Kits Eyecare Ltd

TSX:KITS

Earnings Call Transcript 2021-Q1

[Operator]

Good afternoon, and welcome to the Kits Eyecare first quarter results conference call. [Operator Instructions] This call is being recorded on Thursday, May 13, 2021. Your hosts today are Roger Hardy, Chief Executive Officer; Sabrina Liak, Chief Financial Officer; and Joseph Thompson, Chief Operating Officer. Before we begin, I am required to provide the following statement respecting forward-looking information, which is made on behalf of KITS and all of its representatives on this call. Certain statements made on this call will contain forward-looking information. These forward-looking statements generally can be identified by the use of words such as intend, believe, could, expect, estimate, forecast, may, would, will, and other words of similar meaning. This forward-looking information is based on our opinions, estimates and assumptions in light of our experience and perception of historical trends, current conditions and expected future developments as well as other factors that we currently believe are appropriate and reasonable in the circumstances. Actual results could differ materially from a conclusion, forecast, expectation, belief or projection and the forward-looking information. Certain material factors and assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information. We caution investors not to rely on the forward-looking information. Additional information about the material factors that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information and material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information are contained in KITS filings with Canadian provincial securities regulators. During today's call, all figures are in Canadian dollars unless otherwise stated. And with that, I'd like to turn the call over to Mr. Roger Hardy, Chief Executive Officer. Please go ahead.

[Roger V. Hardy, Co]

Thanks, operator. Good afternoon, and thank you for taking the time to participate on today's call. I'm Roger Hardy, the company's CEO. Joining me today are the Company Co-Founders, Sabrina Liak, and -- CFO; Joseph Thompson, our COO. Today, I will discuss our first quarter 2021 results and share some insights on the trends we're seeing in the sector. After my comments, I'll pass the call over to Sabrina, our CFO, to review more details on our financial results; followed by Joe, who will provide an operational update. Our first quarter results reflect KITS' continued focus on execution and disciplined investments for growth. Volume in the first quarter met our expectations as orders, Autoship subscriptions and eyeglass shipments all hit record levels as we prioritized investments in acquiring new customers this quarter and in scaling our operations. I'm pleased to report that we achieved record revenue in the first quarter of 2021. Revenue grew 42% organically to $20.4 million as the company continued to invest in building its subscription business as well as acquiring first-time glasses customers. We ended the quarter with 750,000 active customers, a new high, up from 700,000 at the end of 2020, as we attracted record new customers. Gross margins improved in Q1, and we expect this trend to continue through the balance of the year as we begin to see repeat orders flow from our current investment in acquiring customers and as we migrate our glasses customers into higher-value and higher-margin specialty segments of eyewear. We are pleased to have ended this quarter with our Autoship subscriptions representing 24% of contact lens orders, up from essentially 0 a year ago, trending toward our target of 25% by the summer and 30% by year-end. We believe investing in acquiring customers on the recurring revenue model differentiates us in the category and offers a clear view to the long-term value of acquired customers. Our Autoship subscription model allows us to create a stable revenue base as well as improve our product and logistics costs through improved forecasting and purchasing. It also allows us to invest in more than just a transaction-oriented acquisition of customers, enabling us to more fully invest in lifetime value of a customer through accelerated shipping and other bundled benefits. We are improving, testing and adding features to this program continuously as we work to deliver the best combination of value and service to our customers, for whom many -- for many of whom vision correction is nondiscretionary. In Q1, we achieved our highest eyeglass volume to date as we delivered 41,000 pairs of eyeglasses. Even at this early stage in our eyeglasses' ramp-up, consumers are attracted to our unique offering of premium quality, attractive prices and incredible convenience. We are in the midst of expanding our giga factory to 4 automated production lines with a total capacity of 4,000 eyeglasses per day and broadening our specialty lens capabilities. To complement our existing blue-light and progressive lens offerings, just this week, we launched prescription sun and photochromatic lenses. This will enable us to serve the needs of more customers while simultaneously improving our revenue and margin profile. We believe there's tremendous value in having built out this complete eye care offering where we are vertically integrated and own our own rails. Customer ratings, which we keenly monitor and believe are a key indicator of the value we deliver, continue to climb as we invest in the customer experience. As we had forecasted, online eye test and the tools that make a customer's life easier online are gaining broad acceptance. We continue to improve our online tools and to enhance product selection, service and experience as we welcome a record number of new customers to our platform. As our financial results validate, our business is well positioned for growth and the opportunities ahead, our company continues to demonstrate robust organic growth, and our strong balance sheet puts us in an excellent position to execute our strategic plan. We look forward to continuing to provide incredible value to our customers as well as our shareholders. I'll now pass it over to Sabrina for a review of the financial results. Sabrina?

