FIGS, Inc. (FIGS) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Part I, Item 1A. “Risk Factors” and other factors set forth in other parts of this Annual Report on Form 10-K. A discussion of the year ended December 31, 2022 compared to the year ended December 31, 2021 has been reported previously in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 28, 2023, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Overview
Our mission is to celebrate, empower and serve those who serve others.
We are a founder-led, direct-to-consumer healthcare apparel and lifestyle brand that seeks to celebrate, empower and serve current and future generations of healthcare professionals. We are committed to helping this growing, global community of professionals, whom we refer to as Awesome Humans, look, feel and perform at their best—24/7, 365 days a year. We create technically advanced apparel and products that feature an unmatched combination of comfort, durability, function and style, all at an affordable price. In doing so, we have redefined what scrubs are—giving rise to our tag-line: why wear scrubs, when you can #wearFIGS?
We have revolutionized the large and fragmented healthcare apparel market. We branded a previously unbranded industry and de-commoditized a previously commoditized product—elevating scrubs and creating premium products for healthcare professionals. Most importantly, we built a community and lifestyle around a profession. As a result, we have become the industry’s category-defining healthcare apparel and lifestyle brand.
We sell products purposefully designed to serve the particular needs of healthcare professionals primarily through our DTC digital platform, consisting of our website, mobile app and TEAMS business. We also recently launched our first physical retail store, which we call a Community Hub, and which represents a first-of-its-kind retail experience for healthcare professionals. Our offerings include scrubwear and non-scrubwear, such as outerwear, underscrubs, footwear, compression socks, lab coats, loungewear and other apparel. We primarily design all of our products in-house, leverage third-party suppliers and manufacturers to produce our product components and finished products, and generally utilize shallow initial buys and data-driven repurchasing decisions to test new products. We directly and actively coordinate and supervise every step of our product development and production process to ensure that our extremely high quality standards are met. We also have a dynamic merchandising model—due to the largely non-discretionary, replenishment-driven nature of scrubwear, we maintain lessened inventory risk driven by a relatively high volume of repeat purchases and a focus on our core scrubs offerings.
At December 31, 2023, we had approximately 2.6 million active customers. Our customers come to us through word of mouth referrals, as well as through our data-driven brand and performance marketing efforts. See the section titled “Key Operating Metrics and Non-GAAP Financial Measures” for a definition of active customers.
In the year ended December 31, 2023, we had the following results compared to the comparable periods in 2022:
◦Expanded our community of active customers by 13.0% from approximately 2.3 million at December 31, 2022 to approximately 2.6 million at December 31, 2023;
◦Net revenues increased from $505.8 million to $545.6 million in the year ended December 31, 2023 representing 7.9% year-over-year growth;
◦Gross margin decreased 1.0 percentage point from 70.1% to 69.1% in the year ended December 31, 2023;
◦Net income increased from $21.2 million to $22.6 million in the year ended December 31, 2023;
◦Net income margin decreased from 4.2% to 4.1% in the year ended December 31, 2023;
◦Adjusted EBITDA decreased from $87.3 million to $86.0 million in the year ended December 31, 2023, representing an Adjusted EBITDA Margin of 15.8%;
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◦Cash flows from operating activities increased from $(35.3) million to $100.9 million in the year ended December 31, 2023; and
◦Free cash flow increased from $(40.7) million to $84.6 million in the year ended December 31, 2023.
See the section titled “Key Operating Metrics and Non-GAAP Financial Measures” for information regarding Adjusted EBITDA, Adjusted EBITDA Margin and free cash flow, including a reconciliation to the most directly comparable financial measures prepared in accordance with GAAP.
Recent Developments
During the quarter and year ended December 31, 2023, we continued to execute on our previously announced fulfillment enhancement project. As part of the project, we intend to transition all fulfillment operations from our current City of Industry facility to a new facility we have leased. In connection with the project and transition, during the year ended December 31, 2023, we incurred $1.2 million in transitory operational expenditures related to implementation costs, nearly all of which was incurred in Q4 2023, and $12.2 million in capital expenditures, $8.8 million of which was incurred in Q4 2023. During the fiscal year ending December 31, 2024, we expect to incur transitory operational expenditures of approximately $14 million and an additional $13 million to $14 million in capital expenditures in connection with the project and transition. We believe the investments we are making in our fulfillment capabilities will enable us to more optimally serve our customers, drive efficiency and support us as we increase scale over the long term.
