National Vision Holdings, Inc. (NASDAQ:EYE) Q3 2022 Earnings Call Transcript

National Vision Holdings, Inc. (NASDAQ:EYE) Q3 2022 Earnings Call Transcript November 10, 2022

National Vision Holdings, Inc. beats earnings expectations. Reported EPS is $0.15, expectations were $0.13.

Operator: Thank you for standing by, and welcome to the National Vision’s Third Quarter 2022 Earnings Conference Call. As a reminder, today’s conference call is being recorded. I would now like to turn the conference over your host, Mr. David Mann, Senior Vice President of Investor Relations. Please go ahead, sir.

David Mann: Thank you, and good morning, everyone. Welcome to National Vision’s Third Quarter 2022 Earnings Call. Joining me on the call today are Reade Fahs, CEO; Patrick Moore, Chief Operating and Financial Officer; and Melissa Rasmussen, CFO-elect. Our earnings release issued this morning and the presentation, which will be referenced during the call, are both available on the Investors section of our website, nationalvision.com, and a replay of the audio webcast will be archived on the Investors page after the call. Before we begin, let me remind you that our earnings materials in 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 in today’s presentation also includes 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 2 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 on the Investors section of our website. Now, let me turn the call over to Reade.

Reade Fahs: Thank you, David. Good morning, everyone. Thank you all for joining us today. Let’s start with Slide 4 and a summary of Q3. For the third quarter, net revenue decreased 3.6% and adjusted comparable store sales declined 8.1% compared to the third quarter of 2021. We delivered adjusted diluted EPS of $0.15 for the quarter. Our third quarter performance was impacted by the continued weaker consumer environment as well as constraints on our exam capacity. The macro headwinds, including higher inflation, weaker consumer confidence and risks of recession are pressuring our lower income predominantly uninsured customers. But at the same time, we saw a broadening in our customer base and an acceleration in trade down of higher-income customers into our stores.

In terms of constraints to our exam capacity, we’re making sequential progress through improved retention, strong hiring and remote medicine. While our exam capacity remains out of sync with our needs in certain markets, which, of course, affects patient traffic, we expect exam capacity to gradually improve into 2023 and throughout next year. As we address these challenges, we’re also focused on our growth initiatives. We opened 18 stores, including a record 7 Eyeglass World locations and we are currently enabled with remote medicine in approximately 300 stores, which is 2 months ahead of our year-end target. Also, as shared in August, we signed a multiyear extension of our current lens purchasing agreement with EssilorLuxottica. We’re proud to have released our 2021 sustainability report last week, providing more in-depth disclosure of the progress we’re making on our ESG journey.

Finally, in today’s release, we reaffirmed our 2022 outlook for revenues and profitability. In a few minutes, Patrick and Melissa will provide more detail on our Q3 results and our 2022 outlook. Turning to Slide 5. As the chart shows, before the pandemic, our business demonstrated quite consistent performance over time, even amidst broader economic challenges. The historical consistency of the optical category has been impacted by macro headwinds, especially higher inflation and temporary disruption to the purchase cycle that began with the start of the pandemic and has been exacerbated by the multiple waves of COVID variants. The chart on Slide 6 highlights the volatile quarterly comp performance over the last 2 years and the purchase cycle disruption caused by the pandemic.

The optical category has been inherently consistent over time due to the biology of the eye and we believe we will see a return to more stable and predictable environment in the future. In terms of third quarter trends, optical consumer demand continues to be impacted by inflationary pressures and weaker consumer confidence. This weaker demand is also being felt more broadly in the industry. During the quarter, our back-to-school season was better than last year as we experienced more engagement with traditional younger school-age patients. Although we were not back to historical pre-COVID seasonal levels, we were encouraged by this movement to a more normal purchase cycle and seasonality. At the same time, we experienced weakness in broader seasonal traffic due to the macro environment and constraints to exam capacity.

