Good morning, and welcome to the KITS Eyecare Third Quarter 2023 Financial Results Conference Call. This call is being recorded and available later today 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'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 intend, believe, could, expect, estimate, forecast, may, would, will, and other words of similar meaning.
This forward-looking information is based on management's opinions, estimates, and assumptions in light of their experience and perception of historical trends, current conditions, and expected future developments, as well as factors that they 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. Management cautions 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 the KITS filings with Canadian provincial securities regulators. During today's call, all figures are in CAD, unless otherwise stated. With that, I'd like to turn the call over to Roger Hardy. Please go ahead.
Thank you, operator, and good morning, everyone. Thanks for joining us. I'm excited to be reporting yet another impressive quarter here at KITS as we continue to make eye care easy for everyone. The vision category remained resilient and non-discretionary, and we grew our revenue, a category leading 32% year-over-year to a record CAD 31.2 million, while expanding our gross margins by 370 basis points year-over-year, all while seeing our operating costs as a percent of revenue decline year-over-year across the board. This resulted in reporting a positive bottom line, growing our adjusted EBITDA by CAD 1.4 million year-over-year, our fourth straight quarter of positive adjusted EBITDA.
We're seeing operational leverage from the scale we invested in early on as we generated another consecutive quarter free cash flow from operations and maintained a healthy cash balance. We've built our infrastructure to scale, and we believe we have ample capacity to more than double revenues and earnings with limited to no CapEx required from here. We hit another record in our two-year active customers count of over 830,000, and we served over 75,000 new customers in the third quarter. We continue to accomplish significant customer growth with a highly efficient marketing platform that is becoming a smaller expense as a percent of our overall sales numbers. It's clear we're beginning to see the network effect of customers telling customers about the experience they have had with KITS, and that is starting to show through in both marketing efficiency and customer retention.
As we've now hit an annualized revenue run rate close to CAD 125 million, we believe we're well positioned to continue growing while expanding growth, both our gross and operating margins. Our offering is continuing to resonate with our customers, and we've been able to attract more and more of them quarter after quarter, while also increasing the average order value. We are also seeing a growing record number of returning customers. This is not an easy thing to do, particularly in such a volatile economy, but it's hard to ignore the substantially higher value we provide compared to the rest of the optical industry. We believe this is a major driver behind our success, and with our word-of-mouth marketing, we don't see it slowing down anytime soon.
We also believe there's a great amount of capacity in the model we have built in terms of scale and leverage, which we are only beginning to see in this quarter. With that, I'd like to pass the call over to Joe to dive into more detail on our operational performance for the third quarter. Joe?
Thanks, Roger. We set out to build a business with consistent growth, fueled by happy, returning customers and an operation that gets more efficient each quarter as we grow. We are happy with the progress we've made this year and this quarter in particular. Let's start with returning customers, our North Star metric, and a good read on the quality of the product, value, selection, and convenience we provide. In Q3, we delivered record revenue from repeat customers, approximately CAD 20 million or 64% of our total revenue. This contributed to both a higher average order value and also helped improve our gross margin. In this category, customers who require vision correction typically remain optical customers for life, and so earning their repeat business is the best investment we can make. As we grow, we believe our scale will continue to make our business more profitable.
With our growth in Q3 came leverage with combined operational expenses across marketing, fulfillment, and G&A, declining 380 basis points versus Q3 2022. Our infrastructure isn't burdened by tens or hundreds of brick-and-mortar locations and all of the associated labor costs and overhead that these locations require. Importantly, our onshore lens lab and fulfillment center still has ample capacity to allow us to scale north of CAD 200 million in revenue. Lastly, the team continues to innovate and build future pillars of growth. Two areas that have been a particular focus of have been our product and our specialty lens offering. Our product team really raised the bar this quarter, introducing new premium product lines, including the titanium rimless collection, the layered acetate collection, and an extension of our athletic performance Trailblazer platform.
KITS customers can now select from a growing selection of over 1,950 styles of eyeglasses. On specialty lenses, our investment and innovation in digital progressives has really taken off. Digital progressives are now the fastest growing part of our glasses business, with revenue up over 60% year-on-year. To prepare for future growth in this important area, we've expanded our digital progressive manufacturing capacity. Thanks to our previous investment in a full surfacing and coating operation, a modest capital investment allowed us to add significant capacity and to do it quickly. We fundamentally changed the value proposition for digital progressives across North America, and we believe the expanded capacity will allow us to further capture this exciting growth opportunity. We expect the expanded capacity to be fully operational by the end of the year. Overall, KITS is humming from an operational perspective.
We are seeing the early signs of the operational leverage that we predicted when we embarked on this journey over four years ago. With ample market share still up for grabs and the customer landscape shifting in our direction, we believe we are well positioned to continue capitalizing on the momentum at hand and deliver long-term shareholder value through our operational excellence. And now, I'll now turn the call over to Sabrina for an overview of our third quarter financial results.