Supply Chain
In the quarter ended December 31, 2023, we continued to evolve our sourcing capabilities to strengthen our supply chain, which includes diversifying certain manufacturing operations geographically and strategically refining our manufacturing base into fewer high-quality partners. In so doing, we recently reallocated a material amount of manufacturing geographically, including to Jordan. Following the recent outbreak of conflict and violence in the Middle East, there has been an increase in attacks on commercial vessels transiting the Red Sea, causing disruptions in an important route for global trade, which our manufacturing partners, including those based in Jordan, utilize. Such attacks have also affected global ocean freight traffic generally, caused shipping delays and increased freight costs.
As a result, during and since the quarter ended December 31, 2023, we have experienced delays in the delivery of raw materials to, and finished goods from, our manufacturers in Jordan and elsewhere, as well as rising ocean freight rates. Although we have not yet experienced a material disruption to our supply chain and have sought alternative ways to ship raw materials and receive inventory, such as selecting new vessel routes, alternative ports and using air freight from time to time, we expect that if there are continued or increased hostilities in the Middle East, there could be continued increases in shipping times and ocean and air freight rates, as well as impacts to our supply chain, which could adversely affect our financial condition and results of operations. See Item 1A. “Risk Factors—Risks Related To Our Business—Shipping is a critical part of our business and changes in, or disruptions to, our shipping arrangements have in the past and may in the future adversely affect our business, financial condition and results of operations” and “— Our reliance on a limited number of third-party suppliers to provide materials for and produce our products could cause problems in our supply chain and subject us to additional risks.”
Key Factors Affecting Our Performance
We believe that our performance and future success depend on a number of factors that present significant opportunities for us. These factors also pose risks and challenges, including those discussed in Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K for the year ended December 31, 2023.
Brand Awareness and Loyalty
Our ability to promote and maintain brand awareness and loyalty is critical to our success. We have a significant opportunity to continue to grow our brand awareness and loyalty through word of mouth, brand marketing and performance marketing. We have made significant investments to strengthen the FIGS brand through our marketing strategy, which includes brand marketing campaigns across platforms, including email, digital, display, site, direct-mail, commercials, social media and ambassadors, as well as performance marketing efforts, including retargeting, paid search and product listing advertisements, paid social media advertisements, search engine optimization, personalized email and
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mobile push notifications through our app. We plan to continue to invest in our brand and performance marketing to help drive our future growth.
Net Revenues per Active Customer
We believe net revenues per active customer is important to understanding our engagement and retention of our customers, and as such demonstrating the value we provide for our customer base. We calculate net revenues per active customer as the total net revenues for a specified time period divided by the number of active customers during that same time period. Through our differentiated core products, limited edition color and style releases and non-scrubwear products, we have repeatedly drawn customers back to our digital platform. As we continue to expand our products to fully outfit the medical professional, we believe we have a significant opportunity to continue to expand our share of both the uniform and lifestyle wardrobe of our customers and to increase our net revenues per active customer over time. Our future growth will depend in part on our ability to increase our net revenues per active customer.
Customer Retention and Engagement
Our continued success depends in part on our ability to retain, and drive repeat purchases from, our existing customers. We monitor retention across our entire customer base. Our goal is to attract and convert visitors into active customers and foster relationships that drive repeat purchases. As of December 31, 2023, we had approximately 2.6 million active customers, up from approximately 2.3 million active customers as of December 31, 2022. Over the last five years, we have consistently achieved robust net revenues from repeat customers while also maintaining a healthy level of new customer acquisitions. One or more repeat purchase in the same year by these newly acquired customers supplements the embedded growth from prior-year cohorts’ customers who continue to purchase from us.
The share of our net revenues from customers who have made a previous purchase with us in a prior year reflects our customer loyalty and the net revenues retention behavior we see in our cohorts. The contribution from repeat customers is reflective of our ability to engage and retain our customers through our differentiated product offerings, community-driven brand and customized customer experience, which is important for our results of operations. This cohort behavior demonstrates our ability to not only retain customers, but also to drive our customers’ spend as they place repeat orders.
Inventory Management
We leverage our technology to buy and manage our inventory, including product assortment and fulfillment center optimization. We generally make shallow initial inventory buys and then use data-driven repurchasing decisions to test new products, which allows us to manage inventory risk. To ensure sufficient availability of merchandise, we generally purchase inventory in advance and, because the vast majority of our production utilizes our main scrubwear fabric technology FIONx, and a substantial amount of our revenue is generated by our core scrubwear styles in core colors, which are in demand year-round, we can hold greater inventory without significant risk of obsolescence or exposure to seasonality.
