Kits Eyecare Ltd. — Management Reports 2021

Mar 15, 2021

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2020

The following Management’s Discussion and Analysis (" MD&A ") dated March 12, 2021 provides information concerning the financial condition and results of operations of Kits Eyecare Ltd. (together with its consolidated subsidiaries, referred to herein as “KITS”, the “Company”, “we”, “us” or “our”). This MD&A should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2020, including the related notes thereto. This discussion contains forward-looking information that involves risks and uncertainties. Our actual results, performance and achievements could differ materially from those implied by such forward-looking information as a result of various factors discussed below, particularly under "Forward-Looking Information" and "Risk Factors".

Forward-Looking Information

This MD&A contains "forward-looking information" within the meaning of applicable securities laws in Canada. Forward-looking information may relate to our future financial outlook and anticipated events or results and may include information regarding our financial position, business strategy, growth strategies, budgets, operations, financial results, taxes, dividend policy, plans and objectives. Particularly, information regarding our expectations of future results, performance, achievements, prospects or opportunities or the markets in which we operate is forward-looking information. In some cases, forward-looking information can be identified by the use of forward-looking terminology such as "plans", "targets", "expects" or "does not expect", "is expected", "an opportunity exists", "budget", "scheduled", "estimates", "outlook", "forecasts", "projection", "prospects", "strategy", "intends", "anticipates", "does not anticipate", "believes", or variations of such words and phrases or state that certain actions, events or results "may", "could", "would", "might", "will", "will be taken", "occur" or "be achieved". In addition, any statements that refer to expectations, intentions, projections or other characterizations of future events or circumstances contain forward-looking information. Statements containing forward-looking information are not historical facts but instead represent management’s expectations, estimates and projections regarding future events or circumstances.

This forward-looking information and other forward-looking information are 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. Despite a careful process to prepare and review the forward-looking information, there can be no assurance that the underlying opinions, estimates and assumptions will prove to be correct. Certain assumptions in respect of the expansion and enhancement of our optical laboratory for glasses and warehouse facilities; the growth of our business and launch of new technologies; our ability to drive sales growth; our ability to maintain, enhance, and grow within our addressable market; our ability to drive ongoing development and innovation of our exclusive brands and product categories; our ability to continue directly sourcing from third party suppliers and manufacturers; our ability to retain key personnel; our ability to maintain and expand distribution capabilities; our ability to continue investing in infrastructure to support our growth; our ability to obtain and maintain existing financing on acceptable terms; currency exchange and interest rates; the impact of competition; the changes and trends in our industry or the global economy; and the changes in laws, rules, regulations, and global standards are material factors made in preparing forward-looking information and management’s expectations.

Forward-looking information is necessarily based on a number of opinions, estimates and assumptions that we considered appropriate and reasonable as of the date such statements are made, are subject to known and unknown risks, uncertainties, assumptions and other factors that may cause the actual results, level of activity, performance or achievements to be materially different from those expressed or implied by such forward-looking information, including but not limited to the risk factors described in greater detail in the Company’s annual information form to be filed prior to March 31, 2020 for Fiscal 2020 (the “AIF”). A copy of the AIF and the Company’s other publicly filed documents can be accessed under the Company’s profile on the System for Electronic Document Analysis and Retrieval (“SEDAR”) at www.sedar.com.

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We caution that the list of risk factors and uncertainties described in the MD&A and the AIF is not exhaustive and other factors could also adversely affect its results. Readers are urged to consider the risks, uncertainties and assumptions carefully in evaluating the forward-looking information and are cautioned not to place undue reliance on such information. The forward-looking information contained in this MD&A represents our expectations as of the date of this MD&A (or as of the date they are otherwise stated to be made) and are subject to change after such date. However, we disclaim any intention or obligation or undertaking to update or revise any forward-looking information whether as a result of new information, future events or otherwise, except as required under applicable securities laws. If we do update certain forward-looking information, no inference should be made that we will further update such or other forward-looking information.

Basis of Presentation

On October 15, 2018, KITS was incorporated under the laws of the Province of British Columbia. On April 5, 2019, the Company completed the acquisition of all of the issued and outstanding shares of Kits.com Technologies, Inc. (“KCTI”), a direct-to-consumer retailer of contact lenses and eyewear, with sales primarily in the United States and Canada (the “Acquisition”).

The Acquisition was accounted for as a business combination using the acquisition method of accounting and KITS financial statements reflect the fair value of assets acquired and liabilities assumed as of the effective closing of the Acquisition. Periods presented prior to April 5, 2019, represent the operations of the KCTI as "Predecessor" and the periods presented after April 5, 2019, represent the operations of KITS as "Successor".

Accordingly, the Company’s financial results as of December 31, 2019, and September 30, 2019, represent only the results of operations subsequent to and including April 5, 2019, the date of the Acquisition. The Predecessor and Successor periods have been separated by a black line on the consolidated financial statements to highlight the fact that the financial information for such periods has been prepared under two different cost bases of accounting. All intercompany transactions have been eliminated.

The Pro Forma Combined Year Ended December 31, 2019, includes the 94 day Predecessor period from January 1, 2019, through April 4, 2019 (the "2019 Pre-Acquisition Period") and the 271 day Successor period from April 5, 2019, through December 31, 2019.

For the purpose of performing a comparison to the Predecessor’s year ended December 31, 2019, and the Successor’s year ended December 31, 2020, we have prepared Unaudited Pro Forma Combined Supplemental Financial Information for the year ended December 31, 2019 which gives effect to the Acquisition as if it had occurred on January 1, 2019, and which we refer to as the Unaudited Pro Forma Combined periods. The Unaudited Pro Forma Combined periods discussed do not purport to represent what our actual consolidated results of operations would have been had the Acquisition actually occurred on January 1, 2019, nor is it necessarily indicative of future consolidated results of operations. The Unaudited Pro Forma Combined periods are being discussed herein for informational purposes only. Refer to Page F-58 of the Company’s prospectus dated January 12, 2021 for details. A copy of the Company’s prospectus can be under the Company’s profile on www.sedar.com.

Unless otherwise noted, all dollar amounts in this MD&A are in C$'000s.

Overview

KITS is a rapidly growing, vertically integrated, digitally native eyecare platform providing eyewear for eyes everywhere. We offer customers access to a vast selection of contact lenses and eyeglasses, including our own exclusive KITS designed products, as well as an advanced suite of online vision tools. Our efficient digital platform, backed by our industry-leading design, distribution and manufacturing, removes intermediaries and enables us to offer fast service, great prices and deliver made to order personalized products with incredible care and accuracy. We inspire customers to join our movement by constantly pursuing cutting-edge technologies to enable the best customer experience, including online eyewear fitting tools, virtual try-on for glasses, and an integrated online vision test. We strive to delight our customers with our competitive prices, a convenient digital shopping experience, fast

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and reliable delivery options – including our convenient "Autoship" subscription program for contact lenses – and an unrelenting focus on earning our customers’ lifelong trust.

Recent Key Events

Completion of initial public offering

On January 19, 2021, we completed our oversubscribed and upsized initial public offering (the "IPO") and listing on the Toronto Stock Exchange ("TSX") and our common stock began trading on the TSX under the symbol “KITS”. For additional information, see “Subsequent Events” section of this MD&A.

Achieved milestone of shipping over 1,000 eyeglasses in a single day and launched progressive eyeglasses offering

On February 16, 2021, we achieved an important milestone of shipping more than 1,000 eyeglasses to customers in a single day. Management estimates that this single-day total is equivalent to the volume that 150 traditional optical retailers would deliver over the same time period and is further evidence that today's customers prioritize value and convenience and are comfortable shopping online for eyewear at an accelerating rate.

On March 2, 2021, we launched and added progressive eyeglasses to our product offering. Unlocking this important category will enable us to accelerate growth by serving a broader customer base.

Financial highlights

We measure our business using both financial and operating data and use the following metrics and measures to assess the near term and long-term performance of our overall business, including identifying trends, formulating financial projections, making strategic decisions, assessing operational efficiencies, and monitoring our business. See the section entitled “Components of Our Results of Operations and Trends Affecting Our Business” and “Non-IFRS Measures and Industry Metrics” in this MD&A.

Financial and Operating Data Revenue……………………………………………. Finance costs -net…. ............................ IPO related fair value accrual for Class A and Class C preferred shares (f)……… Net income (loss)………………….…………… Net income per share………………….…….. Basic…................................................ Diluted…............................................. Total assets………………………………..………. Total non-current financial liabilities….. Non-IFRS Measures (g): EBITDA .............................................. Adjusted EBITDA…............................. Adjusted EBITDA Margin % ............... Free cash flow…………………………………. Free cash flow less principal repayments of lease obligations……….	Successor Year Ended December 31, 2020 (audited) Year Ended December 31, 2019 (a) (audited) $75,217 $ 36,897 $3,090(e) $1,845 $3,773 $(24) $(6,583)(c) $53 $(0.72) $0.01 $(0.72) $0.01 $54,657 $53,382 $18,347 $14,190 $1,788 $3,238 $3,548 $ 3,643 4.7% 9.9% $3,957 $3,153 $3,646 $3,000	Unaudited Pro Forma Combined Year Ended December 31, 2019 (b) $49,946 $2,433 - $(131) NM(d) NM(d) NM(d) NM(d) $4,188 $4,326 8.7% NM(d) NM(d)	Predecessor
			Year Ended December 31, 2018 (audited) $47,620 $(24) - 4,444 NM(d) NM(d) $5,994 $- $6,696 $6,696 14.1% $3,655 $3,655

Notes:

(a) Prior to April 5, 2019, KITS had no operations and beginning April 5, 2019, KITS consolidated the operations of KCTI.

