Figs Inc

NYSE:FIGS

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon, and thank you for joining the FIGS’ First Quarter Fiscal 2023 Earnings 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, Head of Investor Relations at FIGS. You may proceed.

[Jean Fontana, Head-Investor Relations]

Good afternoon. Thank you for joining today’s call to discuss FIGS’ first quarter 2023 results, which we released this afternoon, can be found in our earnings press release and in the stockholder slide deck on our Investor Relations website at ir.wearfigs.com.

Presenting on today’s call are Trina Spear, our Co-Founder and Chief Executive Officer; Daniella Turenshine, our Chief Financial Officer.

As a reminder, remarks on this call that do not concern past events are forward-looking statements. We may see predictions, expectations or estimates, including about future financial performance, market opportunity or business plans. Forward-looking statements involve risks and uncertainties and actual results could differ materially. These and other risks are discussed in our SEC filings, including in the 10-Q we filed today, which we encourage you to review. Do not place undue reliance on forward-looking statements, which speak only as of today which we undertake no obligation to update.

Finally, we will discuss certain non-GAAP metrics and key performance indicators, which we believe are useful supplemental measures for understanding our business. That submission or 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, Co-Founder and Chief Executive Officer]

Thank you, and good afternoon, everyone. We are pleased that exceeded our first quarter expectations across key financial metrics. We delivered profitable growth through disciplined execution of our strategy that are on track to achieve meaningfully improved inventory levels by year-end. While the macro environment remains uncertain, FIGS is an iconic brand and I believe that we will advance our leadership position in the healthcare apparel industry while expanding our TAM.

Touching on the financial highlights from our first quarter. Net revenues grew 9% to $120 million as compared to the first quarter last year. We delivered gross margin of 71.3% and adjusted EBITDA margin of 13.4%, all of which were above expectations. Our growth was fueled by a 22% increase in active customers driven by strong customer loyalty as reflected in record reactivation rates during the quarter as well as new customers. LTM revenue per customer was down 4% to $216, due in part to a nearly 2% decline in AOV and lower frequency versus last year.

While these metrics were down year-over-year, they were ahead of our expectations. Once macro pressures subside and as we continue to advance our initiatives, we believe these metrics will improve. International continued to deliver strong performance with revenue growth of 45%, driven by expanding brand awareness and engagement across our global market. I want to thank our team for their unwavering commitment to serving healthcare professionals each and every day. I also want to thank our awesome humans for their loyalty as we continue to support them through our solutions-based product innovation, as well as through our efforts around advocacy and giving back.

Since our call at the end of February, we’ve continued to build out the layering system with proprietary non-scrubs products engineered to work with our best-selling scrubs. Our recently launched ContourKnit Jacket exemplifies how we transform customer feedback into innovative products with distinct features that address the specific needs of healthcare professionals. Our ContourKnit Jacket has been one of the best-performing outerwear pieces in our history.

As we continue to see notable strength in our extended size offering launched in December, we are encouraged by both new customer acquisition and the positive feedback we are receiving on our extended sizes offering. The work we have done around fit showcases our commitment to serving all healthcare professionals, and we will continue to roll out extended sizes across our assortment throughout the year.

Looking at our marketing initiatives. In celebration of our 10-year anniversary, we launched our FIGS10: The Iconic Series campaign, giving our healthcare professionals a chance over 10 weeks to grab their favorite injection colors by bringing back our most popular ones of all time.

Loyal healthcare professionals jumped at the opportunity to purchase these iconic colors, while those new to FIGS were able to experience them for the first time. This event is a great example of how we create excitement and move through inventory while maintaining discipline around our discount rate. Although our recent color launches have not generated the same level of demand that we saw during the height of the pandemic, they remain one of the most effective drivers of customer traffic and excitement.

For International Women’s Day, we celebrated Dr. Sarah Kilpatrick, Chair of Obstetrics and Gynecology at Cedars-Sinai Hospital. She has done incredible work in women’s medicine and co-founded CREWHS, the Center for Research in Women’s Health and Sex Differences. As a female founder in that organization, we are proud to celebrate Dr. Kilpatrick’s achievement and especially proud to have donated $250,000 toward CREWHS’ medical research.

Our commitment to this community has fostered an enduring brand strength and remains a key differentiator. Data continues to illustrate that this garners industry-leading customer loyalty. In a recent third-party brand survey, FIGS ranked highest on brand sentiment and across several attributes, including quality, comfort, functionality, and style. We also experienced the highest purchasing intent from respondents. This aligns with prior [indiscernible] data indicating that the percentage of customers who repurchased FIGS within one quarter of their initial purchase is two to three times higher than for other scrubs companies. Our goal is to continue to deliver the product and experience that widens the moat and furthers our lead versus everyone else.

To that end, I’d like to provide an update on our growth strategy. As you know, we are laser-focused on innovation. Over the last few years, we built our layering system of scrubs and non-scrubs with purposeful functionality and comfort in every product while combining this with our unique, cool, and playful DNA. We keep our healthcare professionals engaged with our brand with constant innovation, which is informed by our data and customer feedback. Our recently launched Uman Relaxed Jogger was designed based on feedback from our customers requesting a raised waistband. We are seeing strong early results and awesome feedback across social media.

Our FREEx fabric featuring anti-static lightweight water-repellent attributes is another example of innovation resulting from customer requests for lighter-weight alternatives. We will continue to build our solutions-based offerings utilizing this fabrication, which is made almost entirely from recycled and upcycled materials. Our FIGSPRO office-ready collection addresses the demand gap left by traditional apparel companies that don’t meet the specific needs of healthcare professionals. We plan to add several new silhouettes and fabrics to our FIGSPRO line, which is yet another example of how we’re expanding our TAM. Innovation like FREEx and FIGSPRO represent completely new categories from which we’re able to learn and iterate to build out these collections.

