Okay, good morning, everybody. I'm Alex Straton, Morgan Stanley's North America Softlines Retail and Brands analyst here at Morgan Stanley. Thanks to all of you guys for joining us here, the second day of our conference. Hope it's been entertaining, fruitful for you all. Super excited to have Warby Parker with us today. So maybe I'll do a quick introduction before I introduce both of the our special guests. So Warby Parker is an approximately $1 billion market cap, direct-to-consumer provider of holistic vision care. The brand designs and sells high-quality eyewear at lower prices than many competitors, and since its launch, has introduced contacts as well as vision services, like eye exams. So today, we're joined by Warby Parker's Co-Founder and Co-CEO, Dave Gilboa, as well as CFO, Steve Miller. So thanks to you both for joining us here today.
Yeah, thanks for having us.
Perfect. So let me first run through just the format that we're going to have today and then the necessary disclosures before we go into their backgrounds more fulsomely. So on format, fireside chat, we'll explore some of the investor questions we get most regularly, and if we have some time at the end, certainly open it up to you all to ask a couple questions. And then my favorite part of all of these is the required disclosures that I have to give. So on that front, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. Mouthful there. So Dave, maybe let me turn to you. Rather than me trying to give a lengthy bio on your career before Warby, how you ended up here, co-founded the business, maybe I'll turn it to you to do it for me.
Sure. I'll try to keep this brief, but yeah, let's see. I grew up the son of two doctors, and I was sure I was going to follow in their path. It was bioengineering, pre-med, and then last minute veered left. Ended up thinking that there might be a kind of a different path to have meaning and impact in life than being a practicing doctor. Didn't know anything about business, so spent a few years working at Bain & Company and Allen & Company, and then kind of wanted to combine some of those business skills with something to do with healthcare and helping people. Didn't have any great ideas, so I decided to go back to business school and took a few months off to travel.
Handed in my company-issued BlackBerry on my last day at Allen & Company. Traveled for six months without a phone, just kind of staying in hostels, backpacking around the world, and along the way, lost my only pair of glasses, and came back to the U.S., about to start business school. Had to buy two things, a new phone, and a new pair of glasses. Bought an iPhone for $200 and realized my glasses were going to cost $700, and it just didn't make sense to me. So I started complaining to anyone who would listen, including all my new classmates at Wharton, and realized that a lot of people were really frustrated by the cost and the process to buy glasses.
It's a massive category that had had very little innovation, both on the product side or distribution side. This was in 2008, when you know, before kind of you know, Amazon had really turned into the behemoth that it is today. There were lots of examples in other categories of products being sold online, whether that was Blue Nile selling engagement rings, or Diapers.com selling household goods, or Zappos selling shoes, but no one was really effectively selling glasses online. We thought there was kind of an interesting, unique opportunity to to create a brand that could start online, sell glasses, cut out all the middlemen, and offer great value to consumers.
Perfect. Definitely better said than perhaps I could have, to explain the whole bio. Steve, maybe same question for you. Talk to us about your career, how you ended up at Warby.
Yeah, sure. I started my career at a venture capital fund in the city, Flatiron Partners, and then realized I wanted to work for an operating company and spent seven years in a similar role as the CFO of a company, Majestic Research, which was a big data analytics equity research firm. Was the first firm to really commercialize the use of massive amounts of credit card data in investment research, and ironically, it's some of the data that I know investors now track Warby with on a regular basis. We sold that company. I took a little time off, and some of the investors in Majestic were, and are investors in Warby, and got to meet Neil and Dave, the co-founders and co-CEOs, and I became really captured with the customer experience.
I was first a customer in their very first store, in their showroom, where I couldn't believe that the merchandise was easy to interact with. You paid one price instead of four for the frame, the lens, the fancy coatings, free home delivery. And I said to Dave, "If you're looking for a CFO, I'm in. We're onto something." So that was my path.
Great. Well, now that we've covered basic bios, maybe we'll start higher level, in the line of questioning. I think a bigger picture question that I get pretty frequently is just around how Warby fits into the broader eye care ecosystem. As you all know, we primarily cover apparel and, and brands and, and footwear in my part of the world. So help us understand that, how you guys fit in in that broader kind of market.
