Kits Eyecare Ltd

TSX:KITS

Earnings Call Transcript 2020-Q4

[Operator]

Good morning, and welcome to the Kits Eyecare fourth quarter results conference call. [Operator Instructions] This call is being recorded on Tuesday, March 16, 2021. Your hosts today are Roger Hardy, Chief Executive Officer; Sabrina Liak, Chief Financial Officer; and Joseph Thompson, COO. Before we begin, I'm 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, believe, could, continue, expect, estimate, forecast, may, potential, project, plan, 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 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 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 conference over to Mr. Roger Hardy, CEO. Please go ahead.

[Roger V. Hardy, Co]

Thanks, Colin. Good morning, and thank you for taking the time to participate on today's call. I'm Roger Hardy, the company's CEO. With me today are Sabrina Liak, company's CFO; and Joe Thompson, company's COO. Today, I will discuss our 2020 results and share some insights on the growth we are seeing in the eye care sector and walk through the exciting progress we are making in our eyeglass and Autoship businesses. Then Sabrina will provide more details on our financial results, followed by Joe with an operational update. We are thrilled to be here today, hosting our first conference call as a public company. We were encouraged by the strong response to our IPO, which allowed us to upsize our offering. With the proceeds raised from our listing, we are excited to be building a leading vertically integrated, asset-light model in eye care. And when I say asset-light, what I'm really referring to is the fact that we're achieving this impressive growth by being focused on a customer experience that does not require us to invest in physical bricks-and-mortar retail. Our 2020 results reflect KITS' relentless focus on execution and customer experience, buoyed by the positive secular shifts occurring in e-commerce and digital health care. These dynamics provide a supportive tailwind to propel KITS to achieve record results in 2020. Volume in the fourth quarter outperformed our expectation as orders, Autoship subscriptions and eyeglass shipments all continue to strengthen into the year-end as customers sought and discovered value, convenience and selection in our expanded product and service offerings. As we entered the fourth quarter, we were focused on 2 additional goals: first, establish a public currency to enable us to be the most nimble player in a highly fragmented market; and second, laying a firm foundation for KITS to become the most trusted and loved brand in eye care. The team executed to plan on both. 2020 revenue increased 51% year-over-year to $75 million, with revenue from repeat customers representing 65% of total revenue, a testament to the stable base of recurring orders and cash flow generated by our loyal customer base. We achieved record active customers and ended 2020 with over 700,000 active customers, up from 500,000 at the end of 2019 as we reengaged dormant customers and attracted record new customers. We delivered 2020 gross profit of $21 million in 2020, up 57% from $13 million in 2019, representing gross profit margin of 28.4% in 2020 and 27.4% in 2019. The promotional environment was relatively benign for most of the year, and we aggressively worked to drive customer acquisition in the fourth quarter, offering onetime initial discounts to new subscribers, achieving new records for shipments, eyeglass orders and Autoship revenues in the fourth quarter. While this resulted in strong customer growth and peak engagement levels in our core initiatives, it provided a temporary decrease in margin in the fourth quarter. Knowing well the LTV of our customers as we do, we invested prudently in continuing to acquire the best customers in the category with a view to the long-term value of each customer. We quickly have seen margins improve as 2021 got underway, and we became less promotional. And we expect to see continued gross profit margins improve in 2021 as a larger percent of customer base become glasses customers and as we further expand our glasses offering into higher-value and higher-margin specialty segments of eyewear, such as progressive lenses which we just launched, Rx sun, and photochromatic or commonly known as Transition lenses as well as other specialty lens categories. Adding this broader offering, we'll also improve our marketing dollar and our social yields. We also anticipate being less promotional with new Autoship subscribers as momentum and word of mouth spread and drive additional customers to our offering. In February 2020, we launched our Autoship subscription program. We're pleased to have ended 2020 with our Autoship subscriptions representing 20% of contact lens orders in the fourth quarter and continue to aim to reach 25% of orders on subscription by the summer. Investing and acquiring customers on this recurring revenue model, we believe, differentiate us in the category and offer a clear view to the long-term value of acquired customers. The subscription covers allow us to more accurately predict growth rates as well as forecast purchasing and other costs. It also allows us to invest in more than just the acquisition of customers, instead enabling us to more fully invest in the lifetime of the 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 of whom vision correction is nondiscretionary. The key highlight of 2020 is the successful launch of our eyeglass business and construction of our state-of-the-art optical lab, dubbed internally the giga lab, creating a vertical integration moat around our business. We shipped 39,000 glasses from our optical lab in 2020. And in February 2021, we hit a milestone of shipping 1,000 glasses in a single day. We believe that customers looking for eyeglasses want value, convenience and selection and they want them yesterday. Over the year, our design and distribution teams have been working tirelessly to perfect our brand strategy and deliver on what is most important to customers. This remains a work in progress. Since introducing designer eyeglasses alongside our KITS brand, we have seen conversion increase and many styles have sold out quickly. Our strategy is to provide a broad and diverse product offering that appeals across consumer demographics, emulating the most successful business models in other direct-to-consumer categories and driving positive momentum for our company. We are proud to have delivered further proof of the cash flow generating capacity of our business model in 2020 as we produced another positive fiscal year, generating $3.5 million of adjusted EBITDA and $4.2 million of operating cash flow. We believe this makes us fairly unique, again, in the eyeglass category. We entered this pandemic from a position of strength with a strong underlying strategy and a seasoned bench of world-class professionals. It was amazing how quickly our team mobilized and implemented work-from-home operations and scale to meet demand. The thoughtful planning of our capable team ensured that our customer orders continue to be delivered without interruption. Customer ratings, which we watch closely and believe are a good indication of the value we deliver, continue to be strong through this unprecedented time. We took the opportunity to serve many new customers as a shift from in-store retail to digital and direct retail gathered steam. As we had forecasted, online eye test and the many other tools that make a customer's life easier online are gaining broader acceptance. And while these tools are not yet perfect, they will be evolving quickly as we take feedback from customers and look to improve upon them and to optimize our day-to-day operations. We are constantly seeking to enhance product selection, service and experience as we welcome a record number of new customers to our platform. As our financial results demonstrate our business is well positioned for growth and opportunities ahead, we entered 2021 with a greater scale, greater access to capital and a stronger balance sheet. Our company continues to demonstrate strong growth, finishing the year with $75 million inorganic growth fueled revenue, up 51% over the prior year. With our IPO now complete, we look forward to continuing to provide incredible value to our customers as well as shareholders. I'll now pass the call over to Sabrina for a review of the financial results. Sabrina?