Nevertheless, we are still vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases. For example, we previously experienced elevated inventory on hand, as a result of improvements in ocean transit times, following our decision to increase weeks of supply during periods of ocean transit time volatility, and softer sales trends due to adverse macroeconomic factors. We were successful in our efforts to address previous periods of excess inventory, but future inefficiencies in the timing of merchandise purchases and efforts to right-size inventory could have an adverse impact on our operating results.
In addition, our inventory investments will fluctuate with the needs of our business. For instance, entering new locations and expanding to new categories require additional investments in inventory. Shifts in inventory levels may result in fluctuations in the percentage of full price sales, levels of markdowns, merchandise mix, as well as gross margin.
Macroeconomic Environment
Our business and results of operations are subject to domestic and global economic conditions and their impact on consumer confidence. For example, we have seen year-over- year sales growth impacted by moderation of frequency trends, which we believe were due in part to adverse macroeconomic factors such as sustained inflationary pressures on consumer spending and we expect to continue to see the impact of inflation on our customers’ purchasing activity in the near term. Our customers are also affected by other macroeconomic pressures, such as high interest rates, wages, levels of
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employment, inflation, fears of recession or depression or entry into a recession or depression, housing costs, energy costs, income tax rates, financial market fluctuations and consumer confidence in future economic conditions. We are also subject to macroeconomic pressures, such as inflation, which can impact the price of raw materials, labor, freight, and other costs of doing business. While we believe our largely non-discretionary, replenishment-driven business model is resilient in challenging macroeconomic environments, adverse macroeconomic pressures have affected our results of operations and we expect them to continue to do so in the near term.
Components of Our Results of Operations
Net Revenues
Net revenues consist of sales of healthcare apparel, footwear and other products primarily through our digital platform. We recognize product sales at the time control is transferred to the customer, which is when the product is shipped to the customer. Net revenues represent the sale of these items and shipping revenue, net of estimated returns and discounts. Net revenues are primarily driven by the number of active customers, the frequency with which customers purchase and the average order value (“AOV”). See the section titled “—Key Operating Metrics and Non-GAAP Financial Measures” for a definition of average order value.
Cost of Goods Sold
Cost of goods sold consists principally of the cost of purchased merchandise and includes import duties and other taxes, freight-in, defective merchandise returned by customers, inventory write-offs and other miscellaneous shrinkage. Our cost of goods sold has and may continue to fluctuate with the cost of the raw materials used in our products and freight costs.
Gross Profit and Gross Margin
We define gross profit as net revenues less cost of goods sold. Gross margin is gross profit expressed as a percentage of net revenues. Our gross margin has fluctuated historically and may continue to fluctuate from period to period based on a number of factors, including the timing and mix of the product offerings we sell as well as our ability to reduce costs, in any given period.
Operating Expenses
Our operating expenses consist of selling, marketing and general and administrative expenses.
Selling
Selling expenses represent the costs incurred for fulfillment, selling and distribution. Fulfillment expenses consist of costs incurred in operating and staffing a third-party fulfillment center, including costs associated with inspecting and warehousing inventories and picking, packaging and preparing customer orders for shipment. Selling and distribution expenses consist primarily of shipping and other transportation costs incurred in delivering merchandise to customers and from customers returning merchandise, merchant processing fees and packaging. We expect fulfillment, selling and distribution costs to increase in absolute dollars as we increase our net revenues.
Marketing
Marketing expenses consist primarily of online performance marketing costs, such as retargeting, paid search and product listing advertisements, paid social media advertisements, search engine optimization, personalized email and mobile push notifications through our app. Marketing expenses also include our spend on brand marketing channels, including billboards, podcasts, commercials, photo and video shoot development, expenses associated with our Ambassador Program and other forms of online and offline marketing. We expect our marketing expenses to increase in absolute dollars as we continue to grow our business.
General and Administrative
General and administrative expenses consist primarily of employee-related costs, including salaries, bonuses, benefits, stock-based compensation, other related costs and other general overhead, including certain third-party consulting
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and contractor expenses, certain facilities costs, software expenses, legal expenses and recruiting fees. We expect our general and administrative expenses to increase in absolute dollars as we continue to grow our business.