Sure. Yeah, so the optical industry is very large, $76 billion in the U.S. It's split roughly 50/50 between, kind of retail chains, like LensCrafters, Pearle Vision, Sunglass Hut, that are, yeah, predominantly, owned by a couple companies, and then the other half of the market is independent, eyewear practices run by, independent optometrists. It's the only part of human medicine where a doctor can prescribe something to their patient and then sell them that product and make margin on it. So these doctors are, performing eye exams but then also run their own, retail stores....
Because of the kind of concentration of power on the retail chain side, and having doctors act as retailers and gatekeepers on the independent side, there are kind of unique dynamics relative to other consumer products categories that has really limited innovation, has kept margins and prices really high, and the customer experience pretty poor. So the average Net Promoter Score in the industry is low 30. It's the same as the airline industry. And for a product that most people need, we were shocked, as consumers ourselves, that there aren't better options out there.
Really our intent with Warby Parker is to build a brand that engages directly with consumers, that allows us to cut out all the middlemen, all the unnecessary markups, essentially sell the wholesale price to the end consumer, and build those direct relationships. If you look at the way that we built our business, most kind of industry insiders will probably tell you that we've built it completely backwards, that we started by only selling glasses online when that was less than 2% of the market back in 2010. Today, it's still in the kind of single digits in terms of overall penetration. We were selling glasses without offering a way for people to get their exams through us.
If you look across the industry, 80% of glasses are sold at the same place someone gets an eye exam. And the fact that we were able to scale a business to hundreds of millions in sales with that model, I think it's just an indication of the value that we were offering, the customer experience, the brand that was resonating with consumers. And we continue to invest in all those areas. But in addition to that, over the last few years, we've invested in additional parts of our business to enable us to serve all of our customers' and patients' holistic eye care needs. And that starts by opening stores.
So, at the end of this year, we'll have close to 240 stores across the country. We continue to hear that the number one reason that people are familiar with Warby Parker and haven't bought something from us, it's because there's not a store nearby. And the second reason is that they don't have a current prescription, and stores enable us to solve both of those problems. And so, as we open stores across the country, we have more convenient shopping options.
In every one of our new locations, we're putting eye doctors in those stores, enabling people to come to us for their eye exam, to buy glasses, and to buy contacts from us, and to choose whether they want to engage with us online or offline for any part of that customer journey. And even to this day, now, 13 years later, when we kind of launched our business really digitally focused, we've seen that there continues to be very little innovation, very little technology investment from the rest of the category.
And the fact that we have an omni-channel offering that enables people to choose whether they want to engage online or offline remains unique to this day, and something that continues to be a major differentiator relative to our competition.
That's great, Dave. You touched on a number of topics that I think we'll revisit. Before I do that, a couple more on just the higher level market. Definitely some outside spend in eyewear in 2021, followed by a little bit of an air pocket after that. For those that aren't familiar or as close to the industry, can you just talk about how trends have evolved in the last few years relative to history, and then perhaps how you think about 2024 initially from a market perspective?
Sure. Yeah, this is a category that historically has been very consistent in growing a couple points above GDP. It has been very resilient through different economic cycles, including the great financial crisis. We benefited from our first 10 years in business from that steady and predictable growth, where consumers get their eye exam on a regular cadence. They're buying glasses every 2-2.5 years. Patterns had been very predictable and steady.
And then, like a lot of categories, the pandemic was quite disruptive and what we observed is that in 2020, lots of consumers and patients didn't feel comfortable going in to get an eye exam, didn't feel comfortable going to shop for glasses. We saw our e-commerce business spike to grow over 100% year-over-year, and we were probably one of the only companies in the category that were still able to grow in 2020 because of that omni-channel flexibility. But as a whole, the category saw a lot of softness and declined pretty materially in 2020.
Then in 2021, when vaccines arrived and the world opened up, basically anyone who needed an eye exam, anyone who needed to buy glasses served that need in 2021. We saw really significant growth. The category saw above average growth. And then, what we've seen as a result of that is because on average, people are buying a new pair of glasses, getting a new exam every two and a half years.
