National Vision - Q3 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Q3 2023 National Vision Holdings, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to speaker today, Caitlin Churchill, Investor Relations. Please go ahead.

Caitlin Churchill (Investor Relations)

Thank you, and good morning, everyone. Welcome to National Vision's Q3 of 2023 earnings call. Joining me on the call today are Reade Fahs, CEO, and Melissa Rasmussen, CFO. Patrick Moore, COO, is also with us and will be available during the Q&A portion of the call. Our earnings release issued this morning and the presentation accompanying our call are both available in the Investors section of our website, nationalvision.com. A replay of the audio webcast will be archived in the Investors section after the call. Before we begin, let me remind you that our earnings materials and today's presentation include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

These risks and uncertainties include, but are not limited to, the factors identified in the release and our filings with the Securities and Exchange Commission. The release and today's presentation also include certain non-GAAP measures. Reconciliation of these measures is included in our release and the supplemental presentation. We also would like to draw your attention to slide two in today's presentation for additional information about forward-looking statements and non-GAAP measures. As a reminder, National Vision provides investor presentations and supplemental materials for investor reference in the Investors section of our website. I will now turn the call over to Reade. Reade?

Reade Fahs (CEO)

Thank you, Caitlin. Good morning, everyone. Thank you all for joining us today. This morning, we will begin with a review of highlights from our Q3, including ongoing progress on our strategic initiatives. We will then provide an update on the upcoming end of our Walmart partnership, as well as our plans to position National Vision for long-term profitable growth as we look ahead to operating a more streamlined and less complex business model. Then Melissa will review our Q3 financial results and updated outlook in more detail. Turning to our results, we are pleased with our Q3 performance, which reflected ongoing strength from our managed care business and was supported by the continued progress we are making with expanding eye exam capacity, particularly within America's Best.

For the quarter, we delivered net revenue growth of 6.6%, including comparable store sales growth of 4.3%, and we delivered adjusted diluted EPS of $0.15. We saw strength, particularly in America's Best, which was partially offset by softness in our Eyeglass World business. While we've continued to contend with an exam capacity constraint across both our growth brands, our initiatives to date have been predominantly focused on our largest brand, America's Best. Given the improvement we've seen in our America's Best locations, we are applying and incorporating the learnings from that playbook to improve our Eyeglass World performance. As we discussed on our last earnings call, we were encouraged with the early trends we were seeing with the back-to-school season, and we're pleased to see that performance continued through the period.

In addition, we continued to see strength from our managed care business, which is one indicator of the trade-down behavior that is occurring with many customers as we continue to navigate a dynamic macro environment. As I mentioned, the quarter also benefited from ongoing progress on our strategic initiatives, particularly focused in our America's Best business. We have continued to see improvement with stores that do not have optimal coverage, which we refer to as Dark and Dim locations, through expanding exam capacity from our recruiting, retention, and remote initiatives. We are pleased to continue to see much lower levels of Dark Stores compared to the peak we saw last year and are seeing slower but steady progress addressing our Dim Stores as well.

As a reminder, we define dark stores as locations that do not have doctor coverage and dim stores as those locations that have less than three days of doctor coverage. We remain focused on executing our initiatives to continue to drive improvement across our fleet. As I discussed last quarter, where we have the desired level of capacity, stores are delivering comps more in line with our historical operating model. We remain on track to deliver a second year of record recruiting and have contracted more new graduates this year than in any previous year. In addition, we continue to expect to deliver improved retention rates this year. These trends are driven in part by the schedule flexibility options that have been made available to the doctors.

Our remote initiative is also helping us to expand exam capacity and has been a major factor in improving dark and dim store performance, enabling a double-digit productivity lift in sales. As of the end of Q3, more than half of our America's Best locations have been enabled with remote exam capabilities and electronic health records, reflecting the progress we've made through the initial heavy implementation phase over the past two years. We remain on track to roll remote capabilities out to at least 200 stores this year, and as we look ahead, given the work done to date as well as the evolving state regulatory landscape, we expect the pace of our implementation of remote to slow in 2024.

We continue to believe in the opportunity there is for remote exam capabilities across our stores, and we'll continue to monitor the regulatory landscape and assess our plans accordingly. With respect to our EHR rollout, we remain on pace to have EHR installed at all America's Best locations by the end of 2024. Turning next to our digitization plans for our corporate office, we have begun to implement the first phase of our ERP project, focused on finance system upgrades. We are taking a measured approach to this project and plan to evaluate each phase appropriately to mitigate risk and maintain our focus on disciplined capital allocation. Finally, with respect to our white space opportunity, we remain on track to open 65-70 new stores this year and opened 21 new stores in the Q3.

Now let me provide an update on our transition plans with the pending end of our Walmart partnership beginning early next year. We are committed to ensuring the continuity of our Walmart business through the end of our contracts, and actions have been taken to support the retention of the associates and doctors during this time. I'm very appreciative of how our teams have continued to operate with discipline and focus on customer care amidst this transition. As we've previously discussed, the Walmart business has continued to become a smaller piece of our overall performance over the last decade and carries a much lower margin than our larger growth brands. Moving beyond the termination dates of the contracts, we will operate a far more streamlined and less complex model.

