Kits Eyecare Ltd

TSX:KITS

Earnings Call Transcript 2022-Q3

[Operator]

Good afternoon, and welcome to the Kits Eyecare Third 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; Joseph Thompson, Chief Operating Officer.

Before we begin, I'm required to provide the following information or 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 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 in 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 security 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, CEO. Please go ahead.

[Roger Hardy, executive]

Thanks, Collin. Good afternoon, everyone, and welcome to the Kits Third Quarter 2022 Financial Conference Call. Thank you for joining us today. I'm Roger Hardy. I'm the company's CEO, and joining me today are my 2 co-founders, Sabrina Liak, our President and CFO; and Joseph Thompson, our COO.

Today, I'm pleased to share our third 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.

Kits operates in a compelling category at the intersection of health and technology, allowing customers everywhere to access affordable eyecare more easily and cost effectively than ever via technology without the burden or having to struggle to go into a physical location. As health care continues to consolidate and move towards better and more efficient direct models to serve patients, we are uniquely well positioned to capitalize on the opportunity given our asset-light, highly recurring business model.

This quarter, it became clear that the disciplined efforts of our team over the past few quarters delivered superior performance. Previously, we characterized the environment as a volatile one, where consumers had to make important choices against the backdrop of economic uncertainty and rising prices. Against this backdrop, we are especially pleased to have delivered another quarter of accelerating performance, including 18% revenue growth, 39% gross margin growth and achieving EBITDA and net income profitability.

Our Kits team is built on a world-class group with deep unique skill sets, capable of delivering superior performance across the category. This quarter, the team was asking smart questions and achieving disciplined results as the company outgrew the category in meaningful ways, producing growth, earnings and significant cash flow from operations.

The Kits team has built a differentiated model that is revolutionizing the landscape of the optical category. Our timing and listening to what customers are looking for and launching Kits has proven to be excellent. The model is resonating with customers, and we are creating meaningful long-term value for shareholders as we take market share outgrowing the vision category rate and e-commerce generally.

Importantly, the Kits management team is constructive of shareholders who collectively own approximately 75% of the company, who think like and are aligned with investors as they work to deliver superior results and shareholder value. The Kits team has collectively more than 100 years leading the category, which our team believes gives us invaluable experience that will accelerate value creation for shareholders. You'll hear from Sabrina and Joe a little later in this call.

Kits has become a trusted and loved brand over the past 4 years, quickly growing to become a meaningful part of the optical landscape in North America, now exceeding $100 million run rate. This quarter, customers searching for our brand grew a category-leading 64% in Canada, while our marketing spend declined. This type of growth in brand searches demonstrates that our offering is resonating with customers, and they are sharing the brand with others as it grows virally. Whenever a brand begins to experience this type of pull word-of-mouth marketing as compared to push marketing relied on by other brands in the optical category, we believe shareholders and investors can expect asymmetric returns.

It was a disciplined quarter at Kits where we delivered sequential improvements in revenue, which was up to $23.6 million, up 18% year-on-year and up 8% sequentially quarter-on-quarter, while margins improved 470 basis points to 30.6%. These achievements are even more impressive when we consider that marketing expense as a percent of revenue declined year-on-year to 14.2% of sales.

And we continued to drive gross profit dollars higher, up 39% year-on-year, establishing a new quarterly record in positive cash flow of $3.9 million. And for the second straight quarter, positive EBITDA of $1.1 million, along with positive net income for the quarter.

These results reflect tremendous execution by our team and continued growth of our complete eyecare brand. Additionally, in the third quarter, our active customers reached a record of 765,000 active vision corrected customers.

I'll now turn the call over to Joe for discussion of operations. Joe?

[Joseph Thompson, executive]

Thanks, Roger. The momentum from our second quarter certainly strengthened in the third quarter with our business growing in both contact lenses and glasses and in both the Canadian and U.S. markets.

While our growth was broad-based in the quarter, glasses continued to lead the way. We delivered over 61,000 pairs of eyeglasses in the quarter, 93% of which were Kits branded, and glasses revenue grew 81% versus prior year. The continued growth of our prescription eyeglasses business is important. The eyeglasses market is over 4x the size of the contact lens market, and we now have significant momentum and are gaining share. Our growth in glasses is also having a notable impact on our Kits brand as people spread the word about the selection, value and convenience of our offering.

