National Vision Holdings, Inc. Q2 FY2022 Earnings Call

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

Thank you, and good morning, everyone. Welcome to National Vision’s Second Quarter 2022 Earnings Call. Joining me on the call today are Reade Fahs, CEO; and Patrick Moore, COO and CFO. 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 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 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 expects to provide certain supplemental materials or presentations for investor reference on the Investors section of our website. Now let me turn the call over to Reade.

Thank you, David. Good morning, everyone. Thank you all for joining us today. I hope you’re all staying safe and healthy. Turning to Slide 4 and Q2 summary. For the second quarter, net revenue decreased 7.3% versus our record Q2 sales last year, and adjusted comparable store sales declined 12.4% compared to the record 76.7% increase in the second quarter of 2021. We delivered adjusted diluted EPS of $0.21 for the quarter. We’re pleased with the bottom line performance this quarter, which reflected the team’s strong focus to manage expenses. We expect that our second quarter performance would be impacted by the weaker consumer environment as well as constraints on our exam capacity. As the quarter progressed, economic conditions for consumers further deteriorated. The macro headwinds, including higher inflation, weaker consumer confidence and risks of recession are continuing to pressure our lower-income, predominantly uninsured customers, especially when compared to record demand last year. In terms of constraints to our exam capacity, we feel incrementally better about our capacity situation. While exam capacity remains out of sync with our needs in many of our stores in certain markets, thereby affecting patient traffic, we’re making sequential progress towards improved retention and strong hirings and continue to project exam capacity to gradually improve by year-end. Despite these challenges, we continue to focus on our growth initiatives. We opened 22 stores, including our 1,300th location and now operate over 1,000 stores in our 2 growth brands. We continued our rollout of remote medicine and are on track to operate in up to 300 stores by year-end. Also, we recently announced a multiyear extension of our current lens purchasing agreement with EssilorLuxottica. We’re excited to extend this relationship with a key long-term partner that allows us to continue to provide our patients and customers with world-class quality lenses at the low price they have come to expect from us. During the quarter, we repurchased $73 million worth of stock to continue our shareholder return program. Finally, in today’s release, we updated our 2022 outlook. We’ve made significant progress in our cost alignment efforts that should temper the impact of the lower projected revenues on profitability for the year. In a few minutes, Patrick will provide more detail on our Q2 results and updated outlook. Turning to Slide 5. As the chart shows, before the pandemic, our business demonstrated consistent performance over time, even amidst broader economic challenges. During the Great Recession of 2008 and 2009, our business generated comps in the positive low- to middle-single digits. During the pandemic, the historical consistency of the optical category has been impacted by macro headwinds, especially higher inflation and temporary disruption to the purchase cycle that has been exacerbated by the multiple waves of COVID variants. The chart on Slide 6 highlights the volatile quarterly comp performance over the last 3 years and the purchase cycle disruption caused by the pandemic. Turning to Slide 7. The comp volatility was especially pronounced in the second quarter as the chart in the upper right shows. In addition to the disrupted purchase cycle, optical consumer demand is being affected by inflationary pressures and a decline in consumer confidence as well as lapping government stimulus from last year. During the quarter, we experienced modest improvement in comps each month. And as we are now in the third quarter, the back-to-school season has begun amidst the ongoing economic uncertainties. For us, the back-to-school season consists of 2 consumer segments, children getting glasses for school as well as a seasonal return of adult customers. While it’s still quite early, we’ve seen a ramp in the traditional younger back-to-school patients. However, we’re also experiencing weakness in broader seasonal traffic due to the macroeconomic environment and constraints to exam capacity. Let me expand a little more on what we are 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. Last quarter, we noticed that we’re seeing the beginnings of a trade-down of higher-income consumers into our stores, what we’ve referred to in the past as 