[Sabrina Liak, Co]

Thanks, Roger, and good morning, everyone. Fourth quarter revenue reached $20.3 million, increasing $7.6 million or 60% year-over-year. Shipped orders hit an all-time high and were up 70% year-over-year and up 6% over the third quarter. Fourth quarter eyeglass orders also hit a new peak, and we shipped 21,000 pairs of eyeglasses in the quarter, a 25x increase compared to the fourth quarter of 2019. In addition, we are seeing exciting preliminary results from our Autoship subscription launched earlier this year. In the fourth quarter, 20% of contact lens orders shipped through our auto subscription program. Gross profit increased by 20.2% to $4.7 million in the quarter compared to $3.9 million in the same quarter of 2019. Overall, 2020 gross profit margin was 28.4% compared to 27.4% in 2019. While customer growth was solid this quarter, we actively invested in attracting customers to our platform. We provided strong introductory offers on both eyeglasses and Autoship subscriptions to new customers. As a result, shipped order growth exceeded revenue growth quarter-over-quarter and gross margins experienced temporary compression. In our view, this is not reflective of our expectations for 2021, and we continue to optimize our product and pricing mix. We are already seeing margins improve. Separately, we temporarily incurred higher product costs in the fourth quarter as a result of industry-wide logistics issues as we sourced non-optimized purchases to scale our inventory and to reduce shipment time to customers, which also contributed to temporarily lower margins in the fourth quarter. Again, we believe these factors are temporary and reflect short-term issues related to the logistics network being tested by the confluence of increased e-commerce activity, the holidays and COVID-19 restrictions. 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 continue to run above pre-pandemic levels. In 2020, we added 200,000 customers and ended the quarter with over 700,000 active customers, up from over $500,000 at the end of 2019. We began to lean more heavily into upper-funnel channels in the fourth quarter, and these investments are continuing to have a positive impact. For example, in the fourth quarter, we saw year-over-year improvements in organic visits, a key indicator of brand awareness, even as many other retailers stepped up their spending at year-end. We continue to believe that greater investments in brand and marketing will generate outsized returns to companies who can deliver excellent customer experiences. As planned, marketing expenses began to increase in the fourth quarter as we invest in brand and advertising assets that we intend to use throughout the year, for example, TV ads featured in the Super Bowl and The Bachelor. We have earmarked a portion of our proceeds from the IPO to invest in more top-of-funnel activities as we believe this investment in today's customer will benefit us for years to come. Fourth quarter marketing spend was $2.5 million or 12.2% of revenue, up from $1.1 million in the fourth quarter of 2019. Brand marketing spend, which includes television, digital video and brand creative, was 26% of our consolidated marketing spend in the fourth quarter versus 8% in the third quarter. Our other key investment area is in product development to offer customers incredible value, service and selection. This requires investment in vertical integration, product development and accelerated hiring. The impact of this investment can be seen in our P&L in fulfillment and general and administrative expenses as we expanded staff and space required for our state-of-the-art optical lab and simultaneously extended our distribution centers, technology development and customer service capabilities. Fulfillment expenses were 11% of revenue in the fourth quarter, and G&A costs were $1.9 million. Onetime factors affecting our fulfillment and G&A costs for the year included costs associated with transitioning to our own distribution facilities and costs associated with preparing for our IPO. Net loss was $6.6 million in 2020 compared to a net loss of $131,000 in 2019. Aside from the factors already discussed, the change in net loss was primarily due to an increase in onetime noncash finance accruals of $3.8 million related to the conversion of preferred shares to common shares and $1.1 million associated with the BDC fee payable at maturity. In addition, we incurred onetime IPO-related costs of approximately $1 million. Factoring in these adjustments and others, adjusted EBITDA was $3.6 million in 2020 compared to $4.3 million in 2019. Moving to recent events. We closed on our IPO in January, in which we raised $55 million. As part of the transaction, we simplified our balance sheet, and management converted all of their preferred shares into common equity. There is now one, single common