digit negative outlook for revenue at the midpoint. And then just factors that swing you towards sort of the bottom end of the guide and top end. Is it more product launches? Is it more successful promotions? Is it an improved macro that's on the high end of the guide? Like, what are the puts and takes there?

Daniella Turenshine (CFO)

So looking at the cadence of growth throughout the year, we are expecting Q3 to be the most challenged because we are, you know, comping a very successful sample sale in the third quarter of last year that we spoke to, where we did have just a larger inventory position to drive that event. Speaking to kind of outperformance to our outlook, I'll pass it over to Trina.

Trina Spear (Co-Founder and CEO)

Oh, okay. In terms of the outperformance to our outlook, I think there's a number of things that will be able to drive that rate. We saw success with our ScrubLegging. This is a completely new category that didn't exist in healthcare. And so being able to bring that to this community and have it be successful, you know, there are a number of different innovations that we're bringing forth throughout the year, and there is a lot—there is ability to outperform our expectations. And also the core, there's a number of things that we're doing from an evergreen marketing perspective to not only bring excitement around launches, but bring excitement around the replenishment aspect of needing to replenish your Catarina top and your Zamora pant, and how often are you coming back throughout the year to do that?

Matthew Koranda (Managing Director and Senior Research Analyst)

Okay, helpful. And then just on the fulfillment project, just curious what changed on the numbers. It's not a huge difference, but I think it used to be about $18 million in terms of total project costs, and now it's $14 million. Just what came out of that? Maybe help us understand a little bit about the change there.

Daniella Turenshine (CFO)

Yeah. As we've gone, you know, throughout the year and gotten closer to this transition taking place, you know, it's really just updates to our project plan and timing of the duration that we will need to be running both facilities in tandem has helped to bring the cost down. So looking to, you know, optimize that and glad to see that those transitory expenses have come down with our most recent expectations.

Matthew Koranda (Managing Director and Senior Research Analyst)

Okay, thanks. I'll turn it over.

Operator (participant)

Our next question is from Angus Kelleher with Barclays. Your line is now open.

Angus Kelleher (Equity Research Associate)

Hi, this is Angus on for Adrienne. Thanks for taking my question, and Daniella, wishing you well on your next venture. As you look ahead to 2024 for selling expense, how do you think about the timing of the benefit from recapturing warehousing costs? And how many quarters do you expect to get that benefit, along with the degree to which it will offset the fulfillment enhancement project beyond 1Q? And as a follow-up, curious about your new store, given it's now been open for a few months. So any new learnings or early wins you could share there? Thank you.

Daniella Turenshine (CFO)

So as it relates to our outlook for selling expense, we did discuss that we are expecting to see transitory costs as it relates to the transition. Those will be largest in the second quarter, but will take place in Q1 through Q3. And as we look at some of the transitory costs that we had previously to house excess inventory that we pulled forward, we are expecting that the ongoing costs of our new facility will offset the gains that we're getting from those costs looking into 2024. So looking past those transitory expenses, we think that 2023 represents a pretty good baseline for where we expect selling expense to be in the future. And I'll turn it over to Trina to talk about our store.

Trina Spear (Co-Founder and CEO)

Yes. As it relates to our Community Hub in Century City, we've seen really early success, and have really been pleased with the traffic. There are a number of days where we've had lines outside, all down, all the way to the grocery store. We've had lines for our fitting room. And I think what we've realized... We've- there's been a number of learnings. The store is about 1,000 sq ft. We're really excited to open Philly this summer. It is a bigger format, and so we're excited to have that location and that format to see what that does. But, some of the exciting dynamics, over 40% of our customers are new to FIGS, just showing how we can continue to build the brand with people that may not know about FIGS.

And so having that retail presence, having that Community Hub element, where we're having events and we're showing up and really engaging our community in person is so important, and we really think that's gonna unlock a lot of what we're doing digital, digitally. And so, you know, I think we mentioned on the call, only 15.6% of consumers shop online. So having stores, having Community Hubs as part of our strategy is really important. And it's only going to further, you know, further the brand love and community engagement that FIGS has. So very excited about what's to come.

Operator (participant)

Our last question is from Bob Drbul with Guggenheim Partners. Your line is now open.

Robert Drbul (Senior Managing Director)

Hi. Two questions, quick questions. The first one is, you know, on the retail store, just following up from the prior question, is New York City, you know, an area where you're contemplating a store from, like, a branding perspective? And the second question is, you know, as you think about sort of a slower environment, you know, is there a SKU rationalization opportunity that you are considering? Just trying to understand, you know, sort of how you're approaching, you know, this, the slower environment. Thanks.

Trina Spear (Co-Founder and CEO)

Thanks, Bob. Yes, we're very excited about New York City. It has been one of our, you know, key, key markets, one of our largest markets. It's amazing healthcare facilities, amazing hospitals in New York, and so we'll get there. We're lining it all up, but very excited about New York City. In terms of SKU rationalization, I think we are one of the—you know, one of the things that makes FIGS so special and such a great business model is having a very high volume with relatively low SKU count. And so having this level of SKU productivity is something unique to being a uniform company.

It's something unique to being a replenishment-driven company, and so continuing to drive more people to the same products is a strategy that we will continue to follow, but feel very good about where we are from an inventory position and where we are from a SKU count position.

Robert Drbul (Senior Managing Director)

Thank you.

Trina Spear (Co-Founder and CEO)

Thank you. Thank you all for joining our Q4 and 2023 full year, conference call. We'll see you soon.

Operator (participant)

That concludes today's call. Thank you all for your participation. You may now disconnect your line.