Near the end of the quarter, Hurricane Ian impacted our store operations in Florida. Of course, the greater concern was with the well-being of our associates and optometrists, their families and everyone affected by this natural disaster. Our hearts go out to the people whose lives were so disrupted by the storm. We work closely with our internal store teams to help associates, optometrists and customers in need. At Ian’s peak, we had over 100 temporary store closings and 1 store still remains closed due to damage. We estimate the revenue impact was approximately $2 million or a comp impact of approximately 40 basis points with a disproportionate effect Eyeglass World due to its concentration of stores in Florida. We would expect to recover these sales in Q4 and into 2023.

Let me expand a little more on what we’re seeing in terms of consumer behavior. Our lower income, predominantly uninsured consumers are feeling the greatest pressure. Demand softness is noticeably more pronounced for these customers who are paying out of pocket for our products and services, as our insured business continues to comp positively this quarter. In Q3, we also experienced an acceleration of the trade down of higher-income consumers into our stores that began in the first half of 2022, what we have referred to in the past as nicer cars in the parking lot. We’re encouraged by this trade down acceleration and would expect it to build further over time as that is what happened during the last recession. In the current inflationary environment, we believe our value offering should be ever more appealing to an ever larger slice of the American public.

Our business continues to face constraints on exam capacity in certain markets. In other words, demand for exam appointments in some stores goes unfulfilled due to the lack of an available optometrist. Our team is making incremental progress on key initiatives to expand our exam capacity. First, retention levels remain up versus last year. This is a testament to our multiple initiatives to drive retention. In terms of hiring, our increased investments in recruiting continued to pay off. Year-to-date, we’ve experienced strong hiring of optometrists. During Q3, we saw the arrival of the wave of new hires that began to practice in our stores. Lastly, we remain excited about the progress of our remote medicine rollout. As noted in today’s earnings release, remote medicine is currently enabled in approximately 300 stores, thereby achieving our year-end target ahead of schedule.

With the rollout of remote medicine and electronic health records at our stores, associates and optometrists learn new operating processes, which come with a learning curve. In stores that have performed remote exams for the longest period, we’re continuing to see a significant ramp in operating productivity. We are pleased with the incremental increase in exam capacity being added by remote medicine and the role it can play in serving more patients across both geography and time. Because of these initiatives, we expect that our exam capacity should gradually improve going into 2023 and throughout next year. So we’re in an unusual situation today, in that, we are simultaneously facing both demand headwinds across our network of stores given the current macro environment as well as a supply challenge in a subgroup of stores due to the constraints up on exam capacity, but we see these as temporary and we remain confident in the long-term strength of our business model.

Shifting to Slide 7. We continue to progress our core growth initiatives. In terms of store expansion, we continue to see a sizable white space opportunity with growth for many years to come. We had 18 openings in the third quarter, including a record 7 Eyeglass World locations as we ramp up the expansion of this brand. We expect to open at least 80 stores in 2022 and currently have a solid pipeline of specific locations into 2023. Our real estate team has done a fantastic job navigating the growing supply chain challenges. Marketing continues to be a key factor in driving traffic to our stores, given the infrequent purchase cycle for eyeglasses. In the current environment of high inflation, we believe budget-conscious and trade-down consumers are finding us attracted by our value messaging and positive word of mouth.

We continue to focus on marketing efficiency and are pleased to be leveraging marketing expenses this year. Our participation in vision insurance programs continues to be a positive revenue driver, especially in the current environment. In the third quarter, we experienced growth in sales tied to vision insurance as insured consumers because the insurance funds most or all of their purchases are not deterred from shopping in a tight economy. Our comps related to managed care were positive and continued to outperform comps for uninsured consumer. We remain underdeveloped relative to the category and continue to see an ongoing opportunity here as managed care dollars and co-pays tend to go further in our stores than elsewhere. At this point, let me turn the call over to Patrick for a more detailed discussion of our financial results and the 2022 outlook.