(b) The pro forma adjustments made give effect to the Acquisition as if it had occurred on January 1, 2019. This includes $125 in wages, $449 in amortization of intangibles, $624 of finance expense and deducts $479 in transaction related costs and $155 of estimated tax effects associated with these adjustments. (c) Net loss for the year ended December 31, 2020 includes a non-cash one-time fair value accrual for Class A and Class C preferred shares of $3,773, a noncash one-time accrued fee payable to BDC of $1,056 and one-time acquisition and IPO fees of $949.

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(d) NM - Not meaningful to review as KCTI was acquired in 2019. Management reviews and compare these financial and operating data subsequent to the acquisition.

• (e) Finance costs – net for the year ended December 31, 2020 includes a non-cash one-time accrued fee payable to BDC of $1,056.

(f) IPO related fair value accrual for Class A and Class C preferred shares for the year ended December 31, 2020 is a non-cash one-time expense. Subsequent to the year end, these Class A and Class C preferred shares were converted into common shares and are no longer outstanding. Refer to “Subsequent Events” section.

(g) Refer to "Non-IFRS Measures and Industry Metrics" section.

Non-IFRS Measures and Industry Metrics

In addition to our results determined in accordance with IFRS, we believe the following non-IFRS measures and industry metrics provide useful information both to management and investors in measuring the financial performance and financial condition of the Company for the reasons outlined below. These measures do not have a standardized meaning prescribed by IFRS and therefore they may not be comparable to similarly titled measures presented by other publicly traded companies, and they should not be construed as an alternative to other financial measures determined in accordance with IFRS.

Non-IFRS Measures

Management uses these non-IFRS financial measures to exclude the impact of certain expenses and income that management does not believe are reflective of the Company’s underlying operating performance and make comparisons of underlying financial performance between periods difficult. From time to time, the Company may exclude additional items if it believes doing so would result in a more effective analysis of underlying operating performance.

" Adjusted EBITDA " is defined as consolidated net income (loss) before depreciation and amortization, finance cost and provision for income taxes, adjusted for the impact of certain items, including non-cash items such as stock-based compensation, unrealized foreign exchange gains or losses and other items we consider nonrecurring and not representative of our ongoing operating performance.

" Adjusted EBITDA Margin " is defined as Adjusted EBITDA divided by revenue from the same period.

" EBITDA " is defined as consolidated net income (loss) before depreciation and amortization, finance cost and provision for income taxes.

“ Free Cash Flow ” is defined as net cash provided by (used in) operating activities less net capital expenditures (which consist of purchases of property and equipment, leasehold improvements and intangible assets net of proceeds from disposal).

“ Free Cash Flow less principal repayments of lease obligations ” is defined as net cash provided by (used in) operating activities less net capital expenditures (which consist of purchases of property and equipment, leasehold improvements and intangible assets net of proceeds from disposal) less principal repayments of lease obligations.

EBITDA, Adjusted EBITDA, and Adjusted EBITDA Margin are financial measures that are not defined under IFRS. We use these non-IFRS financial measures, and believe they enhance an investor’s understanding of our financial and operating performance from period to period, because they exclude certain material non-cash items and certain other adjustments we believe are not reflective of our ongoing operations and our performance. Accordingly, we use these metrics to measure our core financial and operating performance for business planning purposes and as a component in the determination of incentive compensation for salaried employees.

In addition, we believe EBITDA, Adjusted EBITDA, and Adjusted EBITDA Margin are measures commonly used by investors to evaluate companies in the e-commerce industry. However, they are not presentations made in accordance with IFRS and the use of the terms EBITDA, Adjusted EBITDA, and Adjusted EBITDA Margin vary from others in our industry. These financial measures are not intended to represent and should not be considered as alternatives to net income, operating income or any other performance measures derived in accordance with IFRS as measures of operating performance or operating cash flows or as measures of liquidity.

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EBITDA, Adjusted EBITDA, and Adjusted EBITDA Margin have important limitations as analytical tools and you should not consider them in isolation or as substitutes for analysis of our results as reported under IFRS. For example, these financial measures:

• exclude certain tax payments that may reduce cash available to us;

• do not reflect any cash capital expenditure requirements for the assets being depreciated and amortized that may have to be replaced in the future;

• do not reflect changes in, or cash requirements for, our working capital needs; and

• do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt.

The tables below provide a reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin for the periods presented:

presented:
		Succe	ssor			Prede	cessor
CAD $000s, unless otherwise noted	Three Months ended December 31, 2020	Three Months ended December 31 2019	Year ended December 31, 2020	Year ended December 31, 2019 (a)		Period from January 1, 2019 to April 4, 2019	Year ended December 31, 2018 Unaudited Pro Forma Combined Year ended December 31, 2019
Reconciliation of Adjusted EBITDA….................................... Net income / (loss) for the period….................................. Add back: Income taxes…..…................................................................ Finance costs -net (b) .........................................................	(6,216) $ (1,065) 1,433	(79) $ 13 630	(6,583) $ (505) 3,090	53 $ 37 1,845		380 $ 218 (12)	4,444 $ (131) $ 2,222 100 (24) 2,433
IPO related fair value accrual for Class A and Class C preferred (c) .....................................................................	3,375	(21)	3,773	(24)		-	- -
Depreciation and amortization…..….................................. EBITDA Add back: Share-based compensation (d).......................................... One-time costs (e)…............................................................ Adjusted EBITDA….................................................................. Revenue…................................................................................ Adjusted EBITDA Margin %(f)…............................................	509 (1,964) 307 437 (1,220) $ 20,283 $ -6.0%	477 1,020 130 6 1,156 $ 12,673 $ 9.1%	2,013 1,788 811 949 3,548 $ 75,217 $ 4.7%	1,327 3,238 130 275 3,643 $ 36,897 $ 9.9%		10	54 1,786 6,696 4,188 - 130 - 8 6,696 $ 4,326 $ 47,620 $ 49,946 $ 14.1% 8.7%
						596 - -
						596 $ 13,049 $ 4.6%

Notes:

(a) Prior to April 5, 2019, KITS had no operations and beginning April 5, 2019, KITS consolidated the operations of KCTI.

(b) Finance costs – net for the three months and year ended December 31, 2020 includes a non-cash one-time accrued fee payable to BDC of $1,056.

(c) IPO related fair value accrual for Class A and C preferred shares for the three months and year ended December 31, 2020 is a non-cash one-time expense. Subsequent to the year end, these Class A and Class C preferred shares were converted into common shares and are no longer outstanding. Refer to “Subsequent Events” section.

(d) Represents non-cash share-based compensation expense associated with RSRs and options recognized in the period.

(e) In connection with the Acquisition and IPO, the Company incurred expenses related to professional fees, consulting, legal, and accounting that would otherwise not have been incurred and were directly related to these two matters. These fees are not indicative of the Company’s ongoing costs and we expect they will discontinue following the completion of the IPO.

(f) Represents Adjusted EBITDA divided by revenue from the same period.

Free Cash Flow and Free Cash Flow less principal repayments of lease obligations are financial measures that are not defined under IFRS. We have included free cash flow in this MD&A because it is an important indicator of our liquidity as it measures the amount of cash we generate. Accordingly, we believe that free cash flow provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

Free Cash Flow and Free Cash Flow less principal repayments of lease obligations have limitations as financial measures and you should not consider them in isolation or as substitutes for analysis of our results as reported under IFRS. There are limitations to using non-IFRS financial measures, including that other companies, including companies in our industry, may calculate free cash flow differently. Because of these limitations, you should consider free cash flow alongside other financial performance measures, including net cash provided by (used in) operating activities, capital expenditures and our other IFRS results.

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We have provided a reconciliation below of Free Cash Flow and Free Cash Flow less principal repayments of lease obligations to net cash provided by operating activities, the most directly comparable IFRS financial measure.