[Sabrina Liak, Co]

Thanks, Roger, and good afternoon, everyone. First quarter revenue reached $20.4 million, increasing $6 million or 42% year-on-year. Delivered orders hit an all-time peak and were up 73% year-on-year. First quarter eyeglasses orders also hit a new peak, and we delivered 41,000 pairs of eyeglasses in this quarter. In addition, we continue to see strong enrollment in our Autoship subscription program. In the first quarter, 24% of contact lens orders shipped through our Autoship program. Gross profit increased by 14% to $4.9 million in the quarter, compared to $4.3 million in the same quarter of 2020. Gross margin was 24% in the first quarter compared to 23% last quarter. We are focused on making further progress on expanding our margins as we balance revenue and margin in the short term with the higher long-term value of new glasses and subscription customers. We believe margins will be above 25% to 30% in the near term. And our goal is to generate margins above 35% as our glasses business and returning Autoship subscription customers become a larger percentage of total revenue. Customer growth was strong this quarter as we actively invested in attracting customers to our platform. We continue to provide strong introductory offers on both eyeglasses and Autoship subscriptions to new customers. While this impacts our gross margins, we view this investment in building our glasses business and in transitioning from transactional to subscription revenues to be accretive to shareholders and the company in the long term. Preliminary data on our subscription customer indicates we earn 30% more in revenue per Autoship customer compared to the average customer in the same cohort. We are scaling our investment in 2 ways, both in marketing and in product development. Our active customer and new customer acquisition rates remain robust and accelerated this quarter. From the proceeds earmarked in our IPO, we invested more heavily into upper funnel channels in the first quarter, and these investments have had a positive impact on new customer orders. As planned, marketing expenses increased by $3.3 million to $4.4 million in the first quarter compared to Q1 2020, as we used proceeds earmarked in the IPO to more heavily invest in acquiring customers and building brand assets. Advertising expense as a percentage of revenue was 14%, and brand investment was 6% or $1.3 million. We believe we will continue to derive benefits from these investments for years to come. We're at a really critical early stage of evolution in this category, and we believe that now is a time to differentiate versus our peers. We believe that we can generate outsized future returns if we're able to build a trusted brand that can deliver memorable customer experiences. In the longer term, we expect marketing spend of approximately 8% to 10% of revenue. We are building a platform and infrastructure to support multiple years of growth. As such, we are incurring higher upfront costs now as we grow into our capacity and scale. We are making investments in vertical integration, product development and accelerated hiring. The impact of this investment can be seen on our P&L in fulfillment and G&A expenses as we expand our state-of-the-art optical lab and simultaneously expand the technology development and customer service capabilities. In the long term, we believe this will give us a key margin advantage. Fulfillment expenses were 13.7% of revenue in the first quarter and G&A costs were $2.6 million. Our net loss in the first quarter was $3.6 million, which includes onetime IPO-related costs of $0.7 million, share-based compensation expense of $0.3 million and brand investment of $1.3 million. This compares to a net loss of $456,000 in the first quarter of 2020. Adjusted EBITDA was negative $2.6 million in the first quarter compared to $1.4 million in the comparative period. These changes are primarily due to the strategic investments discussed to support our future growth and costs incurred for our recently completed IPO. We closed our IPO in January, in which we raised net proceeds of $51 million. As part of that transaction, we simplified our balance sheet, and management converted all of their preferred shares into common equity. There is now one single common class of share outstanding, creating alignment across shareholders and management. The use of cash in the first quarter was consistent with our planned use of proceeds from the IPO. We made greater investments to scale our teams and the following onetime items were incurred in the period: a onetime build of inventory purchases of $3.6 million, bringing our inventory up to $9.5 million to improve our speed of service; $1.4 million of cash investment in brand assets; and an IPO-related cash outlay of $1.2 million. We also made an early repayment on our debt of $4.5 million. Subsequent to quarter end, we recently announced that in addition to our TSX listing, we began trading on the OTCQX under the symbol KTYCF. Under this trading platform, we'll increase liquidity of our stock and enhance access for U.S. shareholders seeking to gain exposure to what we believe will become the leading vertically integrated model in eye care. I'll now pass it over to Joseph to talk about some of our operating highlights.