'nicer cars in the parking lot.' We especially are seeing stronger trade-down behavior in markets where our stores are exposed to higher concentrations of higher-income consumers. We continue to be in the early stages of this trade-down and would expect it to build over time. As noted on our last call, we implemented a pricing change to our signature offer at America’s Best in May. Thus far, the consumer reaction is consistent with our expectations. We continue to believe that the signature offer of 2 pairs of eyeglasses, including a free eye exam for $79.95 represents industry-leading value to our consumers. In the current inflationary environment, we believe our value offering should be even more appealing to an even larger slice of the American public. 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 a more stable and predictable environment in the future. Our business is also facing the challenge of constraints on exam capacity in certain markets. In other words, we could not fulfill the demand for exam appointments in some stores due to the lack of an available optometrist. Our team is working hard to expand our exam capacity to mitigate this impact. This quarter, I’m pleased that we are making incremental progress on multiple fronts. First, our retention levels stabilized in Q2 and we are up versus last year. This is a testament to multiple recent initiatives to drive retention, which are being executed by a new level of clinical management. In terms of hiring, our increased investments in recruiting continued to pay off. Year-to-date, we’ve experienced strong hiring of optometrists. We’re beginning to see the wave of new hires who had delayed start dates arrive to practice and expect this benefit to begin to accrue in the third quarter. Lastly, we remain excited about our remote medicine initiative to help address our historical and ever-present need for optometrists to keep up with the demand for eye exams at our stores. With the accelerated rollout, we are on target to operate remote medicine in up to 300 stores by year-end, which would represent nearly 30% of the stores in our growth brands. In stores that have operated remote exams for the longest period, we are continuing to see a significant ramp in operating productivity. We’re extremely pleased with the 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 by year-end. So we are in an unusual operating 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 smaller subgroup of stores due to the constraints 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 8. In addition to our exam capacity and remote medicine efforts, we continue to progress other core growth initiatives. New stores remain a primary focus as we continue to see a sizable white space opportunity. We had 22 openings in the second quarter, including 2 more Eyeglass World locations as we ramp up the expansion of this brand. We continue to plan to open at least 80 stores in 2022 and currently have a solid pipeline of specific locations for this year and into 2023. 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 our value messaging will resonate with budget-conscious consumers. Our focus in 2022 has been to optimize our marketing investment, and we are pleased to be leveraging marketing expense in a difficult environment. Our participation in vision insurance programs continues to be a positive revenue driver, especially in the current environment. In the second 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 from uninsured consumers. This is a reversal from last year’s period of economic stimulation when the uninsured business was stronger than the managed care business. 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. And before turning the call over to Patrick, let me comment on the exciting leadership update that we provided today. Patrick has been appointed Chief Operating Officer in addition to his current role as CFO. Patrick has done great work as our CFO. He’s been instrumental in our growth and success, especially in navigating National Vision through our IPO and important early years as a public company. Patrick has been a terrific partner to me, and I’m really looking forward to continuing to work with him in this new role as we look to drive growth and accelerate our value creation initiatives. At year-end, Patrick will be stepping down as CFO. As part of our planned succession, we are so pleased to be announcing Melissa Rasmussen will become National Vision’s new CFO starting January 1. As Chief Accounting Officer, Melissa has been a vital member of our leadership team for the last 3 years. Melissa is an incredibly talented executive, and as we’ve worked on this succession plan for a while, I believe she will be an excellent CFO. At this point, let me turn the call over to Patrick for a more detailed discussion of our financial results and the 2022 outlook.

