Kits Eyecare Ltd

TSX:KITS

Earnings Call Transcript 2022-Q2

[Operator]

Good afternoon, and welcome to the Kits Eyecare Second Quarter 2022 Financial Results Conference Call. [Operator Instructions] This call is being recorded and available later for replay. 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 intent, belief, growth estimates, forecast, may, will, would and other words in a 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 can differ materially from a conclusion, forecast, expectations, beliefs or projection in forward-looking information.

Certain material factors and assumptions were applied in drawing a conclusion or making forecast or projection as reflected in the forward-looking information. We caution investors not to rely on forward-looking information. Additional information about material factors that could cause actual results to differ materially from conclusions, forecasts or projection in forward-looking information and material factors or assumptions that were applied in the drawing of a conclusion or making a forecast or projection as reflected in the forward-looking information are available on KITS filings with Canadian Provisional Securities Regulators. During today's call, all figures are in Canadian dollars, unless otherwise stated.

And with that, I would like to turn the call over to Mr. Roger Hardy, CEO. Please go ahead.

[Roger Hardy, executive]

Thank you, operator. Good afternoon, and welcome to the KITS Second Quarter 2022 Financial Conference Call. Thanks for joining us today. I'm Roger Hardy, the company's CEO. Joining me today are my 2 co-founders: Sabrina Liak, our CFO; and Joseph Thompson, our COO. Today, I'm pleased to share our second quarter 2022 results and discuss our vision for the company and its future. After my comments, we will review our operational results, followed by a financial summary.

On our last call, we characterized the environment as volatile -- a volatile one where consumers had to make important choices against the backdrop of economic uncertainty and rising prices. When we look at our results against these consumer fundamentals that continue to persist, we are especially proud of our outcomes, including seeing our glasses revenues grow 48% and our gross profit grow 50% year-on-year in the quarter. Our second quarter 2022 results are a testament to the resiliency and nondiscretionary nature of our unique vision care platform and our competitive positioning as a go-to brand for speed, quality and value in eyewear.

It's clear that as we look out across the retail landscape, the novelty of physical retail is wearing off fast. Fighting traffic, struggling to park and standing in line to pay in understaffed stores that have limited inventory doesn't seem like a recipe to deliver a great customer experience. Yet that's exactly what we saw our traditional retail competition deliver this quarter. In our view, as people start returning to the office, they continue to seek the savings and convenience they have come to know and love from buying online and at KITS. We feel that this has been reinforced after customers browse brick-and-mortar stores after a year of being locked inside.

To us, it's clearer than ever that physical retail will face some significant headwinds in the quarters to come. Direct-to-consumer offerings like KITS will continue to take share as legacy companies remain encumbered by expensive store expansions, lease commitments and build-outs. Additionally, those manufacturing offshore are going to continue to see disruptions in the supply chain and are likely to face rising costs in fulfillment. We couldn't be more pleased that our asset-light model can stay focused on wowing customers with high-quality products delivered fast and affordably.

This quarter, we are especially pleased that we became cash flow positive for the first time since our IPO and we're EBITDA positive. The growth of our glasses business was impressive against a challenging retail backdrop, but this was only the beginning, and we believe it will continue to expand in the coming quarters, having earned a meaningful place in the market. Last quarter, as we faced significant macro uncertainty, we continue to focus on the parts of our business that we could control. We delivered sequential improvements in revenue, even as we took a disciplined approach to our marketing investments, which are down 23% year-on-year, and we continue to drive improved gross profit, which was up 50% year-on-year to a new quarterly record, resulting in positive cash flow and EBITDA for the quarter.

Our solid results as our company became a recurring cash generating machine are a direct function of our customers' engagements as we spent less on acquiring new customers and saw our subscription business and repeat customer activity provide a stable, recurring base of business. We remain focused on growing the stable base of highly loyal recurring advocates and on creating lifetime loyal customers.