[Joseph Thompson, Co]

Thanks, Sabrina. I wanted to provide an update on 3 differentiators that continue to fuel our growth: vertical integration, our Autoship subscription program and our asset-light infrastructure. On vertical integration, KITS is continuing to invest to build the most capital-efficient direct-to-consumer business in eye care. Our state-of-the-art optical lab delivered a record 41,000 glasses orders to patients in Q1, and we continue to widen our moat here and build ahead of growth. In Q2 and Q3, we will meaningfully expand our manufacturing and fulfillment capabilities to 4 automated production lines with the capacity to produce 4,000 pairs of eyeglasses per day. Our specialty lens offering continues to expand. In addition to our full selection of blue-light lenses and progressive lenses launched in Q1, we have recently launched prescription sunglasses and photochromatic lenses. Also in Q1, we made a onetime increase in inventory purchases of $3.6 million, bringing our inventory to $9.5 million, increasing our speed of service to customers. We continue to expand our eyeglasses selection in Q1, adding over 250 new styles. In addition to a wide variety of new KITS frames, we welcomed a number of new brands, including Nike, Bottega Veneta, Versace and an exclusive partnership with the Patagonia brand, Karün, who produce sustainable eyewear made from recycled fishing nets and recycled nylon. Our value continues to be category-leading as we pass the savings of our vertically integrated model to our customers. Our KITS glasses are priced at $69 in the U.S., $99 in Canada, including made-to-order prescription lenses. This compares to industry average pricing of $351 per pair of eyeglasses in the U.S. Our subscription operation, Autoship, continued to scale in Q1. Autoship allows customers the "set it and forget it" feature to ensure they never have to worry about their next pair of contact lenses, paired with an additional discount and free shipping on every order. Not only does Autoship improve customer satisfaction and loyalty, but it also makes it more operationally efficient for us to forecast and deliver to customers. Our Autoship subscribers represented approximately 24% of total order shipped in Q1 2020. We'll continue to grow this opt-in rate, which will deliver -- which will drive higher retention and increase the lifetime value of our customers. We have many more benefits to introduce to our Autoship customers in the year ahead. Finally, KITS continues to benefit from an asset-light infrastructure. We remain unburdened with supporting hundreds of physical locations while the market continues to move to e-commerce. Our end-to-end system is highly automated, and our technology team continues to add more automation and speed to the process while launching more online vision tools to allow customers more convenient experience shopping for eye care products online. Without the burden of this legacy infrastructure, we can focus our investment on where the category is going, not where it's been. Over the past year, as the COVID environment has continued, we have invested in safe and healthy workspaces for our team. In the face of a surge in demand this past year, our teams worked tirelessly to keep the supply chain operating and our optical lab and fulfillment centers running. This has allowed our customers across North America to continue to receive the prescription eye care they need around the clock. We are now 14 months into the global pandemic, and it's thought that in this time, our industry has changed for good. Customers' expectation for value and convenience in eye care have increased dramatically, and we will continue to raise the bar to meet their needs. Thank you to our committed KITS teammates, our shareholders and our rapidly growing KITS customer base. We are excited to serve you in the months and years ahead. This concludes our prepared remarks. Operator, please open the line for questions.

[Operator]

First question comes from Matt Koranda at ROTH Capital.

[Matthew Butler Koranda, MD & Senior Research Analyst]

I just wanted to start off on the glasses side of the business. I notice you said 4,000 lenses per day capacity is going in place, and I just wanted to understand when exactly that gets turned on. And then what's a sort of a reasonable expectation in terms of utilization of that capacity by maybe Q3 or so of this year?

[Joseph Thompson, Co]

Matt, this is Joe. Thanks for the question. So we expect to be at the 4,000 pairs of eyeglasses per day capacity by early Q4 of this year. And I think it's important to note with the manufacturing buildup, these are -- this is custom-made equipment specifically for us. And so we're building ahead of demand. And with the results that we've seen in Q1, even though it is still early days in our eyeglasses ramp-up, we saw a double of eyeglasses ordered to 41,000 pairs delivered this past quarter. And with continued investment in more selection on both the lens side with the more premium lens offerings and on the frame side with new styles and new brands coming in, we expect that growth to continue, and we want to make sure that we're investing in manufacturing capability ahead of that.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Okay. That makes sense. And then just on the newer lens products that you guys are launching, obviously, you have progressive, transitions, and you referenced sunglasses and photochromatic lenses going into place. What does that do to AURs? Just curious like -- I mean you referenced the sort of the suggested price of $69 in the U.S., CAD 99. But where does the -- where do the new lenses take us in terms of AUR per unit?

[Joseph Thompson, Co]

Sure, Matt. And this is Joe again. So our $69 price point is single-vision in the U.S. and $99 in Canada, single-vision. On the progressive lenses side, typically in the market, the price ranges for customers outside of KITS anywhere from $700 to $1,200. Our KITS progressive lenses and glasses sell for $198. So it's about a 2x expansion in AOV versus single-vision but also a significant savings for customers.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Okay. And are those products being delivered currently, you have the capacity to fulfill orders on those? And just maybe you could talk about the kind of the early order flow on those more specialized products.