		Succe	ssor	Year ended December 31, 2019 (a)	Year ended December 31, 2019 (a)	Predec	essor
	Three Months ended December 31, 2020	Three Months ended December 31 2019	Year ended December 31, 2020			Period from January 1, 2019 to April 4, 2019	Year ended December 31, 2018
Net cash provided by operating activities……...................................	1,523 $	2,537 $	4,182 $	4,146 $		1,430 $	3,657 $
Deduct …...................................................................................................
Capital expenditures, net of proceeds from disposal ……........... Free Cash Flow …....................................................................................	(63)	(231)	(225)	(993) 3,153 $		106 1,536 $	(2)
	1,460 $	2,306 $	3,957 $				3,655 $
Deduct …..................................................................................................
Repayments of lease obligations ….................................................. Free Cash Flow less principal repayments of lease obligations…	(70)	(153)	(311)	(153) 3,000 $		- 1,536 $	-
	1,390 $	2,153 $	3,646 $				3,655 $

Industry Metrics

“ Active Customers ” As of the last date of each reporting period, we determine our number of active customers by counting the total number of individual customers who have ordered, and for whom an order has shipped, at least once during the preceding four year period. The change in active customers in a reporting period captures both the inflow of new customers as well as the outflow of customers who have not made a purchase in the last four years. We view the number of active customers as a key indicator of our growth—acquisition and retention of customers—as a result of our marketing efforts and the value we provide to our customers. The number of active customers has grown over time as we acquired new customers and retained previously acquired customers.

“ Autoship Subscribers ” We define Autoship Subscribers as customers that have an active Autoship subscription as of the last date of each reporting period.

Summary of Factors Affecting Performance

We believe that our performance and future success depend on a number of factors that present significant opportunities. These factors are also subject to a number of inherent risks and challenges, some of which are discussed below and in the "Risk Factors" section of the AIF.

Impact of COVID-19

The coronavirus disease (COVID-19) pandemic has been a highly disruptive economic and societal event that has affected our business and has had a significant impact on consumer shopping behavior. To serve our customers while also providing for the safety and well-being of our team members, we have adapted aspects of our logistics, transportation, supply chain and purchasing processes accordingly. As reflected in the discussion below, we have seen customers shift more of their total shopping spend to online channels since the COVID-19 outbreak, which has led to increased sales and order activity for our business. While the COVID-19 outbreak has not had a material adverse impact on our operations to date, it is difficult to predict all of the positive or negative impacts the COVID-19 outbreak will ultimately have on our business.

As this crisis has unfolded, we have continued to monitor conditions and adapt our operations to meet required regulatory and public health standards and orders. We have done so to continue meeting the needs of our rapidly growing customers and to ensure the safety and well-being of our team members. We cannot predict the duration or severity of COVID-19 or its ultimate impact on the broader economy or our operations and liquidity. As such, the situation remains unpredictable and risks still remain. Please refer to the “Forward-Looking Information” in this MD&A and the “Risk Factors” disclosed in our AIF available on ww.sedar.com.

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Growth in Revenue and Active Customers

As of December 31, 2020, we had over 700,000 Active Customers, up from over 500,000 as of December 31, 2019, as we succeeded in both attracting new customers and reactivating past customers. Repeat orders from existing customers accounted for approximately 65% (2019: 69%) of our revenue in 2020. The increased proportion of new customers in the year December 31, 2020 was due to our continued marketing efforts and success in attracting new customers during the year many of whom were driven to our site from word of mouth and social media.

Growth of Our Autoship Program

A majority of our revenue base comes from repeat customers, and we continue to codify this repeat business as subscription revenue through our Autoship subscription program. We launched our beta Autoship program in February 2020, and our current Autoship program in July 2020. We had 26,000 Autoship Subscribers as of December 31, 2020 and Autoship orders represented 20% of total orders in the fourth quarter of 2020, indicating that customers value the “set it and forget it” convenience that Autoship offers, as well as the access to free upgraded shipping and perks, an unlimited number of online vision tests and other complimentary vision tools we offer as part of the program. Our goal is to grow our opt-in rate to 25% by the summer of 2021 which we believe will drive higher retention and increase the lifetime value of our customers over time.

Growth of Our Glasses Business

The glasses industry is approximately five times the size of the contact lenses market, and we will continue to introduce our over 700,000 vision corrected Active Customers to our rapidly growing eyeglasses selection. Glasses as a category has yet to be disrupted and is dominated by a few large players. Accordingly, the glasses category presents an attractive opportunity with robust margins for any company that can secure loyal customers with lifelong vision correction needs. Our belief is that being vertically integrated in this category by controlling both the cost of acquisition and the cost of production will create a long-term sustainable advantage for our Company. We delivered 39,000 pairs of eyeglasses to customers in 2020, with glasses shipments compounding at an average rate of over 200% per quarter in 2020. Personalized customer orders enter manufacturing shortly after receipt and our goal is to have custom orders manufactured and ready for shipment minutes after confirmation through our stateof-the-art optical lab and asset light model.

On February 16, 2021, subsequent to the year end, we achieved a key milestone of shipping over 1,000 eyeglasses to customers in a single day. This single-day total was driven largely by word of mouth and social sharing and is equivalent to the estimated volume that approximately 150 traditional optical retailers would deliver over the same time period. This provides further evidence that today's customers prioritize value and convenience and are shopping online for eyewear at an accelerated rate.

We continue to expand our selection of KITS glasses together with other leading brands, adding new frames weekly. Additionally, we have expanded our offering to include blue-light lenses, premium lens coatings, and progressive lenses, which we believe will continue to increase average order value.

Components of Our Results of Operations and Trends Affecting Our Business

Revenue

We derive revenue primarily from sales of both third-party brand and KITS brand contact lenses and KITS designed glasses, and related shipping and handling fees. Revenue is recorded when products are delivered, net of promotional discounts and refund allowances. Revenue is primarily driven by growth of new customers and active customers, and the frequency with which customers repurchase and subscribe to our Autoship subscription program.

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Cost of Sales

Cost of goods sold consists of the cost of third-party brand and KITS brand products sold to customers, inventory freight, inventory shrinkage costs, and inventory valuation adjustments, offset by reductions for promotions and percentage or volume rebates offered by our suppliers, which may depend on reaching minimum purchase thresholds.

Fulfillment

Fulfillment costs primarily consist of those costs incurred in operating and staffing our fulfillment, optical lab, and customer service centers, third party fulfillment costs, and payment processing costs. Fulfillment costs as a percentage of revenue may vary due to several factors, such as payment processing and related transaction costs, our level of productivity and accuracy, changes in volume, size, and weight of units received and fulfilled, the timing of fulfillment network and optical lab expansion, the extent to which we utilize fulfillment services provided by third parties, mix of products and services sold, and our ability to increase efficiency per shipment by implementing improvements in our operations and enhancements to our customer self-service features.

We continually seek to expand our fulfillment network to accommodate a greater selection and higher instock inventory levels and to meet anticipated order volumes from our customers. We regularly evaluate our facility and lab requirements.

Marketing

Marketing costs include brand development, advertising and payroll and related expenses for personnel engaged in marketing and selling activities. We also rely heavily on social sharing of our products and services. We believe that the company with the highest NPS in any category ultimately derives the highest value in the category. Accordingly, we work hard to ensure we deliver exceptional service to customers and actively invest in their long term and lifetime value. We believe this allows our customers to become advocates for our brand and community, and share the KITS experience with friends and family. We have evidence that our strategy is working, as the majority of our customers arrive to our store directly, meaning they arrived without the benefit of any performance marketing source. Since launching our glasses business, we have continued to see this number increase steadily. Our goal is to maintain the highest satisfaction metrics in the category. From a paid media standpoint, we direct customers to our platforms through a number of marketing channels, such as our TV advertising, performance search, third party customer referrals, social micro and macro influencers, online advertising, and other initiatives. Our marketing costs are largely variable and can be adjusted to align with growth objectives. To the extent there is increased or decreased competition for these traffic sources, or to the extent our mix of these channels shifts, we would expect to see a corresponding change in our marketing costs. As the majority of our business is repeat or subscription based, and the majority of our store traffic and customers come to us via word of mouth, we expect to become less reliant on external forms of marketing over time. We specifically design differentiated and relevant marketing programs to accelerate word of mouth adoption and leave us less dependent on large providers such as Google and Facebook.

Selected Annual and Quarterly Consolidated Financial Information

The following table summarizes our recent results of operations for the periods and years indicated. The selected consolidated financial information set out below for the year ended December 31, 2020 and 2019 has been derived from consolidated financial statements and related notes.

The Pro Forma Combined Year Ended December 31, 2019, includes the 2019 Pre-Acquisition Period and the 271 day Successor period from April 5, 2019, through December 31, 2019. For the purpose of performing a comparison to the Successor’s year December 31, 2020, we have prepared Unaudited Pro Forma Combined Supplemental Financial Information for the year ended December 31, 2019 which gives effect to the Acquisition as if it had occurred on January 1, 2019, and which we refer to as the Unaudited Pro Forma Combined periods.