Other Income, Net
Other income, net consists of interest income or expense associated with debt financing arrangements, amortization of debt issuance costs and interest income earned on investments, as well as gain or loss on foreign currency, primarily driven by payment to vendors for amounts not denominated in U.S. dollars.
Provision for Income Taxes
Our provision for income taxes consists of an estimate of federal and state income taxes based on enacted federal and state tax rates, as adjusted for allowable credits, deductions and uncertain tax positions.
Seasonality
Unlike the traditional apparel industry, the healthcare apparel industry is generally not seasonal in nature. However, due to our historical pattern of sequential growth, as well as our decision to conduct select promotions during the holiday season, we historically have generated a higher proportion of net revenues, and incurred higher selling and marketing expenses, during the fourth quarter of the year compared to other quarters, and we expect these trends to continue.
Results of Operations
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
The following table sets forth information comparing the components of our results of operations for the periods indicated and our results of operations as a percentage of net revenues for the periods presented.
| Year ended December 31, | Year ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | 2023 | 2022 | ||||||||||
| (in thousands) | (as a percentage of net revenues) | ||||||||||||
| Net revenues | $ | 545,646 | $ | 505,835 | 100.0 | % | 100.0 | % | |||||
| Cost of goods sold | 168,683 | 151,375 | 30.9 | 29.9 | |||||||||
| Gross profit | 376,963 | 354,460 | 69.1 | 70.1 | |||||||||
| Operating expenses | |||||||||||||
| Selling | 125,149 | 118,449 | 22.9 | 23.4 | |||||||||
| Marketing | 77,094 | 77,692 | 14.1 | 15.4 | |||||||||
| General and administrative(1) | 140,675 | 120,653 | 25.8 | 23.9 | |||||||||
| Total operating expenses | 342,918 | 316,794 | 62.8 | 62.6 | |||||||||
| Net income from operations | 34,045 | 37,666 | 6.2 | 7.4 | |||||||||
| Other income, net | 6,762 | 1,061 | 1.2 | 0.2 | |||||||||
| Net income before provision for income taxes | 40,807 | 38,727 | 7.5 | 7.7 | |||||||||
| Provision for income taxes | 18,170 | 17,541 | 3.3 | 3.5 | |||||||||
| Net income | $ | 22,637 | $ | 21,186 | 4.1 | % | 4.2 | % |
(1)Includes stock-based compensation expense of $45.8 million and $37.5 million for the years ended December 31, 2023 and 2022, respectively.
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Net Revenues
| Year ended December 31, | Change | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | % | ||||||||
| (in thousands) | ||||||||||
| Net revenues | $ | 545,646 | $ | 505,835 | 7.9 | % |
Net revenues increased by $39.8 million, or 7.9%, for the year ended December 31, 2023, compared to the prior year. The increase in net revenues was primarily driven by an increase in orders from existing and new customers and, to a lesser extent, an increase in AOV.
Cost of Goods Sold
| Year ended December 31, | Change | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||||
| (in thousands, except margin) | ||||||||||
| Cost of goods sold | $ | 168,683 | $ | 151,375 | 11.4 | % | ||||
| Gross profit | 376,963 | 354,460 | 6.3 | % | ||||||
| Gross margin | 69.1 | % | 70.1 | % | (100) bps |
Cost of goods sold increased by $17.3 million, or 11.4%, for the year ended December 31, 2023, compared to the prior year. This increase was primarily due to a higher total number of orders in 2023 as compared to 2022.
Gross profit increased by $22.5 million, or 6.3%, for the year ended December 31, 2023, compared to the prior year, primarily due to an increase in the total number of orders.
Gross margin decreased 1.0 percentage point for the year ended December 31, 2023, compared to the prior year. The decrease in gross margin was primarily related 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.
Operating Expenses
| Year ended December 31, | Change | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | % | ||||||||
| (in thousands) | ||||||||||
| Operating expenses: | ||||||||||
| Selling | $ | 125,149 | $ | 118,449 | 5.7 | % | ||||
| Marketing | 77,094 | 77,692 | (0.8) | % | ||||||
| General and administrative | 140,675 | 120,653 | 16.6 | % | ||||||
| Total operating expenses | 342,918 | 316,794 | 8.2 | % |
Operating expenses increased by $26.1 million, or 8.2%, for the year ended December 31, 2023, compared to the prior year and, as a percentage of net revenues, increased by 0.2 percentage points, primarily driven by an increase in general and administrative expenses, offset by lower marketing and selling expenses.