As detailed in our press release this morning, in conjunction with the termination of our Walmart partnership, we will be winding down our remaining AC Lens operations. In doing so, we will be closing our Ohio distribution center, which largely supports the wholesale distribution and e-commerce contact lens services that we provide to Walmart and Sam's Club. While this is a difficult decision, it is a prudent one for our organization. We are continuing to work with Walmart on the transition of the vision center associates and ODs, and currently expect approximately 7% of our total associate headcount to be impacted by this decision and termination of the Walmart partnership, the vast majority of whom will be Walmart Vision Center and AC Lens roles.

In addition, given the changes in our go-forward operating model, we have conducted a comprehensive review of our cost structure and will be implementing expense savings initiatives focused on streamlining corporate overhead, as well as reducing travel expenses and third-party spend. We believe these decisions, combined with benefits from our pricing actions we plan to take on the heels of the pricing study completed earlier this year, will more than offset the profitability gap created by the termination of the Walmart partnership. Through this work and our ongoing execution of our strategic initiatives focused on driving revenue and enhancing performance in our two strategic growth brands, we are well positioned to deliver operating margin expansion and thus drive increased shareholder value. Melissa will discuss details of these actions and anticipated financial impact in a moment.

In closing, we remain committed to our mission of making quality eye care and eyewear more affordable and accessible. While we continue to maintain a conservative approach to our outlook, given the ongoing challenging macro environment that has continued to pressure our core uninsured customer, we remain on track to deliver on our objectives for this year, as reflected in the narrowing of our guidance. I will now turn it over to Melissa.

Melissa Rasmussen (CFO)

Thank you, Reade, and good morning, everyone. As Reade discussed, we are pleased with our Q3 performance and the ongoing progress we are making on our strategic initiatives. For the Q3, net revenue increased 6.6% compared to the prior year, driven by adjusted comparable store sales growth and growth from new store sales. The timing of unearned revenue negatively impacted revenue in the period by 30 basis points. We opened 17 new America's Best and four Eyeglass World stores in the Q3. Unit growth in our America's Best and Eyeglass World brands increased 5.3% on a combined basis over the total store base last year, and we ended the quarter with 1,402 stores. As Reade mentioned, we are still on track to open between 65 and 70 stores in 2023, consistent with our previous guidance.

Adjusted comparable store sales grew 4.3% compared to the Q3 of 2022, driven by an increase in customer transactions and, to a lesser degree, an increase in average ticket. As Reade mentioned, we saw strength, particularly in America's Best, which was partially offset by softness in our Eyeglass World business. As Reade discussed, our initiatives continue to address our Dark and Dim store population. While we have always contended with Dark and Dim stores, however, the combination of post-COVID doctor availability issues and a more challenged lower-end consumer has exacerbated the impact from Dark and Dim on our revenue performance. On average, a Dark store is approximately 80% less productive than a store with full coverage, which we define as having 5-6 days of in-store doctor coverage.

A dim store, on average, is approximately 50% less productive than a store with full coverage. By enabling remote, we have significantly improved this productivity drag, and while there is still more progress to be made, we are making nice headway with dark and dim stores. As a percentage of net revenue, costs applicable to revenue increased 70 basis points compared with the prior year quarter, driven primarily by the deleverage of optometrist-related costs, as well as other components of service revenue, including warranty plan revenue. These costs were partially offset by ongoing strength in exam revenue and a decrease in product costs attributable to higher eyeglass margins and decreased freight expenses. As we discussed last quarter, the pricing actions taken with respect to exams have helped to partially mitigate the increase in optometrists-related costs.

For the quarter, the net impact from deleverage of optometrists-related costs and the increase in exam revenue was approximately 50 basis points. Adjusted SG&A expense as a percentage of revenue increased 90 basis points compared with the Q3 of 2022. The increase in adjusted SG&A as a percentage of net revenue was primarily driven by performance-based incentive compensation, as we expected. Depreciation and amortization expense was $24.4 million, compared to $24.9 million in the prior year period. Adjusted operating income was $15.7 million, compared to $21.5 million in the prior year period. Adjusted operating margin decreased 130 basis points to 3%, due primarily to the same factors I just reviewed.

Net interest expense was $3.7 million, which includes mark-to-market gains and losses on derivative instruments and changes related to amortization of debt discounts and deferred financing costs of $3.5 million. The year-over-year change was primarily a result of lower derivative income and higher interest expense on our term loan, partially offset by higher income on cash balances. Our effective tax rate in the Q3 was 5.8%, primarily due to legacy segment impairment losses. We expect our tax rate on ordinary income items to be in line with our original guidance. Adjusted Diluted EPS was $0.15 per share, compared to $0.15 per share in the prior year period. Turning to our financial results for the nine months to date as compared with the prior year period.

