National Vision Holdings, Inc. (EYE) Q1 2023 Earnings Call Transcript

Good day, and thank you for joining us. Welcome to the National Vision Holdings First Quarter 2023 Earnings Conference Call. I would like to now introduce your speaker today, Caitlin Churchill from Investor Relations. Please proceed.

Thank you, and good morning, everyone. Welcome to National Vision's First Quarter 2023 Earnings Call. Joining me on the call today are Reade Fahs, the 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, 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 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 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.

Thank you, Caitlin. Good morning, everyone. Thank you all for joining us today. Since we last spoke to you in March, we continue to execute our initiatives focused on adapting to the new realities of the post-pandemic marketplace that we believe position us to deliver improved sales and profitability while staying true to our mission to make eye care and eyewear more affordable for all. Before I review our progress on these initiatives, let me review highlights from Q1 performance. Beginning on Slide 4. Q1 came in slightly above expectations with a year-over-year increase in net revenue of 6.6% and adjusted comparable store sales growth of 0.8% compared to Q1 2022. This translated into adjusted EPS of $0.31 for the period. Overall, the quarter reflected a similar sales mix to what we saw in Q4 with an even stronger performance from our managed care business. Our managed care business is less pressured by inflation since the insurance company pays most of the customers' bill. Managed care business is typically strongest in the fourth quarter as insured customers are using benefits before they expire and in the first quarter due to benefit plan reset timing. In addition, during the quarter, we continued to see a greater shift in the number of higher-income customers who traded into our more value-priced offerings as tends to happen in a tough economy. These two trends helped mitigate the sales impact of inflation on our core budget-conscious uninsured customers, as well as the impact from continued exam capacity constraints. Turning now to Slide 5 and the progress we're making against our key initiatives. As we discussed last quarter, National Vision is moving rapidly down the path to adapt our business to thrive amidst the new realities facing our business and the industry. These new realities include exam capacity constraints and persistent inflationary pressures on our business and our customers' wallets. Let's start with exam capacity. On the whole, in stores where we are achieving capacity objectives, comparable sales are positive, thus demonstrating the strength of our business model. There are three components to achieving optimal exam capacity. The first is retention of the optometrists who currently practice in and alongside our stores. As we've previously shared, our optometrist retention rate is in the 80% to 90% range. While there is some variability within that range from 2019 to 2021, mainly due to increased retirements and other pandemic-related factors, our retention rate improved in 2022 compared with 2021. Given our healthy Q1 retention levels, we expect to see another step-up in retention in 2023 over 2022. The second is the recruitment of new optometrists to our network. We are pleased that our recruitment efforts are off to a strong start this year. Both recruitment and retention have been aided by the addition of a menu of more flexible scheduling options available to optometrists in our network. As we discussed last quarter, these updates were piloted late last year, and based on positive results, they are being further rolled out in the first half of this year. We continue to learn how best to optimize the new schedule management that goes along with this program and balance customer desired shopping patterns with the flexibility desired by the optometrist. Third, we're deploying our remote medicine capabilities to help improve exam capacity. Remote medicine provides patients with greater access to care and optometrists with the ability to see patients across geographies. This is because remote optometrists can be licensed in multiple states and see patients in remote-enabled exam rooms across the country where they are licensed. Our remote program is a fairly sophisticated start-up within our organization, and we expect it to significantly unlock additional exam capacity over time. While we continue to learn and evolve the program, it remains on track to contribute to profitability this year. While the greatest benefit, of course, is to dark and dim stores, there's also an important benefit in covering situations where an in-person optometrist is out of the office and is supplementing the coverage that a live doctor provides in-store when there is strong demand. We remain on track with our expansion into at least an additional 200 remote-enabled stores this year, taking into account planned pauses expected for peak volume periods for our stores. I encourage everyone to take a look at the video we recently published on our website, demonstrating a remote exam. In response to the current rising cost environment, we're driving a variety of efforts which should, over time, help to rightsize both our store and our overall cost structure. This includes the ongoing digitization of the store to improve efficiency and productivity. An example of this is our electronic health record or EHR program that we're rolling out in conjunction with our remote medicine capabilities that is designed to make our stores work more efficiently than with traditional paper records. In addition, as we continue our deep dive into our pricing architecture, we're conducting a study that will help us update the competitive landscape and our position within it to best determine options for potential pricing changes while executing our mission to provide quality eye care and eyewear at value to all. Finally, with respect to consumer spending conservatism, we are constantly testing and expanding new marketing programs, including those that attract consumers via a variety of relatively new omnichannel offerings. We continue to believe that, over time, due to the biology of the human eye, the consumer purchase cycle, which remained consistent in the decades prior to the pandemic, will eventually normalize. Now regarding our ongoing store growth. During the first quarter, we opened eight new stores and are on track to open approximately 65 to 70 new stores this year. Our new stores opened over the past 12 months are continuing to perform well and in line with our expectations. As illustrated on Slide 6, we continue to see great opportunity to expand our America's Best and Eyeglass World store base over time, and we'll continue to capitalize on the white space opportunity in front of us. In summary, we are taking aggressive action to position National Vision for success in the post-pandemic marketplace. While April was somewhat softer than we previously anticipated, we are beginning to see encouraging signs of progress from the actions we are taking, which is giving us confidence in reaffirming our 2023 guidance at this time. I'll now turn the call over to Melissa for a more detailed discussion of our financial results and the 2023 outlook.