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CAD $000s, unless otherwise noted Revenue………………………………………………. Cost of Sales………………………………………… Gross profit…………………………………………. Fulfillment………………………………………. Marketing ……..………………………………. General and administrative…………….. Depreciation and amortization……….. Operating income ………………………………. Finance costs, net (c)…………………………… IPO related fair value accrual for Class A and Class C preferred shares (d)………….. Other expenses ………………………………….. Income before income taxes……………….. Income tax expense (recovery)……….. Net income (loss)………………………………… Non-IFRS Measures (e): EBITDA ............................................... Adjusted EBITDA….............................. Adjusted EBITDA Margin % ...............		Successor	Successor	Year Ended December 31, 2019 (a) (audited) $ 36,897 26,085 10,812 2,717 3,168 1,581 1,327 2,019 1,845 (24) 108 90 37 $53 $3,238 $ 3,643 9.9%	Unaudited Pro Forma Combined Year Ended December 31, 2019 (b) $49,946 36,281
	Three Months Ended December 31, 2020 (unaudited) $20,283 15,547 4,736 2,224 2,466 1,947 509 (2,410) 1,433 3,375 63 (7,281) (1,065) $(6,216) $(1,964) $(1,220) (6.0)%	Three Months Ended December 31, 2019 (unaudited) $12,673 8,732 3,941 995 1,057 831 477 581 630 (21) 38 (66) 13 $(79) $1,020 $1,156 9.1%	Year Ended December 31, 2020 (audited) $75,217 53,829 21,388 7,598 7,836 3,819 2,013 122 3,090 3,773 347 (7,088) (505) $(6,583) $1,788 $3,548 4.7%
					13,665 3,456 3,898 1,977 1,786
					2,548 2,433 - 146
					(31)
					100
					$(131)
					$4,188 $4,326 8.7%

Notes:

(a) Prior to April 5, 2019, KITS had no operations and beginning April 5, 2019, KITS consolidated the operations of KCTI.

(b) The pro forma adjustments made give effect to the Acquisition as if it had occurred on January 1, 2019. This includes $125 in wages, $449 in amortization of intangibles, $624 of finance expense and deducts $479 in transaction related costs and $155 of estimated tax effects associated with these adjustments,

(c) Finance costs – net for the year ended December 31, 2020 includes a non-cash one-time accrued fee payable to BDC of $1,056.

(d) IPO related fair value accrual for Class A and Class C preferred shares for the year ended December 31, 2020 is a non-cash one-time expense. Subsequent to the year end, these Class A Class C preferred shares were converted in common shares and are no longer outstanding. Refer to “Subsequent Events” section.

(e) Refer to "Non-IFRS Measures and Industry Metrics" section.

Three Months Ended December 31, 2020, Compared to Three Months Ended December 31, 2019

The following section provides an overview of our financial performance during the three months ended December 31, 2020, compared to the three months ended December 31, 2019. The selected consolidated financial information contained herein for these periods has been derived from our audited consolidated financial statements and related notes.

Revenue

Revenue increased by 60.0% to $20,283 in the three months ended December 31, 2020, compared to $12,673 in the three months ended December 31, 2019. The increase in revenue was primarily attributable to growth in our customer base, through increased spending among our active customers and growth in new customers, driven by the introduction of our Autoship program, glasses offering, and KITS products.

Gross Profit

Gross profit increased by 20.2% to $4,736 in the three months ended December 31, 2020, compared to $3,941 in the three months ended December 31, 2019. The increase was primarily driven by an increase in revenue.

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Gross profit margin was 23.3% of revenue in the three months ended December 31, 2020, compared to 31.1% in the three months ended December 31, 2019. The change in gross profit margin was primarily driven by introductory offers designed to attract and retain Autoship subscription contact lens customers, as well as promotional pricing designed to continue the rapid acceleration of new customers to our eyeglasses offering. Additionally, higher product costs were temporarily incurred as we sourced higher-priced inventory to scale our inventory and reduce the shipment time to customers, contributing to temporarily lower margins in the fourth quarter of 2020.

Fulfillment

Fulfillment expense as a percentage of revenue increased to 11.0% in the three months ended December 31, 2020, compared to 7.9% in the three months ended December 31, 2019, This was due to the expansion of staff and space required for our state-of-the-art optical lab. We temporarily elected to upgrade shipping service levels with our carriers to mitigate delays caused by certain carriers due to high holiday volumes and compounded by COVID-19. We also had increased costs associated with the expansion of our distribution centers, manufacturing and customer service capabilities.

Marketing

Marketing expense as a percentage of revenue increased to 12.2% in the three months ended December 31, 2020, compared to 8.3% in the three months ended December 31, 2019. The increase in marketing costs was primarily due to increased spending on top of funnel activities, including the development and production of several larger creative assets which we anticipate using throughout 2021, costs associated with expanding our Autoship program, expanded social media presence, and personnel engaged in marketing and selling activities to invest in customer acquisition and retention. We continue to believe that greater investments in brand and marketing will generate outsized future returns to companies who can deliver excellent customer experiences.

General and administrative expenses

General and administrative expenses increased to $1,947 in the three months ended December 31, 2020, compared to $831 in in the three months ended December 31, 2019. The increase was driven by expenses related to the continued expansion of our team, technology development costs, and costs associated with preparing for our initial public offering. Many of these costs were one time in nature.

EBITDA and Adjusted EBITDA

EBITDA was $(1,964) and Adjusted EBITDA was $(1,220) in the three months ended December 31, 2020, compared to $1,020 and $1,156, respectively, in the three months ended December 31, 2019, changes of $2,984 and $2,376, respectively.

Adjusted EBITDA as a percentage of revenue was (6.0)% in the three months ended December 31, 2020, compared to 9.1% in the three months ended December 31, 2019.

The change in EBITDA and Adjusted EBITDA was primarily due to expanding our platform as we continue to scale. This includes investments in hiring the best talent, expanding our customer service and optical lab capabilities, and marketing to drive customer acquisition, as well as the additional factors discussed in greater detail above.

Finance costs, IPO related fair value accrual for Class A and Class C preferred shares and Other expenses

Finance costs in the three months ended December 31, 2020, increased to $1,433 from $630 in the three months ended December 31, 2019 primarily due to additional accretion expenses accrued for a one-time fee payable to BDC Capital Inc. (“BDC”) at the maturity of the secured loan entered into with BDC on March 26, 2019 (the “BDC Loan”) which is further described under the heading “BDC Loan” below. These expenses are one-time and non-cash in nature, and we do not expect them to recur going forward.

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IPO related fair value accrual for Class A and Class C preferred shares in the three months ended December 31, 2020 increased to $3,375 due to a one-time, non-cash fair value accrual related to the Class A and Class C preferred shares liability based on the expected conversion of the preferred shares which occurred upon the IPO in January 2021.

Other expenses in the three months ended December 31, 2020, increased to $63 from $38 in the three months ended December 31, 2019, primarily driven by increase in estimated sales taxes payable.

Income Taxes

Income taxes decreased by $6,229 to an income tax recovery of $1,065 in the three months ended December 31, 2020, compared to an income tax expense of $13 in the corresponding quarter of the previous year, as a result of lower taxable earnings during the period within the operating entity and the reversal of estimated income taxes payable from previous quarters.

Net loss

Net loss was $6,216 in the three months ended December 31, 2020, a change of $6,137 compared to net loss of $79 in the three months ended December 31, 2019. The increase in net loss was primarily due an increase in one-time and non-recurring finance costs of i) $3,375 related to the conversion of the preferred shares to common and ii) $1,056 associated with the BDC fee payable at the maturity of the BDC loan, as well as the factors discussed above related to expanding our ability to serve our growing base of customers.

Year Ended December 31, 2020, Compared to Year Ended December 31, 2019, and Unaudited Pro Forma Combined Year Ended December 31, 2019

The following section provides an overview of our financial performance during the year ended December 31, 2020, compared to the year ended December 31, 2019. No revenue or expenses were generated by the Company in the period from January 1, 2019, to April 4, 2019 prior to the closing of the Acquisition on April 5, 2019. Accordingly, the year ended December 31, 2020, compared to the year ended December 31, 2019, may not be directly comparable as changes in the comparative periods in each of the categories in the discussion to follow will be attributable to the lack of revenue or expenses generated in the non-operating period from January 1, 2019, to April 4, 2019.

For the purpose of aiding in the comparison to the year ended December 31, 2020, we have prepared Unaudited Pro Forma Combined Supplemental Financial Information for the year ended December 31, 2019, which gives effect to the Acquisition as if it had occurred on January 1, 2019.

Revenue

Revenue increased by 103.9% to $75,217 in the year ended December 31, 2020, compared to $36,897 in the year ended December 31, 2019. When compared to the Unaudited Pro Forma Combined Year ended December 31, 2019 results, revenue increased by 50.6% to $75,217 in year ended December 31, 2020, compared to $49,946.

The increase in revenue was primarily attributable to higher order volumes driven by growth of first-time customer orders, growth in our Autoship program, growth in our direct traffic, continuous improvements in our site and mobile experience and increased awareness and adoption of our eyeglasses offering.

Gross Profit

Gross profit increased by 97.8% to $21,388 in the year ended December 31, 2020, compared to $10,812 in the year ended December 31, 2019. Gross profit increased by 56.5% to $21,388 in the year ended December 31, 2020, compared to $13,665 in the Unaudited Pro Forma Combined Year ended December 31, 2019. The increase was primarily driven by an increase in order volumes and customer growth and retention through various marketing initiatives including the launch of our Autoship and eyeglasses offerings during 2020.

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Gross profit margin was 28.4% of revenue in the year ended December 31, 2020, relatively consistent with the gross margin of 29.3% in the year ended December 31, 2019. The slight change in gross profit was primarily attributable to no revenue or cost of sales being recorded from the 2019 Pre-Acquisition Period within year ended December 31, 2019, a period when there are typically fewer promotions.