Net revenue increased approximately 5%, driven by new stores and adjusted comparable store sales growth of 2%. Adjusted operating margin declined 180 basis points compared to the prior year period, driven primarily by the same factors I just reviewed, which impacted the Q3. Please note, our adjusted results for the Q3 and nine-month year-to-date period exclude the impact associated with one-time charges related to the termination of our Walmart partnership, including $2 million in retention bonuses and termination benefits for certain employees supporting the Walmart Vision Centers and the AC Lens Distribution Center, and $79.4 million of non-cash impairment charges related to impairment of goodwill, intangible assets, and fixed assets. Turning next to our balance sheet.

We ended the quarter with a cash balance of approximately $266 million, and total liquidity of $559 million, including available capacity from our revolving credit facility. As of September 30th, our total debt outstanding was $563 million, and for the trailing twelve months, we ended the period with net debt to Adjusted EBITDA of 1.9 times. Year to date, we generated operating cash flow of $153 million. In addition, the first nine months of fiscal 2023, we invested $82 million in capital expenditures, primarily driven by investments in new stores, our labs and distribution center, and our remote medicine technology.

We remain on track for capital expenditures to be in the range of $115 million-$120 million in 2023 to support our key growth initiatives. Our balance sheet and liquidity remain strong, enabling our robust and disciplined capital allocation plan, which is designed for continued growth, balanced with opportunistically returning capital to our shareholders. Earlier this summer, we refinanced our Term Loan A and extended our revolving credit facility, and we are continuing to evaluate options with respect to our convertible note, which matures in May of 2025. Given the current environment and our focus on continuing to fortify our balance sheet, our share repurchase activity to date was focused on the first quarter of this year. As of the end of Q3, we have $25 million of share repurchase authorization remaining.

We will continue to deploy capital to ensure we are making prudent decisions that are financially responsible for the company. Moving now to the discussion of our 2023 outlook. Year to date, we remain on track with our expectations for this year, and as we move into the Q4, our seasonally lowest quarter from a profitability perspective, we are narrowing our full year guidance range. We now expect revenue to be in the range of $2.115 billion-$2.125 billion, supported by Adjusted Comparable Store Sales Growth of approximately 2% for fiscal 2023. Our revenue guidance incorporates ongoing execution of our strategic initiatives, focused on expanding exam capacity and contemplates current business trends. We continue to expect depreciation and amortization to be in the range of $99 million-$101 million.

We expect adjusted operating income and adjusted diluted EPS to be in the range of $60 million-$65 million, and $0.53-$0.58 per share, respectively. Our guidance for adjusted diluted EPS assumes approximately 78 million weighted average diluted shares outstanding. As a reminder, our adjusted results, as well as our outlook, exclude the one-time charges related to the termination of our Walmart partnership I reviewed, as well as the expected costs associated with the first phase of our ERP implementation. Regarding our ERP project, as Reade noted, we are taking a disciplined and phased approach. The first phase, which kicked off late in Q3, will focus primarily on finance system upgrades and is expected to be substantially complete in 2024.

We expect to incur one-time expenses associated with the first phase of this project to be between $11 million and $13 million, of which we expect to incur between $2 million and $3 million in fiscal 2023. Now, let me provide an update on the work underway as we plan for the upcoming termination of our Walmart partnership. As we previously announced, as of February 23rd, 2024, we will transition the operations of the 229 vision centers, as well as the related optometric services for Walmart in California, to Walmart. As of June 30th, 2024, we will cease the wholesale distribution and e-commerce contact lens services that we provide to Walmart and Sam's Club through our AC Lens business and will wind down the remaining AC Lens operations.

For fiscal 2023, we expect our Walmart store operations and the wholesale distribution and related services to Walmart and Sam's Club, included in our corporate other segment, to account for approximately $355 million of revenue. The remaining portion of our AC Lens operations, which generates approximately $45 million in sales and is immaterial from an earnings perspective, will be wound down in conjunction with the overall Walmart and Sam's Club exit. Combined, the Walmart store operations and the AC Lens operations are expected to generate approximately $400 million in revenue and earnings before income tax of approximately $15 million. The annualized direct and indirect costs associated with these operations for fiscal 2023 are expected to be approximately $385 million.

We expect costs associated with these operations, including our Ohio distribution center, to be wound down in conjunction with the contract termination date. While we expect to provide our full 2024 outlook as part of our year-end earnings call in 2024, due to the Walmart contract's staggered end date in 2024, we want to provide some additional details now to help with modeling. Using 2023 as our guide, we expect revenue related to the vision center operations and the AC Lens operations in fiscal 2024 to range between $140 million and $150 million, with a margin profile similar to 2023, assuming no material degradation in the Walmart operations.

As we look ahead with an enhanced focus on our largest growth brands, we are taking actions that will further optimize our cost structure and position us to advance our long-term strategy and strengthen our competitive position. As Reade noted, beginning in 2024, we will be implementing an expense reduction program targeting annualized savings of $10 million-$12 million, focused on streamlining corporate overhead, as well as reducing travel expenses and third-party spend. As Reade noted, we are also planning to take additional non-headline pricing actions, which we believe will continue to enable us to deliver on our mission to provide affordable eye care and eyewear while maintaining a competitive position in the marketplace and leveraging our costs more effectively.

