FIGS, Inc. (FIGS) Earnings Call Transcript & Summary

Well, good afternoon, everybody, and thank you for joining us. My name is Nathan Feather, and I work on Lauren Schenk [indiscernible] and cap Internet team here at Morgan Stanley. I am excited to be joined by Daniella Turenshine. FIGS' Chief Financial Officer. Thank you so much for joining us today.

Thank you so much for having us.

Now before we begin, a few quick housekeeping items. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

And with that out of the way, so for those in the audience that may be less familiar with FIGS, can you talk to the company's model, strategy and competitive differentiation?

Yes, definitely. So FIGS is a direct-to-consumer health care apparel company that really revolutionized the scrubwear industry. We are focused on creating technical, comfortable, functional medical apparel that helps health care professionals look good and feel good and performing their jobs every single day. We are focused on really building and connecting with the community, and that's been a really key pillar for us. As we think about our offering, our core scrubber, it's in FIONx technology, that's our proprietary fabrication. It has 4-way stretch, it's antimicrobial for anti-odor. It's anti-wrinkle, it really moves with you and enables you to perform in your job. And our merchandising strategy is a core scrubwear portfolio, and that's partnered with core non-scrubwear pieces as well. And that full portfolio really creates our layering system. And our layering system is meant to outfit health care professionals to work at work, from work on shift and off shift. And we complement that with limited edition styles across the layering system that are really meant to drive newness and excitement and engagement and bring our customers back to the site. And that's how we think about the product and the merchandising experience. I think on the customer experience side, we've created a really seamless e-commerce shopping experience. Before FIGS, it was mostly medical supply stores and health care professionals were going to locations in strip malls and shopping merchandise and boxes. And so we really elevated that experience, made it really seamless and easy to purchase and made it so that health care professionals can get the apparel that they need to do their jobs whenever they want to purchase. Today, we ship to 23 countries outside of the U.S. through our e-commerce platform. And we also have our first retail location in Century City in Los Angeles that opened about a month ago. And we also outfit -- we have a B2B portion of our business, which we refer to as teams, where we're working with health care institutions to outfit their employees and really standardize and professionalize their workforce. We have a really efficient marketing engine. A lot of our business is driven by strong word-of-mouth dynamics. So if you think about health care professionals, they are in densely packed hospitals and institutions. They're working shoulder to shoulder. And so when someone looks good and feels good in their clothing, they really are going to act like walking billboards for us. And we complement that with a really efficient and strong performance marketing engine, where we're able to really chase into new opportunities, see what messaging is working and really adjust as needed and also our brand strategies where we're telling awesome human stories where we're really emphasizing the functionality of our product and just generating a lot of excitement and engagement with the brand. I think for the future, as we think about our opportunities and future growth strategy is, first and foremost, we see a ton of opportunity within product innovation and really continuing to expand our product offering thoughtfully, focusing on solutions-based innovation, focusing on new fabrics, new functionality, new styles and new colors. I think secondly, really continuing to build and connect with our community through brand strategies, through our advocacy, through events and activations, super important for us to really extend beyond just scrubwear and really build a community with our health care professionals. And then we also have our more nascent growth strategies, which is expanding globally within our international business. We're in 23 countries today. We're seeing a really strong response to our brand and really strong growth there. Our Teams business, where we're selling directly to hospitals and institutions. It's an area that's entirely inbound today and seeing really strong tailwinds of institutions wanting to standardize and professionalize their workforce and finally, retail, where we refer to our retail or a community hubs because it's just as much about growing our brand presence and helping people touch and feel the product as it is about hosting programming and events and activations where health care professionals can come together and really engage with one another. And so we're just getting started, and we're so excited to be here to talk more about it.

Awesome. Well, a lot of things in there I want to dig on. But let's start a little more high level. I think a key focus for investors, especially lately has been the weakening macro environment. I guess within your business, how have you seen customer behavior change, at least over the past kind of few months?