Gross profit margin increased to 28.4% of revenue in the year ended December 31, 2020, compared to 27.4% in the Unaudited Pro Forma Combined Year ended December 31, 2019. The increase in gross profit margin when compared to the Unaudited Pro Forma Combined Year ended December 31, 2019 was primarily driven by lower product costs incurred as the Company benefited from a shift in sourcing strategy to increase our inventory levels, offset by introductory offers provided to attract subscribers to our Autoship Program and build our glasses sales.

Fulfillment

Fulfillment expense as a percentage of revenue increased to 10.1% in the year ended December 31, 2020, compared to 7.4% in the year ended December 31, 2019. Fulfillment expense as a percentage of revenue was 10.1% in the year ended December 31, 2020, compared to 6.9% in the Unaudited Pro Forma Combined Year ended December 31, 2019.

The change was primarily due to higher order volumes, costs incurred as we transitioned from a third-party fulfillment provider to our own fulfillment facility which includes a state-of-the-art optical laboratory for manufacturing eyeglasses, and increased costs related to COVID-19 operational adjustments to address carrier delays and health and safety distancing requirements. We began building our own fulfillment facility in October 2019; however until April 2020 we maintained redundant capabilities through a third-party fulfillment provider as we scaled up our in-house capabilities. This resulted in higher fulfillment costs as we were incurred expenses associated with maintaining fulfillment capacity at two centers for this transition period. We also continued to invest in faster shipment options to address carrier delays during the holiday periods in the last quarter of 2020, which we believe was a function of COVID-19 related issues.

Marketing

Marketing expense as a percentage of revenue was 10.4% in the year ended December 31, 2020, compared to 8.6% in the year ended December 31, 2019. Marketing expense as a percentage of revenue was 10.4% in the year ended December 31, 2020, compared to 7.8% in the Unaudited Pro Forma Combined Year ended December 31, 2019.

The increase in marketing costs was primarily due to increased spending on top of funnel activities, including the development and production of several larger creative assets which we anticipate using throughout 2021, costs associated with expanding our Autoship program, expanded social media presence, and personnel engaged in marketing and selling activities to invest in customer acquisition and retention. We continue to believe that greater investments in brand and marketing will generate outsized future returns to companies who can deliver excellent customer experiences.

General and administrative expenses

General and administrative expenses were $3,819 in the year ended December 31, 2020, compared to $1,581 in same period in 2019. General and administrative expenses were $3,819 in the year ended December 31, 2020, compared to $1,977 in in the Unaudited Pro Forma Combined Year ended December 31, 2019.

The increase was driven by expenses related to the expansion of our team, technology development costs, and costs associated with preparing for our initial public offering.

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EBITDA and Adjusted EBITDA

EBITDA was $1,788 in the year ended December 31, 2020, compared to $3,238 in the year ended December 31, 2019. EBITDA was $1,788 compared to $4,188 in the Unaudited Pro Forma Combined Year ended December 31, 2019.

Adjusted EBITDA was $3,548 in the year ended December 31, 2020, compared to $3,643 in the year ended December 31, 2019. Adjusted EBITDA was $3,548 in the year ended December 31, 2020, compared to $4,326 in the Unaudited Pro Forma Combined Year ended December 31, 2019.

The change in EBITDA and Adjusted EBITDA was primarily due to expanding our platform as we continue to scale. This includes investments in hiring the best talent, expanding our customer service and optical lab capabilities, and marketing to drive customer acquisition, as well as the additional factors discussed in greater detail above.

Adjusted EBITDA as a percentage of revenue was 4.7% in the year ended December 31, 2020, compared to 9.9% in the year ended December 31, 2019. Adjusted EBITDA as a percentage of revenue was 4.7% in the year ended December 31, 2020, compared to 8.7% in the Unaudited Pro Forma Combined Year ended December 31, 2019. The change was primarily the result of costs incurred to expand our platform and drive customer growth and retention during the year.

Finance costs, IPO Related fair value accrual for Class A and Class preferred shares and Other expenses

Finance costs in the year ended December 31, 2020, increased to $3,090 from $1,845 in the year ended December 31, 2019. Finance costs in the year ended December 31, 2020, increased to $3,090 from $2,433 in the Unaudited Pro Forma Combined Year ended December 31, 2019. The increase was almost entirely due to additional accretion expenses of $1,056 accrued for a one-time, non-cash fee payable to BDC at the maturity of the BDC Loan. These expenses are one-time and non-cash in nature, and we do not expect them to recur going forward.

IPO related fair value accrual for Class A and Class C preferred shares in the year ended December 31, 2020 increased to $3,773 due to a one-time, non-cash fair value accrual related to the Class A and Class C preferred shares liability based on the expected conversion of the preferred shares which occurred upon the IPO in January 2021. These expenses are one-time and non-cash in nature, and we do not expect them to recur going forward.

Other expenses in the year ended December 31, 2020, increased to $347 from $108 in the year ended December 31, 2019. Other expenses in the year ended December 31, 2020, increased to $347 from $146 in the Unaudited Pro Forma Combined Year ended December 31, 2019. The increase was driven by an estimated accrued sales taxes expense.

Income Taxes

Income taxes decreased by $542 to an income tax recovery of $505 in the year ended December 31, 2020, compared to $37 in the corresponding period of the previous year, as a result of a decrease in net income before taxes and an additional three-months of deferred income tax recovery recognized from the intangible assets recorded as a result of the Acquisition.

Income taxes decreased by $605 to an income tax recovery of $505 in the year ended December 31, 2020, compared to $100 of income tax expenses for the Unaudited Pro Forma Combined Year ended December 31, 2019, as a result of lower taxable earnings.

Net Income (loss)

Net loss was $6,583 in the year ended December 31, 2020, a change of $6,636 compared to net income of $53 in the year ended December 31, 2019. Net loss was $6,583 in the year ended December 31, 2020, an increase in net loss of $6,452 compared to net loss of $131 in the Unaudited Pro Forma Combined Year ended December 31, 2019.

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The increase in net loss is primarily due an increase in one-time, non-cash and non-recurring finance costs incurred of i) $3,773 related to the conversion of the preferred shares to common and ii) $1,056 associated with the BDC fee payable at the maturity of the BDC Loan, as well as the factors discussed above related to expanding our ability to serve our growing base of customers.

Quarterly Results and Performance Measures

The following table summarizes the results of KITS’ operations for the last eight most recently completed quarters. This unaudited quarterly information, other than comparable sales growth, has been prepared in accordance with IFRS.

accordance with IFRS.
CAD $000s, unless otherwise noted Revenue….............................................................................. Net income (loss)…............................................................. Net income per share Basic…............................................................................... Diluted…............................................................................ Adjusted for Share Spilt (b): Weighted average number of shares Basic…............................................................................... Diluted (c) …..................................................................... Net income per share Basic…............................................................................... Diluted…............................................................................ Prior to Share Spilt: Weighted average number of shares Basic…............................................................................... Diluted (c) …..................................................................... Net income per share Basic…............................................................................... Diluted…............................................................................ Average US$/Canadian dollar exchange rate (d) ….....	Summary ofQuarterly Results
	December 31, 2020 September 30, 2020 June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019 June 30, 2019 (a) March 31, 2019 20,283 $ 20,201 $ 20,322 $ 14,412 $ 12,673 $ 12,007 $ 12,218 $ 12,531 $ (6,216) $ (132) $ 221 $ (456) $ (79) $ 285 $ (153) $ 652 $ (0.68) $ (0.03) $ 0.06 $ (0.11) $ (0.02) $ 0.07 $ (0.05) $ 2,173.33 $ (0.68) $ (0.03) $ 0.04 $ (0.11) $ (0.02) $ 0.04 $ (0.05) $ 2,173.33 $ 9,200,000 9,200,000 9,200,000 9,200,000 9,200,000 9,200,000 7,163,934 300 9,200,000 9,200,000 23,000,000 9,200,000 9,200,000 23,000,000 7,163,934 300 (0.68) $ (0.01) $ 0.02 $ (0.05) $ (0.01) $ 0.03 $ (0.02) $ 2,173.33 $ (0.68) $ (0.01) $ 0.02 $ (0.05) $ (0.01) $ 0.02 $ (0.02) $ 2,173.33 $ 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 3,114,754 300 4,000,000 4,000,000 10,000,000 4,000,000 4,000,000 10,000,000 3,114,754 300 (1.55) $ (0.03) $ 0.06 $ (0.11) $ (0.02) $ 0.07 $ (0.05) $ 2,173.33 $ (1.55) $ (0.03) $ 0.04 $ (0.11) $ (0.02) $ 0.04 $ (0.05) $ 2,173.33 $ 1.3029 $ 1.3326 $ 1.3865 $ 1.3432 $ 1.3199 $ 1.3205 $ 1.3376 $ 1.3297 $ Predecessor Successor

Notes:

(a) Successor - June 30, 2019, does not include Predecessor’s revenue, net income and net income per share for period between April 1 to 4, 2019.