That the last couple of years, we've seen more muted activity in ways that are really unprecedented, where last year, National Vision, or sorry, The Vision Council, which is kind of the data source that tracks industry data most closely, basically it believes that the category was roughly flat, and they're expecting 2023 to be down a bit. And that's really a direct result of yeah, that kind of pandemic-related disruption. We believe that the category is beginning to stabilize and that some of those pandemic-related effects are beginning to wane. And so, we're encouraged. We still believe in the strength of this category. We sell products that people need.
Mm-hmm.
As the incidence of myopia and the needs for vision correction continue to increase as a percentage of the population. And so we are certainly you know remain as excited as ever about the long-term prospects of the business but have had to manage through some unprecedented and challenging dynamics in the category over the last couple of years.
Sure. So it sounds like there's definitely been a bit of a reversion dynamic for you all the last couple of years with how the market's trended. Maybe another unique aspect to this, compared to the majority of companies I cover, is the insurance dynamic. So can you walk through that? Where is Warby at? How does Warby compare as it relates to what it's competing against? Because I think some of the consolidation of power that you mentioned is a bit of function of it. So walk us through how you think about it, where Warby stands.
Yeah, vision insurance is interesting. It's not actual insurance. It doesn't cover any catastrophic risk. It's really a prepaid plan that offers defined discounts on exams, glasses, and contacts. But the majority of consumers have vision insurance and like to use those benefits. People can use pre-tax dollars to fund those plans. Sometimes employers fund the plans for them. And it's resulted in kind of an interesting dynamic where the sticker price for a lot of frames and glasses are artificially high, and then insurance basically you know applies a discount to those really high prices. But what we find is that people still end up paying a lot of out-of-pocket.
On average, if someone has a VSP or EyeMed plan, they still pay $250 out of pocket to buy a pair of glasses, plus whatever they're paying for the premiums for that insurance plan. If they come to Warby Parker, they can get a complete pair of glasses with prescription lenses and all the coatings they need for $95. And so, our belief has always been in transparent pricing and offering great value to consumers, whether they're paying out of pocket or using their insurance benefits. But that being said, we recognize that when people have these plans, when they've been paying premiums, that they want a way to leverage those benefits as easily as possible.
So we're really focused on making it easier for people to use their benefits with us in a couple of ways. One is by additional integrations with insurance carriers. So today, we're in-network with 18 million lives, where someone can come to Warby Parker and use their in-network benefits, just pay their copay. That could be, on some plans, $0, on some plans, $10, and get a full pair of glasses, buy contacts, get an exam.
And now that we have over 200 stores across the country, now that we've made such a significant investment in hiring doctors and in telemedicine, in scaling our contacts business, in offering multiple types of lenses, including multiple progressive lenses, the nature of the conversation that we're having with the largest insurance carriers has changed meaningfully, and we believe that there is path for us to significantly increase the number of covered lives that are in network over time. And then in parallel, we're also, we think there's a big opportunity to educate people around being able to use their out-of-network benefits at Warby Parker. Right now, over 60% of our customers have vision insurance.
The vast majority of those people know that we're not in-network, but they still come to Warby Parker because they love our products, they love the brand, the customer experience, and they know that we still will offer great value to them. But we think there's a big opportunity for people to understand that their out-of-network benefits go really far with us as well. So most out-of-network plans cover at least $100 reimbursement for a pair of glasses or contacts. And so, for many of our customers, when they come to us and buy a $95 pair of glasses, even if we're not in-network, the full cost of that will be covered by their existing insurance plan.
We recently introduced a feature on our website called the Universal Eligibility Check, where you can just enter your name, zip code, and birthdate, and we can tell you what your benefits are and how you can apply them at Warby Parker. We're excited to kind of increase the volume of you know the conversation around insurance and how people can get the most out of their benefits with us.