Thank you, Reade, and good morning, everyone. It has been such an enormous privilege to be this company’s CFO for the last 8 years, and I look forward to continuing to contribute in my new position. I also want to say how pleased I am that Melissa will serve as our next CFO beginning in January. Melissa and I have worked side-by-side for the last 3 years and she is an outstanding leader for the team. Together, we are executing a seamless and effective transition. Now let’s start on Slide 10 for some additional financial detail on the quarter. As a reminder, the second quarter of 2021 had the tailwinds to revenue and profitability from pent-up demand from store closures, the benefit of government stimulus and an elevated average ticket. In Q2 2022, net revenue decreased 7.3% compared to 2021 due to macroeconomic headwinds, constraints to exam capacity and exceptional growth last year. The timing of unearned revenue was inconsequential this quarter, benefiting revenue growth by 0.2%. During the quarter, we opened 20 new America’s Best stores and 2 Eyeglass World stores for a 5.2% increase in store count. For our America’s Best and Eyeglass World growth brands combined, unit growth increased 6.9% over the last year. Adjusted comparable store sales declined 12.4% versus 2021 compared to a record 76.7% increase in the second quarter of 2021. Q2 comparable store sales were impacted primarily by a decline in customer transactions. Average ticket declined slightly year-over-year. We remain encouraged by the fact that our average ticket has generally stabilized this year, helped by pricing actions and successful product introductions like Blue Light. Turning to Slide 11. As a percentage of net revenue, costs applicable to revenue increased 310 basis points or better than our expectations of a 400 to 450 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 relative stability of average ticket. Adjusted SG&A declined approximately 1% due to disciplined cost management this quarter. Adjusted SG&A expense percent of net revenue increased 280 basis points. The key factors behind this increase were the deleverage of store payroll and occupancy expense from lower revenue, partially offset by lower incentive compensation and lower advertising investments. We now expect advertising to be slightly leveraged in 2022. Our store and marketing teams have done an excellent job realigning their cost structures to the current environment. Adjusted operating income decreased 58% to $28 million and adjusted diluted EPS decreased 57% to $0.21. Turning to first half 2022 results on Slide 12. Compared to 2019, despite the challenges this year, net revenue increased approximately 17% and adjusted diluted EPS increased 8%. Now turning to Slide 13. Our balance sheet and liquidity remains strong. At the end of the second quarter, our cash balance was over $254 million and total liquidity of nearly $550 million when including available capacity from our revolver. We ended the quarter with total debt of $569 million. Net debt to adjusted EBITDA was 1.3x. While our term loan debt has a variable LIBOR-based interest rate, this debt is more than fully hedged and further increases in our base rate above 1.8% would be helpful to our net interest expense and cash flows. Year-to-date, we funded $56 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. In the second quarter, we continued our shareholder return program and repurchased 2.6 million shares for a total of $73 million and have $50 million remaining under the current share repurchase authorization. Since the inception of our share repurchase program last November, we have repurchased 4.2 million shares for $150 million. At the end of the quarter, inventory per store grew less than 2% on a year-over-year basis. We are comfortable with the current level of inventories and their ability to support our 2022 growth plans. Our merchandising and distribution teams continue to execute very well to help us manage through the current challenging supply chain environment. Overall, we believe that our financial strength and our commitment to invest in our business remain a competitive advantage. Turning now to our outlook on Slides 14 and 15. I’ll conclude with some commentary regarding our updated 2022 outlook, which we included in today’s earnings release. As we all know, the dynamic operating and macro environments are extremely uncertain. The updated 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. Against the backdrop of what we know today, our updated 2022 outlook projects: net revenue between $1.99 billion to $2.02 billion; adjusted comparable store sales growth compared to last year in a range of negative 6.5% to negative 8%; adjusted operating income between $85 million to $100 million; and adjusted diluted EPS between $0.65 and $0.77, assuming 80.1 million weighted average diluted shares. I’d like to share some underlying assumptions in our outlook. Given the uncertain environment, we continue to maintain a more conservative posture for our updated outlook. The high end and low end of the top and revenue ranges represent two potential scenarios for consumer demand for the rest of the year. At the high end of the ranges, we’re assuming continued pressure on consumer demand over the remainder of the year, including a modest back-to-school season as well as gradual improvement in exam capacity. At the low end of the ranges, our comparable store sales and revenue assumptions reflect further deterioration in the macro environment. Compared to the previous fiscal 2022 outlook provided in May, our updated outlook includes lower projected ranges for comps and net revenue to reflect the deteriorating macro environment, exam capacity and current trends. Our updated outlook also projects that the impact of these lower revenues is expected to be significantly offset by cost alignment efforts primarily in store payroll, advertising and corporate overhead. The team has taken smart tactical actions to align costs with the revised near-term revenue outlook. Even amidst the 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 the business. As you model the second half of the year, we now expect comps to be in the negative mid-single-digit range. The improving trend versus the first half performance reflects easier comparisons, moderating average ticket pressure and increased exam capacity. We are projecting Q3 comps in the range of negative mid- to high-single digits and Q4 in the negative mid- to low-single digits. Store openings this year will continue to be predominantly America’s Best locations, coupled with a doubling of Eyeglass World openings. We are on track to open at least 80 stores, and we project a few closings as is typical each year. I would like to express my thanks to our real estate team for successfully navigating the growing supply chain challenges to date. Let me share a couple of other factors assumed in our outlook for 2022. We’re excited about the accelerated rollout of our key remote medicine and EHR initiatives. As Reade noted earlier, we are seeing a significant ramp in operating productivity in remote medicine, such that we now anticipate incremental dilution to be approximately $3 million or half of our original estimate. We continue to expect that the timing of unearned revenue will have a negative impact in 2022. We continue to estimate this 2022 impact on adjusted operating income to be about $9 million, with approximately half of the impact expected to be realized in Q3. As a reminder, unearned revenue recognition is a 7- to 10-day timing impact that can affect our quarter-to-quarter and annual comparisons. For full year 2022, as a percentage of net revenue, we now expect costs applicable to revenue to increase 325 to 350 basis points versus last year, primarily due to the deleveraging of fixed costs as well as the lapping of last year’s record performance that benefited from product mix shift and an elevated ticket. For Q3, costs applicable to revenue are expected to increase about 400 to 425 basis points versus last year. In terms of expenses, we continue to expect 2022 adjusted SG&A to increase between 125 and 150 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 some additional assumptions on depreciation and amortization, interest and tax rates. 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. We continue to view the current issues as transitory. 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 return the business to a growth trajectory. At this point, I’ll turn the call back to Reade.