Thank you, Reade, and good morning, everyone. As Reade discussed, we had a stronger-than-expected start to the year, driven primarily by managed care sales, leading to adjusted comparable store sales growth of 0.8%, slightly better than originally guided. And we are beginning to see progress based on the actions we are taking. Now I'll cover our first quarter financial performance in more detail. Turning to Slide 9. Net revenue for the quarter increased 6.6% compared to the prior year. This includes the impact from the timing of unearned revenue, which benefited revenue growth by 2% in the period. During the quarter, we opened four new America's Best and four Eyeglass World stores and closed five stores. For our America's Best and Eyeglass World growth brands combined, unit growth increased 5% over the total store base last year, and we ended the quarter with 1,357 stores. As Reade mentioned, we are on track to open between 65 and 70 new stores this year, consistent with our previous guidance. Adjusted comparable store sales grew 0.8% compared to the first quarter of 2022, driven by an increase in average ticket and transactions. Turning to Slide 10. As the percentage of net revenue, costs applicable to revenue increased 50 basis points, driven by the deleverage of optometrist-related costs, which was partially offset by higher eyeglass margin and increased eyeglass mix. Adjusted SG&A expense as a percentage of revenue increased 140 basis points compared to the first quarter of 2022. The key factors behind this increase included higher performance-based incentive compensation given the normalization of our incentive plans this year versus last year, as well as higher store payroll. The factors were partially offset by advertising expense leverage during the period. Adjusted operating income was $39.9 million compared to $45.3 million in the prior year period. Adjusted operating margin decreased 150 basis points to 7.1%, driven primarily by the increase in optometrist-related costs and the normalization of incentive compensation compared to last year. Net interest expense was $4.9 million, which includes mark-to-market losses on derivative instruments and charges related to amortization of debt discount and deferred financing costs of $3.9 million. Adjusted diluted EPS was $0.31 compared to $0.33 per share in the prior year period. Now turning to Slide 11. Our balance sheet and liquidity remained strong. We ended the quarter with a cash balance of $246.9 million and total liquidity of $540.5 million, including available capacity from our revolving credit facility. We have total debt outstanding of $566.9 million with no mandatory principal payments due until the term loan matures in July of 2024. We are currently exploring refinancing options for our term loan and revolving credit facility in advance of their maturity, and we expect to provide an update when appropriate. We ended the quarter with net debt to adjusted EBITDA of 1.8x. During the quarter, we generated operating cash flow of $74.1 million. We invested $27.7 million in capital expenditures, primarily focused on new store openings and customer-facing technology investments and remain on track for 2023 CapEx in the range of $115 million to $120 million to support our key growth initiatives. During the quarter, we returned capital to stockholders with the repurchase of 1.1 million shares for $25 million under the share repurchase program at an average share price of $22.90 per share. We have $25 million remaining under the current share repurchase authorization. Inventory per store declined 8% on a year-over-year basis. Our merchandising and distribution teams continue to execute well, and we are confident our current inventory levels are sufficient to support continued growth in 2023. Overall, we will continue to utilize our strong balance sheet and cash flow to invest in our strategic initiatives to enhance our customer experience and strengthen our market position. Turning now to our outlook on Slide 12. We are reaffirming our 2023 fiscal year outlook for key metrics that we provided on our last earnings call. We continue to expect net revenue between $2.075 billion to $2.135 billion, supported by adjusted comparable store sales growth of 0% to 3% and 65 to 70 new store openings this year. Adjusted operating income between $48 million and $66 million; and adjusted diluted EPS between $0.42 and $0.60 per share, assuming 80.2 million weighted average diluted shares. Embedded in our guidance is the expectation for the 2023 fiscal year tax rate to be in the range of 26% to 28%, which includes the impact of reduced deductibility of certain expenses as a result of the expiration of the Consolidated Appropriations Act of 2021. From a quarterly cadence perspective, we expect our tax rate to decrease in the second quarter from the first quarter of 2023, resulting in a second quarter tax rate below the full year expectation. As we move into the back half of 2023, we expect our tax rate to be more in line with our full year guidance. As Reade stated previously, April was somewhat softer than we anticipated due to ongoing macro-related headwinds our core uninsured patients and customers are facing, including lower tax refunds this year versus last year. Given this and the timing of expected increased product costs, doctor-related investments and SG&A deleverage with adjusted SG&A dollar growth in the high single-digit range, we continue to expect adjusted operating margin in the second quarter of this year to be pressured. Looking beyond the second quarter, we continue to expect sales trends to improve in the back half of this year as we execute our strategic initiatives, including addressing doctor capacity constraints. In summary, we remain focused on executing our strategy and believe we are on track to achieve our objectives for this year. As Reade mentioned, while still early, we are encouraged by the progress we are making, especially with respect to our efforts in expanding exam capacity through our recruiting and retention initiatives, as well as the further implementation of our remote exam technology. As we move beyond the initial implementation phase for remote technology, we continue to expect operating margins to improve, especially as we drive further efficiencies with our store and corporate digitization initiative. In addition, we continue to evaluate our pricing structure and opportunities to further offset increased costs while maintaining our position within the industry. Thank you for your time today. I'll now turn the call back to Reade.