(b) On December 14, 2020, the Company completed a one-for-two and three tenths (1:2.3) share split of all of its issued and outstanding common shares (“Share Split”), resulting in an increase in the issued and outstanding shares from 4,000,000 to 9,200,000. Shares reserved under the Company’s equity incentive plan were adjusted to reflect the Share Split. To provide comparability, we had provided additional disclosure on the weighted average number of shares and net income per share prior to the Share Spilt.

(c) An additional 13,800,000 of converted Class B preferred shares are included in the diluted weighted average number of shares only when such shares are not anti-dilutive in nature.

(d) Average US$/Canadian dollar exchange rate is the average of Bank of Canada daily noon rates based on calendar days within the quarter.

Revenue

Over the last eight quarters, revenue has been impacted by the following:

• the acquisition of KCTI in the second quarter of year ended December 31, 2019;

• the accelerated secular change to ordering eyewear products online;

• the growth in orders and increased new customers;

• the successful growth of Kits.com and Kits.ca sites and amalgamation of some of our other web properties;

• the rollout of our own KITS-branded glasses offering; and

• the introduction of our Autoship subscription program in the first quarter of 2020.

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Net Income (loss)

Net income has been affected by the following factors over the last eight quarters:

• the impact of the items noted in revenue above;

• the transaction costs associated with the IPO;

• the increased investment in our Autoship subscription business and glasses offering;

• the increases in brand, marketing, and personnel costs to support our brand launch, corporate growth, and expanded operating capabilities;

• the opening of our fulfillment and optical lab centers;

• the impact of foreign exchange on our revenue and costs; and

• increased one-time, non-cash finance costs associated with debt and preferred shares incurred related to the IPO;

Financial Condition, Liquidity and Capital Resources

Overview

The general objectives of our capital management strategy are to invest in growing our business while maintaining our financial and operating flexibility, provide benefits to our stakeholders and provide an adequate return on investment to our shareholders. We allocated capital based on our assessment of the expected risk and return profile of each investment. This strategy is adjusted with changes in the economic environment and risks of the underlying investments. We are currently subject to working capital and minimum cash requirements through the BDC Loan agreement.

Our primary need for liquidity is to fund working capital requirements of our business, capital expenditures, debt service and for general corporate purposes. Our primary source of liquidity is funds generated by operating activities and proceeds from our recent IPO. Our ability to fund our operations, to make planned capital expenditures, to make scheduled debt payments and to repay or refinance indebtedness depends on our future operating performance and cash flows, which are subject to prevailing economic conditions and financial, business and other factors, some of which are beyond our control.

Working Capital

The Company’s objectives in managing capital are to ensure sufficient liquidity to pursue its growth strategy, to establish a strong capital base to satisfy its obligations towards its creditors, as well as to provide an adequate return to shareholders.

Our primary sources of cash flow are from operations, debt financing, and equity issuances. Our approach to managing liquidity is to ensure, to the extent possible, that we always have a net negative working capital funded by our operations and sufficient liquidity to meet our liabilities as they become due. We do so by monitoring cash flow and performing budget-to-actual analysis on a regular basis.

The working capital deficit as at December 31, 2020, was $24,262 and this is primarily due to the classification of the BDC Loan as current (see “Indebtedness” Section in the MD&A). Excluding the long-term contractual BDC Loan (which is no longer classified as current), the working capital deficit is $5,830. The Company operates on a negative working capital basis, similar to other e-commerce businesses, as customers pay for purchases upfront and we deliver goods from inventory or from suppliers. Overall, on purchase and expenses, we have favorable payment terms from suppliers, which provide us with a net source of cash from working capital. We believe that cash generated from our operations ($4,182 in the year ended December 31, 2020) and cash proceeds from the closing of the IPO will adequately meet our capital requirements and operational needs for the next 12 months. Additionally, our growth focused marketing budget provides a lever we can use to increase cash generated from operations. Our goal is to produce capital as we grow and remain the asset light eyecare company.

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Indebtedness

The Company entered into a secured loan agreement for $23.4 million with BDC on March 26, 2019, with a repayment date of March 15, 2026. The BDC Loan bears interest at BDC's floating rate minus 1%, plus a variance of 2.95% per annum and is payable monthly. As at December 31, 2020, BDC's floating rate was 4.55% (2019: 6.05%). The BDC Loan is subordinated to the Company’s credit card liabilities, senior to any other loans, and secured by the Company’s assets.

During the year ended December 31, 2020, the Company entered into several loan amendments with BDC providing for, among other things, (i) a one-time payment to BDC, due, at its option, upon maturity or completion by the Company of an initial public offering, equal to 0.45% of the Company's annual gross sales for the applicable annual period, which BDC has opted to trigger upon maturity at which time the calculation will be made, (ii) amendments to and waiver of various covenants as at December 31, 2020 and (iii) increase the interest rate variance from 2.95% per annum to 4.45% effective January 15, 2021.

The Company is subject to various covenants under the BDC Loan, including requirements to maintain certain financial ratios. The BDC Loan balance was classified as a current liability as of December 31, 2020 as the Company would not have met a financial ratio requirement as at December 31, 2020 which was subsequently waived by the BDC. The BDC Loan is in good standing as of the date hereof and the long-term debt is no longer considered a current liability.

Cash Flows

The following table presents cash and cash equivalents as at December 31, 2020 and 2019.

CAD $000s, unless otherwise noted		Succe	ssor	Predecessor Year ended December 31, 2019 (a) Period from January 1, 2019 to April 4, 2019	Predecessor Year ended December 31, 2019 (a) Period from January 1, 2019 to April 4, 2019	Predecessor Year ended December 31, 2019 (a) Period from January 1, 2019 to April 4, 2019
	Three Months ended December 31, 2020	Three Months ended December 31 2019	Year ended December 31, 2020
Net cash provided by operating activities……...................................... Net cash provided by (used in) financing activities……..................... Net cash provided by (used in) investing activities……...................... Increase (decrease) in cash…..................................................................	1,523 $ (1,194) (63)	2,537 $ (625) (231)	4,182 $ (4,838) (225)	4,146 $ 28,618 (29,268) 3,496		1,430 $ - 106
	266	1,681	(881)			1,536
Cash and cash equivalents, end of period…........................................ Non-IFRS Measures (b): Free Cash Flow …........................................................................................ Free Cash Flow less principal repayments of lease obligations …..	2,308 $ 1,460 $ 1,390 $	3,398 $ 2,306 $ 2,153 $	2,308 $ 3,957 $ 3,646 $	3,398 $ 3,153 $ 3,000 $	4,401 $ 1,536 $ 1,536 $

Notes:

(a) Prior to April 5, 2019, KITS had no operations and beginning April 5, 2019, KITS consolidated the operations of KCTI. (b) Refer to "Non-IFRS Measures and Industry Metrics" section.

Analysis of Cash Flows for the year ended December 31, 2020, compared to year ended December 31, 2019 and three months ended December 31, 2020, compared to three months ended December 31, 2019

Cash Flows from Operating Activities

Cash flows generated from operating activities increased by 0.9% or $36 to $4,182 in the year ended December 31, 2020, compared to $4,146 in the year ended December 31, 2019. The increase in operating cash flows generated was primarily attributable to the close of the Acquisition in the second quarter of 2019 resulting in an additional quarter of operating cash flows for the year ended December 31, 2020. The increased cash flows from

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operations were partly offset by increased operating costs incurred as we expand operations and our product offering.

Cash flows generated from operating activities was $1,523 in the three months ended December 31, 2020, compared to $2,537 of cash flows used in operating activities in the three months ended December 31, 2019, a change of $1,014. The change in operating cash flows was mainly attributable to an increase in one-time expenses incurred to execute the IPO and increased product costs incurred during the period.

Cash flows generated from operating activities by the Predecessor for the period up to April 4, 2019, was $1,430 for a combined total of $5,576 of cash flows generated from operating activities for the year ended December 31, 2019. The decrease in the cash flows generated from operating activities for the year ended December 31, 2020, of $1,394 to $4,182 was mainly attributable to the increase in operating costs that were incurred to expand the operations and product lines.

Cash Flows Used in Financing Activities

Cash flows used in financing activities for the year ended December 31, 2020, was $4,838 compared to cash flows generated from financing activities of $28,618 for the year ended December 31, 2019.

The cash flows generated from financing activities included the BDC Loan proceeds and issuance of share capital of $23,166 and $7,000, respectively, supporting the Acquisition in 2019.

Cash flows used in financing activities increased by $569 to $1,194 in the three months ended December 31, 2020, compared to $625 of cash flows used in financing activities in the three months ended December 31, 2019. The increase was due to repayment of the BDC Loan principal in the three months ended December 31, 2020, offset by the decreased interest paid resulting from the lower BDC floating rate in the period.

The Predecessor for the period from January 1, 2019 to April 4, 2019 did not have cash flows from financing activities.

Cash Flows Used in Investing Activities

Cash flows used in investing activities decreased by $29,043 to $225 in the year ended December 31, 2020, compared to $29,268 in the year ended December 31, 2019. The change was primarily due to the $28,275 of cash consideration paid in connection with the Acquisition in 2019.