Thank you, Patrick. Turning to Slide 16 and our Moment of Mission. For our Moment of Mission, let me introduce Dr. John Jett, an optometrist who has practiced for 28 years, including about 7 years with National Vision, and who has performed remote exams in our stores for over a year. Recently, a female patient booked an appointment for a newly available remote exam with Dr. Jett at an America’s Best store. Her chief complaint was blurry vision and she assumed she just needed new glasses. Because money was a concern, she put off seeing an eye doctor for some time. Once she could afford to do so, which America’s Best’s affordability made possible sooner than other options, she scheduled a remote appointment with Dr. Jett on a day when an exam with an in-store doctor was not available. During the remote exam performed from a location over 500 miles away from the store, Dr. Jett saw a medical condition on the retinal image that required urgent care. He sent the patient to the emergency room immediately with a recommendation for a spinal tap. Within 2 hours, the patient was airlifted for emergency brain surgery, where a 2.5-inch tumor was removed. As we say, a routine eye exam is routine until it isn’t. When every second counted for this patient’s life, our remote capacity made it possible for Dr. Jett to give her an exam that ultimately saved her life. When we talk about access to eye care, this is what we’re talking about. This is our mission: affordability and access to eye care at its lifesaving best and an example of how remote capabilities are making it possible for us to create greater affordability, greater accessibility and ultimately, make profound even lifesaving impacts on patients’ lives. I want to thank our entire team at National Vision and network of optometrists, including those performing remote exams like Dr. Jett, who provide much-needed medical services to patients at our over 1,300 storefronts every day. In summary, the key takeaways from today’s call are these: after 18 years of consistency and predictability, the pandemic era has temporarily made the optical market and consequently, 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, and 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 is there for exams at our stores. Thus, despite the current challenges, our confidence in our mid- and longer-term prospects remains 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.