We continue to operate at the key intersection of health and technology, allowing customers everywhere to access affordable eye care more easily and cost effectively than ever via technology without the burden of having to struggle to go into physical locations. As health care continues to consolidate and move towards better and more efficient direct models to serve patients, we believe we are uniquely well positioned to capitalize on the opportunity given our asset-light, highly recurring nature.

Innovating to improve the customer experience remains a pillar of our business plan, and we are pleased to have rolled out several new high-value specialty lens designs, enabling customers with more complex prescriptions to experience exceptional vision. Further innovations in routing and logistics algorithms have decreased our fulfillment cost per order, lowering our overall cost to serve each customer and especially notable achievement for our teams as carriers are simultaneously adding escalating fuel surcharges.

Onshore vertical integration is critical in today's supply chain environment. We believe we're at the forefront of that movement to onshore manufacturing, which allows us to serve customers more predictably and do so more cost effectively than those importing finished goods. We provide speed, quality and reliability through our own owned onshore manufacturing and fulfillment. We continue to believe that controlling the rails of production and being the low-cost manufacturer onshore is integral to our business model and provides key long-term strategic speed and cost advantages. Our efforts were validated this quarter as we saw our fulfillment cost per ship has decline in the quarter.

Customer engagement and NPS continue to be key metrics for our company. Our NPS scores continue to rise as we continue to innovate and exceed customer expectations. KITS has earned over 179,000 5-star reviews, reflecting our focus on truly delivering a superior experience. We are on track to achieve the highest real NPS in the category, a fact easily confirmed by looking at the thousands of customer comments online and by looking at the growth of our glasses business even while marketing investments declined. It's a great achievement when an offering goes viral, and its growth becomes fueled by delighted customers as we experienced this quarter.

We served a record more than 740,000 customers over the past 24 months as customers are spreading the word and momentum is built. During the second quarter of 2022, we delivered $21.8 million of revenue, which was consistent year-on-year but on 23% lower marketing spend and 1,060 basis points or 50% higher gross margin. Revenue was up 8.6% sequentially, and gross margin expanded 175 basis points sequentially as we maintained our focus on improving margins while growing our glasses business.

Some other highlights of our second quarter of 2022 included that we delivered 74,000 pairs of eyeglasses to customers, a 48% year-on-year improvement in revenue and 72% improvement in units. Our overall revenue from our repeat or returning customers was 62% in Q2. As I mentioned, we did reduce marketing spend by 23% year-on-year, and we delivered 175,000 orders in Q2, almost 2,700 orders a day. Given our unique strategy of offering glasses to our existing vision care customers with a category-leading customer acquisition cost for the quarter of $21, a 21% decline over last year.

I'll now turn the call over to Joe with an update on operations. Joe?

[Joseph Thompson, executive]

In Q2 2022, our KITS community of active customers grew 23% to 740,000 customers. Our eyeglasses business continues to lead the way. In Q2, KITS customers bought even more glasses and leveraged more of our expanded range of lenses and frames available than ever before.

We continue to attract new customers with our growing selection, our unbeatable value and our lightning fast delivery. In Q2, we served over 50,000 new glasses to customers, welcoming them to our growing KITS community across North America. Our repeat business is growing even faster, with eyeglasses delivered to returning customers increasing over 174% year-on-year in Q2. Overall, return customers accounted for 69% of our revenue this quarter, demonstrating the strength of our vision-corrected community and the annuity we have begun to build. Our investment in onshore vertically-integrated eyeglass manufacturing has enabled us to cut out the middleman, deliver predictably and quickly become one of the leading players in the market. With our digital surfacing facility, we can produce high-quality custom digital progressives and specialty glasses in-house.

With all of our production local and onshore, we can ship patient orders quickly and cost effectively. Our custom-built fulfillment model allows us to produce and ship in under 2 days, with the vast majority shipping out the same day. And we're just getting started on our expansion into the eyeglasses market. Our team is working to manufacture and deliver even faster. Each month, we add new eyeglasses styles, colorways and brands to the collection of over 800 styles we had at the end of the quarter. We're adding new lens designs and innovation to our fast-growing digital progressive business. With the investments we've made, we are competitively advantaged to capture the higher AOV and margin segment within eyeglasses.