While we continue to expect our core scrubs to represent a high percentage of our overall sales, we are excited about the potential to drive significantly higher net revenue for active customers by addressing a greater portion of healthcare professional needs with expanded offerings. Importantly, our ability to drive revenue in non-scrubs illustrates that healthcare professionals have entrusted us to address their lifestyle needs beyond their scrubs.

Next, I will speak to our marketing strategy. Across our communication channels, we are being more intentional in our storytelling to emphasize our product attributes. We create brand moments that showcase our leadership and product innovation and our relentless support of the healthcare community. Without a doubt [ph], the first campaign highlights our product attributes. This theme was introduced for our launch of the ContourKnit Jacket and will align with future product launches throughout the year. Our stream of product innovation creates a flywheel effect in our business work now.

As our loyal healthcare professionals go to work each day wearing the latest FIGS, they generate new customers, and as our base gets bigger, we expect this flywheel effect to multiply. This is how we have maintained efficiency in marketing spend that enables us to invest in new ways to reach our communities. We’re also delivering a more consistent cadence of marketing communication around product education. It keeps us top of mind among the healthcare community.

This evergreen marketing approach is showing early success in driving stronger traffic on non-launch days, which is enabling us to maintain a highly efficient marketing spend. Our ambassador program remains an important driver of this organic growth. We’ve employed a more localized strategy to better leverage our growing network of influential ambassadors by hosting frequent events across North America. For the second quarter, these events will include our Nurses Week event in Seattle, Meet FIGS in Toronto, and Pride Day in San Francisco.

Turning to personalization, we are encouraged by the signs we are seeing as our database has grown and we have expanded our product offerings. We’re building on our personalization strategies, and we’re effectively tailoring our communication to every single healthcare professional based on their individual needs and wants.

Lastly, we’re driving the revenue in our early stage business. Internationally, we’re already seeing the benefits of localization strategies, and we’re rolling out translations for certain non-English speaking countries starting this month. We continue to build upon our early learnings, as well as grow our local ambassador networks within each market. Importantly, we’re maintaining our investment discipline as we build our presence across regions.

With almost 120 million healthcare professionals outside of the United States, we are extremely energized by the opportunity in front of us. Within Teams, we remain on track to launch an updated version of our technology platform as we look to elevate our customer experience and expand our available assortment. Today, this is a small portion of our revenue, and we’re making sure we maintain a methodical approach to grow this business over time. We believe this is a significant opportunity that we barely have in queue.

Turning to retail. We are on track to open our first store this fall. We believe that our retail stores will provide a great opportunity for healthcare professionals to connect and experience our products and to engage with each other through our community hubs. Operationally, we are committed to making investments that will support long-term profitable growth. We are making progress on our fulfillment enhancement project, which we expect to drive greater flexibility, reliability, and speed to market across our distribution channel. Daniella will provide an update on the project details shortly.

We are also continuously working to diversify our supply chain with the best-in-class manufacturers. We’ve always prided ourselves on the strength of our supply chain, and we’re excited to build next-level capability as we work with amazing partners that help us bring our vision to life.

In closing, we continue to expect growth in 2023 to be moderated by a challenging and uncertain macro environment. While we continue to see that the healthcare industry has greater resilience than other industries, our healthcare professionals are not immune to inflation. We continue to focus on building strong loyalty and connections with our customers. So, when these macro headwinds subside in the future, we’re well-positioned to deliver accelerated growth. In the meantime, we’re managing our business prudently, enabling us to deliver continued profitability.

Overall, we plan to continue to disrupt the landscape of the healthcare apparel industry and expand our TAM by helping healthcare professionals do their jobs better and look and feel great on-shift, off-shift, head to toe. We see tremendous opportunity globally and believe that our product innovation, combined with the power of our brand, will fuel further market share gains. We have scale, profitability, and a strong balance sheet with no debt. We expect to generate free cash flow to support our sustainable long-term profitable growth for years to come.

With that, I’ll turn the call over to Daniella.

[Daniella Turenshine, Chief Financial Officer]

Good afternoon, everyone. We are pleased to deliver better-than-expected results for the first quarter with strong flow-through of top-line outperformance. We are making progress against our initiatives while exercising discipline around expense management, and we expect to deliver positive free cash flow for the remainder of the year.

I’ll begin with a review of our first-quarter financial results, followed by our outlook. Beginning with first quarter net revenues, we grew 9.2% to $120.2 million compared to $110.1 million in Q1 last year, reflecting an increase in orders, partially offset by modestly lower AOV. While frequency trends and AOV were down year-over-year, they were better than expected. Growth in active customers remains robust, increasing 22% as we welcome new healthcare professionals to the FIGS brand globally. In addition, we continue to see more of our customers who have not purchased within the last year come back to the brand after month 12.

Turning to AOV, we saw a decline of 1.7% to $114. This compares to $116 in Q1 2022, which benefited from an elevated mix of non-scrubber associated with one of the largest shoe product [ph] launches, as well as supply chain disruptions causing out-of-stocks in our core scrubs products. In addition, a higher mix of sales were derived from promotions, again, in line with our expectations given the macro environment.

Gross margin for Q1 was above our expectations at 71.3% compared to 71.2% in Q1 2022. The 10 basis point increase compared to Q1 last year was primarily due to lower airfreight utilization, partially offset by the higher mix of promotions and higher duties.

