National Vision Holdings, Inc. Q3 FY2023 Earnings Call

Thank you, and good morning, everyone. Welcome to National Vision's third quarter 2023 earnings call. Joining me on the call today are Reade Fahs, CEO; and Melissa Rasmussen, CFO. Patrick Moore, COO, is also with us and will be available during the Q&A portion of the call. Our earnings release issued this morning and the presentation accompanying our call are both available in the Investors section of our website, nationalvision.com. A replay of the audio webcast will be archived in the Investors section after the call. Before we begin, let me remind you that our earnings material 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 presentation and supplemental materials for investor reference in the Investors section of our website. I will now turn the call over to Reade.

Thank you, Caitlin. Good morning, everyone. Thank you all for joining us today. This morning, we will begin with a review of highlights from our third quarter, including ongoing progress on our strategic initiatives. We will then provide an update on the upcoming end of our Walmart partnership, as well as our plans to position National Vision for long-term profitable growth. As we look ahead to operate a more streamlined and less complex business model, then Melissa will review our third quarter financial results and updated outlook in more detail. Turning to our results, we are pleased with our third quarter performance, which reflected ongoing strength from our managed care business, and was supported by the continued progress we're making with expanding eye exam capacity, particularly within America's Best. For the quarter, we delivered net revenue growth of 6.6%, including comparable store sales growth of 4.3%, and we delivered adjusted diluted EPS of $0.15. We saw strength particularly in America's Best, which was partially offset by softness in our Eyeglass World business. While we've continued to contend with exam capacity constraints across both our growth brands, our initiatives to date have been predominantly focused on our largest brands America's Best. Given the improvement we've seen in our America's Best locations, we are applying and incorporating the learnings from that playbook to improve our Eyeglass World performance. As we discussed on our last earnings call, we were encouraged by the early trends we're seeing with the back-to-school season, and we're pleased to see that performance continue through the period. In addition, we continue to see strength from our managed care business, which is one indicator of the trade-down behavior that is occurring with many customers as we continue to navigate a dynamic macro environment. As I mentioned, the quarter also benefited from ongoing progress on our strategic initiatives, particularly focused in our America's Best business. We have continued to see improvement with stores that do not have optimal coverage, which we refer to as dark and dim locations. To expand the exam capacity from our recruiting, retention, and remote initiatives. We are pleased to continue to see much lower levels of dark stores compared to the peak we saw last year. And are seeing slower but steady progress addressing our dim stores as well. As a reminder, we define dark stores as those locations that do not have doctor coverage, and dim stores as those locations that have less than three days of doctor coverage. We remain focused on executing our initiatives to continue to drive improvement across our fleet. And as I discussed last quarter, where we have the desired level of capacity, stores are delivering comps more in line with our historical operating model. We remain on track to deliver a second year of record recruiting and have contracted more new graduates this year than in any previous year. In addition, we continue to expect to deliver improved retention rates this year. These trends are driven in part by the schedule flexibility options that have been made available to the doctors. Our remote initiative is also helping us to expand exam capacity, and it's been a major factor in improving dark and dim store performance, enabling a double-digit productivity