Thank you, Melissa. Turning to Slide 13 and our moment of mission, which focuses on our latest technology investment in an early-stage health care, artificial intelligence start-up called Toku, which we're investing in alongside Topcon Healthcare. Eye exams are more than simply getting an eyeglass or contact lens prescription. They also assess ocular and overall health. The picture of the retina that we're able to take in most of our stores provides a treasure trove of valuable information that an optometrist can use to assess ocular and overall health and identify potential diseases that otherwise may go undetected for a long period of time, thus helping to improve the health outcomes for our patients. Through our investments in Toku, we're enhancing these capabilities. Toku analyzes retinal images for biometric markers linked to overall health and risk of cardiovascular events, including stroke, which is highly prevalent in people living with diabetes. Theirs is among the first AI screening approaches designed primarily with optometry in mind. In addition, Toku is working on validating an AI assessment of cardiovascular risk from the retinal photo, which would be a first, connecting optometry and primary care. In supporting Toku, National Vision is investing in a future for optical care in which more people are able to have affordable access to potentially life-saving health data to an easily accessible, noninvasive test. In summary, the key takeaways from today's call are: we are rapidly adapting our business to thrive amidst the new realities of the post-pandemic marketplace. Our retention, recruitment, and remote medicine efforts are all heading in the right direction towards improved exam capacity. The digitization of our stores, corporate office, and marketing efforts continue to progress towards improved productivity. And longer-term, we're making investments for improved patient care and optometric experience, including investments in AI. While our more budget-conscious consumer remains pressured, we are reiterating our guidance for the year and reiterating our conviction that the optical purchase cycle will eventually return to the normal historical patterns. Now I'd like to turn the call back to the operator to start our Q&A session.