share class outstanding, creating alignment across shareholders. In January, we also paid down $4.5 million of our debt with the Business Development Bank of Canada in exchange for increased flexibility to execute on our growth plan going forward. This flexibility, combined with our strong cash position, will enable us to fund all of our anticipated capital expenditures and customer investments. In 2020, KITS' growth outpaced broader e-commerce growth in our sector and significantly outperformed versus retail peers. It remains our ambition to continue to outgrow both our e-commerce competition and traditional stores, fueled by the shift towards broader acceptance of online health care and by growing awareness of our unique brand offering. I will now pass it over to Joe to talk about some of our operating highlights.

[Joseph Thompson, Co]

Thanks, Sabrina. As the category continues to shift to e-commerce, there are 3 things that differentiate KITS in the market and will continue to fuel our growth: vertical integration, our growing subscription program and our asset-light infrastructure. I'll start with vertical integration. In our view, vertical integration is one of the highest value creators in our industry, and KITS is investing to build the most capital-efficient direct-to-consumer business in eye care. A key development in 2020 was the establishment of our own design, distribution and manufacturing lab to improve quality and speed of service for our customers. Our focus is on maintaining the lowest cost of manufacturing in the eye care category and passing that savings and efficiency on to our customers. For example, in 2020, we shipped 39,000 glasses orders, compounding at more than 100% quarter-over-quarter. In this time, KITS introduced over 500 new frame styles for customers, including over 150 frame styles under the KITS line. We expanded our lens selection to offer a wide range of single-vision, blue-light blocking and progressive lenses. Into 2021, we will continue to dramatically grow our product selection, aiming to have a selection of over 2,000 unique styles for customers by the end of 2021 and a complete range of lens options. By owning sourcing, production and distribution, we are also able to offer customers a disruptive price point on high-quality glasses. Our glasses are currently priced at $69 in the U.S., $99 in Canada, including a made-to-order prescription lens. This compares to industry-average pricing of $351 per pair of eyeglasses in the U.S. Our digital progressive eyeglasses are priced at an introductory price of $148 in the U.S., $198 in Canada, which compares to industry pricing at approximately $800 to $1,000. This is just the beginning of our disruption into the high-margin specialty lens market. Vertical integration also offers our customers more convenience and speed. Our automated lab can complete an order of glasses in as little as 8 minutes. Our current lab capacity is 2,000 pairs of glasses per day. And over the next year's demand increases, we plan on doubling this capacity to 4,000 pairs of glasses per day. Our state-of-the-art fulfillment network allows us to deliver to customers across North America as quickly as 1 to 2 business days. Next, I'll discuss our subscription operation, Autoship. In 2020, we began to offer our already loyal customers the opportunity for even more convenience and savings. Autoship allows customers a "set it and forget it" feature to ensure they never have to worry about their next pair of contact lenses. 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. As of December 31, 2020, our Autoship subscribers were 26,000 and represented approximately 20% of total orders shipped in Q4 2020. Our goal is to grow this opt-in rate to 25% in 2021, which will drive higher retention and increase the lifetime value of our customers over time. Finally, KITS benefits from an asset-light infrastructure. We are not burdened with supporting hundreds of physical locations, like many of our peers, 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 a more convenient experience shopping for eye care products online. Without the burden of this legacy infrastructure, we can focus our investments on where the category is going, not where it's been. Our dedicated and hardworking team delivered all of these results while adhering to the higher demands of operating in a pandemic environment as well as navigating through an inconsistent supply chain environment. This gives us confidence that our momentum and efficiency will only improve in 2021 as we begin to enter a post-pandemic world. As our financial results demonstrate, our business is well positioned for growth and opportunities ahead. We entered 2021 with greater scale, greater access to capital and a stronger balance sheet. This concludes our prepared remarks. Operator, please open the line for questions.