We expect the combined impact of the non-headline pricing increases and the cost savings program to more than offset the profitability gap created by the termination of the Walmart partnership. We believe these actions, combined with gross margin tailwinds from the exit of the lower-margin Walmart operations and the ongoing progress of our strategic initiatives, including the completion of the large initial implementation phase of our remote and EHR capabilities, position us well to return to mid-single-digit Adjusted Comparable Store Sales Growth and operating margins by fiscal 2025. In summary, we are pleased with ongoing progress in expanding exam capacity and expect to continue to build on this momentum as we move forward with an even greater focus on our strategic growth brands. We believe the actions we have announced today will further support our plans to drive long-term success and shareholder value.

Thank you for your time today. I will now turn the call over to Reade for closing remarks before we open the call for your questions. Reade?

Reade Fahs (CEO)

Thank you, Melissa. To summarize, we're pleased with our Q3 results and the ongoing improvement we are making regarding the strategic initiatives we've put in place this year, particularly with expanding exam capacity. While we continue to navigate an ever-changing macro environment, we remain focused on the aspects of the business we can control. With respect to profitability, we are taking actions to mitigate the impact of the termination of the Walmart partnership and streamlining our organization to align with our go-forward operating model. As we look ahead, I'm confident that we will continue to build on the progress we've made throughout this year, positioning us well to deliver on our long-term objectives. Now we'll open it up for questions.

Operator (participant)

As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question will come from the line of Anthony Chukumba from Loop Capital Markets. Your line is open.

Anthony Chukumba (Managing Director and Senior Research Analyst)

Good morning. Thank you so much for taking my question. Congrats on the strong results. You know, I found the cost savings opportunities interesting. I'd have to imagine you're gonna save a ton of money just not having Reade having to fly to Bentonville all the time. There's that. Seriously, so my first question, you know, you've talked in the past about, you know, the comp differential between managed vision care versus out-of-pocket. I was just wondering if you can just give any commentary, particularly on the out-of-pocket and whether you're seeing any improvement in the comp trend there.

Reade Fahs (CEO)

Yeah, so as you pointed out there, our Managed Care business has been really great year to date. Our Managed Care penetration started strong and just has strengthened throughout the year. You know, the great thing about our Managed Care business is that it's not our customers' money, so that's good. Also, I think the Managed Care customers have realized that their money goes further with us than it has than it does otherwise.

Anthony Chukumba (Managing Director and Senior Research Analyst)

Got it. Then, you know, you've talked in the past, you know, sort of anecdotally about, you know, seeing better cars in the parking lot is, you know, evidence of the trade down impact, and it sounds like you got some impact from that. I mean, is that sequentially getting better? I'm just trying to think about, you know, the sequential comp acceleration, how much of that was, you know, remote eye exams versus, you know, normalization of purchase patterns versus, like, trade downs. How should we kind of think about that?

Reade Fahs (CEO)

yes. Trade down continues, and we're seeing a greater percent of our customers coming from over $100,000 households, and managed care is part of that, but some relates to non-managed care as well.

Anthony Chukumba (Managing Director and Senior Research Analyst)

Got it. That's helpful. Keep up the good work. Thanks.

Reade Fahs (CEO)

Good. Thank you, Anthony and yes, I will be saving money by not going to Bentonville. That was very good.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Michael Lasser from UBS. Your line is open.

Michael Lasser (Equity Research Analyst)

Good morning. Thank you so much for taking my question. Your expectation that you can get to a mid-single digit operating margin by 2025, can you give us a bridge on the components that are gonna drive that? As part of it, how much is going to be driven by pricing? What are you finding about your ability to pass through additional price increases without disrupting the value proposition to your customer?

Reade Fahs (CEO)

I'll take the pricing side of that first, Michael. You know, we've been taking some peripheral pricing action throughout the year, non-headline pricing action, and I think we mentioned two calls ago that we were doing a deeper dive study. We're always monitoring prices, of course, but that we're doing a deeper dive study in sort of our pricing architecture relative to competition. Based on that, we have some programs that we're gonna be putting in place at the very end of this year, that as Melissa said, we think are gonna play a nice role in improving our margins next year.

Melissa Rasmussen (CFO)

Hey, Michael, it's Melissa. We're expecting that we will have some benefit into 2025 as we complete the remote implementation phase. We spoke about that earlier in the year, and with that, we'll save on some rollout expenses. We'll expect to see some gross margin improvements as we move past the Walmart lower margin business and the AC Lens distribution lower margin business. With that, we'll see some operating margin benefit as we roll into 2025.

Michael, can I follow up? Can-

Michael Lasser (Equity Research Analyst)

Yes.

Reade Fahs (CEO)

Can I just follow up on one other thing relative to the pricing side of that? We are putting in the pricing actions that we referred to. I think ever since we met, you've heard us say that we like to grow by transaction count more than by average sale, and we're very pleased that Q3 showed a positive comp transaction for the quarter. That's the way we like to grow. That was the primary focus of the growth in the quarter.