Branded searches for Kits were up 64% year-on-year as measured by Google. And we are the fastest-growing brand in search in Canada, while other brands declined. This word of mouth and organic growth on Kits contributed to our industry-leading $21 cost of acquisition.

Key to our continued profitable growth is the operational foundation we have built with our onshore automated optical lab. In the quarter, we delivered 173,500 patient orders or about 2,700 per day. We're able to manufacture single vision prescription glasses in one day and deliver them quickly to patients. In Q3, our order to delivery time reduced by 25% on glasses versus prior year. We also launched same-day delivery in Vancouver and next-day delivery options across Canada.

Automation and a disciplined approach to costs allowed us to deliver these results while reducing fulfillment expense as a percentage of revenue to 13.4%, down year-on-year and sequentially. Our team also kept a close eye on inventory levels, which moderated to 12.3 million, a decline of 1 million sequentially and a decline of 3 million year-over-year.

I'll now turn the call over to Sabrina.

[Sabrina Liak, executive]

Thanks, Joe. We're pleased to see sound strength across our business. Our new and repeat customers are responding well to our compelling offering.

With respect to the third quarter of 2022, revenue was $23.6 million, up 18% year-on-year and up 8% sequentially. Gross profit was up 39% year-over-year or up $2 million to $7.2 million.

Kits brand awareness continues to grow with loyalty and our pricing power improving as seen in our lower marketing expense, which decreased to 14.2%, and the tremendous gain in gross margin, which expanded 470 basis points from 25.9% to 30.6% compared to the third quarter of 2021. Our gross margin expansion year-over-year reflects improved product margins, driven by pricing strength continuing into the third quarter.

We generated positive EBITDA of $1.1 million, up $2.6 million year-on-year. Operating cash flow was also strong as we generated $3.9 million of cash from operations, which contributed to the strong cash position we ended the quarter with of $20.4 million.

Given the macro environment, we moved up our targets for gross margin growth, returning to EBITDA positive and returning to positive operating cash flow, achieving all 3 in both the second and third quarter of this year.

In terms of guidance, we are maintaining 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 scale and improving EBITDA as demonstrated in our third quarter results. In this environment, we will continue to prioritize funding growth from internally generated cash flow.

Our team is prepared to react as conditions change. We believe our asset-light customer-focused model, coupled with our onshore manufacturing facility, positions us well competitively, and we expect to continue to outperform our peers as the momentum in our brand continues to grow.

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

[Operator]

[Operator Instructions] And your first question comes from Derek Dley from Canaccord.

[Derek Dley, analyst]

Congratulations on some nice growth in this quarter. Just looking forward, it seems like you've got some really strong momentum here on the eyeglass side. Average pricing based on the disclosure you gave us is moving in the right direction. And clearly, there's still a lot of capacity within the production facility. So how should we think about growth going forward on a percentage basis? Should we expect eyeglasses to exceed contacts? And should we still be expecting contacts to grow in the final quarter this year and into 2023?

[Roger Hardy, executive]

Yes. Great. Derek, so maybe take those a bit -- one at a time. So I think you're right. Glasses has been growing very aggressively or -- it's been growing well and -- over the past couple of quarters to become a more meaningful part of the business. And so we expect it to continue to keep growing high double-digit numbers.

And contacts similarly should be in the low double digits. So we think we exceed the category in contact, and we think high double-digit growth in glasses. That's been consistent. It's just starting to become a more meaningful part of the business.

So I think your last part of your question was kind of looking into Q4. I think we're kind of seeing the estimates around The Street, and they look -- we feel comfortable about being in that range. So growth is going to continue sequentially. And it's -- I think we're expecting a very strong finish to the year-end.

[Derek Dley, analyst]

Okay. And then I suppose as you continue to drive that eyeglass revenue, we should start to see margins creep upwards. But I'd imagine in the near term that the level that you achieved this quarter, sort of that low 30%, is probably a bit more of an appropriate target over the next couple of quarters before we move up into that 35% to 40% range?

[Roger Hardy, executive]

Yes. Derek, I think there's a lot of moving parts in that number. We've been happy with where we were kind of balancing growth and earnings. And so that's kind of the way we're thinking about it is to have consistent growth rate, and we'll be looking to have margins continue in this kind of 30% range. As glasses becomes a bigger part of the business and especially returning glasses' customers, we expect margins to enhance from there.

[Derek Dley, analyst]

Okay. And then sorry, just one more...