[Operator]

Your first question comes from Derek Dley from Canaccord Genuity.

[Derek Dley, MD & Consumer Products Analyst]

Congrats on a strong first quarter out of the gate here. I've got a few questions. Just wondering if you could give us an update on the average run rate of eyeglass production today in Richmond. I mean if I just kind of run the quick math for Q4, I get about 235 glasses per day. But can you give us an update of where you're at for Q1?

[Roger V. Hardy, Co]

Yes. Sure, Derek, and thanks for joining. So you saw that we highlighted the 1,000 pair a day in February. Our expectation is that, that business has grown 100% per quarter over the past couple of quarters, and we see that kind of continuing to trend that way for Q1. So our expectation is it would, roughly speaking, double again in Q1. This is a very large category. I think what we're offering consumers is really resonating with consumers. And you've seen us do a bit of high-level brand marketing investment. That's built awareness. That's brought more new customers to the site, and we're definitely seeing the benefit of that in the glasses number specifically.

[Derek Dley, MD & Consumer Products Analyst]

Okay. That's great. And you mentioned that 65% of your revenue was driven by repeat customers. Could you maybe break that down a little bit further like you guys did in your IPO documents in terms of how many of those are customers that are making their second purchase or maybe how many are making greater than their fifth repeat purchase?

[Sabrina Liak, Co]

Yes. Sure. Happy to do that, Derek. So in terms of new customers, it's 35%. Second purchase is 16% of customers. Between third and fifth purchases, 22% of customers; and 6 or more is 27% of our customers.

[Derek Dley, MD & Consumer Products Analyst]

Okay. Great. That's helpful. I wanted to talk to you as well just on the gross margin. There was a couple of things in the MD&A. Just wondering if you could provide a bit more clarity. So one was the COVID impact, which, Sabrina, I think you did address in your prepared remarks. But number two is this industry-wide holiday. I'm just not familiar with what that was referencing.

[Sabrina Liak, Co]

Yes. Sure, sure. So on gross margin, we made a conscious decision overall to invest in making our customer experience exceptional, and this meant 2 things. And the first one is something Roger touched on in terms of providing attractive introductory offers on both eyeglasses and Autoship and having that first-time customer experience be wonderful and have people experience the quality of our offering. Secondly, and this is, I think, what you're referring to, we temporarily saw higher product cost in the fourth quarter. And this was due to sourcing more from authorized distributors as opposed to directly from manufacturers. And this is a function of a number of things, including reduced capacity at some of our manufacturers over the holidays due to COVID-related staffing restrictions as well as nationwide logistic issues across our carriers. And so those are like the holiday and seasonal things that we're talking about in terms of just like e-commerce activity at the end of the fourth quarter kind of overwhelming the system. So an example of this would be a sourcing directly from a distributor who might be located closer to one of our customers, and we are thus kind of decreasing the shipping times to that customer and improving their experience.