Michael Lasser (Equity Research Analyst)

Without a doubt, reade. With that being said, your implied Q4 guidance does suggest that your comp is gonna slow. A, is that what you've seen already thus far this quarter? B, why do you think it would be slower?

Melissa Rasmussen (CFO)

Yeah. Michael, we do expect some deceleration in the implied Q4 comp. We believe that's prudent, given the uncertain environment. We have factored in the current trends that we're seeing in the business. Something to keep in mind is that our comp has always factored in two key drivers. First, being the health of the consumer, and second, being the success that we have as we expand exam capacity. We are gaining traction with respect to that and controlling the factors of the business that we can control. We're pleased with the performance to date and expect to have positive comps in 4Q and full year.

Michael Lasser (Equity Research Analyst)

Thank you very much, and good luck.

Reade Fahs (CEO)

Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Zach Fadem from Wells Fargo. Your line is open.

Zachary Fadem (Managing Director)

Hey, good morning. When you look at your 4% comp in the quarter, and nearly 6% at America's Best, could you parse out the comp impact from fully staffed stores relative to the drag of understaffed and dark stores? Then maybe talk about how these metrics, each of them, have been tracking throughout the course of the year.

Melissa Rasmussen (CFO)

Yeah, sure, Zach. Related to the dark and dim stores, that number can fluctuate greatly throughout the year and year to year. It's difficult to tie a specific comp because you're not looking at the same store. Now, with that, what we have said is that we do expect to see, or we have seen, that we have, comps in line, more in line with our historical performance when it's staffed at the capacity that we desire. When we're thinking about the total sales productivity, we can talk about that from a perspective of the dark and dim impact on overall revenue. With the dark stores, that has a productivity drag of about 80% compared to a fully staffed store, and a dim store has about a 50% drag as compared to a fully staffed store.

With this, we have continued to expand our strategic initiatives in recruiting, retention, and remote. Remote is something that can help the dark and dim situation quite significantly, and that has become a factor in stores that we are looking to open. As we expand our fleet, we think about whether or not a remote state will allow us to implement remote as we're moving in there, when we think about our recruiting initiatives. Overall, remote can help, and it continues to have a positive impact as we drive forward on dark and dim.

Zachary Fadem (Managing Director)

I'm gonna try to ask that a little bit differently. What is your comp for fully staffed stores?

Melissa Rasmussen (CFO)

We haven't spoken specifically to comp on our fully staffed stores. What we did talk about is that we have our dark stores that were a percentage of our fleet at their highest of America's Best, at mid-single digit number of stores, and we're now low single digit number of dark stores. We haven't spoken specifically to comp on fully staffed versus not staffed.

Reade Fahs (CEO)

I believe I said in my comments, though, where we have the capacity, the stores are delivering comps in line with historical norms. We didn't. We aren't giving a specific number, but it is in line with historical norms.

Zachary Fadem (Managing Director)

Gotcha.

Reade Fahs (CEO)

Where we can execute our model, it works great.

Zachary Fadem (Managing Director)

Appreciate that, reade. Then just, it looks like the spread between America's Best and Eyeglass World has widened over the past couple of quarters. With your initiatives largely focused on America's Best, just curious if you could talk about the state of Eyeglass World as a concept strategically, and whether you still expect Eyeglass World to be an accelerating unit growth driver in the years ahead, and how those returns compare to AB.

Reade Fahs (CEO)

Zach, you got it 100% right. We have been focusing our, so the challenge is primarily the same. It's primarily a coverage-related challenge. We've been implementing our key programs in America's Best first, 'cause it's bigger, right? Now we are turning our attention, as we've been getting the nice success there, to taking that same playbook and applying it to Eyeglass world. Yes, it is. It is a similar challenge. We just focus on America's Best first, but we're putting the playbook in place now with Eyeglass World.

Zachary Fadem (Managing Director)

Got it. Thanks for the time.

Reade Fahs (CEO)

Thank you.

Operator (participant)

One moment, for our next question. Our next question comes from the line of Paul Lejuez from Citi. Your line is open.

Brandon Cheatham (VP of Equity Research)

Hey, everyone, this is Brandon Cheatham on for Paul. Just want to follow up on that. You mentioned how many stores at America's Best are dark or dim. You know, could you unpack that for what that looks like at Eyeglass World versus what's kind of a normal level?

Reade Fahs (CEO)

We haven't shared that. We might share that in the future. We just haven't broken that out yet.

Melissa Rasmussen (CFO)

Yeah, Brandon, we specifically spoke about the America's Best fleet because that's the larger fleet, and we wanted to quantify what that was doing to the business overall. As we thought about the dark stores, we talked specifically about the improvement that we've made related to hiring, retention, and remote rollout, and we'll, we'll look to apply that learning and playbook to our Eyeglass World stores.

Brandon Cheatham (VP of Equity Research)

Gotcha. I was wondering, you know, if we could dive in a little bit into margin impact in the H1 of 2024. You know, I believe that, you know, the contact business had increased costs that, you know, is impacting the back half of this year. You know, can we expect a similar headwind in the H1 of next year? Then just the timing of the AC Lens business rolling off, which I believe is a lower margin business than your Walmart stores. You know, should we see incremental pressure in the H1 of next year, and then, you know, as that rolls off, things improve from there?