I think for us, we're seeing some similar trends I think we've been speaking to over the course of the year. So first and foremost, I think we're really proud to see a growing number of new customers entering the FIG family. We've added more gross new customers each and every year with 2023 being our largest new growth customer adds. I think that really shows us how underpenetrated we are both in the U.S. and internationally and how much runway there is to continue to grow. I think we're also seeing strong replenishment dynamics where 70% of our revenue is made up of repeat customers. And finally, strength in AOV. It's a metric that we've grown almost 20% since 2019, driven by the expansion of our layering system and seeing customers really want to engage with that full product portfolio. I think where we see the most evidence of the weakening macro is in frequency rates. And so customers are -- they're extending the length between their purchases and they're stretching their dollar a bit more in this high inflation, high interest rate environment, 2/3 of our customers make less than $100,000. So we serve a really diverse range of health care professionals, and we're mindful of the fact that they are impacted by what's going on in the broader macro environment. I think for us, what gives us a lot of confidence about the future is continuing to add more new customers into the fold is really great to see. And also, customers that maybe haven't shopped with us in a while, and they're still really engaged with the brand. So they are on our e-mail list, they're on our SMSs, they're following us on Instagram. And I think that gives us a lot of confidence that we need to -- the macro is challenging, but they're still really engaged, they're loyal, and we have a lot of opportunity for the future.

Great. And since student loan payments restarted in the U.S., have you seen any shifts in consumer spend or frequency across different income or age brackets.

I think for us, we think it's still too early to really fully know kind of the impact from student loan repayments. I don't think we're seeing anything material in the business. But it's definitely something we're watching for and monitoring for and something that we were thinking about as we guided for Q4. I think while there might be some near-term digestion from student loan repayment. I think for us, it doesn't really change anything about how we're thinking about the 3- to 5-year growth outlook, and we -- it's a very important ethos for us to remain focused on the things that we can control. And so that's where we're going to continue to focus product innovation and building and connecting with our community. And we think that's going to be the drivers of growth over time.

Great. And I would be remiss not to ask about Black Friday and Cyber Monday. Many companies have called out that sales may have been pulled forward a bit earlier in the selling season. Is that what you've seen? And any other key differences from your initial expectations there?

We did call out on our third quarter call that we did expect to see some pull forward from the outperformance that we did in the third quarter. So that's something that we messaged to, I think, something that we're seeing a little bit -- for us, we don't really speak to inter-quarter metrics. And so we're definitely going to plan to provide more information about Black Friday and performance on our next call.

Now as you know in FIGS been one of the few e-commerce or DTC companies that has consistently grown net customer adds every quarter over the past 4 years. What has enabled FIGS to do that and avoid the COVID giveback, if you will? And how should we think about net add growth in the medium term?

Yes. I think we're really proud of being able to continue to add more new customers each and every year. I think it's a function of really strong new customer growth and also really strong reactivation rates. I think for us, like I spoke about in the beginning, we do get a lot of benefits from the word of mouth dynamics. And so we continue to see that organic traffic is our #1 kind of customer acquisition channel. I think outside of that, we're really focused on being super intentional and personalized in our performance marketing and coupling that with larger top-of-funnel brand strategies. And that's where we're going to continue to focus and be really efficient and make sure that we're allocating correctly between channels, remaining really nimble and flexible in our marketing spend. And on the reactivation side, really personalized targeted communication and messaging because like I said, we see that they're still engaged with the brand, and so they really just need that extra push, and we're really focused on how to do that in a really segmented and personalized way.

Great. And on the flip side from customer adds, frequency has pulled back from COVID highs. Do you see this as a temporary macro-lead drop or the new base to build off of?