At the core of our KITS focus is building happy, loyal, vision-corrected customers for a lifetime. We measure our success by whether customers come back, and how often they return is reflected in retention. We earn the retention of our customers by continually raising the bar in selection, quality, value and convenience with every customer and with every order. As we look back at the performance of our retention rates by customer cohort, it's clear we're building something special for customers and for shareholders.

We evaluate the strength of our retention by measuring the purchase behavior of our customers over time. For example, within a 24-month period, we have 100% retention rate on our 2019 cohort, meaning that customers from that cohort have matched their initial purchase within 24 months. As we review this across 12 months, 24 months, 36 and 48 months, we are encouraged to see we're doing a better and better job of retaining customers, particularly when compared to other publicly-traded eye care companies. We believe this favorable trend gives us a sustainable and valuable annuity and positions us well for growth and to weather uncertainty.

I'll now turn the call over to Sabrina for the financial overview.

[Sabrina Liak, executive]

Thanks, Joe. Second quarter 2022 revenue was $21.8 million, up slightly year-on-year and up 8.6% sequentially as gross margins and profitability improved materially. Gross profit was up 50% or up $2.3 million to $7 million year-on-year. Our gross margin expansion reflects improved product margins, driven by pricing strength throughout the first quarter that continued into the second quarter. This is achieved through disciplined execution around promotions as we focused on investing in loyal customers and retaining them. We also made significant progress in growing our glasses business, where revenue was up 48% year-on-year.

The KITS brand continues to build momentum and loyalty, and our pricing power improved, as seen in our 23% lower marketing expense and the tremendous gains in gross margin, which expanded 1,060 basis from 21.6% to 32.2% compared to the second quarter of 2021. This quarter, we generated positive EBITDA of $141,000, up $5.6 million year-on-year. Operating cash flow was also strong as we generated $2.3 million of cash from operations, which contributed to the strong cash flow position we ended the quarter with of $18.9 million.

Given the macro environment, we moved up our targets for gross margin growth, returning to EBITDA positive and returning to operating cash flow positive, achieving all 3 in the second quarter of 2022, ahead of our original forecast to achieve all 3 milestones. In terms of guidance, there are no changes to our long-term goal to generate margins above 35% to 40%, as our glasses business and returning customers become a larger portion of total revenue, driving revenue and improving EBITDA as demonstrated by our second quarter results.

We expect the broader macro economy and supply chain environment to remain volatile. And as a result, we'll not be providing a revenue forecast at this time. In this environment, we will prioritize funding our growth from internally generated cash flow. In the second quarter of 2022, cash on hand increased to $18.9 million. As always, we are prepared to react as conditions change or new challenges emerge. We believe our asset-light customer model, coupled with our onshore manufacturing facilities, position us well competitively, and we expect to continue to outperform our peers during the uncertain times ahead.

I'll now turn the floor over to questions. Operator?

[Operator]

[Operator Instructions] The first question comes from George Doumet from Scotiabank.

[George Doumet, analyst]

I guess you, Sabrina, officially kind of removed your revenue guidance for the year. So I was hoping maybe you can give us a little bit of context around that. I understand that supply chains have been tight and there's uncertainty. But just can you maybe give us a little bit of color in terms of maybe prior expectations to maybe revise? Or anything you can provide there that can help us maybe get a sense of the growth trajectory in the second half of the year.

[Sabrina Liak, executive]

Yes. Thanks for the question, George. I think the shift in strategy, I think, which we tried to communicate was really around instead of having a revenue target, having an EBITDA and cash flow positive target for the rest of the year. We -- I guess in this current environment with the uncertainty that companies are facing kind of across the spectrum, we're prioritizing profitability and the ability to generate cash flow internally to fund our operations. We do expect growth. It will really be a function of maximizing kind of across all 3 factors.

[George Doumet, analyst]

Okay. So if I understand correctly, you are expecting second half growth compared to the first half of the year.

[Sabrina Liak, executive]

Yes, we are.