Great, so that's insurance. One other topic that you mentioned was that the business is digitally native. But that said, you've rolled out quite a few number of stores, almost, I think it'll be over 200 this year, where you land. So how do you think about the store base? What's the right mix over time as you've kind of progressed since the IPO and since, you know, the founding, of what's, what's the right kind of mix between those channels over time?
Yeah, so we believe that we'll, you know, have a relatively balanced, you know, omni-channel offering over time. We find that many of our customers will start their shopping journey online, they'll shop on our website, create a few favorites, download our app, and then go into our store to, you know, try on a handful of glasses. Or opposite, they might get an eye exam in one of our stores, try on a couple glasses, but then they want to come home and get their husband or wife's opinion or look up their insurance benefits and complete that journey and transact online. And we just want to make that shopping journey as easy as possible whenever and wherever people want to engage with us.
As it relates to stores, we, yeah, we have, at the end of Q3, we had 227 stores, that compares to 48,000 optical shops across the U.S. We believe that, there's still a really significant path for us to continue to open stores around the same pace that we have. We hired an external firm that did kind of a, you know, market map, and they believed that we could open at least 900 stores at the same productivity levels that we have. And so, we remain as excited as ever about our retail rollout. We continue to target what we believe are best-in-class economics, where our stores pay back in less than 20 months.
We target at least 35% for four-wall margins, and we continue to see those numbers from our existing fleet, from our most recent cohort of stores. I think that just serves as an indication that it continues to be a lot of opportunity for us to continue that retail rollout.
Perfect. So maybe now moving kind of into the more financial heavier questions. At the time of the direct listing, I think your hopes were for about 20% top line growth. Now, Dave, you mentioned some industry dynamics that have perhaps constrained that, but if there's anything you would add towards kind of what's been holding you guys back from that level, and then whether or not this is the right level over time? I could even push this over to Steve.
Yeah. Yeah, for sure. So at the time we went public, in terms of top line and bottom line algorithm that we put out there in September 2021, was, top line will grow at 20%+ for the foreseeable future, and from an Adjusted EBITDA margin perspective, we'll add an incremental 100-200 basis points of Adjusted EBITDA margin every single year as we march toward our target of 20%+ Adjusted EBITDA margins. That was our kind of frame of record, and, we reported numbers like that for, a quarter, and then the market changed. And as Dave talked about, the change in the market was reflected in a few ways.
We saw an industry that went from a very regular growth profile and repeat purchase profile to one in which some of these very predictable and regular trends were disrupted. So the optical industry, pre-COVID, had typically grown 3%-5% a year, and the purchase and repeat purchase cycle for a pair of glasses was one person buys a new pair of glasses every two years. For a range of reasons, we've seen that repeat purchase cycle extend beyond two years to three, to four. As we look ahead to 2024, we're certainly optimistic that we'll see some of that repeat purchase demand release in 2024 versus 2023. We'll say a couple things just from a numbers perspective about what we saw in the industry.
Regular growth of 3%-5% up until 2020, the industry contracted by 15%. We were still up 6%. In 2021, there was a surge in pent-up demand. As Dave mentioned, folks felt comfortable going into a physical environment and shopping, getting their eyes tested. The industry was up 21%, we grew 37%, and then for the last two years, the industry itself has been flat to down. Last year, industry was flat. This year, the industry will be moderately down. Against that backdrop, we are still pleased to report that we are growing faster than anybody else at scale. In Q3 of this year, we reported our strongest quarterly revenue results. Year to date, we were up 14%. Year- over- year, the industry itself is relatively flat.
We saw one large competitor, report being up 2%, and we saw another one report being up 7% off of a -4% comp, last year. So even in the context of this backdrop, where there's less foot traffic and that repeat purchase cycle has become a little bit longer, because you can push out buying your pair of glasses for another six months, twelve months, you can't, push out buying groceries and, and gasoline, and reallocate your pocketbook as, as you need to. And so would point to that macro factor, as one that we're paying close attention to, which has been quite disruptive, to an industry which has had a very, very regular formulaic growth pattern and repeat purchase cycle.