Our first question comes from Michael Lasser of UBS.

Reade, if you had to mention the improvement in your comparable store sales in the most recent quarter between the cycle getting better, meaning we're getting closer to the replacement of glasses that were purchased in the last few years, the improvement in optometrist capacity, and the trade-down benefit that you might be seeing because of the challenging economic conditions, how would you disaggregate and quantify those three factors?

Thank you, Michael. Great question. I would rank order them in this way. I would start with capacity, with improvements on the eye exam appointment and availability front. Your second piece was the trade-down piece, but I'd actually not say it as trade down. I'd say it has increased in managed care because the increase in managed care does correlate with the trade-down effect in that wealthier people tend to have managed care benefits. So I'd say capacity, managed care, and I think it's premature to talk about normalization of the cycle just yet. I'm looking forward to the day, Michael, when we can announce that. It will come. I am confident it will come, but I think it's premature to point at that at this point.

Okay. And the softness in April that you talked about, would you attribute that mostly just to tax refunds and not any sort of internal execution challenges that a reversal of the benefits that you were seeing that drove the improvement in the first quarter? And I want you to clarify the comments you were making about potential price changes. Does that mean you could continue to take prices up while at the same time trying to maintain the deep value offering of National Vision?

Let me start with your first point. Yes, I think April is more related to tax-related softness than other things. And again, we are reiterating our guidance for the balance of the year, but we did want to point out that April was a little softer than anticipated. And I do think it was the tax refund piece. On the pricing side, that's something that we're always looking at, especially in an inflationary world. There's a small amount of pricing baked into our guidance, but we're looking at other aspects. So yes, on a regular basis, we do sort of price checks on various aspects relative to the industry as a whole. We shared in our comments that we're doing a little deeper dive in getting some fresh perspectives on it also because we think that there may be some opportunities there that we're looking at. So always good to have fresh perspectives on that in an inflationary environment. And Michael, you are absolutely correct. We are committed to being a value player. We are committed to having a nice price gap between us and the competition. That is what people come to us for. That is what we are known for, and that is what we want to constantly deliver. But in this world, there may still be opportunities for further pricing actions.

Our next question comes from Zach Fadem from Wells Fargo.

Reade, you called out encouraging results from your optometrist recruiting and retention initiatives. Could you talk a bit about what that means for existing versus new stores and whether it has an impact on your new store openings? And then separately, I'm curious what type of things you're looking for as proof points that remote medicine is working.

In terms of existing versus new stores, we see this year improving compared to last year, which was also better than the year before. This positive trend in retention is encouraging. Our recruitment is also looking strong, particularly with student recruitment surpassing last year's record. It's still early in the season, so decisions will wait until the end, but in Q1, we're ahead of last year. Regarding new stores, those opened in the last 12 months have met our expectations, reinforcing our belief in the available opportunities. We believe that remote services can further enhance these opportunities. For remote success, we aim to increase our capacity cost-effectively and provide more exam slots for our customers. It’s significant that we are meeting our capacity goals and seeing positive comparable sales, which validates our business model. Despite the challenges in securing optometrists, we are focused on attracting them to maintain our service model, and wherever we can implement our model, the results are encouraging.

Got it. And Reade, now that we are a solid two years away from the pandemic and the stimulus gains of 2021, can you talk about the impact of a multi-year replacement cycle in the category? And just considering the pull forward we saw in '21 and just a 3- to 4-year replacement cycle, to what extent would you expect 2024 and '25 to be a year of accelerated growth for the category?