[George Doumet, analyst]

And can you maybe talk to -- there was a decline in the contact business this year. Can you maybe talk -- I guess you probably would need to have that business stable to up to have any meaningful growth in the back half. So can you maybe talk a little bit about initiatives for that business or for that part of the business that you hope to implement?

[Sabrina Liak, executive]

Yes, sure. So quarter-on-quarter, we're up sequentially. Look, over the last 6 quarters, we've been really focused on expanding gross margin, and that means really triaging out customers that were not profitable, long-term value customers. And so you did see a decline in the contact lens business over the last period for that. I think the outlook is positive on that. Also, we expect to grow that business. It did grow sequentially quarter-on-quarter. We expect that trajectory to continue in the back half.

[George Doumet, analyst]

Okay. And just so I understand correctly, you guys expect to maintain EBITDA positive trajectory in the next couple of quarters. And maybe just wondering if that's -- number one, if that's the case; and number two, do you feel like you need to maybe invest more in marketing or customer acquisition than you have in the first half of the year?

[Sabrina Liak, executive]

Yes, we do expect to continue our expansion of EBITDA and to be EBITDA-positive in the back half of the year. In terms of the marketing expense that we put behind it, we don't expect the ratio of marketing expense to increase materially, if at all. To Roger's point, at this point, the growth is really being primarily funded by repeat customers and people telling the story.

[Operator]

Your next question comes from Derek Dley from Canaccord Genuity.

[Derek Dley, analyst]

Just a couple of questions from me. I'm just trying to assess what are you seeing in terms of inflationary pressure currently. Any impact on your long-term gross margin target in terms of timing? Or any more color on that would be appreciated.

[Joseph Thompson, executive]

Sure. So a couple of questions in there. Maybe we'll start with gross margin improvement. We have seen gross margin improvement, and it's really the result of a couple of factors. First, you've seen us demonstrate more pricing discipline, particularly in the U.S. And we were encouraged that we're able to sustain our results and grow our active customer base, even with that price discipline because of the service levels that you heard Roger describe. High customer service ratings, over 179,000 5-star ratings and NPS north of 80.

On glasses, we're continuing to see the market and you saw a 72% increase in glasses units. And the team is doing a better and better job of introducing customers to premium upgrades. And of course, on repeat business, our glasses continues to grow at a higher gross margin level. And really, this was our plan: to invest in the onshore infrastructure, not investing in more retail locations. So it allows us to serve customers more efficiently than the market. And so as our glasses business continues to grow, we're seeing the potential for even more gross margin expansion.

You mentioned some -- maybe some raw material increases, I think, was the second part of your question. And I guess what I'd share on that is we've been fortunate to have some long-standing partnerships with nearly all of our vendors. And in large part, we've been able to offset potential cost increases with the benefit of more scale. And the growth of our glasses business by 72% really helps with that.

[Derek Dley, analyst]

Okay. That's very helpful. And then just in terms of consumer behavior, with inflationary backdrop right now, have you seen any changes in the behavior at all?

[Joseph Thompson, executive]

On the cost side or on the consumer side? On the retail side or on the cost side?

[Derek Dley, analyst]

On the consumer side.

[Joseph Thompson, executive]

Yes. On the consumer side, we continue to see customers who are looking for great quality products. These are -- and so we're continuing to invest in a broader selection. We ended the quarter at over 800 styles across a variety of brands, across a variety of price points because what we hear from the customer is they're looking for convenience, they're looking for selection, and -- but they want to pay a fair price for it.

And so we're happy that our vertically integrated model allows us to pass the -- we feel we've got the most efficient manufacturing cost in the market, and we're able to pass that scale and savings on to customers. So they're still able to get a high-quality pair of glasses, superior lens, but for a fair price. And we feel that's what's driving the growth on the glasses side.

[Derek Dley, analyst]

Okay. That helps. And then just maybe one last one. I know you touched upon marketing spend earlier and how you're targeting the loyal customers. I'm just wondering any plans on increasing marketing activity or promotional spending at all.