Selling expense increased by $6.7 million, or 5.7%, for the year ended December 31, 2023, compared to the prior year and, as a percentage of net revenues, decreased by 0.5 percentage points. The decrease in selling expense as a percentage of net revenues was primarily driven by leverage within shipping expense due to higher AOV, partially offset by a higher mix of promotional sales.
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Marketing expense decreased by $0.6 million, or 0.8%, for the year ended December 31, 2023, compared to the prior year and, as a percentage of net revenues, decreased by 1.3 percentage points. The decrease in marketing expense as a percentage of net revenues was primarily due to reduced brand marketing spend.
General and administrative expense increased by $20.0 million, or 16.6%, for the year ended December 31, 2023, compared to the prior year and, as a percentage of net revenues, increased by 1.9 percentage points. The increase in general and administrative expense as a percentage of net revenues was primarily driven by higher investment in people, including salaries, bonus, payroll tax, and stock-based compensation expense and, to a lesser extent, an update to our accrual methodology for charitable donations in the prior year. This increase was partially offset by reduced legal and insurance expenses.
Other Income, Net
| Year ended December 31, | Change | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | % | ||||||||
| (in thousands) | ||||||||||
| Other income, net | $ | 6,762 | $ | 1,061 | 537.3 | % |
Other income, net increased for the year ended December 31, 2023, compared to the prior year, primarily due to an increase in interest income driven by higher interest rates.
Provision for Income Taxes
| Year ended December 31, | Change | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | % | ||||||||
| (in thousands) | ||||||||||
| Provision for income taxes | $ | 18,170 | $ | 17,541 | 3.6 | % |
Provision for income taxes increased by $0.6 million, or 3.6%, for the year ended December 31, 2023, compared to the prior year, primarily due to an increase in pretax income.
Key Operating Metrics and Non-GAAP Financial Measures
We report our financial results in accordance with GAAP. In addition to the measures presented in our financial statements, we use the following key operational and business metrics to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions. We believe the non-GAAP financial measures, Adjusted EBITDA, Adjusted EBITDA Margin and free cash flow, are useful in evaluating our performance. Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP.
Active Customers, Net Revenues per Active Customer, and Average Order Value
We believe the number of active customers is an important indicator of our growth as it reflects the reach of our digital platform, our brand awareness and overall value proposition. We define an active customer as a unique customer account that has made at least one purchase in the preceding 12-month period. In any particular period, we determine our number of active customers by counting the total number of customers who have made at least one purchase in the preceding 12-month period, measured from the last date of such period. Active customers as of December 31, 2023 and 2022, respectively, are presented in the following table:
| As of December 31, | ||||
|---|---|---|---|---|
| 2023 | 2022 | |||
| (in thousands) | ||||
| Active customers | 2,593 | 2,294 |
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We believe measuring net revenues per active customer is important to understanding our engagement and retention of customers, and as such, our value proposition for our customer base. We define net revenues per active customer as the sum of total net revenues in the preceding twelve month period divided by the current period active customers. Net revenues per active customer as of December 31, 2023 and 2022, respectively, are presented in the following table:
| As of December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| Net revenues per active customer | $ | 210 | $ | 221 |
We define AOV as the sum of the total net revenues in a given period divided by the total orders placed in that period. Total orders are the summation of all completed individual purchase transactions in a given period. We believe our relatively high average order value demonstrates the premium nature of our product. As we expand into and increase our presence in additional product categories and price points as well as expand internationally, AOV may fluctuate. AOV for the years ended December 31, 2023 and 2022, respectively, are presented in the following table:
| Year ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| Average order value | $ | 115 | $ | 112 |
Adjusted EBITDA and Adjusted EBITDA Margin
We calculate Adjusted EBITDA as net income (loss) adjusted to exclude: other income (loss), net; gain/loss on disposal of assets; provision for income taxes; depreciation and amortization expense; stock-based compensation and related expense; transaction costs; and expenses related to non-ordinary course disputes. Adjusted EBITDA Margin is calculated by dividing Adjusted EBITDA by net revenues.
Management believes that excluding certain non-cash items and items that may vary substantially in frequency and magnitude period-to-period from net income provides useful supplemental measures that assist in evaluating our ability to generate earnings, provide consistency and comparability with our past financial performance and facilitate period-to-period comparisons of our core operating results as well as the results of our peer companies.