Melissa Rasmussen (CFO)

yeah. We'll talk more specifically about 2024 as we release our year-end guidance. What we did put out related to AC Lens and Walmart, we did want to quantify what the impact of that roll-off would be because of the staggered end date. We put out that the expected revenue would be between $140 million and $150 million, with a similar profit profile to what you're seeing in 2023. We do expect that we'll continue to have, as we go into Q4, the gross margin headwinds and tailwinds that we've spoken about previously. The quarter and the year has played out largely as we had expected. We have had doctor cost headwinds offset by exam pricing benefits and expanded exam capacity.

In addition, we have seen some product favorability from freight expense as well as some additional product favorability.

Brandon Cheatham (VP of Equity Research)

Got it. I appreciate it, and good luck.

Melissa Rasmussen (CFO)

Thank you.

Reade Fahs (CEO)

Thank you.

Patrick Moore (COO)

One moment, our next question. Our next question comes from the line of Adrienne Yih from Barclays. Your line is open.

Adrienne Yih (Managing Director)

Great. Thank you so much. Good morning. Reade, happy to hear the progress on the remote exam, but I think what would be super helpful, at least for me, would be sort of more the, the long range plan. Definitely you're making progress kind of quarter by quarter, but maybe on a three-year basis, could you talk about the pace of remote implementation possibly slowing? I think I heard that correctly next year. It just seems like such low - I mean, I'm not gonna say low hanging fruit, but it seems like it, it's such an impactful when you, when you get, you know, the, the coverage on the exam. Are there, well, I guess I'll, I'll ask it. Can you share with us your sort of base case, kind of status quo, if you don't, if you kind of do it as planned?

Then maybe I'm sure you have an upside sort of accelerated, you know, big goal, right, over that same time horizon. Does that require, you know, you just to go faster with what you're doing, or are there disruptive technologies that you can implement? I know it's a very long, long-winded question, but it just seems like there's so much opportunity over the one, two, and three year horizon to get to that 5% and higher. If you can speak to that, and then I have a follow-up for Melissa. Thank you.

Reade Fahs (CEO)

Good, Adrienne, and first, I'm gonna turn it over to Patrick, who's the captain of our remote initiatives here, but I just wanna—it was a little hard to hear you, so I'm gonna just serve it up. It's understanding the expansion game plan. Adrienne agrees that it's a huge opportunity. I think there was a little bit of a why not go faster aspect to the question. Patrick, take it, could you handle that?

Patrick Moore (COO)

Yeah, Adrienne, I'll follow up your long-winded question with a long-winded answer. How about that?

Adrienne Yih (Managing Director)

Great.

Patrick Moore (COO)

No, I do wanna unpack, I do wanna unpack that a little bit. I'm glad you asked that question. Just, you know, as a precursor, great results out of remote. We're seeing it as a win for doctors, patients, store teams. It's driving incremental sales, incremental comps, incremental profitability. As a side note, we will be EBITDA profitable this year, as expected, after being diluted last year. Melissa talked about the benefits of remote for dark and dim. I won't recover that, but that's a big factor. We're on track to set up another 200 this year, taking us to 500, and really just kind of brings the first big initial phase to a close. We still have future phases, but there's really a couple of things there.

A, we have now equipped two-thirds of the states where we operate America's Best. While there is opportunity remaining in some other states, and there are a couple of few larger states out there that we look forward to hopefully equipping one day, we are at critical mass now. Remote has become a really big factor in our site selection for new stores as well. You know, this slowing is both natural, based on what we've done thus far, but we're also kind of continuously monitoring state regulatory and navigating state regulatory rules and looking for other states to open up. You know, my own belief is that over time, telemedicine will become more and more normal and natural, but it's gonna, it's gonna take a while.

You know, as we look, as we've always said since earlier this year, as we clear the big initial investment phase of remote, we are looking to see, you know, about a turn of operating margin improvement. We have guided towards that happening in the H2 of 2024, you know, by the end of the H2 of 2024, and still feel really good about that. Pace is slowing based on good work. Pace is slowing based on our confidence to take our model into each state, which can have varying rules. Again, we monitor that super closely, and we'll be looking to take more states into remote. It just won't be quite as broad scale and lumpy as this first big phase.

Adrienne Yih (Managing Director)

Okay, just a quick follow-up to that. Is there an alternative technology or newer technologies that you're testing that you have not yet implemented?

Patrick Moore (COO)

You know, in the States, it really comes down to what do regulatory bodies allow for a full health exam. We believe we have as good, maybe the best remote exam out there in the market today. It's probably less about, you know, us doing things differently and more about us kind of navigating into those states, and maybe even those states becoming a little more open to telemedicine.

Reade Fahs (CEO)

I'll also say this, technologies evolve and new technologies emerge, and we are generally testing a couple of different things in the area of exam technology, and who knows what will be invented, who knows what will be made legal, but we'll be ready on both those fronts. Remote's sibling, electronic health records, I think we are-- we're saying by the end of next year, all of America's Best will have electronic health records.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Brian Tanquilut from Jefferies. Your line is open.