lift in sales. As of the end of Q3, more than half of our America's Best locations have been enabled with remote exam capabilities and electronic health records. Reflecting the progress we've made in the initial heavy implementation phase over the past two years. We remain on track to roll remote capabilities out to at least 200 stores this year. And as we look ahead, given the work done to date, as well as the evolving state regulatory landscape, we expect the pace of our implementation of remote to slow in 2024. We continue to believe in the opportunity there is for remote exam capabilities across our stores. And we'll continue to monitor the regulatory landscape and assess our plans accordingly. With respect to our EHR rollout, we remain on pace to have EHR installed at all America's Best locations by the end of 2024. Turning next to our digitization plans for our corporate office, we have begun to implement the first phase of our ERP project focused on finance system upgrades. We are taking a measured approach to this project and plan to evaluate each phase appropriately to mitigate risk and maintain our focus on disciplined capital allocation. Finally, with respect to our whitespace opportunity, we remain on track to open 65 to 70 new stores this year and opened 21 new stores in the third quarter. Now let me provide an update on our transition plans with the pending end of our Walmart partnership beginning early next year. We are committed to ensuring the continuity of our Walmart business to the end of our contracts and actions have been taken to support the retention of associates and doctors during this time. I'm very appreciative of how our teams have continued to operate with discipline and focus on customer care amidst this transition. As we previously discussed, the Walmart business has continued to become a smaller piece of our overall performance over the last decade and carries a much lower margin than our larger growth brands. Moving beyond the termination dates of the contracts, we will operate a far more streamlined and less complex model. As detailed in our press release this morning, in conjunction with the termination of our Walmart partnership, we will be winding down our remaining operations. In doing so, we will be closing our Ohio distribution center, which largely supports the wholesale distribution and ecommerce contact lens services that we provide to Walmart and Sam's Club. While this is a difficult decision, it is a prudent one for our organization. We are continuing to work with Walmart on the transition of the Vision Center associates and ODs and currently expect approximately 7% of our total associate headcount to be impacted by this decision, and the termination of the Walmart partnership. The vast majority of whom will be Walmart Vision Center and roles related to AC Lens. In addition, given the changes in our go-forward operating model, we have conducted a comprehensive review of our cost structure and will be implementing expense savings initiatives focused on streamlining corporate overhead, as well as reducing travel expenses and third-party spending. We believe these decisions combined with benefits from repricing actions we plan to take on the heels of the pricing study completed earlier this year will more than offset the profitability gap created by the termination of the Walmart partnership. To this work and our ongoing execution of our strategic initiatives focused on driving revenue and enhancing performance in our two strategic growth brands. We are well-positioned to deliver operating margin expansion and thus drive increased shareholder value. Melissa will discuss the details of these actions and anticipated financial impact in a moment. In closing, we remain committed to our mission of making quality eye care and eyewear more affordable and accessible. While we continue to maintain a conservative approach to our outlook, given the ongoing challenging macro environment that continues to pressure our core uninsured customers. We remain on track to deliver on our objectives for this year, as reflected in the narrowing of our guidance. I will now turn it over to Melissa.