Moving to operating expenses. Selling expense for Q1 was $31.2 million, representing 25.9% of net revenues compared to 20% in Q1 2022. This 590 basis point increase was largely due to higher costs within fulfillment, including a 290 basis point impact from incremental warehouse storage and associated labor necessary to help inventory be pulled forward. To a lesser degree, the increase in selling expense reflects duty subsidies that we put in place in the third quarter of last year for international sales.

Marketing expense for Q1 was $17.1 million, representing 14.2% of net revenues compared to 14% in Q1 2022. Our marketing initiatives enabled us to maintain a healthy return on ad spend while driving strong new customer acquisition.

G&A expense for Q1 was $34.2 million, representing 28.4% of net revenues compared to 24.7% in Q1 2022. The increase was due to the change in accrual methodology we discussed in our Q3 2022 call related to charitable donations, an increase in stock-based compensation, an increase in professional fees including public company costs such as those associated with the implementation of Sarbanes-Oxley 404.

Our net income was $1.9 million or $0.01 in diluted EPS for the first quarter. Adjusted net income was $2.5 million, and adjusted diluted EPS was $0.01 in Q1. This compares to adjusted net income and adjusted diluted EPS of $10.5 million and $0.05 per share in Q1 2022, respectively.

Finally, our adjusted EBITDA for Q1 was $16.1 million for an adjusted EBITDA margin of 13.4% and compared to 22.7% in Q1 2022.

Turning to our balance sheet. We maintained a strong cash position, finishing the quarter with $156 million in cash and cash equivalents. Inventory totaled $180 million at the end of the first quarter. As we stated on our last call, we expected inventory to peak in Q1 and declined sequentially through the remainder of 2023.

Looking at inventory on hand, approximately 55% is comprised of always in stock, seasonless core styles and classic colors and therefore, doesn’t have significant obsolescence risk. An additional 20% of our inventory balance is an upcoming styles and colors. We are making good progress toward getting inventory to 25 weeks of supply by year-end while maintaining discipline around promotional activity to protect the long-term health of our brand.

Moving to our outlook. Consistent with the factors we discussed last quarter, our guidance assumptions incorporate a challenging macro environment through the remainder of 2023. We expect these headwinds to continue to impact frequency trends and result in a higher mix of promotional sales. As we manage through these temporary headwinds, we remain profitable, and we’ll continue to make investments in our business to drive healthy long-term growth.

For the second quarter, we expect net revenue growth to be between 8% and 10%. We expect future gross margin to be slightly below 68% due to a higher mix of promotional sales associated with our Annual Nurses Week Event and product mix related to new launches. We expect these headwinds to be partially offset by lower airfreight utilization year-over-year.

Looking at operating expenses. Due to higher labor utilization than we previously anticipated, we now expect the warehouse storage fees and associated costs to impact selling expense by approximately 220 basis points in the second quarter.

For G&A, we continue to expect to leverage year-over-year due to an increase in stock-based compensation and personnel-related costs. As a result of these factors, we expect second quarter adjusted EBITDA margin to be between 9% and 10%. For the full year, we expect net revenues to increase between 5.5% and 7.5%.

As we look at the second half of the year, we expect tougher compares for two reasons. First, we are anticipating a difficult macro environment; and second, we will be lapping the very strong new customer adds last year. We expect Q3 to be the most challenged in terms of year-over-year net revenue growth due to the shift in timing of our product launch and marketing calendars.

We now expect gross margin for the year to be closer to 69% as we pass through the better-than-expected Q1 results. We expect gross margin to improve sequentially in the back half due to timing of promotional calendars and product launches.

Turning to selling expense. As it relates to our fulfillment project, we are providing an update on the timing of this initiative. The estimated cost associated succeeded with the implementation and execution of this project remain between $16 million and $18 million. However, we now expect to incur the bulk of these costs in 2024. Associated with this timing shift, we plan to extend the use of storage facilities through the end of 2023. As a result, we now expect selling expense pressure from excess storage and associated costs in addition to initial fulfillment costs combined to be approximately 250 basis points for the full year 2023 versus our previous expectation of 300 basis points.

G&A is still expected to deleverage for the full year, in part due to investments associated with growing our international and Teams businesses, product innovation, and an increase in stock-based compensation, as well as our accrual for future inventory donations. As a reminder, our G&A for Q3 last year reflected a 190-basis-point benefit due to a change in our accrual methodologies for charitable donations.

As a result of these factors and based on our Q1 outperformance, we now expect adjusted EBITDA margin for the full year of 2023 to be between 12% and 13%. We expect capital expenditures of between $24 million and $26 million for the full year of 2023. This reflects approximately $20 million for the fulfillment project with the remainder being related to software investments at our retail store build-out. We remain a clear leader in healthcare apparel with significant growth opportunities in front of us.

Our strong balance sheet and ability to generate healthy free cash flow positions us well to invest in our future growth. Near term, we remain focused on managing our business prudently through macro and cost headwinds. We believe we have a line of sight to return to high-teens-plus EBITDA margin as we move past some transitory costs, fulfillment investments, and as we rightsize our inventory.

With that, I will turn it over to the operator to kick off our Q&A session. Operator?

[Operator]

Thank you. [Operator Instructions] Our first question will be from the line of Ed Yruma with Piper Sandler. Your line is now open.