Our first question comes from Kathleen Brenneck of Goldman Sachs.

Actually, this is Kate McShane from Goldman Sachs. We were interested in hearing a little bit more about the sequential improvement you could be seeing as a result of customers trading down. It sounds like it maybe was a little bit more than what you saw in Q1. But are there any more details around quantifying it?

Thank you, Kate. We're gradually seeing more expensive cars in the parking lot, similar to what we experienced back in 2008 and 2009. This trend is particularly noticeable in markets with wealthier consumers. We're starting to see this more clearly now. The month-to-month comparisons have been improving slightly, which is encouraging. However, we are still in the early stages of this trend with nicer cars in the parking lot, and we expect it to grow over time.

As a follow-up question, we wanted to ask about the price increases that were implemented later in the first quarter and the beginning of the second quarter. Can you provide any details on the impact on the comparable sales for the quarter and the second half, as well as the elasticity response to the higher prices? It’s been quite some time since you last increased the exam price.

It has been a significant amount of time since we last raised prices. I can say that the outcomes have aligned with our expectations. We believe this was the right decision and are satisfied with it. We maintain close communication with our store associates, who have indicated that we anticipated a larger impact, but it turned out to be minimal at the store level. Regarding our low-price model, we think the disparity between us and our competitors will grow in these inflationary conditions, and we are confident that this was the right approach and feel very positive about it.

Our next question comes from Simeon Gutman.

Back to Kate’s question, I guess you prefer not to answer regarding a price increase, like how much it’s helping the comp just to clarify? And then can you discuss how it impacts the incremental margins, meaning do we get back to an average rate of incremental flow-through with the price increase? Does it help relative to history or does it not fully account for all the costs that are running through the business?

Yes, we have analyzed the percentage increase based on that base offer and accounted for a certain level of volume decline in the short term. We anticipated a net benefit this year, and we are experiencing that. Reade confirmed this. As I reflect on the entry-level pricing and the value we provide to customers, the margin is lower than the overall eyeglass margin, but it remains quite healthy. Many customers opt for the base offer and often add one or two additional items. The pricing positively impacted our second quarter due to the net advantage I mentioned.

Okay. My follow-up is more high level. Looking at some metrics from 2019 compared to today, a couple of things stand out. It seems that sales per store are not significantly higher than that period. Gross profit per store has decreased a bit as well. SG&A has increased, which is not unreasonable, but it’s noticeably impacting EBIT, leading to a lot of deleverage, and I’m sure you notice the same. In terms of explaining this, it could mean that the business isn’t gaining market share, perhaps you’re opening too many stores, maybe prices aren’t being raised enough, or you’re under-earning, and this could all improve next year. I understand it could be a mix of these factors, but I’m curious about your perspective on the growth compared to 2019.

Yes. I think we've shared some of these figures before, so I’ll provide an update. Looking at 2022, we’ve faced significant challenges and setbacks. The severe Omicron phase definitely affected us, and while I can’t recall the exact numbers offhand, we noted a couple of hundred million in sales that we initially expected as we began the year. You’ve seen those adjustments in our guidance. The primary issue has been the substantial headwinds the business has encountered this year, starting as early as January 1. I don’t anticipate that such a degree of headwinds will persist. I understand that it's a challenging time to analyze these metrics, and we're looking at the same data. As I think about the future, I reflect back to 2019 as a reference point. I consider where we peaked during the pandemic in 2021 when stimulus and volumes were at their highest. I believe our performance will settle somewhere between those two points, likely not reaching the peak, but I do expect some improvements compared to 2019.

And to another part of your question, Simeon, we do not believe we’re losing market share. We think we are holding our own in terms of market share, which we think is impressive, given our consumer and the impact of inflation on our consumer and the fact that managed care is such a small part of our business and also given the market share gains we’ve had in recent years. But we do not believe we’re losing market share.

Our next question comes from Stephanie Wissink of Jefferies.

One, we wanted to explore the supply and demand balance. And if you could just help us think through what percentage of opportunity do you think you’re missing because of capacity? And how much do you think remote medicine can help close that gap? Just give us some sense of maybe what you’re implying in the back half guidance, but also how much you think you’re leaving on the table with respect to just the capacity constraints you’re experiencing.

Yes, we believe that the macroeconomic environment and capacity issues are currently balanced in terms of their effect on our business. Therefore, as we expand our OD capacity, we expect this to be beneficial for us. Additionally, we are pleased to see that retention is improving compared to last year, and we are having a very successful recruiting season. Accelerating our remote capabilities should also contribute positively. Overall, we find the situation balanced, and we anticipate a significant increase in productivity with remote work. We are encouraged by these developments and consider them important.

Yes, I would like to add one more point about remote. At the beginning of the year, we mentioned a figure of about $6 million of net dilution, which included the remote benefit to profitability minus the startup and ramp costs. We have effectively reduced that by half as we've progressed through the year, thanks to the contributions from the initiative, particularly in the markets where we implemented remote early in the year and where it was much needed.