There are several limitations related to the use of Adjusted EBITDA and Adjusted EBITDA Margin as analytical tools, including:
•other companies may calculate Adjusted EBITDA and Adjusted EBITDA Margin differently, which reduces their usefulness as a comparative measure;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect other income (loss), net;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect any gain or loss on disposal of assets;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect our tax provision, which reduces cash available to us;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect recurring, non-cash expenses of depreciation and amortization of property and equipment and, although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect the impact of stock-based compensation expense;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect transaction costs; and
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect expenses related to non-ordinary course disputes.
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The following table reflects a reconciliation of Adjusted EBITDA to net income, the most directly comparable financial measure prepared in accordance with GAAP and presents Adjusted EBITDA Margin with net income margin, the most directly comparable financial measure prepared in accordance with GAAP:
| Year ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| (in thousands, except margin) | ||||||
| Net income | $ | 22,637 | $ | 21,186 | ||
| Add (deduct): | ||||||
| Other income, net | (6,762) | (1,061) | ||||
| Provision for income taxes | 18,170 | 17,541 | ||||
| Depreciation and amortization expense(1) | 2,942 | 1,924 | ||||
| Stock-based compensation and related expense(2) | 47,757 | 37,533 | ||||
| Expenses related to non-ordinary course disputes(3) | 1,256 | 10,128 | ||||
| Adjusted EBITDA | $ | 86,000 | $ | 87,251 | ||
| Net Revenues | $ | 545,646 | $ | 505,835 | ||
| Net income margin(4) | 4.1 | % | 4.2 | % | ||
| Adjusted EBITDA Margin | 15.8 | % | 17.2 | % |
(1)Excludes amortization of debt issuance costs included in “Other income, net.”
(2)Includes stock-based compensation expense, payroll taxes and costs related to equity award activity.
(3)Exclusively represents attorney’s fees, costs and expenses incurred by the Company in connection with the Company’s now-concluded litigation against Strategic Partners, Inc.
(4)Net income margin represents net income as a percentage of net revenues.
Free Cash Flow
We calculate free cash flow as net cash (used in) provided by operating activities reduced by capital expenditures, including purchases of property and equipment and capitalized software development costs. We believe free cash flow is a useful supplemental measure of liquidity and an additional basis for assessing our ability to generate cash. There are limitations related to the use of free cash flow as an analytical tool, including that other companies may calculate free cash flow differently, which reduces its usefulness as a comparative measure, and free cash flow does not reflect our future contractual commitments, nor does it represent the total residual cash flow for a given period.
The following table presents a reconciliation of free cash flow to net cash (used in) provided by operating activities, the most directly comparable financial measure calculated in accordance with GAAP.
| Year ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| (in thousands) | ||||||
| Net cash (used in) provided by operating activities | $ | 100,915 | $ | (35,329) | ||
| Less: capital expenditures | (16,348) | (5,348) | ||||
| Free cash flow | $ | 84,567 | $ | (40,677) |
Liquidity and Capital Resources
As of December 31, 2023 and 2022, we had $144.2 million and $159.8 million of cash and cash equivalents, respectively. Since inception, we have financed operations primarily through cash flows from operating activities, the sale of our capital stock and borrowings under credit facilities.
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We completed our IPO in June 2021 by issuing 4,636,364 shares of our Class A common stock at a price to the public of $22.00 per share, resulting in net proceeds to us of $95.1 million, after deducting the underwriting discount and commissions of $6.1 million and deferred offering expenses of $0.8 million, net of reimbursements. The Company incurred a total of $8.7 million of expenses, before reimbursements, in connection with the IPO.
In September 2021, we entered into a credit agreement with Bank of America, N.A. providing for a revolving credit facility in an amount of up to $100.0 million (as amended, the “2021 Facility”). The 2021 Facility will mature in September 2026. As of December 31, 2023, we had no outstanding borrowings under the 2021 Facility (other than $4.9 million of outstanding letters of credit) and available borrowings of $95.1 million.
See Note 8 to our audited financial statements included elsewhere in this Annual Report on Form 10-K for more information regarding the 2021 Facility.
Our cash requirements have primarily been for working capital and capital expenditures. We believe that existing cash and cash equivalents, cash flows from operations and available borrowings under our 2021 Facility, if needed, will be sufficient to support our working capital and capital expenditure requirements for at least the next 12 months.
Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of international expansion efforts and other growth initiatives, the expansion of our marketing activities and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and cash requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of additional debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations. There can be no assurances that we will be able to raise additional capital when needed or on terms acceptable to us. The inability to raise capital if needed would adversely affect our ability to achieve our business objectives.
Historical Cash Flows
The following table summarizes our cash flows for the periods presented:
| Year ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| (in thousands) | ||||||
| Cash flows from operating activities | $ | 100,915 | $ | (35,329) | ||
| Cash flows from investing activities | (117,187) | (5,848) | ||||
| Cash flows from financing activities | 670 | 3,522 | ||||
| Net change in cash, cash equivalents, and restricted cash | $ | (15,602) | $ | (37,655) |
Operating Activities
Cash flows from operating activities consist primarily of net income adjusted for certain items including depreciation and amortization, stock-based compensation expense and the effect of changes in operating assets and liabilities.
Cash flows from operating activities increased by $136.2 million for the year ended December 31, 2023, compared to the same period last year. The increase in operating cash flows was due to a net change in operating assets and liabilities of $133.2 million primarily driven by lower inventory purchases of $150.8 million, the timing of payments against accrued compensation and benefits of $7.0 million, and the timing of income tax payments of $6.5 million. These improvements were partially offset by the timing of payments against accrued expenses of $20.1 million and the timing of payments against accounts payable of $12.5 million.
Investing Activities
Cash flows from investing activities consists of capital expenditures and purchases of investments.
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Cash flows from investing activities were $(117.2) million for the year ended December 31, 2023. Cash flows from investing activities decreased by $111.3 million as compared to the same period last year. The decrease in investing cash flows was primarily due to purchases of available-for-sale securities of $150.1 million, with no comparable activity in the prior year, and an increase in capital expenditures of $11.0 million, primarily attributable to our fulfillment enhancement project. These decreases were offset by maturities of available-for-sale securities of $49.3 million, with no comparable activity in the prior year.
Capital expenditures during the year ended December 31, 2023 were primarily related to capitalized projects in progress, including our fulfillment enhancement project, capitalized software development costs, purchases of computer equipment, and leasehold improvements.
Capital expenditures during the year ended December 31, 2022 were primarily related to capitalized software development costs, purchases of machinery and equipment, and purchases of computer equipment.
Financing Activities
Cash flows from financing activities consists primarily of proceeds and payments related to transactions involving our common stock, borrowings, and fees associated with our existing line of credit.
Cash flows from financing activities of $0.7 million for the year ended December 31, 2023, were primarily attributable to proceeds from stock option exercises and employee stock purchases of $0.9 million, offset by tax payments related to net share settlements on restricted stock units of $0.2 million.
Cash flows from financing activities of $3.5 million for the year ended December 31, 2022, were primarily attributable to proceeds from stock option exercises.
Contractual Obligations and Commitments
Our most significant contractual obligations relate to purchase commitments on inventory and operating lease obligations on our facilities. See Note 9 to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K for a description of our contractual obligations and commitments.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with GAAP requires us to make estimates and judgments that affect the amounts reported in those financial statements and accompanying notes. Although we believe that the estimates we use are reasonable, due to the inherent uncertainty involved in making those estimates, actual results reported in future periods could differ from those estimates. We believe that the following accounting estimates are those that involve the most significant level of estimation uncertainty. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of our operations. See Note 2 to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K for a description of our other significant accounting policies.
Revenue Recognition
Our primary source of revenues is from sales of healthcare apparel, footwear and other products primarily through our digital platform.
We determine revenue recognition through the following steps in accordance with Topic 606, which we adopted effective January 1, 2018:
•identification of the contract, or contracts, with a customer;
•identification of the performance obligations in the contract;
•determination of the transaction price;
•allocation of the transaction price to the performance obligations in the contract; and
•recognition of revenue when, or as, we satisfy a performance obligation.
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Revenue is recognized upon shipment when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Our revenue is reported net of sales returns and discounts. We estimate our liability for product returns based on historical return trends and an evaluation of current economic and market conditions. We record the expected customer refund liability as a reduction to revenue, and the expected inventory right of recovery as a reduction of cost of goods sold. If actual return costs differ from previous estimates, the amount of the liability and corresponding revenue are adjusted in the period in which such costs occur.