[Ed Yruma, Piper Sandler]

Hey, good afternoon. Thanks for taking the question. I guess, first, thanks for the update on inventory and when you kind of expect to get to alignment. I guess just maybe looking at some of the promos you ran in the first quarter, how would you gauge your success in kind of closing out the inventory you wanted to close out? And as we think about the promotional cadence going forward, are there – how should we think about the shape of that kind of promotional curve as you wind through that excess inventory?

And then as a follow-up, I know you guys had some really interesting innovation in the quarter, you launched Reed Scrub Jacket. Maybe just any more color on the performances, some of the new SKUs you launched, and kind of how you see that unfolding for the balance of the year? Thank you.

[Daniella Turenshine, Chief Financial Officer]

Thanks, Ed. I’ll start with your inventory question. So, as it relates to the success of our promotions in the first quarter and what that curve looks like for the remainder of the year, our inventory was as expected at the end of the first quarter and really getting our inventory into a more normalized position is a really big priority for us, and we do have initiatives in place to get to 25 weeks of supply by year-end.

I think just as a reminder, we’re a uniform business. Our product is seasonless. It doesn’t go out of style. 55% of our product is in core styles and classic colors, which are always in stock, always available on our site. And so, we’re confident we’ll move through the products at reasonable sell-through rates and disciplined promotional levels. We’re really focused on balancing, protecting the brand for the long term with the pace – with the right pace to move through our inventory balance. And so, as we’ve done, we’re going to continue to really keep a similar promotional cadence that we have to the prior year. We did that in the first quarter. We’re planning to do that into the second quarter as well, but we are being mindful of mix shift that we’re seeing into some of these more promotional times.

And looking at our inventory balance, we have initiatives that we’re doing to really work through the balance outside of promotions. First, as we’ve seen shipping times normalize, we’ve been able to shorten our lead times, which has really enabled us to be more flexible with our inventory planning. We’re updating our purchasing to buy more shallow in the future, and we’re bringing back previous launches of limited edition inventory in ways that feel really new and exciting to the consumer like you saw on the FIGS10 Iconic Series.

And with that, I’ll turn it over to Trina.

[Trina Spear, Co-Founder and Chief Executive Officer]

Thanks, Daniella. And thanks, Ed, for the question. So, in terms of the Reed and Page Jacket, those were great additions. They’re cargo scrub jackets, eight pockets. I think it’s actually one of our most technical scrub jacket that we’ve launched. And we had a number of other product introductions throughout this year that we’re super excited about and really resonated well with our community.

To the point about innovation, I really want to reinforce how we think about it at FIGS. Product innovation is first and foremost about solving real problems for healthcare professionals. And we do that with premium products. And sometimes this is just as simple as updating pockets like what you saw with the scrub jackets, adding zippers, changing our waistband to classic silhouettes. And that’s on one end. On the other end, it’s building completely new businesses, and you’re seeing that right now with our FIGSPRO line. You’re seeing that with our FREEx fabrication, and you’re going to see more going forward on all of these fronts.

And this all comes back to listening to our customers and creating products that enable them to perform at their best. Everything we do at FIGS is designed with intention. And every product we make becomes part of our layering system, which coordinates across our product lines, across our colorways, and our accessories. And it’s one of the reasons that almost 70% of our revenue is from repeat customers.

And to Daniella’s point, when we think about our inventory levels, they’re not impacted by the amount of newness and innovation that we’re able to deliver to our customers. New – our new launches keep our customers engage with our brand, whether they’re purchasing the product that we just launched, like you saw with the Reed and the Page jackets, or whether they’re coming back to buy their favorites, our core or other products that have existed on our site. And so, as we think about innovation, it’s happening at FIGS every single day, 24/7, 365 days a year and it’s driven by solving real problems in the most creative, comfortable, and functional way possible. And that’s why we are where we are. And this is a huge differentiator for us.

[Ed Yruma, Piper Sandler]

Thanks so much.

[Operator]

Thank you. Our next question will be from the line of Alice Xiao with Bank of America. Your line is now open.

[Alice Xiao, Bank of America]

Hi. Thanks for taking my question. Can you please elaborate on the quarter-to-date trends that you’ve seen and also how AOV conversion and customer purchase – purchasing frequency have trended since the end of the quarter?

[Daniella Turenshine, Chief Financial Officer]

So, our Q2 guidance is not necessarily reflective of our growth rate quarter-to-date, but really, it’s an expectation of the quarter’s performance in aggregate. Given our main event of the quarter, Nurses’ Week is actually kicking off today. We still have a lot of volume in front of us, and we’re cognizant of that in the guide. So, we’re not speaking specifically to trends intra-quarter today.

[Alice Xiao, Bank of America]

Got it. Thank you. And then just really quickly, can you talk a little bit more about the team’s business percent of mix? And any progress in signing up more customers? Like what percent of the assortment is currently available versus what you want to make available through that program? Just any quantifications around that would be really helpful.

[Trina Spear, Co-Founder and Chief Executive Officer]

Sure. Our team’s business is smaller today, but there’s a massive opportunity in front of us. 15% of healthcare professionals receive scrub, receive their uniforms from their institution. And so, we’re really excited about this opportunity. We’re on track in terms of upgrading our platform to incorporate more availability across our assortment. It’s going to enable more types of institutions to participate and be a part of the FIGS brand, from hospitals to schools to med spas to concierge clinics, private practice. So, we couldn’t be more excited about our Teams platform, everything that we’re doing to help standardize and professionalize medical teams across the U.S. and across the world.

[Alice Xiao, Bank of America]

Thank you.

[Operator]

Thank you. Our next question will be from the line of John Kernan with TD Cowen. Your line is now open.