[Joseph Thompson, Co]

We did launch our progressive lenses in Q1, which was an expansion. We've had blue-light -- the full suite of premium blue-light lenses since last year. The pickup has been -- has met our expectation and we're -- it gave us the confidence to expand our premium lens offering into sun Rx and then photochromatic this past week.

[Roger V. Hardy, Co]

And probably worth just adding, when you think about a vision-corrected customer that's in contact lenses, how we think about it is it's a very accretive sale to introduce that customer to on Rx sun. So -- and that's just launched, as I said, this week, but Rx sun and photochromatic, we see this as an opportunity to really migrate that customer up the value chain. So if they start in contact lenses, then they come into a single-vision pair of glasses. And over time, they've got an Rx sun and maybe a photochromatic pair as well. So it's really a migration and a much fuller basket. That's why we always say we have the most valuable customer in eye care because we start with that contact lens customer who is a recurring customer, a well-known lifetime value. And then we're able to introduce these other higher-margin and higher-value parts of the vision chain to these customers. So yes, that's what's exciting there.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Okay. That's helpful, Roger. Just a couple more really quickly, and then I'll jump back in queue. But on the contact side of the business, I noted you guys are on track to achieve the 25% of orders on subscription by the summer. You were already at 24% in Q1. I guess you're saying 30% by the end of the year. It seems like you're pretty close to the target already, I guess. Why not up the 30% target? Is there just sort of an optimal mix of subscription-based customer and contacts that you want to maintain, you don't want to go above a certain level?

[Roger V. Hardy, Co]

Yes. I think it has been a bit of testing and learning on what's the right acquisition strategy and then what's the long-term value. I think as Sabrina touched on, we've seen a 30% increase in value of a customer moving from transactional to subscription revenue. But that program is really only anniversary-ing just past a year now. So I think we want to steadily march up the sort of subscription level, but we're going to do it in a disciplined way. It has an impact on gross margin, as we've seen, when we give that first discount. The LTVs to cost of acquisitions make a lot of sense to us, but we -- I think we just want to be disciplined as we march that up. Anything else there, Sabrina? No. Okay.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Okay. Fair enough. And then just last one on the inventory build and just cost front. Maybe you could just talk a little bit about the pricing environment with your suppliers. Are you seeing any price increases on certain fronts? And how do you deal with those when they're put through? And maybe just talk a little bit about the inventory build and where it was really built up this last quarter. I know you mentioned it was onetime, but just would be helpful to understand the mix there.

[Roger V. Hardy, Co]

Yes. Maybe I'll touch on inventory, and then I'll pass to Joe on pricing. When we think about the pillars of our strategy, being the subscription being one piece, vertical being another, and NPS being the third, the focus on NPS for us being the key -- the company with the highest NPS in every category is the most valuable. And so part of what we found is that having a customer's product in stock, being able to ship that out quickly with the Tier 1 carrier is the way to drive parts of the NPS. And so we've taken the opportunity to make sure we've scaled having one of the largest contact lens inventories in North America that will enable us to fulfill for customers faster than almost anybody out there. And that's really our goal. And then -- and I think -- so that's why you saw the build of inventory in the queue. It's to make sure that we can have that product in stock and be more likely than anyone else to have it in stock and then get it out to customers quickly. From a pricing standpoint, I'll let Joe just touch on what we saw.

[Joseph Thompson, Co]

Yes. We -- I guess the business is really broken into glasses and contact lenses. So quite a bit of the inventory build is in the glasses area as we invest into this growth that we're seeing quarter-on-quarter and planning for more growth in Q2 and Q3. We've not seen these relationships on raw materials with our glasses providers. We've not seen much movement there, which has been great. On contact lenses, we have strong partnerships with all the manufacturers. There are a couple that have taken the usual annual price increase, but we've worked with them with lots of lead time in advance. We did decide to increase our inventory position on a couple of these SKUs. And this was really informed by some of the supply chain friction we saw in Q1 around the U.S. storm in February and then identified a couple of areas where if we had a little bit more inventory on hand, we'd be able to serve customers faster and achieve that highest NPS in the category. So we took the opportunity to correct that and are happy with the position that we have moving forward.

[Operator]

Next question comes from Derek Dley at Canaccord.