The challenge we are encountering regarding the normalization of the purchase cycle is one that affects the entire category. Last year, around March or April, there was a decline across the category. If a company had a high involvement in managed care, they were somewhat shielded from this. However, we have a low rate of managed care since most of our customers pay in cash and typically fall within a lower-income, budget-conscious demographic. The consensus in the category is that the purchase cycle remains unnormalized, but there is a common belief that it will eventually stabilize, as the category has shown consistency for decades prior to the pandemic. There was a significant surge in sales for about a year following the reopening, with many consumers purchasing glasses, often opting for higher-quality options. However, inflation has now affected the entire category, causing a slowdown. We are convinced that the purchase cycle will normalize in time, given the natural biology of the human eye and trends such as increased screen time, which leads to eye strain, ultimately expanding the category and attracting younger consumers. Unfortunately, I cannot specify when this will occur as the situation is unusual and unprecedented.

Our next question comes from Taj Phillips of Jefferies.

It's Brian Tanquilut from Jefferies. Congrats on the quarter. Reade, I guess my first question for you. As we think about remote eye exams and the virtual strategy, are there any metrics that you can see from your early rollout in terms of maybe improvement in clinician capacity or store productivity or recruitment or reducing the days or hours that you don't have a clinician in the store and can't see patients that way?

Well, Patrick is our COO. One of his big responsibilities is looking over our remote program. Patrick, I'll turn that to you.

Our remote care initiative is beneficial for doctors, patients, and our store teams. It significantly improves operations in less busy stores. We analyze coverage and capacity concerning stores with high demand. We've experienced a significant productivity boost and monitor various metrics related to capacity, demand, and productivity among doctors and stores, as well as sales comparisons. This quarter, we positively impacted EBITDA, recovering from a previous downturn last year. We plan to establish at least 200 new sites this year, increasing the total to 500. We believe that remote care also enhances retention—this is a broader trend among doctors in the industry. Providing this flexibility allows doctors to adopt practice methodologies that align with their lifestyles. In summary, we consider many factors as we advance these crucial initiatives.

And then maybe my follow-up. You talked about Toku here really briefly. But maybe if you can share with us sort of the strategy on how you are intending to or planning to reach out to healthcare companies so that you can leverage your capabilities into more of the healthcare side of things versus just your traditional retail footprint.

Thank you for the question. When I consider the broader trends in optometry, I see three main aspects. First, there's a growing preference for employment positions over non-employee roles. Second, flexibility is increasingly important, especially in this post-pandemic era, encompassing not just work schedules but also diverse practice models, including our remote initiative. Finally, I believe that a more medical approach to practice will become more attractive to optometrists over time. Our focus for the past 15 years has been to create supportive environments for optometrists aimed at fostering long-term careers. We offer various practice options, from leasing to employee models, ensuring that we accommodate different preferences across our brands. On the medical side, we conduct millions of eye exams each year, with thousands of optometrists working within our stores and the National Vision network. These professionals are trained to detect not just vision problems but a wide range of ocular and health-related issues. They often serve as the first contact for patients to learn about conditions like diabetes or hypertension, which may be their only encounter with a medical professional for the year. We consider this a significant responsibility as we provide primary health care through our network of optometrists, many of whom act as an entry point into the healthcare system for our patients. Toku is an early-stage startup, and while it's still developing, we see potential for patients to use a simple photograph of the back of their eye to assess various health conditions, such as diabetes and cardiovascular diseases. We believe this could enhance the overall healthcare system, although it is a long-term vision and not directly tied to this year’s financials. Ultimately, the optometrists in our network play a crucial role in American healthcare, and we think that advancements in technology, like those being pursued by Toku, could significantly improve health outcomes for patients. We are exploring collaborations to better understand and enhance our contributions in this area.

Our next question comes from Anthony Chukumba from Loop Capital Markets.

Congrats on the strong start to 2023. Just my question, is there anything that you're seeing notable in the competitive landscape, whether it's from the independents or some of the larger chains or some of the stores that are in deep discount retailers like Costco, Walmart? Is there anything you're seeing from a promotional perspective or just competition from an optometrist perspective?