[John Kernan, TD Cowen]

Excellent. Thanks for taking my question, and congrats on a nice first quarter. Daniella, can you talk to the path back to that high-teens adjusted EBITDA margin? Previously, it was in the 20s. Obviously, there’s been a lot of changes in inflation since that original target came out, but you are giving us pretty specific detail on some of the selling expenses related to inventory and fulfillment costs. Just wondering how we think about – should think about the sequencing of that path back to high teens adjusted EBITDA margin?

[Daniella Turenshine, Chief Financial Officer]

Definitely. So, based on what we see today, we believe we have significant opportunity to drive EBITDA margin expansion over the longer term. And so, in 2023, as we spoke about, we’re seeing pressure from a few factors. First, we’re seeing transitory gross margin pressure, couple of hundred basis points due to the combination of promo mix and also freight related to sell-through of inventory that we purchased last year.

Secondly, we’re seeing approximately 250 basis points of selling pressure mostly from excess storage fees. Moving to 2024, we do have the bulk of the $16 million to $18 million in incremental costs related to the fulfillment enhancement project, but excess storage fees are going to largely go away. So, net-net, we will see some more pressure in fulfillment in 2024 versus 2023. All that being said, our core business is high-margin, replenishment-driven, highly profitable, and cash-generative in a normalized state.

There’s a lot of short-term impacts that are creating pressure, but the fundamentals of our business remain strong. And over the longer term, we continue to expect gross margin to approximate 70%, we’re going to aim to keep marketing expense at around 15% of net sales. Selling is going to normalize in 2025 and beyond. And looking further into the future, we do expect as we accelerate growth, that G&A is also going to be able to leverage from where we are today.

So, ultimately, our goal is really to ensure that we’re making the right decisions for the long term while sustaining a strong profitability profile today, and we feel really confident in our ability to do so.

[Unidentified Analyst]

Excellent. That’s helpful. And maybe, Trina, you could talk to customer acquisition and retention costs. Daniella has just said you plan on keeping marketing expenses relatively flat as a percent of sales.

So, I’m just curious in terms of near-term marketing trends, it looks like marketing expense per active customer ticked down a little bit from where it was and year-over-year. So, just curious what you’re seeing from a marketing spend and an acquisition and retention perspective. Thanks.

[Trina Spear, Co-Founder and Chief Executive Officer]

Yes. I mean, I think it’s been really encouraging. You’ve seen our customer acquisition trends over the last number of quarters, and it’s incredibly strong. I think the similar – same dynamics that we’ve always talked about remain to be true.

How do we acquire customers? It’s mainly word of mouth, right? Every fixed customer is a walking billboard, acquiring that next customer for us. That’s a trend that drives our efficiency to the levels that you’ve seen over the last number of years. And that’s what – over 60% of our traffic is organic. And the second thing that we have that many don’t is the replenishment nature of our business.

And so, almost 70% of our customers are repeat that we’re not acquiring for the first time. And so, those two dynamics really drive what we would call a paradigm shift, right, flipping that paradigm on its head, where as we grow, as we scale, we can become more and more efficient. Now, if we wanted to drive that way down, we could. But our goal is to keep to Daniella’s point our marketing at around 15% as a percent of sales, which as a direct-to-consumer almost 100% digital company, many haven’t been able to pull that off.

So, we are proud of our ability to keep acquiring customers at such a – at efficient level and do it while bringing more and more healthcare professionals into the FIGS family.

[Unidentified Analyst]

Got it. Thank you.

[Operator]

Thank you. Our next question will be from the line of Brooke Roach with Goldman Sachs. Your line is now open.

[Brooke Roach, Goldman Sachs]

Good afternoon, and thank you for taking our question. Trina, I was wondering if you could start by talking about the drivers of the record reactivation rates that you saw in the quarter. What was it that brought those customers back to the brand now? And are they engaging in any specific types of new innovation or promotional activity that they didn’t in the past?

[Trina Spear, Co-Founder and Chief Executive Officer]

Yes. I think it is a function of our repeat frequency has been extended a bit. And so, you’re seeing that show up, where customers are spending a little bit more time between purchase and it’s not that they’re leaving FIGS, right? They’re just spending a little bit more time before they come back and shop again. And I do think it’s a function of a few things.

It’s definitely a function of our innovation. We launch products every single week, and our customers are coming back. It’s driving traffic. It’s driving height. Its driving excitement and bringing our healthcare professionals back to engage with us. A bit on the promotion side, we’re seeing more customers engage on that level, just given the environment and given what’s happening from an inflation perspective, but we feel really good as macro pressures subside over the long run that given how much bigger our base is, given how much customers we’re acquiring. The position that we’re going to be in as we – as the macro normalizes over time, we’ve never been in a stronger position, and it’s really exciting to see and you see it in the customer acquisition. You see it in the reactivation, and you see it as we’ve seen as the frequency is normalizing as well.

[Brooke Roach, Goldman Sachs]

Great. And then maybe a question for Daniella. Daniella, I think you mentioned airfreight recapture as a driver of some of the outperformance in gross margin in the quarter. Can you quantify the benefit that air freight was in 1Q? And then perhaps help us understand what airfreight quantification is embedded within this updated 69% gross margin guide for the year. Thank you.

[Daniella Turenshine, Chief Financial Officer]

Yeah. So, as expected, we are anticipating to see better air freight utilization year-over-year. It was one of the benefits year-over-year from the first quarter. It was also – came in better than we expected.