[Joseph Thompson, executive]

I'm glad you've asked. It's an important question. We were -- we really hit the inflection point of on the -- in particular, on the glasses business this quarter. To see glasses grow that significantly with a 23% decrease on marketing year-over-year means that word is getting out. And the best marketing that we could have is one of our customers telling 3, 4, 5, 10 friends about the experience that they had at KITS. And so we're going to continue to fuel that and invest in that. But we were happy, in particular, in this quarter that we did not need to fund the growth in glasses with more marketing. In fact, it was just the opposite.

[Roger Hardy, executive]

And probably just to add one last thought. I think Sabrina touched on that we will forecast staying disciplined in the back half and keep marketing investment consistent as a percent of sales to where you've seen over the last couple of quarters.

[Operator]

Your next question comes from Matt Koranda from ROTH Capital Partners.

[Unknown Analyst]

This is Ray, on for Matt Koranda. So I just wanted to know if you guys can explain some key factors in the decline of the contacts revenue. Are we seeing more, I guess, more similar traffic and lower conversion? Or are we seeing lower traffic and a somewhat stable conversion? If you could talk a little bit about that.

[Roger Hardy, executive]

Yes. I think -- so as Joe noted, sequentially, the contact lens business did improve year-on-year. We shifted some of the marketing investment from contacts into glasses. And so we're kind of seeing a more efficient use of spend in glasses. And so I think that's kind of -- the contact lens business did sequentially grow. I think probably Q1 was sort of -- there was a bit of a decline there, but it's recovered and turned in Q2. And that's what we'd forecast continuing for the rest of the year, sequential growth in contacts and then glass is becoming a larger and more meaningful part of the business.

In many cases, we've taken a contact lens order that's significantly higher AOV and put that customer into a pair of glasses, which is a lower AOV, which is a sense why the top line hasn't really moved even though glasses continues to grow so impressively. So I think over the next couple of quarters, glasses will become a bigger and bigger part of our mix and the growth rate there is going to be what really drives the top line while we've seen margins improving as glasses becomes a bigger part of the mix. So I think that's kind of where we're focused. We're pleased with the contact lens business kind of even staying consistent. We're happy with that and continue to grow the glasses business. Thank you.

[Unknown Analyst]

Okay. That was helpful. And then also just one more question. In terms of working capital, it's good to see some -- a little bit of reduction in inventory. I was just wondering where days of inventory on hand might end up or normalize for the rest of the year.

[Joseph Thompson, executive]

Sure thing. This is Joe. So as you said, our inventory level was stable. It was down marginally quarter-over-quarter. With inventory planning on this business, we have the advantage of the direct-to-consumer model, which really gives us excellent visibility of traffic and purchases and where that traffic and purchases are headed. We also don't need to see hundreds or thousands of retail stores with various inventory levels, which helps us as well. And of course, we've got great partners to work with on planning and on delivery. So there's different parts of our business.

I think on the contact lens side, you'll continue to get tighter and tighter on inventory on hand. And with the data that's available to us, we're seeing improved performances, as you've noted. And on glasses, we're just aware of the macro environment. And so there's times where if we think raw materials will be a little bit longer to arrive, we'll occasionally increase our inventory position marginally. But really, we've got great data and great partners. And so we've been -- we've seen a lot of stability and some improvement over the last quarter.

[Operator]

[Operator Instructions] There are no further questions at this time. Please proceed. Sorry to interrupt.

[Roger Hardy, executive]

Great. Thank you. Thanks, operator. Overall, it was an impressive quarter of execution by the team. Our group managed the complexity of a fast-growing glasses business while improving gross margins and while reducing marketing expenses, manufacturing and fulfillment expenses amidst a volatile backdrop of rising costs all around us. We became a cash-generating machine and generated positive EBITDA, which demonstrates clearly a predictable, recurring nature of our growing revenues. We look forward to updating shareholders on the many exciting developments in our business in the quarters to come.

Thank you to all of those who attended the call today. And thank you, operator. Have a great day.

[Operator]

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.