[Roger Hardy, executive]

And, Derek, one last point on that. I think longer term -- speaking kind of long term, the goal and the target was margins to be at sort of 35% to 40% consolidated. So that's sort of the -- as we look out, that's where we think the business kind of normalizes, again, as glasses and returning glasses' customers become a bigger part of the business.

[Derek Dley, analyst]

That makes sense. And then last one for me. Just in terms of -- and I know it's early days on these, but some of your larger partnerships, for example, with Sun Life, can you just comment on how the initial days of those partnerships are going?

[Joseph Thompson, executive]

Yes. Thanks, Derek. This is Joe. In Q3, we launched another exciting partnership in the Canadian market with Green Shield insurance. And that's a deeper partnership that allows customers to see the coverage that they have right on kits.ca and avoid any out-of-pocket expense.

So as you mentioned, it's still very early days, but we love the unit economics that we're seeing in the early days, and we expect both that -- the Sun Life partnership and others to just continue to grow and play a material part of our growth in 2023.

[Derek Dley, analyst]

Is the average transaction size larger for customers that come in through these partnerships?

[Joseph Thompson, executive]

Yes, that's right, Derek. It -- while it is early days, compared to the base, we have a big base outside of our insurance business. But we are seeing our insurance customers come in with even more favorable economics on average order and other.

[Operator]

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

[Unknown Analyst]

This is Ray on for Matt. Congrats on the quarter. I wanted to see if you could talk a little bit about the consumer behavior you're seeing given the macroeconomic backdrop right now and how that's affecting the -- I guess the mix that you're seeing in glasses revenue. I think you mentioned it was 93% Kits branded. Do you kind of see the consumer trading down and looking for more value right now? If you could just give a little color on that, that would be helpful.

[Roger Hardy, executive]

Yes, sure. I think, overall, we continue to think that the vision category is quite compelling. This is really vision nondiscretionary for our customers. And so they need to be able to see. It positions us well in this sort of moment where people are looking for better value. They're having to rationalize expenses. And so we think we are seeing sort of the macro is a strong tailwind for our business.

As far as the Kits branded frames, being -- I don't think of that as a trade down. I think from a quality standpoint, from a service standpoint, customers come to the Kits brand because they've heard from others that this is a great pair of glasses delivered quickly. That's the wow experience, is that the quality and the savings and the convenience are just so good.

So from a -- I think from a glasses standpoint, glasses is being driven more by word-of-mouth around the offering. And I think the rest of our business in terms of the contact lens business, there is a bit of a -- I think when customers are looking for better value than they can get at retail optical stores, they're going online and they're finding that type of savings. And so both of those are sort of tailwinds for our business.

[Unknown Analyst]

Great. And then just one more question, if I can. It looks like marketing stayed relatively flat on a dollar basis compared to last quarter and down a little bit as a percent of sales. I know you guys mentioned that it should stay relatively flat. Are we still expecting that to be around like the 14% range? And then also last quarter, I believe you guys mentioned that there was some marketing mix shift over to glasses. If you could give some color on that as well.

[Joseph Thompson, executive]

Sure, Ray. Yes. This is Joe. So I guess the first part of your question, yes, it's our view that our marketing expense which decreased slightly in the quarter is a trend that will continue.

And to your point on the shift to glasses, which we noted last quarter, the one thing that we wanted to call out in the remarks is that we have seen an increase in organic search and word of mouth. That really took hold last quarter and it continued in this quarter with brand searches on the Kits name up significantly, about 64% year-on-year.

So we do see the glasses growth really contributing to more word of mouth, which is helping us achieve the growth numbers that we saw, about 80% on the glasses business while holding marketing consistent, and that's a trend we expect to see continue in our view.

[Operator]

[Operator Instructions] There are no further questions at this time. I'll turn it back for closing remarks.

[Roger Hardy, executive]

Thanks, Collin. And thanks, again, everyone, for joining us today. Our Kits team has been headed down moving the category in a new direction to better serves customers while scaling our differentiated model. The vision category remains compelling, given its legacy burdens and it's clear we are driving accelerated long-term value for shareholders in a quickly changing landscape. That hard work consolidated in superior performance across all functional areas of business this quarter.

Congratulations to the entire Kits team on a great quarter of disciplined execution and improving momentum. We look forward to updating shareholders on our progress as the year progresses. Thank you, again, to all those who attended the call today. This concludes our call, operator.

[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.