I think within frequency, so probably helpful to take a step back and talk a little bit about where we've been and what we've seen. So in 2020 and 2021, we saw a big acceleration in frequency. I think that was partially the same dynamics that every e-commerce company was seeing with stimulus and stay at home orders and shift from services into goods. And then I think separately, there were things that impacted our customer base specifically with working longer hours needing to launder their scrubs more frequently. And as a result, we saw a big acceleration of frequency. I think looking to where we are now, we're in a very different macro environment where interest rates and inflation are weighing on our customer. I think -- we are in an interesting place because we're a premium brand with a premium product, but we have a very different customer base, where 2/3 of our customers make less than $100,000. And so they're impacted by what's going on in the broader macro environment. And I also think there's some element of stocking up that happened in 2020 and 2021, and we're still in a digestion period for that. And so I think looking at the future, we do believe that where we are today is lower than what we would expect for normalized frequency. When we look at the last time we were in a normalized place is 2019, and we are below the frequency levels from there. Our business is also very different from what it looked like in 2019. We were doing $110 million in sales. And so I think over time that normal frequency will become more apparent. And similar to your last question, I think for us, we're really focused on the things that we can control and the things that we can do to drive frequency higher over the long term. And we think the biggest contribution to that are going to be extending our layering system and delivering solutions-based product innovation and also continuing to really connect with our community in authentic in meaningful ways.

Great. Now switching gears a little bit. Your B2B team segment has continued to really gain traction and outpaced the overall business. Can you add some color on who the primary team's customer is? And then do you see a path to reach the same B2C, B2B mix is the overall industry?

So the overall industry in the U.S. is about 15% B2B. And today, we're at about mid-single digits of revenue. And so we do see a lot of opportunity to continue to penetrate that over time. I think it's important to note that today, this is entirely inbound. And so really, our D2C business is fueling this growth in Teams where employees are going to their health care administrator, they're going to their office manager, and they're saying, "We want FIGS." And so looking to the future, we think there's a lot of opportunity to drive this closer to that 15%. And we do think that's a good target. And where we're seeing a lot of strength and where we're seeing kind of the customer segments are in concierge clinics and medical associations and private practices in travel nursing and universities, particularly in concierge clinics. We're seeing this shift in consumerization in medicine where, you know, concepts are popping up that are really focused on the patient experience, I think [indiscernible] and One Medical and modern health -- and these institutions, they want to build that one-to-one relationship with their patients and they want to, as part of that, ensure that their employees look and feel like a team. And so that's been a really important segment of the market for us. And I think there's a lot of room to continue to grow and penetrate within that. Right now, we've been really focused on building the tech requirements to serve these different portions of the market. We have a tech platform that's -- makes it really seamless and automated to order, but we're expanding the assortment within that, and we're continuing to really enhance that tech product. And I think looking into 2024, we do want to start testing into outbound. I think combination of performance marketing on the smaller medium business side and also a small sales team for larger accounts. And so we're super excited to see what this business looks like with a little fuel, a little horsepower behind it.

Now another place that's seeing a lot of strength in international, real bright spot with organic traction leading to formal launches in a variety of countries. I guess given the differing health care systems internationally, how are you thinking about that market opportunity? And then what steps do you take to move a country from prelaunch some organic traction to being fully ramped?

So yes, we've seen a lot of success in our international business. Just for some history, our first markets that we opened were Canada, U.K. and Australia in 2019 and 2020. And then we opened 10 more markets in 2022 and an additional 10 markets in 2023. And I think what's really interesting is that take Canada, for instance, it's our largest international market and they have a nationalized health care system, but we see really similar purchasing dynamics as we do in the U.S., where it's largely a D2C market. They're engaging with our new products. They have a lot of flexibility in the color that they can wear. And so for us, it really, I think, shows that around the world, people are underserved by the product and experience available to them. And I think we will -- we're seeing a lot of success in growing these existing markets, and we're doing that through localization strategies, translations, marketing communication, site merchandising, really making sure that, that experience is tailored to the market that we're serving. And also through -- in some of our more established markets, testing into brand initiatives. So building out our ambassador network events and activations, all things that have been really instrumental in building the U.S. business, we're going to start in Canada, in U.K. and Australia. Australia particularly. So I think there's a lot of opportunity to continue to expand in our existing markets. We're going to continue to test into new markets where it makes sense to enter. And I think operationally, it's really easy for us to enter a new market because it's an e-commerce experience. And so we want to make sure that we're testing into and we have the right portfolio of markets open and available.