Taji Phillips (Equity Research Senior Associate)

Good morning, and great job on the quarter. You have Taji on for Brian. Maybe I'll kick off with a question on optometrist labor first. It'd be helpful maybe if you'd provide some KPIs to help us understand how optometrist capacity has been trending quarter-to-quarter, you know, things like ads, turnover, and retention. Then also, as you continue to roll out remote, I know it's still in early phases, but can you detail the impact on average productivity per clinician? Then I have a follow-up.

Reade Fahs (CEO)

good. While we don't quantify specific capacity levels, I think if we're saying retention has improved for the second year in a row, that our recruitment is gonna deliver a second record year and record new grads who tend to start in July and August. Then Patrick just went through the remote successes, those do add up to improved capacity.

Patrick Moore (COO)

Yeah, in terms of remote doctor productivity, we're laser focused on continuing to improve that through really three key emphasis areas. The first is just the technological optimal alignment of supply and demand, doctors to patients. Remote has introduced complexity into what was a more simple model for scheduling. We continue to improve our scheduling capabilities, we continue to improve training and feedback loops for doctors and technicians and store associates. Then finally, you know, a lot of the time, it comes down to the remote software and electronic health record interfaces. We have teams that are continually making those more streamlined and fluid for doctors. Our expectation is remote doctors will, you know, at least mirror the productivity of in-line doctors, and again, in some theoretical manner, I see them going to surpass that over time.

Reade Fahs (CEO)

Yeah, I certainly hope you're taking away that we are pleased with our progress in capacity expansion. As we like to say, retain, recruit, remote. I think that is showing in our Q3 results. As we said, positive comp transactions because we're able to offer more eye exams and this more exam appointment slots. This remains our constant focus, and we'll be now bringing that playbook to Eyeglass World.

Taji Phillips (Equity Research Senior Associate)

Absolutely, and really appreciate the color. To switch topics a little bit, on managed care penetration, I mean, clearly, that's been trending really well throughout the year. As we look at this on a long-term basis, you know, Reade, maybe can you talk about, you know, where you think the high water mark is in terms of just penetration in the managed care population as it relates to your entire book of business? And, you know, I guess what it would take to get there.

Reade Fahs (CEO)

So, we only publish our Managed Care penetration once a year because of changes in seasonality and the like. The last time we said it was a third of the business, we've been repeating that it's been very healthy and getting healthier throughout the year. I think what has been discovered is that by customers with some help from our marketing, that we're a great place to use your Managed Care benefits. Of course, there's also the word-of-mouth side of that. You have the same Managed Care as your coworkers, and you tell them about your good experience, and that snowballs from there. W, I'm not sure there is a high water mark.

I think it will continue to grow. I think we are on a roll here, and so I think when we publish our number at the end of the year, it's gonna be up nicely, and I would expect that to continue.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Simeon Gutman from Morgan Stanley. Your line is open.

Simeon Gutman (Director)

Hey, good morning, everyone. Pace of openings for the go-forward in terms of new units, is that commensurate, so you don't have Dark or Dim stores? Then can you speak to, you mentioned the new hires from this recruiting class. Can you talk about the prevailing wage that you're hiring at versus the prevailing wage of your system?

Patrick Moore (COO)

Hey, Simeon, good morning. It's Patrick. Hitting on new stores, I do want to add that, you know, assuming the year end-of-the-year timing works out well, we do expect to be at the, hopefully, the tip top of that 65-70 range for 2023. We're happy, really happy with what we've accomplished over the last two years for our real estate and store teams in terms of continuing the unit growth. In terms of how we're thinking about next year, hey, look, we're, you know, we're in the midst of planning. I will tell you that there are a lot of factors that come into that, as every year. You know, state, site brands, doctor recruiting, optionality for remote has become a significant factor, as it is, it is not plan A, but it is a really nice plan B.

We're looking at all that very carefully right now and expect to be able to share those details with you in, as we close the quarter in Q4. W, you know, rest assured, we're still focused on taking advantage of the White Space Opportunity that remains in front of us, while carefully balancing the, you know, the other dynamics that we mentioned.

Simeon Gutman (Director)

Okay.

Melissa Rasmussen (CFO)

Well, I-

Simeon Gutman (Director)

Then a follow-up. Oh, sorry, go ahead.

Melissa Rasmussen (CFO)

Oh, I'm sorry. This is melissa. Just to add onto that a little bit about the doctor component. We don't expect that the supply environment will change as it relates to doctors anytime soon. W what we are doing, we had implemented a incentive compensation program to incent the doctors to be more productive, and that would - their level of productivity would drive their incentive compensation. In addition to that, as far as base wages go, we had previously seen wages expand in the low single-digit range historically, and now that's closer to the mid-single digit range, and we do expect that going forward at this time. We will leverage our cost structure at mid-single digits, and we've laid out the plan to get back to mid-single digits as we roll into 2025.