And as we see the results come in, in 2024, we'll hopefully be able to report that we're now starting to see a lot of that demand that accelerated in 2021 starting to get released over the course of 2024. But even while that's occurring, we still continue to gain roughly 10 basis points of market share per year. We still have less than 1% of the $76 billion optical industry, and it is nice to still be growing at scale. We do want to get back closer to that long-term algo that we put out there from a top-line growth perspective. I think as close as we can get to 20% would be great.
What has been table stakes for us, and it's reflected in our Adjusted EBITDA margin improvement, is the long-term guidance we gave as it relates to Adjusted EBITDA, which is 100-200 basis points of improvement every single year. And so if we think about what that means, the first nine months of this year, we've generated Adjusted EBITDA margins of 8.5%, which is up from 4.1%, the same period last year, so roughly 440 basis points of improvement year-over-year. And we've done that, a few different ways, largely, through controlling spend within our SG&A architecture. So we've brought down marketing spend dramatically as a percent of revenue to balance marketing spend back to where we were pre-pandemic at 12% of revenue.
We had elevated that to 20% of revenue while our stores were closed. So that's number one. Of the 650 basis points of SG&A improvement year-over-year, about half of that has been driven by marketing efficiency, and the other half, just very disciplined spend across the other categories within SG&A. So we embed all of our store labor salaries in SG&A, our customer service salaries, our corporate expenses. And so we're leveraging our corporate expense fixed costs as much as possible and only incrementally adding. But we've done a very thoughtful job of optimizing labor, in particular, across our retail stores to make sure that, to Dave's point, we're maintaining those 35% four-wall margins, but that retail labor within SG&A is a meaningful source of leverage as part of our bottom line growth story. So try to hit on kind of the top line growth algo, talk a little bit, more about what we're doing from an Adjusted EBITDA perspective, and happy to go into any more detail from there.
Yeah, we'll certainly revisit some of that Adjusted EBITDA algorithm in a bit. Maybe before that, on gross margin, that's been a line item that's had a lot of moving pieces, perhaps been a bit more volatile than some of the others. So walk us through those puts and takes, Steve, and, and how you think about the right level longer term.
Yeah, absolutely. So I'll say, given the amount of expenditure that we include in cost of goods, we view that where we are today is actually quite a strong gross margin of 55%, a little bit under 55%, which has been consistent sequentially last quarter versus this quarter, where we have seen deleverage in gross margin from a percentage perspective is year- over- year. Gross margin is down by about 200 basis points, but as anticipated, we guided this year to seeing gross margin maintain in the mid-50s. And a big portion of that gross margin deleverage is for good and understandable reasons. We're in the process of going through an investment cycle where we're evolving from a glasses-only brand into a holistic vision care company.
And for that, for us, that means offering the three main elements of vision care, eye exams, contact lenses, and eyeglasses. Eye exams and contact lenses have a lower gross margin profile, but are accretive to gross margin dollars. Contact lenses, in particular, because they have a more subscription-like, repeat purchase cycle. The average person buys one pair of glasses every two years. The average contact lens buyer, on the other hand, buys contact lenses twice a year. And as it relates to eye exams, we've added 40 new eye exam rooms at all of the 40 stores that we've opened up over the past year.
It takes some time for those eye exam offerings to ramp as brand awareness grows, that we now offer eye exams, and as those eye exam rooms reach higher utilization, that will help to lever gross margin. The other important point, and why we're comfortable going through this product mix evolution, which is having a shorter-term impact on gross margin, is that it's the right thing to do for the customer. Roughly 80% of all prescription glasses are purchased at the same location where you got the eye exam. So for us, it's really viewing eye exams as a gateway to becoming a Warby Parker customer and, and really the intelligent thing to do. As we think about some of the, you know, the puts in the other direction, we are seeing increased glasses growth.
So last year, glasses grew in the, you know, the mid-single-digit range, 5%-6%. In Q3, glasses had started to reaccelerate. This is a green shoot that we hope to continue to see continue in the business. In Q3, glasses grew 10%, while eye exams and contacts both grew 44%-45% year-over-year. And so there's a product mix dynamic that we'll continue to manage, but we feel the elements within our cost of goods will continue to work in favor of us. We're sending more and more volume to our two owned optical labs, where we insource more and more of our prescription jobs. Those cost us less to make, generate higher gross margin. We're selling more and more prescription progressive lenses.