Other than the determination of returns reserve discussed above, there is not significant judgement required in the determination of performance obligations, allocation of our sales price, or the recognition of revenue. See Note 2 to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K for further discussion.
Stock-Based Compensation
We have granted stock-based awards consisting primarily of stock options and restricted stock units (“RSUs”) to employees, non-employee directors, and consultants. We measure and recognize stock-based compensation expense for all stock option awards granted to employees and non-employees based on their estimated fair values as of the grant date using the Black-Scholes option-pricing model. Our use of the Black-Scholes option-pricing model to estimate the fair value of stock options granted requires the input of various assumptions. The following range of assumptions was used to estimate the fair value of options granted during the year ended December 31, 2023:
| Risk free interest rate | 3.39 - 4.65 % | |
|---|---|---|
| Expected volatility | 40 - 41 % | |
| Expected dividend yield | 0 | % |
| Expected term (in years) | 6.2 - 6.25 |
Risk-free interest rate—determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award.
Expected volatility— we derive our volatility from the average historical stock volatilities of several peer public companies over a period equivalent to the expected term of the awards. We expect to continue to do so until such time as we have adequate historical data regarding the volatility of our own traded stock price.
Expected dividend yield—we have not paid, and do not currently anticipate paying, cash dividends on our common stock; therefore, the expected dividend yield is assumed to be zero.
Expected term—the expected term of stock options granted to employees has been determined utilizing the “simplified” method for awards that qualify as “plain-vanilla” options, which calculates the expected term as the average of the time-to-vesting and the contractual life of options.
Fair value of common stock—the fair value of our common stock is the closing stock price of our Class A common stock as reported on the New York Stock Exchange.
For employee and non-employee options, we recognize compensation expense based on the grant date fair value of the award over the requisite service period, which is generally four years. We account for forfeitures as they occur.
We measure the fair value of restricted stock units (“RSUs”) granted to employees and non-employees based on the fair value of our Class A common stock on the grant date. Our RSU grants vest upon the satisfaction of either a service condition or both a service condition and a performance condition. The service condition is generally satisfied ratably over four years. The performance condition related to our outstanding performance-based awards was satisfied in connection with the IPO.
See Note 2 to our audited financial statements appearing elsewhere in this Annual Report on Form 10-K for further discussion.
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Inventory
Inventories are stated at the lower of cost and net realizable value. Cost is determined using an average cost method. Cost of inventory includes import duties and other taxes and transport and handling costs. We write down inventory where it appears that the carrying cost of the inventory may not be recovered through subsequent sale of the inventory. We analyze the quantity of inventory on hand, the quantity sold in the past year, the anticipated sales volume, the expected sales price and the cost of making the sale when evaluating the value of our inventory. If the sales volume or sales price of specific products declines, additional write-downs may be required. A hypothetical 10% change in our inventory reserves estimate as of December 31, 2023 would not result in a material impact on our financial statements.
Income Taxes
We are subject to income taxes in the United States. We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized and the charge is recorded to earnings.
Significant judgment is required in determining our uncertain tax positions. We continuously review issues raised in connection with all ongoing examinations and open tax years to evaluate the adequacy of our tax liabilities. We evaluate uncertain tax positions under a two-step approach. The first step is to evaluate the uncertain tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon examination based on its technical merits. The second step is, for those positions that meet the recognition criteria, to measure the largest amount of benefit that is more than 50% likely of being realized. We believe our recorded tax liabilities are adequate to cover all open tax years based on our assessment. This assessment relies on estimates and assumptions and involves significant judgments about future events. A hypothetical 10% change in our recorded tax liabilities as of December 31, 2023 would not result in a material impact on our financial statements. To the extent that our view as to the outcome of these matters changes, we will adjust income tax expense in the period in which such determination is made. We classify interest and penalties related to income taxes as income tax expense.
Loss Contingencies
We may be involved in legal proceedings, claims and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business resulting in loss contingencies. We accrue for loss contingencies when losses become probable and are reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. We do not accrue for contingent losses that, in our judgment, are considered to be reasonably possible, but not probable; however, we disclose the range of such reasonably possible losses. Loss contingencies considered remote are generally not disclosed.
Recent Accounting Pronouncements
Refer to Note 2 to our financial statements appearing elsewhere in this Annual Report on Form 10-K for a discussion of accounting pronouncements recently adopted and recently issued accounting pronouncements not yet adopted and their potential impact to our financial statements.