Well, yes. So it's not new since we've been talking about it since the pandemic, but competition for optometrists is very real. This is what all groups' operating chains of any size are talking about. So that is very real. The growth of managed care and strength of the managed care sector more so than the cash pay sector that is also very real. In terms of sort of market share trends, my sense is we're at best maintaining or at least maintaining our market share. I don't sense large share changes, with the exception of a deceleration in the e-commerce space, which is in line with what I think is being seen in other aspects of direct-to-consumer that there was a big high in e-commerce-related pieces that sector throughout retail during the pandemic, and now there's a trend towards back to stores. So that is happening within our category as well. But again, we think we are at least maintaining share, maybe even growing a little bit on the managed care front. Aside from that, the optometrist shortage and managed care growth, I'm not saying a deceleration of e-commerce towards more back to store. I wouldn't say there are other changes other than those.

Got it. Just a related question. With the competition for optometrists in mind, how does that affect optometrist compensation compared to your expectations? I know you have implemented some new initiatives as well, so perhaps you can touch on that a bit.

Melissa mentioned that there has been an increase in optometrist compensation over the past year, with optometrist-related costs rising by about 90 basis points for the quarter. The company continues to experience inflationary pressures and wage increases in this area. They have introduced significant variable compensation opportunities for doctors to link their pay to productivity, which incentivizes them to provide more productive eye exams. Various efforts are underway to restructure store costs to offset these increased expenses and improve overall efficiency. However, they still anticipate about a 100 basis points headwind from increased optometrist and product costs throughout the year.

Our next question comes from Paul Hughes from Citi.

This is Brandon Cheatham on for Paul. I just wanted to kind of dig in on the capacity-constrained stores. Like are there any similarities with the stores? Are they the same ones? Or is it really just a doctor turnover issue? And do you know where the optometrists are going? Is it a retirement issue? Or is it really just making sure that you offer a competitive enough package to retain them? Or are they going to kind of open their own practice?

So thank you, Brad. In terms of that, there are not broad themes in terms of where optometrists go when they leave us; it's sort of all over the board. Having said that, they're leaving up in lower numbers. When I say that our retention was better in '22 versus '21, and it looks like we're on track for a nice improvement in '23 again, what that says is we're doing a better job of keeping them associated with us. So that's the trend. And again, recruitment is healthy as well. To your point about retirements, there have been more retirements in the year following the pandemic. But actually, the bigger factor has been that many optometrists wanted to cut back on the number of days they work. If you think about that overall, as a trend, it just means that, nationally, there are fewer exam slots than there would be otherwise. Therefore, those are two factors, and we have a variety of incentive programs that incentivize doctors to stay at their traditional five days or to pick up a day here and there if they want to be at three days but during busy times sort of maybe ramp up a bit. Again, when we talk about flexibility, we're trying to offer all sorts of different options to appeal to the lifestyle decisions of an ever-wider collection of optometrists, which, by the way, change over time through the life cycle of their careers. We are designing our programs to be flexible to change over time throughout optometrists' careers. Again, trying to create environments where optometrists want to spend their entire careers. We are pleased with the success we're seeing on those fronts.

Makes sense. And then on the product cost front, I think most of that, and correct me if I'm wrong, is coming on the contact side of the business. So can you just kind of walk us through some of the competitive dynamics that you're seeing in that business? And then what's flowing through on contact pricing?

Yes. As we think about the higher product costs, we announced in March that we were expecting to see about 100 basis point impact split between both the doctor investment and the increase in product costs. We expected those increased product costs to go into effect in the second quarter of the year, and it is primarily related to the contact lens side of the business. That is a product that is easily shoppable, so it's harder to take price as cost increases. We have taken non-headline pricing where it makes sense to do so, and we have been able to offset some of the cost increases that we have seen to date. That has been factored into our guidance that we released in March, and we'll continue to evaluate the competitive landscape and take pricing measures where it makes sense.

Our next question comes from Simeon Gutman of Morgan Stanley.

It's Simeon. I wanted to ask about price changes. I think we've been talking about this for a few quarters. It seems like there's more openness. Can you talk about what's being contemplated? Is it opening price point? Is it the better invest? And I guess, what time frame are you expecting to make a decision that enact changes?