Progressives make up 22.5% of our business, and that particular product is our highest priced and highest gross margin product. In addition to that, we'll just call out two other factors. One is we are opening a consistent number of new stores every single year, 40 new stores a year. So this year, our store base will increase by 20%, next year by 16%, the year after that by 14%. Assuming the consistent 40 new store number, we embed store rent and the depreciation of store buildouts and cost of goods sold.
And so there will be just a less dilutive effect from embedding that aspect of COGS rent and store depreciation in our architecture, because the number of new stores that we're opening on a relative basis will continue to go down and be able to absorb those costs quicker. Lastly, I'll just talk a little bit about our e-com channel. In Q3, we saw our e-com channel comp positive for the first time in nine quarters. Part of that was comping off of these massive COVID gains, where e-com was growing 100%. But for the past four quarters, we pulled back dramatically on marketing spend every single quarter to the tune of 30% plus to get marketing spend as a percent of revenue back to where it was pre-pandemic at 12% of revenue.
We saw that have some impact on our e-com channel in particular. Of our two channels, e-com and retail, e-com is the one that's more sensitive to marketing pullbacks. Our stores really have built-in marketing muscle. We put them in high traffic street locations. They look beautiful. They're very efficient customer acquisition vehicles. And so the color that we gave on our earnings call is that we plan to see e-com comp positive for the first time in H2. We were pleased to see that occur in H3, and the overall trend line that we're looking at for e-com for us is very positive.
We gave some commentary on the call that the growth for e-com may not be linear, and that was really based on wanting to call attention to the fact that we are heading into our December selling season, where there's a significant number of orders that we get. Our biggest order week of the year is really the final week of the year, where customers come in to flush their flex spend dollars. Those orders get delivered next year, not this year, and so there's a revenue transfer from December into January. And so any color that we gave around non-linearity as it related to the e-com recovery, largely, was due to that business cycle and that revenue deferral that we typically see concentrated in December. So I tried to touch on most of the points, but we do have a lot in gross margins, so I tried to cover most of them.
Very comprehensive, I will say. Maybe one thing I wanted to dig in on there was you mentioned some success with these stores that have eye exams and some of those services. Is there anything you shared in terms of how that cohort performs versus the legacy fleet that doesn't have that capability?
Yeah, it's a great question. So the color that we've given is that stores with eye exam capabilities are moderately larger from a revenue perspective because we can record the revenue of the eye exam itself. We'll also see a mix of more complex lenses and products that get prescribed because there's an eye doctor on staff who can prescribe progressives or precision progressives. And so those are the two main benefits that we've seen. In terms of benchmarking the performance of those stores to the industry, the numbers that we've given are well in line with the industry, that 80% or in excess of 80% of all people who get prescriptions at one of our stores, then go and convert and become a product buyer in store.
Perfect. Super helpful. Maybe one other thing that you touched on was marketing, and you had proactively curtailed that in the last year. So now that you're lapping it, how is that impacting the business? How are you thinking about that line going forward?
Yeah. So we're thinking about that line in a very consistent way going forward. So pre-COVID, 2019, we spent 13% of revenue on marketing, and we're opening, you know, approaching 30-40 new stores a year. And so that was our customer acquisition algo, given stores acquire customers, and we need to spend money largely online to acquire customers online, and we'll see some benefit by driving incremental traffic to stores as well. Fast forward to what occurred through the pandemic. We kept marketing spend elevated as all of our stores were closed, and then it took us some time to get back to a cadence of opening 40 new stores a year.
So we opened up 10 new stores a year, the year of the pandemic, and then got back to the 40 number, where we are now. And so we feel very comfortable with this level. And let's say, hypothetically, it stays at 12%, where it lands this year, it's 12% next year. Given we see revenue growing, that natural revenue growth will free up marketing dollars, which will see comp marketing dollars spend up year- over- year. And so we feel like we've right-sized our customer acquisition capital allocation strategy, where we're at that 12% in terms of deployment spend, but we're now back to, more importantly, deploying capital to open up 40 new stores. It's really those new stores that build brand awareness, acquire new customers, and allow us to interact with the customer in an eye exam capacity as well.