Patrick, if I could offer one follow-up. On the average ticket, it was really encouraging to see that stabilize from quarter-to-quarter. I also want to make sure we’re hearing what you’re saying about back-to-school with the children’s business outperforming maybe some of the traditional seasonal adult business. Do you anticipate average ticket could dip in the third quarter before it recovers in the fourth quarter? Or are you assuming that it stays quite stable, given a full quarter of the price increase in the base business?

Thank you for the question. We are expecting a slight decrease in ticket averages, which is somewhat cautious but understandable. This decline is seasonal, especially noticeable with customers under 18, who typically show a lower ticket average. We're also considering the current economic challenges affecting lower-income consumers. Therefore, we anticipate a reduction in ticket averages through the third quarter, although we are pleased that overall, it remains significantly higher than in 2019. We have implemented some price increases and added options like Blue Light to our lens offerings, which have been well received. Overall, we are satisfied with how ticket averages have stabilized this year, and we are not particularly concerned about any short-term dip.

Our next question comes from Adrienne Yih of Barclays.

Reade, I want to return to the exam capacity because that appears to be a key area for potential margin and profit growth. What is the current state of exam capacity compared to a more normalized level? Additionally, remote medicine will be available in 30% of the 300 stores once fully implemented. How much will this boost exam capacity? I assume that having remote medicine in the stores will significantly increase the percentage of exam capacity. Patrick, what is your breakeven comp point for the latter half of the year? How should we approach this regarding COGS and SG&A? Also, you mentioned a reduction in store payroll hours. Is this decrease indicative of reduced staffing, and will it affect the productivity levels that you aim to achieve in the stores?

I’ll take the first part. Adrienne, you’re right. Optometric capacity is a key focus area for us. And again, we’re pleased that retention is up versus last year and improving, and we’re pleased that our hiring is going very well and remote is a key part of the improvement program that we have. We are seeing incremental progress in exam capacity with every month and we’re expecting it to improve by year-end. We don’t go into a lot of detail on the exact specific productivity related to remote because it’s an internal program that we have and like to keep it as such. But you’re right, what are we believing is going to help us going forward. These improvements in exam capacity, what are we seeing? We are seeing that occurring and we’re expecting continued improvement by the end of the year.

On the breakeven comp, we've been consistent in the 4% to 5% range regarding our comp leverage point. We are guiding significantly lower for the second half of the year. However, we have been making smart cost reduction decisions. A significant part of our costs is store labor, and we do our best to align labor with the demand we see and expect, which isn't an easy task. Our store teams have done a commendable job in managing this. We will also leverage advertising in a year where most would have anticipated we could do that. I'm pleased with how our marketing teams have handled this. Additionally, we've reduced some costs in corporate areas, though it hasn't been significant. We're focused on opening over 80 stores, rolling out remote medicine, and advancing omnichannel initiatives. We are progressing with the understanding that the biology of the eye cannot be postponed, and we will be prepared for it. When I refer to smart cost reductions, I mean that these adjustments are well-suited for now but are not too deep to prevent us from responding to increased demand when it arises.

And then a really quick question on Walmart, the operated stores. Are they performing in kind with your core and similar to your core?

Yes, the Walmart stores are roughly in line with the America’s Best stores in terms of comp performance.

Our next question comes from Michael Lasser of UBS.

My question, so Reade, I understand that market share data is difficult to come by. You do have some publicly traded competitors that are generating positive growth. So what’s driving your belief that you’re not losing market share? And if you’re not losing market share and it’s just that core customer is deferring the purchase of a medical necessity that they’ll eventually have to make and you’re going to improve your capacity, is it reasonable for us to expect that when you get into a more normalized economic period, perhaps in 2023, that there’s going to be outsized comp gains to retrace some of what was lost this year?

I’ll take the market share piece of that, and Patrick will tie into your second part of your question. So our cross-referencing on market share relates to talking to some of the larger vendors who deal with all aspects of the industry and sort of touching all aspects of the industry. And they have reinforced to us that we are not losing market share from talking to the large insurers and seeing where we are in terms of market share within their portfolio and also watching the trends of online, which the recent data suggests a continuation of the online consumers returning to stores post pandemic when stores reopened. So those are the three factors that give us confidence in our market share.