[Derek Dley, MD & Consumer Products Analyst]

Okay. And then one more from me. Just in terms of the SG&A trends as we head into 2021, I believe you mentioned plans to step up the marketing inclusive of a few different initiatives by about $12 million year-over-year. I'm just wondering on the G&A cost as well, where you sort of see that playing out over the course of 2021.

[Sabrina Liak, Co]

Yes. Thanks for that question. So on the G&A, like fourth quarter and third quarter were a little bit burdened by onetime costs. So after you back out onetime IPO-related costs and foreign exchange gain losses, which we do include in our G&A, fourth quarter G&A was 5% of revenue and full year G&A was 4% of revenue. We expect to continue to run at about 5% of G&A -- sorry, of revenue for our G&A. And we will be investing in technology and improving our tools and our site to make the at-home shopping experience easier for our customers and more fun as well as investing in people to support our company-wide growth.

[Derek Dley, MD & Consumer Products Analyst]

Okay. That's great. Congratulations again.

[Roger V. Hardy, Co]

Thanks, Derek.

[Operator]

Your next question comes from Matt Koranda from ROTH Capital.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Congrats on getting the IPO done and a good quarter out of the gate here. I wanted to cover customer acquisition costs and what we saw during the quarter and maybe trending into the first quarter here and return on ad spend. What are you seeing there? And how does that inform your thoughts on sort of order and revenue growth heading into 2021?

[Roger V. Hardy, Co]

Yes. Sure, Matt. Maybe I'll start, and I'll turn it over to Joe if he wants to chime in. So in the quarter, it was consistent with our expectations around acquisition costs. As we think about the new year, one of the use of proceeds is earmarked towards investing in awareness and some higher funnel activities. We've earmarked about $2.5 million per quarter throughout this year to invest in that higher-level activities. What we see is that, that typically brings down the direct acquisition costs. So the performance marketing campaigns all get more efficient when we do that type of activity. So we are going to build out the awareness campaign this year. The -- what we will attribute to acquisition cost is actually declining through the first quarter. And that's kind of what we expect. So over time, as you know, Matt, the model is really built around having the lowest acquisition cost in the category, which is ultimately fueled by word of mouth. It's fueled by happy customers. It's fueled by having a high NPS score and having customers tell the story. So we're really trying to build that group of advocates for our brand, and that's kind of how we think about the trend this year.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Got it. And then when we're doing that customer acquisition cost calculation, are we also including some of the discounts that are given to put people into the Autoship program? Or is that a separate item? And I was curious. I know you guys mentioned the goal to get to 25% penetration in Autoship by the summer. Does that mean that by the third or fourth quarter, we should kind of expect less discounting and sort of upward pressure on margins at that point?

[Roger V. Hardy, Co]

Yes. That's how we're about it as well. It's that it is representing that initial customer discount targeting for 25% by halfway through the year and already less pressure on margins. We've learned a number of things through the last year about what's the right balance between an introductory price. And so we feel good about sort of how that trends going forward.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Got it. And just on how you load customer acquisition costs or factor that in with the Autoship discounts, is that factored in? Or is that something separate?

[Sabrina Liak, Co]

On the Autoship discounts and the glasses discounts, those are -- we just factor that into like our revenues net of discounts and returns. So it's not explicitly in customer acquisition costs.

[Matthew Butler Koranda, MD & Senior Research Analyst]

Okay. All right. Got it. Fair enough. And then on the progressive lens, I was curious, could you just talk a little bit about the portion of the glasses TAM that, that unlocks? Because obviously, you guys [ cited LTV ] as being quite a bit higher in that category. Wondering the size of that opportunity, if you could address that. And then any differences in acquisition costs, customer acquisition cost on that front? And then lastly on that one, if you could address capacity and what that looks like to address that market as well, that would be helpful.

[Roger V. Hardy, Co]

Yes. Great question, Matt. And so from the category size, it's approximately an opportunity of about $8 billion. So it's quite interesting. We also are anticipating adding additional specialty segments and offerings, including the Rx sun and the Transition lenses that I talked about. Really, from an acquisition standpoint, those just make our existing marketing channels more efficient. So today, customers are coming to our site looking for these products. And as we just started introducing progressive, so we've had a -- we've started to acquire a number of customers in progressive. And we'll expand the collection and the offering into these other specialty categories. That will reduce acquisition costs. That will lever off the existing marketing spend.

[Operator]

There are no further questions. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.