Yes. Thank you, Simeon. Yes, we are talking about non-headline pricing actions. Some level of those are baked into our guidance, and we have several ideas that we're sort of vetting on how potential other pricing actions could be taken. As we said, we're doing a deeper dive study and getting some fresh perspectives on it also, and we're looking forward to that, and we would feather those in over time. Generally, these things can be done reasonably quickly, but there are a lot of different aspects of our business beyond the headline price. There was a small price increase taken at the very end of Q1. Again, this is something that gets feathered in over time, but we think there could be more opportunity, especially in this environment where we think our competitors have been more apt to pull the pricing lever than we traditionally are.

And then my follow-up, I have two parts. First, if you look at your comparable store sales between managed care and customer pay, that's the right notation?

Yes. Yes.

Can you talk about the spread between those? Is it getting wider and why or narrower and why? And then the second part of my follow-up is the adjusted EBITDA or EBIT, which is down year-over-year. I don't know if you could talk about it in basis points but the few drivers that are causing it and then how the movement of that throughout the year may abate or not based on investments, deleverage, ODs, etcetera?

I will address the first part, and Melissa will cover the second part. There is a notable difference between our managed care and cash pay comparisons. Managed care remains robust, while the cash pay segment is not as strong. The strength in managed care was a key factor in achieving the positive comparisons for Q1. Melissa, would you like to take the second part?

Yes. As we think about the decline in adjusted EBITDA year-over-year, many of the factors that are tied into that were what we discussed in March related to the increasing product costs, related to the increasing costs in doctor investment and, in addition, the incentive compensation reset that we spoke about in March. With all of those factors combined, in addition to the initiatives that we've been putting in place, that is creating the drag on year-to-year EBITDA that you're seeing.

Our next question comes from Robbie Ohmes of BofA Securities.

This is Molly Baum on for Robbie Ohmes. One clarification question I wanted to ask on gross margin. You mentioned, I think, that you still expect 100 basis points of pressure for the full year. So I just wanted to dive a little bit deeper. Could you provide some details on maybe what your expectations are in terms of the cadence of that? Did 1Q come in ahead of your expectations? Should we anticipate the second quarter maybe to come in a little bit weaker just given some of the year-to-date trends that you're seeing? Sorry, just any additional details that you might be able to give there.

Yes. So as we think about gross margin for the year, the first quarter came in relatively close to expectations. The reason for that is because the increased product costs that we referred to in March go into effect largely starting in the second quarter. We expect the 100 basis points that we talked about in March to be split between doctor investment, which is pretty ratable throughout the year, and then 50 basis points tied to product cost increases, which began in the second quarter.

Got it. That makes sense. So then in terms of the second quarter, a bigger function is just related to the top line and then maybe some expense deleverage on SG&A. Is that a better way of thinking about it as opposed to the gross margin piece?

Yes. So as you think about the SG&A piece, we expect that we'll have some growth in SG&A as we go into the second quarter. The dollars will be slightly lower than what you saw in the first quarter. However, we're expecting the high single-digit range, largely driven by the incentive compensation reset that we spoke about. In addition to that, based on the timing of our new store openings, we expect to see occupancy expense to be a little bit higher in the second quarter and beyond.

Our next question comes from the line of Dylan Carden of William Blair.

I was just curious, as you speak to sort of encouraging trends in doctor availability capacity, between recruitment, which I would imagine is sort of more of a now and go-forward issue, some of the initiatives you've done around sort of more flexible scheduling and remote care and anything else, kind of what you're seeing is that is working this early in the year and kind of walking through more tangibly how you expect to kind of get your way out of this and maybe some of the timing around that?

We are seeing ever-improving retention and health in recruitment and remote care, which is encouraging. With recruitment, there is usually a delay; for a working doctor, it typically takes at least 60 days from the time they agree to start. The students usually arrive in the summer, so this timeline is factored into our projections and guidance. We have confidence in our initiatives regarding flexible programs and the potential of remote care, but we acknowledge that it's not fully resolved yet. We are making progress, and the trends are moving in a positive direction. We are pleased with this progress and confident about our future. Additionally, where we have capacity, the comparisons are favorable, and it is crucial for us to deliver this capacity because consumers are eager to access our services.

So I'm taking from that, that retention is really driving the encouragement at this point relative to.