And so, continuing to drive lower air freight utilization. As a reminder, we’re not bringing in really much product at all inbound via air freight today. But what we are doing is selling through product that was air freighted in 2022, that’s already in our balance. So, inclusive in our gross margin guide of just below kind of 69% for the full year. We’ve incorporated that continued benefit that we expect to see from lower air freight utilization over time.

[Brooke Roach, Goldman Sachs]

Great. Thanks. I’ll pass it on.

[Operator]

Thank you. Our next question will be from the line of Matt Koranda with ROTH/MKM. Your line is now open.

[Matt Koranda, ROTH/MKM]

Hey, guys, good afternoon. Thanks for taking the questions. Just maybe I want to see if I could get at the reengagement from a different angle. Curious maybe could you quantify or maybe just qualitatively discuss how big is the pool – the lapsed active users that you have to pull from. And what does that mean for marketing efficiency on a go-forward basis?

[Daniella Turenshine, Chief Financial Officer]

So, it’s definitely been – what we’ve been seeing, as Trina spoke to before, is a record number of reactivations. And so, we have people in our customer base who as kind of those frequency trends expand and as we see a little bit of an increase in days between purchase, they’re waiting longer, and we see them coming back in month 13, 14, 15. Definitely, on the marketing side, we’re targeting those customers through our personalization strategies and focused on providing them with messaging and content to drive them back to the site. And so, it’s definitely an opportunity for us in the future to continue to drive more of those reactivations over time.

[Matt Koranda, ROTH/MKM]

Okay. Great. And then just one more on the inventory if I could. You mentioned 25 weeks is still the goal toward the end of the year. Just curious if you could maybe kind of level set us on what to expect in terms of cadence to get there. Is it just a steady drop through the rest of the year? Are there going to be chunkier periods around some of the promotions for like Nurses Week or whatnot just kind of level set us there?

[Daniella Turenshine, Chief Financial Officer]

So, as we discussed, the first quarter was a peak in terms of inventory, and we do expect it to decline from here. And a pretty kind of just sequential decline. There isn’t a ton of lumpiness and we’ve planned kind of our future purchases to get to the 25 weeks of supply by year-end, but there isn’t a lot of choppiness to speak to before then.

[Matt Koranda, ROTH/MKM]

Okay. Great. I’ll leave it there. Thank you.

[Operator]

Thank you. Our next question will be from the line of Bob Drbul with Guggenheim. Your line is now open.

[Bob Drbul, Guggenheim]

Hi. Just two questions for me. The first one is, are you seeing any change in competitive pressures? And then the second question that I have is, can you elaborate a little bit more on international takeaways, what you’ve learned so far with the growth that you’re seeing? Thanks.

[Trina Spear, Co-Founder and Chief Executive Officer]

Sure. Thanks, Bob. So, as we think about competition, if competition didn’t exist, we wouldn’t be doing our jobs, one of my favorite lines. But competition is healthy, right? It’s a sign that you’re doing something worth copying and I really believe that.

But I also believe there’s only one spot for first place and FIGS plan to remain in that seat for decades to come. How are we evolving to stay ahead? How do we plan on remaining as the number one brand in the healthcare apparel space? First and foremost, product integrity and innovation. We’re light years ahead of our competition in terms of product development, research, innovation, and production.

We’ve been working with our healthcare professionals for 10 years on fit, style, functionality, and we have the manufacturing partners so that we can stay agile, increase the extraordinary. Secondly, and this point is something that I’m passionate about. We have the scale. We are 10 times larger than our closest D2C competitor, and our marketing budget alone is bigger than the revenue.

Third, we’re profitable. And what this means is that we have resources to continuously get better, faster, smarter across all areas of our business. And finally, we have brand love, intangible brand love. We’ve mentioned this on calls, but this is what we’ve built for 10 years.

It can’t be replicated in a day by any competitor. Our relationship with our community is deep, and our brand trust is unmatched. We’re the only brand in the healthcare apparel space that has tapped into what it means to be a human in healthcare. As it relates to international, I think you saw the growth in the quarter.

We feel really great about our progress in the markets that we’re in, and we’re going to continue to localize across markets, and you’re seeing that as we talked about translations actually coming this month, for non-English-speaking countries, and that’s something that we’re super excited about. But localization isn’t just about translation. It’s also about how we communicate with our healthcare professionals in and around the world in the way in which they want to communicate and engage. And so, this is a big priority for us, and we’re just getting started.

We talk about penetration. We have 10% market share in the U.S. We have, I mean, a fraction of that internationally. And so, we have a huge runway ahead of us, and we’re excited to keep connecting with the 118 million healthcare professionals outside of the U.S.

[Bob Drbul, Guggenheim]

Thank you.

[Operator]

Thank you. Our next question will be from the line of Dana Telsey with Telsey Advisory Group. Your line is now open.

[Dana Telsey, Telsey Advisory Group]

Good afternoon, and nice to see the progress. As you think about the supply chain, I think either Daniella or Trina, where you mentioned it in diversifying the supply chain. How far along are you? What will it mean go forward, whether in terms of how you manage inventory or the cost? And then with the fulfillment enhancement program, what should we be looking for as guideposts along the way that will lead to improved margins? Thank you.

[Trina Spear, Co-Founder and Chief Executive Officer]

Thanks, Dana. As it relates to the supply chain, we’re really taking advantage of this opportunity to lay the foundation with new supply partners and where are we focused? We’re really focused, first and foremost, in innovation, right? That’s our lifeblood. We’re also really focused on flexibility, on scale, consistency, and reliability and we are in the process of diversifying further not just around country, but also around how we can make the best product across our layering system and deepening our partnerships with the suppliers that we already have and building new partnerships around the world. As it relates to the fulfillment project, we are on our way to – in terms of this initiative. And I think, Daniella, I don’t know if you have any other points on that.