Thanks, Joe. We are pleased with all the progress we made in the third quarter. Revenue in the third quarter increased 32% to CAD 31.2 million, compared to CAD 23.6 million in the prior year period. The increase was attributable to strong repeat customer behavior in both contact lenses and eyeglasses, as well as higher average order values. Gross profit in the third quarter increased 48% to CAD 10.7 million, compared to CAD 7.2 million in the year ago period, while gross margin increased 370 basis points to a record 34.3%, compared to 30.6% in the year ago period. The increase in gross margin is due to a reduction in promotions and to capturing improved margins from returning customers.
Looking at the breakdown of our operating expenses, our fulfillment expenses as a percentage of revenue declined year-over-year by 80 basis points to 12.6%, while our G&A as a percentage of revenue declined year-over-year by 250 basis points to 6.5%, as we continued to leverage efficiencies of scale. Our marketing expenses as a percentage of revenue also declined year-over-year by 50 basis points to 13.7%, as we continued to capitalize on organic word-of-mouth brand awareness. In the third quarter, net income was CAD 0.5 million, or CAD 0.02 per share. EBITDA was positive CAD 1.4 million, compared to positive CAD 1.1 million in the prior year period.
We generated positive Adjusted EBITDA of CAD 0.6 million, compared to negative Adjusted EBITDA of CAD 0.8 million in the prior year period. We ended the quarter with a strong cash balance of CAD 19.3 million. Overall, KITS is in a strong financial position to further capture operating leverage as we continue our growth. With a long runway for growth ahead of us, a healthy balance sheet, and the ability to generate positive Free Cash Flow, we plan to continue delivering long-term value to all our stakeholders. I'll now turn the floor over to questions. Operator?
Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. If you have a question, please press star, followed by the number one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request. If you would like to cancel your request, please press star two. Your first question comes from the line of Luke Hannan from Canaccord Genuity. Your line is now open.
Thanks. Good morning, everyone. I wanted to start on the topic of progressives. I think I heard you mention that the revenue from that product line in particular was up 60% year-over-year. Can you give us a sense today of where that penetration as a percentage of maybe your overall mix, overall revenues is? And what would be an appropriate long-term level for you? I believe the industry benchmark is around 40%, but considering your infrastructure, do you think it's reasonable to assume that maybe you could over-index on that particular category?
Hi, Luke. Thanks for the question. This is Joe. So you're right on your size of the digital progressive market around... It represents around 40% of the dollars in the category. With KITS, we are still below that, and as you mentioned, growing pretty rapidly. And so, you know, we've upgraded our manufacturing to prepare for further growth in this area. It's probably a bit too soon to say how high is up on the business, but we have been delighted with the growth and, you know, we really feel like we are changing the value equation in this category. You know, typically, digital progressives can cost customers $800-$1,000 and more.
And customers on kits.com or kits.ca can buy digital progressives for under $200, in some cases under $100. And so, you know, we think that that value equation is really gonna shake up the digital progressive market. Probably too soon to say how high is up, but we're very excited about the momentum in this last quarter.
... Okay, thanks for that. And then, and then my follow-up here is just on your, your outlook for the holiday season. If we could compare and contrast what you're seeing so far in the quarter to date versus maybe what we saw last year or even pre-pandemic, what are you seeing as, as far as ordering patterns? For example, are, are customers ordering more closely to their needs or, or more closely to, mid to late December, or is it historically in line, or in line with what you've seen, historically?
Yeah, Luke, you know, we've typically, the eyeglasses industry has seen a repeat cycle of 18-24 months. That's not really because that's magically the time when everyone's prescription changes, but that's, on average, folks have around $300-$400 of vision insurance that renews every two years. In a striking coincidence, that happens to be what a pair of prescription glasses has cost in the past. When you think about the KITS model, our vertically integrated process and the waste we've eliminated from the system, we're able to offer prescription eyeglasses, even progressives, as you mentioned, for under $100.
So that's really allowed us to shorten the repeat cycle to under 12 months, and in some cases, even sooner. So I can't really speak for the industry trend, but on our business, repeat glasses sales cycle has been speeding up.
Got it. Thanks for that. And then maybe my last question here, and then I'll pass it on, is overall from Clearly, we've seen the macroeconomic environment soften a little bit over the course of the last several months. What are you seeing from your competitors as far as the promotional environments right now?
Yeah, Luke, this is Joe again. So, you know, there's two trends that we're seeing in the category that you know that do have an impact on our business. The first is the percentage of revenue that continues to move online. So, you know, pre-pandemic, under 20% of contact lenses were sold online and under 10% of glasses were sold online. And now the latest numbers that we've seen have contact lenses approaching 40% online and glasses approaching 20%, and really showing no signs of slowing down. So, you know, as you suggest, there likely will be pockets of this industry that see the effects of the economy.