Now thinking kind of more broadly by the opportunity, you've launched a lot of partnerships recently, including Star Wars collaboration, the Eko co-branded stethoscope, V-Coterie jewelry and some third-party brands sold directly on wearfigs.com. I guess, can you touch on the broader partnership strategy here and how that impacts customer [indiscernible] and additions?

I think for us, we aim to do partnerships in a really strategic and targeted way. We want to identify brands that have similar values to FIGS that are doing things maybe outside of our core competencies and places where we're really able to leverage and build brand awareness through that partnership. And so I think we're going to continue to test and do it where it makes sense for us. and leverage it in small ways. But I think we've seen a lot of success there and something we're going to continue to do. I think it drives both brand awareness and introduces us to new members of our community who might not know but also drives excitement and engagement with our repeat customers as well.

Now, I'm sure one of your favorite questions, but 3Q marked a turning point for inventory growing less than revenue. And unlike many peers, FIGS has done that without being significantly more promotional. And so can you talk through the strategy and time line clear through the remaining inventory along with the composition and shape right now.

I do love that question. So yes, I think we're really pleased with where our inventory is. I think it came down close to 14% for the quarter. And we have been doing that in a really disciplined way. I think for us, the biggest priority was protecting the brand over the long term. And so we weren't willing to move through our inventory balance at deep markdowns. Deep markdowns or deep discounts. And I think it's important to note that our inventory is very different from a fashion retailer where we're selling a uniform. It's nonseasonal. Our core portfolio is always on our site, always in style, never goes out of stock. And so I think we have more flexibility to work through this inventory balance at the rate and pace. And we're on track to be at our goal of 25 weeks of supply by year-end. And then that's a bit higher than where we want to be over the long term, closer to 16 to 20 weeks but we expect to be able to get there in 2024. And I think what we've been really focused on is lowering our inventory balance through lowering the receipts that we're bringing in, and we've seen that be really effective. And really proud being able to deliver strong margins of 69% despite having a higher than a higher inventory balance than we would like. And I think it just speaks to our ability to move through that without resorting to deep discounts.

Now you're embarking on a fulfillment project starting in 4Q that's leading to some short-term impact on selling expense. Can you touch on the product background and rationale? How investors should think about the cadence of investment there and then the positive impact what's finished.

So this is a really important fulfillment enhancement initiative for us. It's going to drive greater reliability, greater efficiency, more automation. And ultimately, it's going to really enable us to scale over time. As part of this fulfillment enhancement initiative, we have spoke to $16 million to $18 million of operating expenses. About $2 million of that is going to take place in the fourth quarter of this year, and the remainder will take place in the first 3 quarters of next year. I think -- also importantly, this initiative is going to set the groundwork for us to expand our distribution capabilities over time. So in our business today, we're shipping everything from one distribution center outside of Los Angeles, including our international business. And we spoke on our third quarter call to opening up a Canadian distribution center in the first half of 2025. That's going to drive meaningful profitability savings for the business. If you think about shipping expense, duty fees where we're subsidizing the cost of outbound duties today to our international customers. And also just creating a better customer experience where people don't have to wait as long to receive their package. And then looking further into the future, I think a distribution center in Europe and Asia over time and that's going to really enable us to grow the international business and grow it in a really profitable and sustainable way.

Now moving to a little bit of a different place. So with more than $200 million in cash and short-term investments on the balance sheet along with consistently solid cash flow, how are you thinking about capital allocation and the potential for capital returns or M&A?

I think we are a growth company. I think first and foremost, we see the best opportunity for our cash is to invest back in our business. And we're going to continue to do so and identify opportunities to do so. I think that being said, we have a pretty capital-light model, and we deliver strong profitability. And so as we continue to generate cash flow over time, we're definitely going to explore other capital allocation opportunities that may make sense for us. I think M&A is something that's not really on the horizon today, but if there was a company that made sense in our portfolio, maybe outside of our core capability or enabling us to leverage the technology. It's something we would definitely explore. And similarly, a share buyback, if our stock price continues to remain challenged, and we feel it's a good return on our investment. It's definitely something we would continue to explore as our cash balance growth.