[Daniella Turenshine, Chief Financial Officer]

Yes. I think for the fulfillment enhancement initiative, it’s really going to enable us to drive flexibility and reliability and ultimately improve the customer experience. It’s also going to set the foundation for us for future distribution expansion as we think about potential distribution centers in the East Coast or internationally in the future. And so, over the long run, it’s going to enable to drive efficiency and scale, but there’s also a lot of benefits as it relates to the experience that we’re providing to our customers, and we’ll be sure to update you along the way as we get deeper into that project.

[Dana Telsey, Telsey Advisory Group]

Just one last thing. On the non-scrubwear, the rate of growth there versus the past, anything to note on non-scrubs in the lifestyle product and looking at that this quarter or go-forward? Thank you.

[Trina Spear, Co-Founder and Chief Executive Officer]

Yes. I mean, I think our view around our non-scrubs business is that they’re all tied together. We have a really holistic and intentional view around the entire layering system. It’s meant actually to be layered.

So, our categories aren’t really competing with one another. They’re really complementing each other. So, they add value by being part of someone’s uniform. So, really, as you think about the uniform, it’s not I know we break it out, scrubs and non-scrubs, but it’s all supporting each other.

So, if you’re wearing FIGS, you’re most likely not just wearing a set of a FIGS scrubs, you’re also wearing our underscrub, or you’re wearing our vest or our jacket. And our hope over time is that you’re wearing the full layering system on shift, off shift, head to toe. And so, you might see some of these categories fluctuate in growth, but our goal is that the remaining a healthy percentage of the total, and that’s the intention, and that’s what you’re seeing. The only other thing I would add is that as much as we’re known – we’re known for our scrubs, right? And I think we’re getting known over time, especially with our repeat customers, they’re coming back in their second, their third, or fourth purchase for these other pieces.

Our first-time customers, 85% of them are buying just the scrub. So, that’s kind of why you’re seeing that growth rate in the quarter.

[Daniella Turenshine, Chief Financial Officer]

I would also – just to add, as a reminder, Dana, last year, in Q1 2022, we saw at a normally high kind of non-scrubber percentage as we were out of stock on some of our core scrubwear products, and we also had a really strong new balance launch. So, there’s a little bit of year-over-year comps going on as well.

[Dana Telsey, Telsey Advisory Group]

Thank you.

[Operator]

Thank you. Our next question will be from the line of Rick Patel with Raymond James. Your line is now open.

[Rick Patel, Raymond James]

Thank you. Good afternoon, and congrats on the strong execution. Can you talk about replenishment trends? I believe at the time around the IPO, it was around 98 days, but it’s about a month longer now. Does guidance assume that this trend has stabilized, or does it reflect frequency continues to stretch longer?

[Daniella Turenshine, Chief Financial Officer]

So, as we discussed, frequency continues to be a bit pressured by the macro environment, but that days between purchases has stabilized from the last quarter. I think it’s important to note that a portion of kind of the increase that we’ve been seeing here is that we are reactivating more customers and as customers extend their purchase life cycle. And that metric, that higher reactivation that has customers coming back after 12 months, and that’s just inherently going to drive this metric up. I think from here, there’s a lot of opportunity for us to drive frequency higher over the longer term.

As we’ve discussed, we’re really focusing on product innovation and expanding our layering system. We’re taking steps through our marketing strategies to drive higher engagement through personalized messaging through tailored communication, as well as really amplifying product education and value. And so, we’re still early in these initiatives. So, we’re not factoring in a lot of upside into our guide from here, but a lot of opportunity for us to improve this over the long term.

[Rick Patel, Raymond James]

Can you also talk about the outlook for AOV? What’s the right way to think about the puts and takes as we consider the mix of business versus your expectations for consumer behavior during promotional times?

[Daniella Turenshine, Chief Financial Officer]

So, for AOV, as we, I think, spoke about, we expect it to be kind of flat over the remainder of the next three quarters. And I think what’s really great is we’re continuing to see higher UPT and we’re continuing to drive that metric higher as customers expand and purchase more into our layering system. However, that is going to be pressured in the near term by a lower AUR as we are seeing that higher promotional mix. But over the long term, it gives us confidence in our ability to continue to drive UPT and ultimately, AOV up from here in the future.

[Rick Patel, Raymond James]

Thanks very much.

[Operator]

Thank you. Our next question will be from the line of Brian Nagel with Oppenheimer. Your line is now open.

[Brian Nagel, Oppenheimer]

Hi. Good afternoon. Congrats on the nice progress. So, my first question – my first question and just a bit of a follow-up. But with regard to shipping costs. So, we saw the gross margin track above plan in Q1 and then the update to the gross margin guidance for the year. But as we’re getting now further path to shipping disruptions broadly, I mean, how should we think about the ultimate sort of say, benefits to FIGS? If either – you mentioned before, Daniella, less reliance on air freight but then also just lower shipping costs, either through 2023 and then maybe some commentary beyond 2023.

[Daniella Turenshine, Chief Financial Officer]

Yes. So, as we discussed, we are seeing lower inbound rates for both ocean and air, and we’re also driving better air utilization. In 2023, we’re continuing to sell through inventory that was largely brought in, in 2022 at higher ocean and air freight rates. And so, net-net, we’re seeing a benefit in air freight utilization year-over-year.

That’s still being offset a bit by higher ocean freight rates. But as we look further into the future, looking into 2024, we do think there’s a couple of hundred basis points of gross margin pressure, both from freight, but also promo mix that we’ll be able to recapture over the long term.