No, all three. I'd say retention is encouraging, and recruitment is encouraging. Remote is still a start-up, still on a learning curve, but it's generating exams profitably for us, and we see it getting better and better over time.

Okay. And then the comments around how managed care maybe is not directly related to trade down impact. Can you help me understand that? And...

No, I hope you took away it is directly related. Wealthier people tend to have managed care, managed care benefits go further with us than they do otherwise. And so there's a strong overlap between the two. So you would think they would go in lockstep.

No, I think...

I'm sorry if I misstated that before. But you're correct, there is overlap.

No. It's my fault. And so is the idea or is the commentary that the trade-down impact that maybe was delayed relative to where people thought last year that's happening in greater force at this point?

Yes, the trade-down compared to last year is increasing. And as inflation affects even those with higher incomes, this trend is likely to continue.

Our next question comes from Robert Drbul from Guggenheim.

My question is around the new store opening plan. I guess, when you look at all the headwinds around optometrists, why does it make sense to keep adding stores at the same pace as recent years? And do you consider maybe slowing the pace of the new store rollout?

So again, overall, if you look at the stores we've opened over the past 12 months, they continue to perform in line with historical expectations. Where the ability to get doctors is a highly localized thing sort of that relates to where you place a store, it may be either an encouraging place to have doctors practice or otherwise. So it's very store related. We're always striving to not open a dark store. And yet if, for some reason, a doctor doesn't show up in many of our many places, we can open with remote, and that's a factor also which we never had in the past. Again, the promise is that over time, remote could actually increase our white space opportunity. But if the new stores are still working, and we have then we're still going. We think that white space is very real.

Our next question comes from Adrian Yih.

Reade, I have a couple of broader questions for you. Considering the comments about April experiencing some pressure from tax refunds, how do you feel about the macro changes in the second half of the year? Is it too early to anticipate any recovery? Is the tax refund pressure primarily a short-term issue? Also, as we expect more doctors to be onboarded this summer, what increase in doctor capacity do you anticipate to help reduce unfulfilled exams? Melissa, regarding SG&A, how should we approach that if we look ahead one or two years? What portion of that is related to heavy investment, and how will it become more balanced in 2024?

Melissa, why don't you go through what the guidance contemplated for the second half of the year, the balance of the year in the SG&A? And then I'll take the question about the increasing capacity from the hiring.

Sure. Adrienne, as we think about with April being a little bit softer, we did tie that to what we believe to be a lower tax refund season for our low-income consumer. We expect that the initiatives that we're putting in place to continue to take hold and expand exam capacity. And it's too soon to talk about May as we're just a couple of weeks into that period. However, we have taken all the information that we have to date and factored that into the guidance that we reaffirmed today. So we do expect the back half of the year to have slightly better comps than what we've seen so far in the first quarter. As we think about SG&A, the modeling that we've talked about this year, we do expect the headwinds related to the incentive compensation reset and the increased occupancy expense that we talked about a few moments ago. As we think about beyond this year, with the initiatives that we're putting in place, as we get back to mid-single digits, we expect to leverage many of the investments that we're putting in place currently. As we get past the implementation phase, we spoke last March that we expect to see at least a 100 basis point improvement in operating margins related to some of those implementation teams being expanded in the productivity that we expect for many of those initiatives.

And so the part of your question, Adrienne, about the new hires and the increase in capacity, we're encouraged by Q1 student hiring. It's better than Q1 last year. Last year, we had record student hiring, so that's a plus. Doctors, new doctors coming on is always part of our plan, but right now, it's looking a little bit more encouraging than what was in the plan, but this is all part of the puts and takes on the balance of the year that Melissa just took you through. There are a lot of factors that you've got to balance that you project out through the balance of the year. But as we assess all those, we felt quite comfortable reiterating our guidance.

At this time, I would now like to turn it back to Reade for closing remarks.

Good. Thank you very much, Gerald, and thank you all for joining us here today. And thank you for your ongoing support, and we look forward to speaking to you again when we report our second quarter results. Thank you all very much. Have a great day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.