Cash flows used in investing activities decreased by $168 to $63 in the three months ended December 31, 2020, compared to $231 of cash flows used in investing activities in the three months ended December 31, 2019. The decrease is primarily due to a decrease in capital purchases of computer equipment.

Cash flows provided by investing activities by the Predecessor for the period up to April 4, 2019, was $106 for a combined total of $29,162 of cash flows used in investing activities for the year ended December 31, 2019. The decrease in cash flows used in investing activities of $28,937 was mainly due to the cash consideration paid in connection with the Acquisition in 2019.

Free Cash Flow and Free Cash Flow less principal repayments of lease obligations

Free Cash Flow in the year ended December 31, 2020 increased by $804 to $3,957, compared to $3,153 in the year ended December 31, 2019, primarily due to the timing of the close of the Acquisition that resulted in an increase in cash provided by operating activities and a decrease in capital purchases of computer equipment and domain names.

Free Cash Flow less principal repayments of lease obligations in the year ended December 31, 2020 increased by $646 to $3,646, compared to $3,000 in the year ended December 31, 2019, primarily due to an increase

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in Free Cash Flow for factors discussed above offset by an increase in periods of lease payments and additional leased equipment.

Free Cash Flow in the three months ended December 31, 2020 decreased by $846, to $1,460 compared to $2,306 in the three months ended December 31, 2019, primarily due to additional IPO expenses and higher product costs incurred offset by a decrease in equipment additions during the period.

Free Cash Flow less principal repayments of lease obligations in the three months ended December 31, 2020 decreased by $763, to $1,390 compared to $2,153 in the three months ended December 31, 2019, primarily due to the decrease in Free Cash Flow for factors discussed above offset by a decrease in lease payments as we paid an upfront principal repayment for a lease on equipment in the previous period.

Off-Balance Sheet Arrangements and Commitments

We have no off-balance sheet arrangements.

Contractual Obligations

The following table summarizes certain of our significant contractual obligations and other obligations as at December 31, 2020:

at December 31, 2020:	at December 31, 2020:
		Contractual		Less than						After 5
Contractual obligations		cash flows		1year		1-3years		4-5years		years
Accounts payable and accrued liabilities……………………………………………... Loan Principal amount………………………… Loan Interest ………………………………………		$ 9,616 21,886 4,318		$ 9,616 3,000 1,236		$ - 6,000 1,888		$ - 6,000 1,110		$ -
										6,886
										84
Lease liability……………………………………..		1,219		283		482		394		60
		$37,039		$14,135		$8,370		$7,504		$7,030

As of December 31, 2020, we had additional liabilities which included pending or in-transit orders, sales returns, and deferred income tax liabilities. These long-term liabilities have not been included in the table above as the timing and amount of future payments are uncertain.

After the year end, the holders of preferred shares provided notice of conversion to the Company. These preferred shares were converted to the Company’s common shares and the Company issued a promissory note to the holders for the dividends payable. Refer to “Subsequent Event” Section.

Financial Instruments

The Company’s financial instruments comprise of cash and cash equivalents, account receivables, accounts payable, accrued liabilities, the BDC Loan, Class A, Class B and Class C preferred.

The carrying value of cash and cash equivalents, account receivables, accounts payable, and accrued liabilities approximate their fair value because of the short-term nature of these financial instruments. These financial instruments, the BDC Loan and Class B preferred shares are classified as financial assets and liabilities at amortized cost. The fair value of the BDC Loan and Class B preferred shares as at December 31, 2020, was $24,317 (2019: $23,400) and $4,298 (2019: $3,914), respectively. The fair value of the BDC Loan and Class B preferred shares was determined using a discounted cash flow method with Level 2 and Level 3 inputs, respectively, that considers the present value of expected payments, discounted using a risk-adjusted discount rate. Class A and Class C preferred shares are classified as financial liabilities measured at fair value less cost to sell and are valued using Level 3 fair value inputs.

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BDC Loan

As of December 31, 2020, the carrying amount of the BDC Loan was $21,457 (2019: $23,199) For the year ended December 31, 2020, the Company recognized $1,594 (2019: $1,428) of interest expense and a one-time, noncash cost of $1,056 (2019: $nil) relating to the accrual of the one-time payment at maturity to BDC in finance costs. Interest expense is calculated by applying the effective interest rate of 6.95% (2019: 8.59%).

Class A and Class C preferred shares

Subsequent to year end, the Company completed its “IPO” on the Toronto Stock Exchange and the Class A and Class C preferred shares are no longer outstanding.

On April 5, 2019, we issued 10,000 Class A and 300 Class C preferred shares with a par value of $1,000 for each preferred share. These preferred shares are redeemable and retractable at $1,000 per share, non-voting with a cumulative dividend at 8%. The holders of the preferred shares may convert the issued par value of the preferred shares into: (i) common shares of the Company at a price equal to 80% of the issuance price of future issuances of common shares of the Company at the time of such issuance; or (ii) debt due at the request of the holder or at the option of the Company, with written consent from BDC prior to the long-term debt maturity.

Since these shares are redeemable and the Company is obliged to pay annual dividends to the holders, these shares are recognized as financial liabilities (the " Host Instrument "). As the holders may convert these shares to common shares of the Company, the conversion right is an embedded derivative that is closely related to the Host Instrument since the conversion right would modify the timing of the cash flows of the redemption and dividends payment. These shares are measured at fair value through profit/loss. Fair value gains/losses are recognized in finance costs.

The fair value of the Class A and Class C preferred shares was determined using a discounted cash flow method that considers the present value of expected value of the redemption feature, dividend payable and the conversion right, discounted using a risk-adjusted discount rate with an expected probability of occurrence. The estimated fair value would increase (or decrease) if: (i) the average risk adjusted discount rate were lower (or higher); or (ii) the probability of redemption decreased (or increased) or probability of exercising the conversion right increased (or decreased).

As at December 31, 2020, the fair value of the Class A and Class C preferred shares was $14,049 (2019: $10,276) with incremental fair value loss recognized in finance costs. For the year ended December 31, 2020, the Company recognized an increase of $3,773 (2019: decrease of $24) in a one-time, non-cash fair value accrual related to the Class A and Class C preferred shares liability based on the expected conversion of the preferred shares which occurred upon the IPO in January 2021 in finance costs.

After the year end, the holders of preferred shares provided their notice of conversion to the Company. These preferred shares were converted to the Company’s common shares and the Company issued a promissory note to the holders for the dividends payable. (Refer to “Subsequent Events” section).

Class B preferred shares

Subsequent to year end, the Company completed its “IPO” on the Toronto Stock Exchange and the Class B preferred shares are no longer outstanding.

On April 5, 2019, the Company issued 7,000 Class B preferred shares with a par value of $1,000 for each preferred share in exchange for $7,000. These preferred shares are non-redeemable, non-retractable, each convertible into 1,971 3/7 common shares, entitled to 1,971 3/7 votes and are entitled to a cumulative dividend of 8%.

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Since the Company is obliged to pay annual dividends to the holder, dividends payable are recognized as liabilities. The initial fair value of the liability portion of the Class B preferred shares was determined by management using a discounted cash flow method that considers the present value of expected payments, discounted using a risk-adjusted discount rate. This was determined to be $3,500. The liability is subsequently recognized on an amortized cost basis until extinguishment.

The remainder of the proceeds of $3,500 are allocated to the conversion option and recognized in shareholders’ equity and not subsequently remeasured.

During the year ended December 31, 2020, the Company recognized an interest expense of $562 (2019: $414) and recorded a one-time gain of $178 (2019: $nil) due to an update in the expected timing and contractual cash outflows relating to the annual dividends payable to the holder. Interest expense is calculated by applying the effective interest rate of 8.25% (2019: 8.00%).

After the year end, the holders of preferred shares provided their notice of conversion to the Company. These preferred shares were converted to the Company’s common shares and the Company issued a promissory note to the holders for the dividends payable. (Refer to “Subsequent Events” section).

Risk Factors

For a detailed description of risk factors associated with the Company, refer to the “Risk Factors” section of the Company’s AIF, which is available on SEDAR at www.sedar.com.

In addition, we are exposed to a variety of financial risks in the normal course of operations including foreign exchange, interest rate, credit, liquidity and equity price risk, as summarized below. We believe that our overall risk management program and business practices help minimize any potential adverse effects on our consolidated financial performance.

Risk management is carried out under practices approved by our Board of Directors. This includes reviewing the adequacy of our risk management policies and procedures with regard to identifying the Company’s principal risks and implementing appropriate systems and controls to manage these risks. Risk management covers many areas of risk including, but not limited to, foreign exchange risk, interest rate risk, credit risk, liquidity risk and equity price risk.

Quantitative and Qualitative Disclosures about Market Risk

We are exposed to a variety of financial risks in the normal course of operations including foreign exchange, interest rate, credit, and liquidity risk. Our overall risk management program and business practices seek to minimize any potential adverse effects on our consolidated financial performance. For a detailed description of risk factors associated with the Company, refer to the “Risk Factors” section of the Company’s AIF, which is available on SEDAR at www.sedar.com.