Thank you, Reade. And good morning, everyone. As we discussed, we are pleased with our third quarter performance in the ongoing progress we were making on our strategic initiatives where the third quarter net revenue increased 6.6% compared to the prior year, driven by adjusted comparable store sales growth and growth for new store sales. The timing of unearned revenue negatively impacted revenue in the period by 30 basis points. We opened 70 new America’s Best and for Eyeglass World stores in the third quarter. Unit growth in our America’s Best in Eyeglass World brands increased 5.3% on a combined basis over the total store base last year, and we ended the quarter with 1,402 stores. As Reade mentioned, we are still on track to open between 65 stores and 70 stores in 2023, consistent with our previous guidance. Adjusted comparable store sales grew 4.3% compared to the third quarter of 2022, driven by an increase in customer transactions to a lesser degree, and increase in average ticket. As Reade mentioned, we saw strength particularly in America’s Best, which was partially offset by softness in our Eyeglass World business. As Reade discussed, our initiatives continue to address our dark and dim store population. Well, we have always contended with dark and dim stores. However, the combination of post-COVID doctor availability issues and a more challenged lower-end consumer has exacerbated the impact of dark and dim on our revenue performance. On average, a dark store is approximately 80% less productive than a store with full coverage, which we define as having five to six days of in-store doctor coverage. A dim store on average is approximately 50% less productive than a store with full coverage. By enabling remote, we have significantly improved this productivity drag and while there is still more progress to be made, we are making nice headway with dark and dim stores. As a percentage of net revenue, costs applicable to revenue increased 70 basis points compared with the prior year quarter driven primarily by the deleverage of optometrist-related costs, as well as other components of service revenue, including warranty play revenue. These costs were partially offset by ongoing strength in exam revenue and a decrease in product costs attributable to higher eyeglass margin and decreased freight expenses. As we discussed last quarter, the pricing actions taken with respect to exams have helped to partially mitigate the increase in optometrist-related costs. For the quarter, the net impact from the deleverages of optometrist-related costs and the increase in exam revenue was approximately 50 basis points. Adjusted SG&A expense as a percentage of revenue increased 90 basis points compared with the third quarter of 2022. The increase in adjusted SG&A as a percentage of net revenue was primarily driven by performance-based incentive compensation, as we expected. Depreciation and amortization expense was $24.4 million, compared to $24.9 million in the prior year period. Adjusted operating income was $15.7 million, compared to $21.5 million in the prior year period. Adjusted operating margin decreased 130 basis points to 3%, primarily due to the same factors I just reviewed. Net interest expense was $3.7 million, which includes mark-to-market gains and losses on derivative instruments, and changes related to amortization of debt discount and deferred financing costs of $3.5 million. The year-over-year change was primarily a result of lower derivative income and higher interest expense on our term loan, partially offset by higher income on cash balances. Our effective tax rate in the third quarter was 5.8%, primarily due to legacy segment impairment losses. We expect our tax rate on ordinary income items to be in line with our original guidance. Adjusted diluted EPS was $0.15 per share compared to $0.15 per share in the prior year period. Turning to our financial results for the nine months to date, as compared to the prior year period, net revenue increased approximately 5% driven by new stores and adjusted comparable store sales growth of 2%. Adjusted operating margin declined 180 basis points compared to the prior year period, driven primarily by the same factors I just reviewed, which impacted the third quarter. Please note our adjusted results for the third quarter and nine months year-to-date period exclude the impact associated with one-time charges related to the termination of our Walmart partnership, including $2 million in retention bonuses and termination benefits for certain employees supporting the Walmart Vision centers, and the AC Lens distribution center and $79.4 million of non-cash impairment charges related to impairment of goodwill, intangible assets, and fixed assets. Turning next to our balance sheet, we ended the quarter with a cash balance of approximately $266 million and total liquidity of $559 million, including available capacity from our revolving credit facility. As of September 30th, our total debt outstanding was $563 million. And for the trailing 12 months, we ended the period with net debt to adjusted EBITDA of 1.9 times. Year-to-date, we generated operating cash flow of $153 million. In addition, during the first nine months of fiscal 2023, we invested $82 million in capital expenditures, primarily driven by investments in new stores, our labs, and distribution center, and our remote medicine technology. We remain on track for capital expenditures to be in the range of $115 million to $120 million in 2023 to support our key growth initiatives. Our balance sheet and liquidity remain strong, enabling our robust and disciplined capital allocation plan, which is designed for continued growth balanced with opportunistically returning capital to our shareholders. Earlier this summer, we refinanced our term loan A and extended our revolving credit facility, and we are continuing to evaluate options with respect