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Patrick Moore: Thank you, Reade, and good morning, everyone. Let’s start on Slide 9 with third quarter financial details. In Q3, net revenue decreased 3.6% compared to 2021 due to macroeconomic headwinds and constraints to exam capacity. The timing of unearned revenue negatively impacted revenue growth by 0.4%. During the quarter, we opened 11 new America’s Best stores and 7 Eyeglass World stores for a 5.5% increase in store count. For our America’s Best and Eyeglass World growth brands combined, unit growth increased 7.4% over the last year. Adjusted comparable store sales declined 8.1% versus 2021. As Reade noted, we estimate that Hurricane Ian impacted our Q3 comps by approximately 40 basis points. Q3 comparable store sales were impacted by a decline in customer transactions.

Average ticket was flat year-over-year. We’re pleased that our average ticket has stabilized this year, helped by pricing actions and successful product enhancements like Blue Light. Turning to Slide 10. As a percentage of net revenue, cost applicable to revenue increased 209 basis points or better than our expectations of a 400 to 425 basis point increase. This increase was driven by deleveraging of optometrist-related costs, reduced eyeglass mix and lower eyeglass margin. The better-than-expected performance primarily resulted from the stable average ticket. Adjusted SG&A increased 3.9% and adjusted SG&A expense percent of net revenue increased 320 basis points. Our store and marketing teams continue to execute disciplined cost management this quarter.

The key factors behind this increase was the deleverage of store payroll, corporate overhead and occupancy expense, partially offset by lower advertising investment. We continue to expect advertising to be slightly leveraged in 2022. Adjusted operating income decreased 61% to $21.5 million and adjusted diluted EPS decreased 60% to $0.15. Turning to the year-to-date 2022 results on Slide 11. Compared to 2019, despite the challenges this year, net revenue increased by approximately 16%. Adjusted diluted EPS increased nearly 5%. At this point, I’ll turn the call over to Melissa to discuss our financial position.

Melissa Rasmussen: Thank you, Patrick, and good morning, everyone. Turning to Slide 12. As I transition into the CFO role at year-end, I am inheriting a strong balance sheet and excellent liquidity to support our growth strategy. We are in this enviable position as a result of Patrick’s stewardship over the last 8 years, and I plan to continue executing the long-term financial strategy that we have developed. At the end of third quarter, our cash balance exceeded $256 million with total liquidity of nearly $550 million when including available capacity from our revolver. We ended the quarter with total debt of $568 million. Net debt to adjusted EBITDA was 1.5x. I want to take a moment and highlight one item related to our term loans debt and the hedging that we have in place.

In the first quarter of 2020, we hedged our term loan debt using an interest rate collar. While the term loan has a variable LIBOR-based interest rate, this debt is more than fully hedged by the interest rate caller due to voluntary term loan prepayments made in 2020 and 2021. As a result, when our LIBOR rate passed 1.8% in late July, we began to receive payments from our counterparty, which totaled $400,000 this quarter. Based on the current rate outlook, we expect to continue to receive counterparty payments in the fourth quarter. These payments are helpful to our net interest expense and cash flows are incorporated in our lower interest expense outlook provided today. Year-to-date, we funded $86 million in capital expenditures that were primarily focused on new store and customer-facing technology investments.

We remain on track for 2022 CapEx in the range of $110 million to $115 million as we continue to invest in key growth initiatives, including our remote medicine rollout. We did not repurchase any shares of common stock in this quarter and have $50 million remaining under our current share repurchase authorization. At the end of third quarter, inventory per store declined more than 7% on a year-over-year basis. Our inventory levels are in good shape, and we are comfortable with the ability to support our growth plans. Our merchandising and distribution teams continue to execute well to help us manage through the current challenging supply chain environment. Overall, in this environment, we believe that our financial strength and our commitment to invest in our business remain a competitive advantage.

Let me turn the call back over to Patrick for a discussion of our outlook.