Foreign Exchange Risks

The presentation currency for our consolidated financial statements is the Canadian dollar. Because we recognize sales in the United States in U.S. dollars, if the U.S. dollar weakens against the Canadian dollar it would have a negative impact on our U.S. operating results upon translation of those results into Canadian dollars for the purposes of financial statement consolidation. We may face similar risks in other foreign jurisdictions where sales are recognized in foreign currencies.

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Interest Rate Risks

We are exposed to changes in interest rates on our cash and cash equivalents, loans and borrowings. Debt issued at variable rates exposes us to cash flow interest rate risk. During the period, we had a variable interest rate loan from the BDC.

Credit Risks

Credit risk refers to the possibility that we can suffer financial losses due to the failure of our counterparties to meet their payment obligations. We are exposed to minimal credit risk. We do not extend credit to customers but do have some receivables exposure with respect to payment processors transferring customer funds to us and to rebates receivable from our vendors. In order to reduce this risk, we use industry leading payment processors, including Chase Paymentech, American Express, and PayPal. We deposit our cash and cash equivalents with major financial institutions that have been assigned high credit ratings by internationally recognized credit rating agencies. We do not have any derivative contracts.

Liquidity Risk

Liquidity risk is the risk that we cannot meet a demand for cash or fund our obligations as they come due. We manage liquidity risk by managing our balance sheet and monitoring actual and projected cash flows, considering the seasonality of our revenue, income and working capital needs.

Related Party Transactions

The Company enters into transactions from time to time with its Principal Shareholders (as defined below) and organizations affiliated with members of its Board by incurring expenses for business services. During the year ended December 31, 2020, the Company has paid rent of $77 (2019: $32) to a company owned by a major shareholder of the Company and paid rent of $120 (2019: $90) to a company under common control of a major shareholder of the Company. These amounts have been included in other general and administrative expense and are part of the Company’s ordinary course of business. The contract terms are based on market rates for these types of services and amounts are payable on a monthly basis for the duration of the contract.

During the year ended December 31, 2020, the Company reimbursed a company owned by the minority shareholders of the Company for purchased inventory of $56 (2019: $nil). These amounts had been included in cost of sales and are based on market/third party invoiced rates for the inventory purchased.

During the year ended December 31, 2020, the Company recorded $7 (2019: $ nil) of Board fees to the directors, all of which is unpaid as at December 31, 2020.

Majority holders of the Class A, B and C preferred shares were directors and certain key management of the Company, their families or related entities. Subsequent to the close of the IPO in January 2021, approximately 75% of the common shares of the company are controlled by key management, their families or related entities. We believe this aligns the management team with investors and shareholders.

Key management compensation

Key management consists of the Board, the Chief Executive Officer, and the executives who report directly to the Chief Executive Officer. As at December 31, 2020, the Company recorded a bonus payable of $50 (2019: $ nil) to key management. Our goal is to convene the best talent by compensating our executives and employees based on performance. While we believe base salaries should reflect at or below market rates, we believe in incentivizing outperformance through bonuses and additional share-based incentives to achieve category leadership.

Key management compensation comprises of wages and short-term employee benefits. For the year ended December 31, 2020, the Company paid $804 (2019: 508) of wages and short-term employee benefits to key management and recorded $555 (2019: 125) of key management share based compensation.

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Subsequent Events

Conversion of preferred shares and issuance of promissory note

On January 18, 2021, the Company issued 15,314,709 common shares in connection with the conversion of all the Company’s Class A, B and C preferred shares and a promissory note of $2,412 which represented the accrued dividends payable to the holders of the preferred shares. The note matures on the earlier of January 31, 2026 or the date after the Company’s current loan from BDC Capital has been repaid in full (the “Maturity Date”). Unpaid principal shall be payable in quarterly installments beginning on March 31, 2021 of $121, subject to the consent of BDC Capital. Any unpaid principal shall be payable in full upon the Maturity Date.

Completion of initial public offering

On January 19, 2021, the Company is completed its oversubscribed and upsized initial public offering (the "IPO") and listing on the Toronto Stock Exchange ("TSX"). The IPO consisted of the issuance of 6,470,588 common shares of the Company (the "Shares") at a price of $8.50 per Share (the "Offering Price") for gross proceeds of $55,000. In connection with the completion of the IPO, the Company issued 14,706 common shares and paid $125 in cash to Agents of the listing. In addition, the agents exercised 50% of their overallotment option in a transaction that closed on February 5, 2021.

Additional BDC principal payments

The Company made a prepayment of $4,500 in January 2021 towards the BDC Loan principal. The repayment schedule of the loan was revised accordingly to reflect this prepayment made where the balloon payment was reduced by the prepayment amount. On March 5, 2021, BDC waived a financial ratio requirement as at December 31, 2020. The BDC Loan is in good standing as of the date hereof and the amount outstanding thereunder is no longer considered a current liability.

Lease agreements

The Company entered into two separate lease agreements to lease a retail space and a fulfillment and manufacturing facility in Vancouver, British Columbia. The new KITS beach community store lease commences on January 1, 2021 and includes escalating rent payments and an initial five-year term. The fulfillment and manufacturing facility lease commences on or about July 1, 2021 and includes escalating rent payments and an initial seven-year term.

Critical Accounting Estimates and Judgments

Our Financial Statements have been prepared in accordance with IFRS as issued by the International Account Standards Board (“ IASB ”). The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and are based on a set of underlying data that may include our historical experience, knowledge of current events and conditions and other factors that are believed to be reasonable under the circumstances. We continually evaluate the estimates and judgments used in the preparation of the financial statements. Actual results could differ from these estimates. Areas requiring the most significant estimates and judgments are outlined below.

Inventories

In estimating net realizable value of inventory, we use estimates related to fluctuations in inventory levels, planned production, customer behavior, obsolescence, future selling prices, and costs necessary to sell the inventory.

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Leases

We exercise judgment when contracts are entered into that may give rise to a right-of-use asset that would be accounted for as a lease and determining the appropriate lease term on a lease-by-lease basis. Changes in the economic environment or changes in the retail industry may impact the assessment of the lease term and any changes in the estimate of lease terms may have a material impact on the Company’s consolidated statements of financial position.

The critical assumptions and estimates used in determining the present value of future lease payments require us to estimate the incremental borrowing rate specific to each leased asset or portfolio of leased assets. We determine the incremental borrowing rate of each leased asset or portfolio of leased assets by incorporating the Company’s creditworthiness, the security, term, and value of the underlying leased asset, and the economic environment in which the leased asset operates. The incremental borrowing rates are subject to change mainly due to macroeconomic changes in the environment.

Impairment of non-financial assets (goodwill, intangible assets, property, plant & equipment, and right-of-use assets)

We are required to exercise judgment in determining the grouping of assets to identify their CGUs for the purposes of testing non-financial assets for impairment. In determining the recoverable amount of the CGU, various estimates are employed. Estimates including projected future revenues, margins, costs, and capital investment consistent with strategic plans presented to the Board and key management. Discount rates are consistent with external industry information reflecting the risk associated with the Company and its cash flows.

Fair value of financial instruments (Class A and Class C preferred shares)

The critical assumptions and estimates used in determining the fair value of the preferred shares are: probability of the occurrence of the redemption/retracting; probability and timing of payment of dividends to the holders; the likelihood and timing of the holders exercising their conversion rights; and the discount rate used.

Share-based payments

Compensation expense for share-based compensation granted is measured at the fair value at the grant date using the Black-Scholes option pricing model. The critical assumptions used under the option valuation model at the grant date are: stock price valuation; exercise price; risk-free interest rate; expected time to exercise in years; expected dividend yield; and volatility.

Significant New Accounting Standards Adopted

The Company applied for the first-time certain standards and amendments, which are effective for annual periods beginning on or after 1 January 2020. The Company has not early adopted any other standard, interpretation or amendment that has been issued but is not yet effective.

Amendments to IAS 1 and IAS 8: Definition of Material

The amendments provide a new definition of material that states, “information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of generalpurpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.” The amendments clarify that materiality will depend on the nature or magnitude of information, either individually or in combination with other information, in the context of the financial statements. A misstatement of information is material if it could reasonably be expected to influence decisions made by the primary users. These amendments had no impact on the consolidated financial statements of, nor is there expected to be any future impact to the Company.

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Significant New Accounting Standards Not Yet Adopted

A number of new standards are effective for the annual period beginning on or after January 1, 2021, and earlier application is permitted. We do not expect these standards to have a material impact on the consolidated financial statements and plan to adopt the new standards on the required effective date.

Current Share Information

As at March 12, 2021, an aggregate of 31,000,003 common shares were issued and outstanding. There were no preferred shares are issued and outstanding as of such date.

As at March 12, 2021, there were 2,236,061 options and 35,979 restricted share rights outstanding under the Company’s equity incentive plans, of which 782,576 options and 12,451 restricted share rights were vested as of such date. Each option is exercisable for one common share. We expect that vested restricted share rights will be paid at settlement through the issuance of one common share per restricted share right.

Additional Information

Additional information relating to the Company, including the Company’s AIF, is available on SEDAR at www.sedar.com. The Company’s common shares are listed for trading on the TSX under the symbol “KITS”.

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