to our convertible note, which matures in May of 2025. Given the current environment and our focus on continuing to fortify our balance sheet, our share repurchase activity to date was focused on the first quarter of this year. And as of the end of Q3, we have $25 million of share repurchase authorization remaining. We will continue to deploy capital to ensure we are making prudent decisions that are financially responsible for the company. Moving now to the discussion of our 2023 outlook, year-to-date, we remain on track with our expectations for this year. And as we move into the fourth quarter, our seasonally lowest quarter from a profitability perspective, we are narrowing our full-year guidance range. We now expect revenue to be in the range of $2.115 billion to $2.125 billion, supported by adjusted comparable store sales growth of approximately 2% for fiscal 2023. Our revenue guidance incorporates ongoing execution of our strategic initiatives focused on expanding exam capacity and contemplates current business trends. We continue to expect depreciation and amortization to be in the range of $99 million to $101 million. We expect adjusted operating income and adjusted diluted EPS to be in the range of $60 million to $65 million to $0.53 to $0.58 per share, respectively. Our guidance for adjusted diluted EPS assumes approximately $78 million weighted average diluted shares outstanding. As a reminder, our adjusted results as well as our outlook excludes the one-time charges related to the termination of our Walmart partnership I reviewed, as well as the expected costs associated with the first phase of our ERP implementation. Regarding our ERP project, as Reade noted, we are taking a disciplined and phased approach. The first phase, which kicked off late in the third quarter, will focus primarily on finance system upgrades, and is expected to be substantially complete in 2024. We expect to incur one-time expenses associated with the first phase of this project to be between $11 million and $13 million, of which we expect to incur between $2 million and $3 million in fiscal 2023. Now, let me provide an update on the work underway as we plan for the upcoming termination of our Walmart partnership. As we previously announced, as of February 23rd, 2024, we will transition the operations of the 229 Vision Centers, as well as the related optometric services for Walmart in California to Walmart. And as of June 30, 2024, we will cease the wholesale distribution and ecommerce contact lens services that we provide to Walmart and Sam's Club through our AC Lens business and will wind down the remaining AC Lens operations. For fiscal 2023, we expect our Walmart store operations and the wholesale distribution and related services to Walmart and Sam's Club included in our corporate other segments to account for approximately $355 million of revenue. The remaining portion of our AC Lens operations, which generates approximately $45 million in sales and is immaterial from an earnings perspective, will be wound down in conjunction with the overall Walmart and Sam's Club exit. Combined, the Walmart store operations and the AC Lens operations are expected to generate approximately $400 million in revenue and earnings before income tax of approximately $15 million. The annualized direct and indirect costs associated with these operations for fiscal 2023 are expected to be approximately $385 million. We expect costs associated with these operations, including our Ohio distribution center, to be wound down in conjunction with the termination date of the contracts. While we expect to provide our full 2024 outlook as part of our year-end earnings call in 2024, due to the Walmart contracts staggered end date in 2024, we want to provide some additional details now to help with modeling. Using 2023 as our guide, we expect revenue related to the Vision Center operations and the AC Lens operations in fiscal 2024 to range between $140 million and $150 million with a margin profile similar to 2023. Assuming no material degradation in the Walmart operation. As we look ahead, with an enhanced focus on our largest growth brands, we are taking actions that will further optimize our cost structure and position us to advance our long-term strategy and strengthen our competitive position. As Reade noted, beginning in 2024, we will be implementing an expense reduction program targeting annualized savings of $10 million to $12 million focused on streamlining corporate overhead as well as reducing travel expenses and third-party spend. As Reade noted, we are also planning to take additional non-headline pricing actions, which we believe will continue to enable us to deliver on our mission to provide affordable eye care and eyewear while maintaining a competitive position in the marketplace, and leveraging our costs more effectively. We expect the combined impact of the non-headline pricing increases and the cost savings program to more than offset the profitability gap created by the termination of the Walmart partnership. We believe these actions combined with gross margin tailwinds from the exit of the lower-margin Walmart operations and the ongoing progress of our strategic initiatives, including the completion of the large initial implementation phase of our remote and EHR capabilities, position us well to return to mid-single-digit adjusted comparable store sales growth and operating margin by fiscal 2025. In summary, we are pleased with ongoing progress in expanding exam capacity and expect to continue to build on this momentum as we move forward with an even greater focus on our strategic growth brands. We believe the actions we have announced today will further support our plans to drive long-term success and shareholder value. Thank you for your time today. I will now turn the call over to Reade for closing remarks before we open the call for your questions.