Simeon Gutman (Director)

Thanks for that. Then my follow-up is on SG&A. I saw the factors in the release, especially regarding, I think, incentive comp, which you just mentioned. Can you talk about advertising expense? Is that - are you spending along the lines at which you planned, or did you spend any more? Then the outlook for that for the rest of the year, please.

Melissa Rasmussen (CFO)

yeah. With advertising, we do see a little bit of advertising leverage as we move into the Q4. that's just due to more productive advertising that we're expecting to have. SG&A overall, yes, we will expect to deleverage for the full year, and that is largely related to the incentive compensation reset that we spoke about initially with our year-end release.

Simeon Gutman (Director)

Thanks.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Dylan Carden from William Blair. Your line is open.

Reade Fahs (CEO)

Thank you. Just curious, what % of your stores are dim? Sorry if I missed that. Do you count a store as dim if it's got remote capacity? Maybe how that's trended over time.

Melissa Rasmussen (CFO)

Hey, Dylan. We didn't specifically quantify the number of Dim stores because that number changes quite significantly, because Dim is less than three days of coverage. If you have part-time doctors, you may be Dim one week and not the next week. That number is a little bit harder to nail down, but we were able to nail down the productivity drag for a Dim store, which is about 50% of a productive, fully productive store. Now, with that, we are enabling remote in as many stores as possible that are specifically impacted by Dark and Dim, and that increases the productivity, you know, in double-digit range based on adding remote to a Dark or Dim store.

Reade Fahs (CEO)

So, can you just directionally give us a sense of how, I mean, if you can nail down the productivity, I guess, how many stores are you counting in that calculation? Just sort of how that's worked through the year.

Broad strokes.

Melissa Rasmussen (CFO)

With dark stores, we talked specifically about, we've improved that from the mid-single digits at the high point to, now we're at low single digits. With dim stores, again, that number changes quite significantly and, from period to period, year to year. We will continue to figure out ways to explain that to you all, but dark is the one thing that we can nail down. We do have more dim stores than dark stores, and that impacts, though, as I said, with dim stores is a little bit less than it is with dark stores. We'll continue to work on that. We'll continue to put remote into those stores and increase productivity at, with, with the levers that we do have.

Dylan Carden (Equity Research Analyst, Consumer)

Okay. Then in the services and plans segment, just thoughts on kind of the margin degradation, and plans to kind of get that back, if you can get it back to more historical ranges?

Melissa Rasmussen (CFO)

yeah. What we had talked about initially was that we would continue to expect to see the doctor cost headwinds, and that is being offset partially by the exam expansion and exam pricing initiatives. We will continue to work to get back to mid-single digits, which will leverage that cost structure. With the warranty plans revenue, that that's a component that you know our stores will be working on, and we'll continue to expand those offerings so that we can service our customers.

Dylan Carden (Equity Research Analyst, Consumer)

Thank you.

Operator (participant)

Thank you. One moment for our next question. Our last question for today will come from the line of Molly Baum from Bank of America. Your line is open.

Molly Baum (VP of Equity Research)

Hi, thanks for taking my question. I just had one quick one, kind of high level on the competitive landscape. You know, I know you talked a little bit about, you know, you're leveraging marketing and advertising dollars a little bit better. You know, other competitors this week have announced that they're returning to growth in marketing and advertising dollars. Just curious how you feel about the, you know, current competitive landscape. Then I guess on top of that, how you're thinking about Walmart as a competitor now that they're taking their optical business in-house. Thank you.

Reade Fahs (CEO)

Good. Overall, we haven't seen significant changes in the competitive landscape. Yes, we're aware that one competitor did announce more aggressive marketing efforts. You know, you've got to just think about market share in this category, because it is just a highly fragmented category. An increase in marketing spend from one competitor doesn't drive massive pieces, and especially sort of different competitors attract different customer bases. Ours is a more lower income, budget conscious, less high-end consumer. Oftentimes we're talking to different consumers in our marketing.

While Walmart is, yes, sort of taking the 227 stores, we're not expecting them to be a more aggressive competitor, and they do not historically do marketing of their vision center business. In general, the competitive landscape, I think is pretty similar to the last call that we did, and ecommerce has stayed very stable for a long time as a percentage of the business, of the category.

Molly Baum (VP of Equity Research)

Got it. That's it for me. Thanks so much. Appreciate it.

Reade Fahs (CEO)

yeah. W I would like to just point out one other thing is to your first piece, even in light of some competitive marketing increases, positive comp transactions for Q3. They're still coming in.

Operator (participant)

Thank you. I would now like to turn the conference over to Reade for closing remarks.

Reade Fahs (CEO)

Great. Hey, thanks, everyone, for joining us today. Well, yeah, we're pleased with the Q3, on track to deliver on our objectives for the year. The macro environment, of course, is uncertain, but we're pleased with the customer count growth, both for Q3 and year to date, and believe it supports the progress we're making in our key strategic initiatives, especially in the area of building capacity, so that we can provide eye exams to the patients and customers who wanna come to us. We appreciate your interest and support. We look forward to talking to you and taking you through our Q4 earnings next year. Thank you very much.

Operator (participant)

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.