[Derek Dley, MD & Consumer Products Analyst]

I just had a question on the promotional calendar. I get you guys are spending on attracting new customers just given the strong LTVs there. But how should we sort of expect the sequencing of these promotions to go throughout the year? Like are we going to see the promotion slow down as we get towards the back half of the year?

[Roger V. Hardy, Co]

Yes. That's -- I think that's a safe assumption, Derek. So we've been, I would say, aggressive over the past 12 months in terms of acquiring customers, offering larger discounts upfront. So you can see that we've gone from 0 to 25% of business in Autoship, and then moving to 30% by year-end is not quite as big a build. So you see the discounts come off the front end on contacts. And in glasses, as we start to see customers returning at full price, I think we'll start to see a ramp there from a margin perspective.

[Derek Dley, MD & Consumer Products Analyst]

Okay. And Sabrina, I think you mentioned the increase in fulfillment expenses in the near term, obviously, as you expand the production capacity to Q4. Can you perhaps give us the magnitude of what you expect for an increase on that expense or even a rough percentage of where we would expect it as a percentage of revenue in the -- over the near term?

[Sabrina Liak, Co]

Yes. I think in the near term, it will likely be between 12% and 14%, so consistent with where we were this quarter, but we're scaling up on the revenue side. And so I think that's probably the best rule of thumb. We are, as Joe mentioned, expanding to the floor lines of production. And so there's going to, in the near term, be a little bit of temporary overlap or also moving to an expanded facility. So we expect to incur those costs over the next 6 months.

[Derek Dley, MD & Consumer Products Analyst]

Yes. Okay. And then just in terms of -- you mentioned the increase in, I guess, revenue or eyeglass shipments as you do that, which obviously makes sense. So this quarter, my math says you had about 455 glasses sold per day or throughput through the lab. That's up almost close to double where you were in Q4 '20. Now I guess just looking ahead to the next couple of quarters, like should we expect a 50%-odd increase in that throughput as we ramp up to 4,000?

[Sabrina Liak, Co]

I think in terms of the full year, we're hoping to have over, like, 0.25 million pairs of glasses sold. And so -- and we see that kind of ramping up from this point through to the end of the year.

[Derek Dley, MD & Consumer Products Analyst]

Okay. Yes. That's helpful. And then the last one from me. Just given that you guys do sell throughout North America and obviously, within North America, throughout North America, lots of differences right now in terms of COVID-related restrictions in different regions, Canada being more strict than the U.S., can you just talk about -- have you seen any changes or any learnings and customer behavior in areas that have, I guess, come out of the COVID restriction period a little quicker?

[Joseph Thompson, Co]

Derek, it's Joe. I think the one thing that we have seen in Canada is -- specifically is kind of a longer lockdown environment in some regions like Ontario, which is -- which has really continued to benefit the e-commerce channel. So that's one of the reasons why we continue to invest in greater selection and a greater inventory position so that we can have that inventory on hand for our Canadian customers and continue to fulfill very quickly for them. In the U.S. market, we continue to see strong demand, as evidenced by the Q1 customer build both on glasses and contact lenses. So -- but I think to your point, the Canadian environment is still very much under the -- either partial or full lockdown environment.

[Roger V. Hardy, Co]

Yes. And I think, Derek, just to talk about sort of the trend as we've moved forward past Q1 -- and I think we would all agree the U.S. has opened up. We've seen the momentum in our business continue in terms of contacts and glasses. There hasn't been a pullback as stores have opened or anything like that. We continue to view ourselves as -- the shift from off-line to online as being quite permanent and seeing the continued benefit of that in the U.S. as the years progress.

[Derek Dley, MD & Consumer Products Analyst]

Okay. No. That's great to hear. And one more, actually. I'm going to slide it in just -- you mentioned the inventory build there and now offering more products. Can you give us an update just on where you're at even roughly in terms of SKU count on your website? I mean I've noticed a lot more -- a lot larger of a product offering on your website. So where are you at? And are there any goalposts of where you want to be in the next couple of years?

[Joseph Thompson, Co]

Yes. Derek, this is Joe. It's our view and definitely from hearing from customers that more selection and convenience are a good thing. And so this quarter alone, we've added 250 new styles. We're moving towards having 2,000 unique styles of eyeglasses, and then every selection of contact lens is available for customers by the end of 2021.

[Operator]

At this time, I will now turn the call back over to Roger Hardy for closing comments.

[Roger V. Hardy, Co]

Great. Thanks, again, everyone, for joining us this afternoon. And a special thank you to the KITS team for what was a great quarter, lots of hard work. All came together in the quarter and was reflected in the numbers. So thank you to the KITS team, and thanks, everyone, for joining us. Have a great day.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines. Enjoy the rest of your day.