But, you know, where we are sitting in this growth vector of online, it seems to insulate us from any of the pullback that we're seeing in the marketplace. And so, you know, we see no slowdown in share moving online. And as a result, you know, we've been less reliant, as the team called out on promotions in the past quarter, than we have previously. Maybe the second factor that in the market that impacts our category, that's maybe a bit more unique versus other categories is insurance. So, the optical market is anchored to a degree by vision insurance, which, you know, which provides hundreds of CAD of vision coverage per person or higher.
And so, you know, this is a bit of an advantage to optical versus other categories. And our focus is really just on providing a selection to allow all customers to meet their vision needs within their coverage or within their budget. And so, you know, those are really the trends we've been closest to and paying the most attention to. And, you know, we're happy with the business model and the infrastructure that we've built to allow us to capitalize on both.
Great. Thank you very much.
Your next question comes from the line of Matt Koranda from Roth. Your line is now open.
Hey, guys. Good morning. Just wondered if we could speak to some of the AOV drivers, and unpack those during the quarter. AOV has continued to rise pretty significantly, and I assume a pretty strong driver of that growth would be repeat customers probably helping with that metric. But just wondering if there's other elements at play here, like contacts, pricing, anything else you can speak to in terms of AOV drivers that would help us kinda think about the sustainability of that as a driver of growth on a go-forward basis.
Hi, Matt. It's Joe, and as you mentioned, you know, we did see average order value come up this quarter. It was up to about CAD 156 per transaction, and that's up about 15% year-on-year. We did see growth across both contact lenses and eyeglasses, approximately comparable. I think you're right to call out repeat customers as a driver. You know, typically, when customers have had a great first experience with KITS, when they return, they're more likely to purchase more. And that's really been a driver of it. You know, the other driver has been, we talked a few minutes ago, just about digital progressives and specialty lenses. You know, that's an area that's grown.
We, you know, had seen growth in that, in specialty lenses, and it's picked up even above our expectations, and so that's been a driver as well. You know, I'd probably call out that average order value will fluctuate a little quarter-over-quarter. This past quarter, as you mentioned, in particular, did have a strong mix of repeat customers.
... Okay, makes a lot of sense. Thanks for that, Joe. And then just, you've been outgrowing the industry by a pretty healthy margin for the last several quarters. Just wondered if you could maybe speak to sort of, is there any change in the trends that would that would cause you guys to not continue to outgrow the industry by the healthy margin that you've been outgrowing it by over the last several quarters?
Yeah, thanks, thanks, Matt. You know, we, of course, I'll mention, you know, we aren't providing any guidance at this point, but, you know, but happy to share how, you know, how we're seeing the market and how we're thinking about it. You know, we don't see anything on the horizon that would indicate a slowdown. The macro trends, you know, continue to seem to be in our favor. We're happy with the operations, and we feel like we have the operations and team in place, and have a good, consistent track record in 2022 and 2023 of growth. Each quarter is a little different, and so on a quarter-by-quarter basis, you know, we would expect to see a little fluctuation in the growth levels.
But we don't have any plans to slow down, and so you can expect to continue to see growth focus from us over towards our next revenue target of CAD 200 million in revenue, and then onwards from there.
Okay, great. And then maybe just last one for me. The Adjusted EBITDA margin continues to kind of hover in this low single-digit % range. So it's nice to see sort of the sustainability there. Wondering how we should think about the next steps toward your long-term Adjusted EBITDA targets, and can you just remind us sort of what those are, and how we should think about sort of the path to those over the next year or two years? However you want to frame it.
Yeah, Matt, I think, you know, as Joe said, we feel like we've got a lot of momentum right now. There's a lot of momentum in taking share. We're pleased with how the business is running. We feel good about not being in a position with a lot of legacy infrastructure, lots of legacy costs. We are pleased with the single-digit EBITDA percentage as we continue to take share and grow. We feel like there's a lot of leverage in the model, to keep growing, and you saw some efficiency start to flow through to EBITDA and to net income.
I would say, you know, our focus is on serving customers, on making eye care easy for customers, and to the extent we're able to do that and continue to do that, our business will continue to grow. One of the biggest, I think, points of leverage we start to see is this, you know, is the network effect of in towns and cities when, you know, we're acquiring thousands of glasses customers who all start to see the brand on others, you know, and become these billboards for KITS telling the story of a great eye care experience. So, I think those are the things we're focused on. The model is playing out, I think, fairly predictably. So over the next couple of quarters, we'll continue to see growth. We'll continue to become more and more efficient.