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

Our first question comes from the line of Anthony Chukumba from Loop Capital Markets. Your line is open.

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

Yeah. So as you pointed out, our managed care business has been really great. Year-to-date, our managed care demonstration started strong and just strengthened throughout the year. The great thing about our managed care business is that it's not our customers' money that they're using. So, that's good. And also, I think that the managed care customers have realized that their money goes further with us than it does otherwise.

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

Yes, so trade down continues, and we're seeing a greater percentage of our customers coming from households earning over $100,000. And managed care is part of that. But some relates to the non-managed care as well.

So thank you, Anthony. And yes, I will be saving money by not going to Bentonville; that was very good.

Our next question will come from the line of Michael Lasser from UBS. Your line is open.

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

I'll take the pricing side of that first, Michael. We've been taking some peripheral pricing action throughout the year non-headlined pricing action. And I think we mentioned two calls ago that we're doing a deeper dive study. We're always monitoring price scores, but that we're doing a deeper dive study in ourserver pricing architecture relative to competition. Based on that, we have some programs that we're going to be putting in place at the very end of this year that, as Melissa said, we think will play a nice role in improving our margins next year.

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

And Michael, can I just follow up on one other thing regarding pricing? We are implementing the pricing actions we mentioned. Since we met, we've emphasized our preference for growing by transaction count rather than by average ticket. We are very pleased that Q3 demonstrated a positive comparable transaction for the quarter. This aligns with our preferred growth strategy, which was the main focus for this quarter.

Without a doubt, Reade, that being said your implied fourth-quarter guidance does suggest that your comp is going to slow, though. A, is that what you've seen already thus far this quarter? And then B, why do you think it would be slower?

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

Thank you very much. Good luck.

Thank you.

Next question on the line of Zach Fadem from Wells Fargo. Your line is open.

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

Yeah, sure, Zach, related to the dark and dim stores, that number can fluctuate greatly throughout the year and year-to-year. So, it's difficult to tie a specific comp because you're not looking at the same store. Now, with that, what we have said is that we do expect to see or have seen that we have a constant line more in line with our historical performance when it's staffed at the capacity that we desire. When we're thinking about the total sales productivity, we can talk about that from the perspective of the dark and dim impact on overall revenue. So with the dark stores, that has a productivity drag of about 80% compared to a fully staffed store, and the dim stores have about a 50% drag as compared to a fully staffed store. And with this, we have continued to expand our strategic initiatives and recruiting, retention in remote, which is something that can help the dark and dim situation quite significantly. And that has become a factor in stores that we are looking to open as we expand our fleet, we think about whether or not a remote state will allow us to implement remote as we're moving in there when we think about our recruiting initiatives. Overall, remote can help and it continues to have a positive impact as we drive forward on dark and dim.

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

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

But I believe I said in my comments, though, where we have the capacity, the stores are delivering comps in line with historical norms. So, we didn't give a specific number, but it is in line with historical norms, where we can execute our model effectively.

I appreciate that, Reade. It seems that the gap between America's Best and Eyeglass World has grown in recent quarters. With your efforts mainly directed towards America's Best, could you discuss the strategic status of Eyeglass World and whether you still view it as a potential growth driver in the coming years? Additionally, how do its returns compare to those of America's Best?

That you've got it 100% right; we have been focusing on specific challenges primarily the same. It's primarily a coverage-related challenge. We've been implementing our key programs in America's Best first because it's larger, right. And now we're turning our attention, as we've been getting nice success there, to taking that same playbook and applying it to Eyeglass World. So, yes, it is a similar challenge. We just focus on America's Best first, but we're putting the playbook in place now with Eyeglass World.

Got it. Thanks for the time.

Thank you.

Next question offline of Paul Lejuez from Citi. Your line is open.

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

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

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

Got you. I was wondering if we could dive in a little bit into margin impact in the first half of ‘24. I believe that the contact business had increased costs impacting the back half of this year. So, can we expect a similar headwind in the first half of next year? And then just the timing of the AC Lens business rolling off, which I believe is a lower margin business than your Walmart stores? So, should we see incremental pressure in the first half of next year? And then, as that rolls off, things improve from there?

Yeah, so we'll talk more specifically about ‘24 as we release our year-end guidance. But what we did put out related to AC Lens and Walmart, we did want to quantify what the impact of that roll-off would be because of the staggered end date. So we put out that the expected revenue would be between $140 million and $150 million with a similar profit profile to what you're seeing in 2023. We do expect that we'll continue to have, as we go into fourth quarter the gross margin headwinds and tailwind that was spoken about previously; the quarter and the year has played out largely as we'd have expected. We have doctor cost headwinds offset by exam pricing benefits and expanded exam capacity. In addition, we have seen some product favorability from free to expenses as well as some additional product favorability.