Patrick Moore: Thanks, Melissa. Turning now to Slides 13 and 14. I’ll conclude with some commentary regarding our 2022 outlook, which we included in today’s earnings release. As we all know, the dynamic operating and macro environments remain extremely uncertain, our fiscal 2022 outlook reflects the currently expected impacts related to macroeconomic factors, including inflation, geopolitical instability and risk of recession as well as the ongoing COVID-19 pandemic and constraints on exam capacity. Given the uncertain environment and continued forecasting challenges, we are maintaining a more conservative posture for our outlook. Against the backdrop of what we know today, we are reaffirming our 2022 outlook as follows: Net revenue in the range of $1.99 billion to $2.02 billion, representing adjusted comparable store sales growth in the range of negative 6.5% to negative 8% with at least 80 store openings.

Adjusted operating income between $85 million and $100 million and adjusted diluted EPS between $0.65 and $0.77, assuming 80.1 million weighted average diluted shares. Even amidst a difficult macro backdrop, we are continuing to invest in the business and key initiatives and our store growth and capital expenditure plans remain unchanged. Our ongoing commitment to investment is further evidence of our confidence in the future of our business. Let me provide some underlying assumptions in our outlook. As you model the fourth quarter, we continue to expect comps to be in the negative low to mid-single-digit range. In terms of profitability, we would look for fourth quarter adjusted operating income to be slightly negative. We expect Q4 profitability to be impacted by expense deleverage during our seasonally low period as well as 2 additional factors.

First, we now expect that the timing of unearned revenue will have a negative impact in 2022 of about $10 million to $11 million, a slight increase from our previous estimate, with the impact to be realized in Q4. As a reminder, unearned revenue recognition is a 7- to 10-day timing impact only that can affect our quarter-to-quarter and annual comparisons. Second, we elected to make an incremental $2 million wage investment for retention bonuses primarily for district managers and store managers. For full year 2022, as a percentage of net revenue, we now expect cost applicable to revenue to increase approximately 290 to 300 basis points versus last year, primarily due to the deleveraging of fixed costs as well as lapping last year’s record performance that benefited from product mix shifts and an elevated ticket.

For Q4, costs applicable to revenue are expected to increase about 300 to 325 basis points versus last year or similar to the trend experienced during the third quarter. In terms of expenses, we expect 2022 adjusted SG&A to increase approximately 195 to 205 basis points as a percentage of net revenue year-over-year. The SG&A increase primarily reflects sales deleveraging and to a lesser extent, higher levels of wage investments with a partial offset from advertising leverage. To assist with modeling, we have also provided updated assumptions for depreciation, amortization and interest. The lower net interest expense assumption reflects the positive benefit in the current higher rate environment from our hedges and interest income on cash balances that Melissa highlighted.

In summary, while there are significant challenges in the current environment, I have every confidence in the underlying health of our business and our value proposition. Our company has experience with successfully weathering difficult market conditions, and we continue to view the current issues as temporary. In the interim, our management team is focused on what we can control continuing to invest in key growth initiatives and taking the necessary actions now to emerge from the pandemic era stronger than ever. On a personal note, I’ll be transitioning full time to Chief Operating Officer in the next couple of months after 8 years as CFO. As COO, I’m looking forward to continuing to help the company achieve our long-term mission and execute our strategic plan.

I could not be more confident in handing off the CFO role to Melissa, as she is an outstanding leader, trusted colleague and talented financial executive. And with that, I’ll turn the call back to Reade for closing remarks.

Reade Fahs: Thank you, Patrick and Melissa. Turning to Slide 15 and our Moment of Mission. We are proud to have recently published National Vision’s 2021 Sustainability Report, guided by our ESG strategic framework, this detailed report covers our impact on society and highlights the progress of our efforts across environmental, social and governance activities. The report shares many impressive data points as well as some of our goals for the future. For example, we had a fivefold increase in our annual impact for philanthropic activities, and we shared our intention to impact at least 5 million people through our philanthropic efforts in the next 5 years. For full details on our activities, you can access the report via the link in the presentation or on the corporate responsibility page of the National Vision website.