And before opening up for some audience Q&A. I guess one of the 1 or 2 things you think investors most underappreciate or misunderstand about the FIG story.

I think -- I think, first of all, we've been, I guess, lumped into kind of a class of 2020 on IPOs, where I do believe we have stronger underlying fundamentals. We're profitable. We've been profitable since 2019. And we have a strong balance sheet like we just talked about $230 million of cash and no debt. And so I think for us, we're going to continue to just perform and deliver, and I think that will sort itself out over time. I think the other thing is just -- we have a really strong moat around our business. I think we're delivering industry-leading product innovation. We're continuing to extend our layering system. We're building a really category defining authentic brand. And I think all of those things really insulate us, and we're continuing to widen that over time and using our scale and our capital and our data to continue to just widen that even further.

Okay. Do we have any questions from the audience.

Can you just talk about any [indiscernible] exposure that you may have or -- and how your fabric is relative to your competition?

So we don't have -- I know cotton is a big topic. We don't really have any cotton in our fabrication. I couldn't fully hear you. But our main fabrication FIONx is a poly-rayon blend, really meant for movement, for stretch. And we have a really diversified supply chain where we're partnering with manufacturers across the globe. So we don't see a ton of risk to fabric and raw materials at the moment.

And can you touch a bit more on the competitive mode, I guess, in the context of maybe other brands? Fabletics launched scrubs, for example, I'm curious how you think about just the competitive moat in general with a brand like that.

So I think from Fabletics, a competitive moat, there have been new entrants to the space. And I think what's interesting is they're really competing on low cost, low quality, which is really different from how we're differentiating ourselves where we're really focused on the value and the quality that we're providing to the consumer. And I think similarly, that authentic brand and building a connection with the community. I think that is integral to what we do and we really reinforce that with our advocacy efforts as well, where we're really showing health care professionals that we get them and we got them and we're fighting for better pay and better working hours alongside them. And so I think that, that is really hard to replicate. And I think consumers can really see when you're trying to expand for the sake of expansion and not really focused on the needs of the community that you're serving. And so I think that's where we're going to continue to really set ourselves apart and again, leverage the scale that we have, leverage the data that we have, leverage the relationships that we have with our community to just further emphasize that.

Anything else from the audience? I have a few more here. Okay. So picking up on a thing you talked about earlier, the exciting launch FIGS, first store opened in November in L.A. I guess given the recent opening, can you talk through the store strategy in the context of the overall business? Anything about the community hub aspect of it.

So really excited about our first store opening in Century City. We have one more store in Philadelphia that's slated to open in the first half of 2024. And for us, we're an apparel company. So I definitely think it's important for people to be able to touch and feel the product, to try on the product. And I also think there's a brand awareness element where we're focused on markets where we have a community, but there's also the opportunity to continue and grow and penetrate and serve more health care community or serve more health care professionals. But the community hub aspect of it is incredibly important. I think these are just as much about building that community more so than anything else. So programming is a big part of it. speaker series, ambassador speakers, meditations, events, community events, that's all going to be really instrumental within the store. And I think what we've seen from pass pop-ups and pass activation is that health care professionals, they love FIGS. They want to engage with the brand, but just as much they want to engage with each other. They want to meet other health care professionals. They want to talk about what they're seeing in their specialty and what they're seeing in their day-to-day. And so providing them the space to do that, I think, is incredibly important. We're going to test into this in a really thoughtful and deliberate way. We want to take the data and insights that we get from these first 2 stores and really use that to determine what the optimal kind of cadence and strategy looks like. But we're going into this with the ethos that these are profitable growth drivers for us, and that's how we're building them, that's how we're planning them. And we're going to continue to test and do it. And I definitely think over time, we'll provide more about what exactly that rollout strategy looks like.

Okay. Great. Well, we'll wrap it there. Thank you so much for joining us.

Thank you for having me.