[Brian Nagel, Oppenheimer]

That’s very helpful. And sorry about the background noise if you can hear it. But the second question I have and also a follow-up. So, with regard to the better customer engagement you’ve seen recently, is that more as you’re looking at this happening, I guess maybe one, if you could help size it.

I mean, how big of a shift has this been? And then also, is it – do you think it’s more tied to timing? Or are you seeing this correspond well with some of these new products you’re launching on the innovation side?

[Trina Spear, Co-Founder and Chief Executive Officer]

Yes. I think as you think about, what’s happening with the environment more broadly for consumers and then I’ll talk a bit about what’s happening within our community that are both impacting healthcare professionals. So, as you know – and economists are telling us the macro environment continues to be challenged. Consumers have spent their stimulus checks and they’re moved through their savings, layoffs are happening across industries, consumers are in save mode and inflation is creating additional pressure.

Those factors are impacting our healthcare professionals, but on the other end, there are dynamics within the healthcare environment that give us a lot of confidence and, you know, about our community’s buying behavior. And what we’re seeing is that the healthcare community is reenergized and they’re getting back to work. Since 2020, our customer has been fighting a global pandemic that’s taken a meaningful toll on them. And the COVID fog is lifting and we’re entering a new era of medicine.

We’re talking to healthcare administration and hospital CEOs every day. And there has been an uptick in hiring, in wages, and staffing levels. And zooming out, over the long run, there’s going to be – continue to be an incredible need for healthcare professionals as they are the fastest-growing job segment and they’re an incredibly attractive customer base due to a number of factors, including stable income, the wages as we discussed, their jobs are incredibly purposeful, and as discussed, it’s a stable and growing industry. So, that’s kind of the – zooming out the bigger picture.

And then to your point, everything that we do from a product standpoint, from a marketing standpoint, that’s kind of layering on top of how the environment is evolving over time.

[Brian Nagel, Oppenheimer]

Thank you. I appreciate it.

[Operator]

Thank you. Our next question will be from the line of Noah Zatzkin with KeyBanc Capital Markets. Your line is now open.

[Unidentified Analyst]

Hi. This is [indiscernible] on for Noah. Just a quick one for me. Could you expand more on the upcoming retail presence? Any early updates around that first store that’s opening in 3Q? And I guess, how are you thinking about an omnichannel approach to business longer term and maybe evaluating any other potential future locations?

[Trina Spear, Co-Founder and Chief Executive Officer]

Thanks for the question. We are on track to opening our first permit store this fall. As we’ve seen with our pop-ups and activations that we’ve had in the past, our healthcare professionals are obsessed with FIGS and love experiencing us in person. They want to feel and touch and experience our products.

They want to learn more about our brand. It’s why we have five-hour lines around the block with any physical activation or pop-up that we’ve done. And so, we’re really excited. We’re really excited that we’re opening our store and we have a plan to open more in the future.

We’ll give you more details on all of that going forward. But this is the future, right? The fact that we only have one channel today with over $0.5 billion in net revenue, layer on top of our DTC channel, international layer on top teams, layer on top retail, there is so much opportunity in front of us.

[Unidentified Analyst]

Thank you.

[Operator]

Thank you. Our next question will be from the line of Adrienne Yih with Barclays. Your line is now open.

[Adrienne Yih, Barclays]

Thank you very much. Just two quick questions. I guess the first one is on extended sizing. I’m wondering if you can share with us kind of visibility on how much it has aided in new customer acquisition.

And then, Daniella, my question is really on modeling the $16 million to $18 million fulfillment in 2024, was going to be spread pretty equally over 4Q and 1Q, should we expect now that in 1Q and 2Q of 2024? And then I guess the 250 of excess storage fees, should we just assume that that is negated kind of to wash between moving the total expense into 2024, offset by the 250 excess storage this year? Thanks so much.

[Trina Spear, Co-Founder and Chief Executive Officer]

For the release to extended sizing, this was a long time coming. We’re super excited to bring 3XL to 6XL to our healthcare professionals. We’re seeing 5% of new customers engaging in our extended sizing. And we’ve only really incorporated a few styles.

So, we’re really excited to bring it across our assortment and continue to give our healthcare community not just a few of our core styles, but all of them in addition to the full layering system, that’s really the goal, and we’re going to do that over time. But FIGS is for everybody and everybody, and that was our campaign, and it’s – we are the most inclusive brand in the world where we aim to be because that’s what this brand is all about. It’s for all healthcare professionals, and all awesome humans wear FIGS.

[Daniella Turenshine, Chief Financial Officer]

And as it relates to your questions on the fulfillment enhancement initiatives, so we are now expecting to incur the bulk of the costs of the $16 million to $18 million in incremental expenses in 2024 and that will be spread mostly in the first half with some trickling into the third quarter as well. And the 250 basis points, basically, from the move of the fulfillment enhancement project into 2024, we are seeing a 50 basis points benefit in 2023, the differential between the 300 basis points of incremental expense we spoke about in our past call and the 250 basis points we’re now seeing in excess storage and fulfillment expenses.

[Operator]

Thank you. There are currently no additional questions registered in the queue at this time. So, I will now pass the call to Trina for closing remarks.

[Trina Spear, Co-Founder and Chief Executive Officer]

Thank you so much. Thank you all for joining us. We look forward to updating you on our next call and hope you have a great night.

[Operator]

That concludes the FIGS First Quarter Fiscal 2023 earnings call. Thank you for your participation. You may now disconnect your lines.