I think it's important to be cautious about what we consider good growth and to examine when each competitor closed, reopened, and regained traction. When analyzing growth rates this year, it’s crucial to look back a few years to understand what the growth was based on, which could contribute to some stabilization or a slight pause in market share. Regarding the second question, 2022 faced several challenges that we hope won't occur again. We won't discuss our expectations for 2023 today, but we are confident that this business will perform well in the long term and can thrive even during tough economic conditions. I'm optimistic that we will face fewer challenges next year, which relates to how we approach our comparisons.

And to add to the first part of Patrick’s comment, I am very proud of the crisp execution we had coming out of the pandemic, amongst the first to reopen in a very safe, high protocol manner when others were not sort of opening as rapidly. Our ability to do eye exams when others were having constraints on their capacity. And so we are up against healthier numbers than many others had.

Okay. My follow-up question is on the long-term margin outlook. Given some of the cost reductions that you’ve taken, such that you’ll be able to maintain your operating income outlook in the face of lower-than-expected sales, should we assume that your normalized margin over the long term is going to be higher than what it was previously on the same level of productivity? Or as your sales come back, some of these costs might come back as well?

Yes, Mike. Reflecting on the margin developments, we saw a significant improvement in 2019. However, we entered a challenging phase with poor margins due to store closures, which was followed by a recovery period. I believe we will exceed our performance from 2019. While I won’t provide long-term guidance today, there have been substantial impacts on margins this year. Nonetheless, I remain optimistic about margin improvement. As we work towards positive comparable sales, we are overcoming the wage investments made. I anticipate that remote medicine will enhance productivity and yield benefits. Additionally, we just secured an important long-term contract with a major supplier, which we previously mentioned. Typically, we also achieve some productivity gains in our labs each year, and we’re continuing to focus on maximizing our advertising. With ticket sales stabilizing and demand improving, I expect a return to volumes better than those in 2019. Ultimately, we have reduced some costs, and I foresee this positively impacting our results as well.

Our next question comes from Dylan Carden, William Blair.

I’m just curious, you’re speaking to, obviously, the macro headwinds. But there seem to be some sort of nuances as well as it relates to capacity constraints. I’m wondering maybe even price increases and maybe even pullback in marketing, if that’s having some impact? And sort of combined, those non-macro issues, if you could just really speak to the magnitude as you understand it, that’s sort of embedded in your current performance? And then the biology of the eye, how long do you typically see the sort of lower-income customer defer that purchase and you go back to other periods of economic uncertainties?

Dylan, I'm glad you brought that up because explaining our business on a national scale can be quite confusing. While it's true that national demand is softening due to inflation, our capacity issues are very localized to specific stores and markets. In those areas, there is underserved demand, and there are customers we are not reaching. They are booking appointments further in advance, which makes it more challenging. It's essential to highlight the difference between national trends and the localized demand we could meet if we had more capacity, and we are making positive strides in expanding that capacity. We monitor our marketing efforts closely and believe we are at the right level of engagement. On your second question, we have observed that consumers can postpone addressing vision issues for many months, which can be frustrating. Similar to not being able to pay rent, some may choose to wait until they are in a better financial situation. During the last recession, we noticed that some of our lowest-income customers opted out and decided to endure their vision problems until they had more disposable income. We're starting to see signs of consumers with higher incomes driving nicer cars in the parking lots, particularly in areas with wealthier customers.

Our next question comes from Zack Fadem of Wells Fargo.

So this is now the second quarter in a row that you’ve knocked down your ‘22 outlook even with some Q2 upside. So can you talk through the change in your back half assumptions? And what gives you the confidence today that you’re now in the right place? And then second, Patrick, is there any extra detail you can share on the margin cadence from Q3 to Q4? And whether you’re assuming positive operating income in Q4 despite the unearned revenue headwind?