I would just add that Q3 was the first quarter in five quarters that marketing spend comped positively. We saw the benefit from that as we expected, where, as Steve noted, it was we saw an acceleration in overall top line growth as our strongest growth quarter of the year. We also saw e-com trend positively for the first time in nine quarters.
And so, again, the dynamics that we expected to play out are playing out, and so we are, you know, encouraged that we believe the industry dynamics will move to a better place going forward, and then we'll be in a position to support that increased level of demand with additional spend.
So maybe to tie this up in a bow here, you've guided to, and Steve, you mentioned this, 100-200 basis points of Adjusted EBITDA margin expansion each year. Remind us the building blocks, is that still intact? Where do you guys stand there?
Yeah, that is still intact, and we feel very comfortable standing by that guidance. We'll talk first a little bit about COGS and then move to SG&A as sort of the two main aggregators of where we could see adjusted EBITDA margin improvement. From a COGS perspective, the factors that work in our favor one we'll be hopefully seeing continued glasses momentum and glasses growth, given that category is our highest gross margin product, and we're seeing some green shoots around that. Two, is through seeing higher utilization at our newer eye exam stores. Takes time for an eye exam practice to ramp and for customers to understand that they can get an eye exam at Warby Parker. So seeing exam utilization go from 10% to 20% to 50% to 70%, all will help leverage gross margin.
In addition to that, we will continue to send more and more volume to our two vertically integrated factories, our two optical labs. We have one outside New York, one in Nevada, one for East Coast customers, one for West Coast customers. I will also say two other things. As the proportion of new stores that we open up each year go down as a percentage of the base, they'll also naturally be less dilution from store rent and the ramp-up period for opening up those stores. So as I mentioned, we'll open up 20% new stores this year, 16% next year, 14% the year before. Absorbing those fixed costs will become easier just because the number of new stores that we're opening on a relative basis go down.
As we've talked about, we're seeing a very positive trend line for e-com longer term. E-com has been a tailwind, and has been a challenge to gross margin. We're going to see that flip to where e-com is now no longer a challenge to gross margin, and those fixed costs embedded in our cost stack will no longer be amplified while e-com is comping negative.
Perfect. Lightning round for you guys. The three questions we're asking all the companies at the conference, so I'll keep it quick for you. First one, how you think about demand next year? Accelerate, decelerate, hold. What's the view?
Yep. Probably won't get into specifics, but we expect that the optical industry will be in a better place next year with more demand than what we saw this year.
Perfect. Next quick one is just on margins, how you guys are planning them, up, down, neutral?
Certainly planning them up. Adjusted EBITDA margins up 100-200 basis points year-over-year.
Perfect. So then finally, how you guys think about capital allocation going forward between whether it be CapEx, buybacks, dividends, et cetera? What's the b igger framework?
Absolutely. So we finished Q3 with $216 million in cash. We were free cash flow positive in Q2 and Q3, and we've added roughly, you know, $7 million-$8 million in free cash flow year to date, which is a good place to be from a stability perspective. There will be more cash flow generation to come, but the color and context we've given is this year will be keep free cash flow neutral. We'll be positive next year, and we'll provide more quantification of that on our Q4 call.
But for right now, we view the best capital allocation for the business is continuing to invest in retail and roll out 40 new stores, to continue to invest intelligently in marketing spend and brand awareness and, customer demand generation, and continuing to support, other growth initiatives throughout the company. So no plans to return capital just yet. At some point, we might, we might choose to do so. I do wanna underscore from a capital perspective, we feel that we're very stable, we're fully funded. We've generated cash the last few quarters. We do have a $175 million undrawn credit facility as well. It's a revolving credit line, that is $100 million. We can upsize it to $75 million. So we're feeling very, very comfortable from a capital perspective.
Okay. Well, we are up on time. Thank you so much for joining us here today. Super helpful.
Great. Thank you.