I’m also pleased to note that our ESG programs and disclosures are being acknowledged by key stakeholders and ESG radar. Following our first corporate responsibility report last year, our MSCI ESG rating was recently increased to AA from BBB. National Vision is now considered a leader in our industry sector. I want to thank our entire team at National Vision and network of optometrists who provide much-needed medical services to patients at over 1,300 storefronts every day and to the ecosystem of the philanthropic partners we work with, including VisionSpring, RestoringVision and the International Agency for the Prevention of Blindness. In summary, the key takeaways from today’s calls are these: after 18 years of consistency and predictability, the pandemic era has temporarily made the optical market our business more volatile.

We believe that the marketplace over time should return to trends more consistent with the pre-COVID era, especially as our customers’ eyes only continue to get worse with time as we remain a low-cost provider of this medical necessity. We operate in a highly fragmented industry with ongoing structural tailwinds, such as an aging population and increased eye strain from such things as greater screen usage, and we believe that several initiatives, including our remote medicine rollout should help us to get our exam capacity more in line with the demand that there is for exams at our stores. Thus, despite the current challenges, our confidence in our mid- and longer-term prospects remain unchanged. This concludes our prepared remarks. And at this time, I’d like to turn the call back to the operator to start our Q&A session.

Q&A Session

Operator: Our first question comes from Zack Fadem of Wells Fargo.

Zack Fadem: So first question for me is on your structural margin profile. As going back to 2019, this was a mid- to high single-digit operating margin business that accelerated to nearly 10% in 2021. So as we look at sub 5% margins today, could you walk us through the puts and takes around where the business should ultimately land as your sales levels normalize in 2023 in the years ahead?

Patrick Moore: Sure. I’ll start with — we do a lot of margin comparisons back to 2019, found that that’s the last most consistent year. And as you fast forward up to 2022, there’s just a lot of distortion in us being kind of off our original sales plan by a couple of hundred million and turning in comps and the negative 7%, negative 8% range on the year for our guide. And so I don’t consider this year a great year to do the margin analysis because you are going to see some deleveraging. But yes, you are right, we’re aiming towards a 4.5% to 5% operating margin this year that was 6.6%, 7.8%, 9.8% over those few years with the 9.8% high watermark being reached due to just incredible demand and a really elevated average ticket.

If I kind of go back and think, what really changed, okay? As we just think about margins since that time, gross margins have really held up nicely. I mean we’ve had some cost pressures there with investments and wages for optometrists. We’ve had some pressures there a little bit for cost of sale, a little bit for rate, and none of those have been huge, and we’ve managed them well and it’s been offset with, number one, productivity increase in our labs every year, and second, some of the pricing. So as I look at gross margin, it’s been fairly stable. SG&A is more deleveraged. If I were to give you kind of a normalized version of where SG&A margins moved structurally, I would say, a little wage inflation for associates, which I think we’ve managed pretty well; a slight deleveraging of advertising, but we are going to leverage this year even amid that $200 million miss; and then from there, rents are up a little.

Some of the areas where we have seen the most cost increase and deleverage is, frankly, in our corporate headquarters, and that’s really around key growth initiatives. And what we’ve decided there is to kind of accept the short-term deleverage, betting on the growth propulsion coming out of the capital that we’re in now. That’s been our remote medicine initiative, very significant, Reade mentioned it. We’ve already hit our 300 stores. We’ll be doing a lot more of those next year. That includes omnichannel initiatives, that includes kind of beefing up in areas around doctor recruiting and retention. So we have made some very definitive investments there and have held on to that cost again, being willing to take the short-term leverage to come out of that in better shape in the future.

As I think about margins, again, it’s tough to talk from a base of negative 7% comps. But as we move into a more kind of a normal future, I think, where disruption to purchase cycles is decreased, deferrals are less, I think we’re going to see a similar gross margin story. Those same factors that I mentioned affecting us from 2019 to ’22, will probably going to all still be there, both pro and con. And then below the line, we probably will see a little bit of wage inflation still, but I’m expecting that we’re going to continue to leverage advertising. I think that we will eventually leverage corporate overhead. So I see us having a good chance to get back to the trajectory we were on as we move from ’19 through ’21, noting that ’21 was really — was a high watermark.