Sure. Let me address both of those, Reade. If you look back to our guidance in May, we set an upper range, indicating that we expected a gradual improvement in consumer demand along with significant hiring and net hiring for doctors. At the lower end, we noted that both of these factors would weaken. Unfortunately, we did not see an improvement in consumer demand; in fact, it further declined. We also experienced some delays in the start dates for our doctor hiring. Additionally, we observed higher vacation levels compared to what we historically anticipated. As a result, we adjusted our expectations for sales and comparable figures downward. For our revised outlook, we expect demand for the remainder of the year to be at the upper end of our range, which is roughly where we are now. We anticipate decent hiring for doctors and have already begun to see some progress as new leadership comes on board. Therefore, that's our outlook for the upper end. On the lower end, the focus is more on consumer demand rather than the doctor hiring, which is why we’ve been implementing disciplined cost management strategies. Regarding margins from Q3 to Q4, let me first explain what we expect from Q2 to Q3. We anticipate some decline in gross margin from Q2 to Q3 primarily due to eyeglass margins. I mentioned earlier that we expect a slight dip in ticket sales due to macroeconomic pressures during back-to-school season. Moreover, when new doctors start, it takes a bit of time for them to become fully effective, which means there’s a period of investment required. This situation is likely influencing the margin expectations from 3% to 2%, but we see a better chance for margin improvement in Q4.

Got it. And then you notched down the expected gross margin dilution from remote medicine. Should we read this as lower cost to implement? Or is this more about better uptake from consumers than expected? And then second, is there any way to quantify the productivity or throughput improvement per store for remote medicine stores versus non-remote medicine stores?

The reduced dilution is due to scaling a bit faster than we initially anticipated when we provided that first dilution figure. Things are going well with less dilution, and it's not a matter of scaling back. We haven't really released any productivity improvements yet, as we are still about a year into examining what we are achieving. In some markets, we faced a shortage of doctors, so we introduced remote services earlier in the year, which has resulted in significant productivity gains. However, not all markets will reflect this, as some have better doctor availability. In the initial areas where we implemented remote capabilities, we experienced a notable positive impact.

Got it. I appreciate the time, and Patrick, congrats on the new role.

Thank you very much.

Our next question comes from Bob Drbul of Guggenheim Partners.

First off, congratulations to Patrick, Melissa, and David on your new roles. I wanted to explore the traffic in stores further. Can you elaborate on that with the introduction of remote? Will there be any cannibalization from your own customers? Do you anticipate an increase in foot traffic? Additionally, regarding data analytics related to remote, are there any extra data points being collected that could potentially be used to boost digital sales penetration? Any insights on that would be appreciated.

Considering the patient journey, they reach a point where they decide to take action because their vision issues are troubling enough to warrant an appointment. If they are familiar with our brand and perceive it as valuable, they will contact us. However, if a doctor is unavailable or if there's a wait of 2 to 3 weeks for an appointment, they may opt to seek an exam elsewhere, especially since we live in an impatient society. This results in a loss of potential customers when we cannot provide an appointment when they desire it, particularly in markets where they either face longer wait times or where we do not have available doctors. This illustrates the dynamics of demand. We also gather a significant amount of data from remote services, which we believe will play a role in our company's future development in various ways. The data we collect can be surprisingly beneficial, and it is worth noting that remote exams are highly digitized.

Got it. Can you clarify whether the lack of optometrists is an industry-wide issue or if it's specific to certain locations?

There is a shortage of optometrists in America due to a significant number retiring during the pandemic. Some may be thinking about retiring early because of the situation. During the pandemic, around 2% to 3% of independent practices closed. We’re noticing that many optometrists are now seeking more flexible work arrangements. For example, those who previously worked five days a week are opting to reduce their hours to four days. Additionally, the educational institutions are not producing more optometrists each year, leading to a mismatch in the usual cycle of new optometrists entering the field and those retiring. This has created a demand for optometrists, compounded by the growing interest in flexible working conditions, which we are addressing in multiple ways. The situation is quite different now compared to before the pandemic.

Ladies and gentlemen, this does conclude today’s conference. I’d like to turn the call back over to Reade Fahs for any closing remarks.

Valerie, thank you very much for your great management of the call, and we’d like to thank everyone who joined us today and all of our stakeholders for your continued support. We look forward to speaking with you again when we report our third quarter results. Thank you all very much.

Thank you. Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating. You may now disconnect. Have a great day.