Our operation has tremendous capacity to scale from here. At least, we could at least double with very limited CapEx, like we've said a few times. So to the extent we're able to grow the business, we'll start to see that, you know, bottom line continue to scale. And I think just to add on to what Joe said, you know, we've had the benefit of building this model, from the ground up exactly for the time we're in right now. So we are, you know, we're happy with where we sit relative to competitors. You asked about competitors. I think, you know, we're not focused on competitors, we're focused on serving customers, and we really do think that we've got the best model in the category. So, you know, we'll keep working away at it.
Anything I missed, Sabrina?
No, I would just say, yeah, we're putting in cash flow from, you know, organic growth, and we think that that's the best use of our capital at this time, to invest in continuing to grow our business. And as you see, we've been able to sustain a strong cash balance throughout this outsized growth. So I think that would be our objective going forward also.
Okay. Awesome, guys. Thank you.
Yeah. Thanks, Matt.
Your next question comes from the line of Doug Cooper from Beacon Securities. Your line is now open.
Hey, good morning, everybody, and congratulations on a nice quarter. First of all, just a clarification, the 60% recurring or returning customers, is that both on the contacts and glasses on a consolidated basis?
Yeah. Yeah. Hi, Doug. That's a, that's a combined, the percentage of, of total revenue, including both, glasses and contact lens business that comes from repeat customers.
Is it sort of equally split between the two? Are they both 60%, in other words, or, or is it more on the contact side?
Yeah, we don't, you know, Doug, we don't break out the specifics of it. Our contact lens business has been around a little bit longer and so is probably a little bit more mature. And our glasses business is a newer one.
Sure. So we saw some good growth in the glasses business, just under CAD 4 million for the quarter, up obviously nicely from just over CAD 3 million last year. Do you see this just, you know, continue to be incremental growth, or does at some point, you know, Rog, to your point of friends tell two friends, tell two friends, that this just sort of we'll see in a really big inflection point at some quarter here?
Yeah, Doug, I mean, when we think about the glasses business, we just think it's so early today, and you're right. I mean, as we start to get that critical mass in markets, we really see that referenceability from one customer to another take effect. We see the marketing expense, you know, start to go away, and we see the effect of customers telling customers. So I would say, you know, in a very small number of markets, that started to occur, and that's one of the beauties of this category, is just how big it is, how many markets there are, how big the opportunity is. And so we're working away on getting that referenceability, getting that network effect in a small number of markets, like literally a couple.
And once we see that lift, we think that we'll be able to replicate that in many more markets. So, I think our view is that it is early and that it does start to... You know, it's just so early, but we will start to see the effects of that growth compound.
Speaking of markets, you know, just take either from Q1 or Q2, most of the growth has been in Canada. Is that by design, or is there anything we should read into that?
I think, like I said, you know, we're focused on a couple of markets and getting that kind of network effect spinning. You know, I think Canada has been probably just because we are in Vancouver and because we're located here, that it's been, you know, the market's been receptive to the offering. But no, I wouldn't take anything away from that other than that we were probably underrepresented in Canada historically, and so, you know, we've—I think, you know, it hasn't been a much of a more of a push or anything like that. It's just that the offer is well received in Canada. It's well received in the U.S. Yeah, there's no...
I think we're probably more that we were under-penetrated in Canada, Doug, and it, it's kind of, you know, the growth has been pretty straightforward here.
Okay, and just my last one. Any comments on LVMH moving into the glasses category? I think they announced that, what, on Monday through an acquisition in L.A. And one of the things they talked about was, you know, glasses becoming a fashion- you know, more and more of a fashion accessory. So maybe that speaks to, Joe, your point about returning customers, and you know, especially with that cost point you're talking about, it could really- it can really become more of a fashion item.
Yeah, Doug, no, no question we're seeing, you know, a small number of customers that are really breaking the trend, and as Joe touched on, you know, many times in optical, customers will buy one pair of glasses, you know, every 18 months. We're seeing customers buying many, many pairs of glasses from us, and so, I think it is, it's obvious with a cohort that that's happening, and, you know, our hope is that as we make things easier, consumption goes up, make them more cost-effective, consumption goes up. So I'd say that's really the focus on our side. You know, making eye care easy is really what we've been about, and I think that's resonating with consumers.
Great. Thanks very much.
Thanks, Doug.
As a reminder, if you have a question, please press star, followed by the number one on your touch-tone phone.
Yeah, thanks. Thank you, operator. Thanks, everyone, for joining today. It's once again an exciting time to be a part of Team KITS. This team is one filled with great intangibles that you see in companies that do great things while achieving outstanding results. I've said it many times, we're on a mission to make eye care easy for everyone, and I firmly believe we're accomplishing that with every passing quarter. We believe we're just starting to hit our stride and starting to see the network effects take hold. I'd like to thank all our stakeholders for their continued support. Thanks so much for joining us today, and have a great rest of the day. Thanks, operator.
Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.