And our next question comes from Adrienne Yih from Barclays. Your line is open.

Thank you very much. Good morning, Reade. I'm glad to hear about the progress on the remote exam. However, it would be helpful for me to understand the long-term plan. You're definitely making progress each quarter, but could you discuss the pace of remote implementations over a three-year period? It seems like it might be slowing down next year, which I think I heard correctly. It feels like there is significant potential here when you improve coverage on the exam. Can you share your current use case and whether you're following the planned approach? Also, I'm sure you have a more ambitious goal for that same time frame. Does that require you to speed up your current efforts, or are there disruptive technologies you can adopt? I realize that's a lengthy question, but there seems to be a lot of opportunities over the next few years to reach that 5% and higher. I would appreciate your insights on that. Then I have a follow-up for Melissa. Thank you.

Good, Adrienne. I'm going to turn it over to Patrick, who leads our remote initiative. I wanted to mention that it was a bit difficult to hear your comments. Therefore, I'll highlight the importance of understanding the expansion plan. I agree that it represents a significant opportunity. There seemed to be some concern regarding the pace of progress, so Patrick, could you address that?

Yeah, Adrian, I'll follow up your long-winded question with a long-winded answer. No, I do want to unpack that a little bit. I'm glad you asked that question. And just as a precursor, great results out of remote. We're seeing it as a win for doctors, patients, and store teams. It's driving incremental sales, incremental costs, and incremental profitability. As a side note, we will be even more profitable this year after being dilutive last year. Melissa talked about the benefits of remote for dark and dim and recover that. But that's a big factor. We're on track to set up another 200 this year, taking us to 500. And really, this kind of brings the initial phase to a close. We still have future phases. But there's really a couple of things there. And we have now equipped two-thirds of the states where we operate America's Best. While there is opportunity remaining in some other states, there are a couple of the larger states out there that we look forward to hopefully equipping one day. We are at critical mass now; remote has become a really big factor in our site selection for new stores as well. So, this slowing is both natural based on what we've done thus far. But we're also kind of continuously monitoring state regulatory and navigating state regulations, looking for other states to open up. I believe that over time, telemedicine will become more and more normal and natural, but it's going to take a while. And so as we look, as we've always said since earlier this year, as we clear the big initial investment phase of remote, we are looking to see about a turn of operating margin improvement. We have guided towards that happening in the second half of 2024, by the end of the second half of 2024, and still feel really good about that. So, pace is slowing based on good work, pace is slowing based on our confidence to take our model into each state, which can have varying rules. But again, we monitor that super closely and we'll be looking to take more states into remote; it just won't be quite as broad scale and lumpy as this first big phase.

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

In the states, it really comes down to what our regulatory bodies allow for a full health exam. And so we believe we have as good, maybe the best remote exam out there in the market today. And so it's probably less about us doing things differently and more about us navigating into those states and maybe even those states becoming a little more open to telemedicine.

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

Thank you. Our next question comes line of Brian Tanquilut from Jefferies. Your line is open.

Good morning and great job on the quarter. You have made progress on optometrist labor first; it'd be helpful maybe if you provide some KPIs to help us understand how optometrist capacity has been trending quarter-on-quarter, things like adds, turnover, and retention. And then also, as you continue to roll out remote, I know it's still in early phases. But can you detail the impact on average productivity per commission, and then I have a follow-up.

Good. So, while we're not where we don't quantify specific capacity levels, I think if we're saying retention has improved for the second year in a row, that's our recruitment is going to deliver a second record year and record new grads who tend to start in July and August. And then Patrick just went through the remote successes; those do add up to improved capacity.

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

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

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

So, we only publish our managed care penetration once a year because of changes in seasonality and the like. And so, the last time we said it was a third of the business. We've been repeating that it's been very healthy and getting healthier throughout the year. Again, I think what has been discovered is that by customers, with some help from our marketing, that we’re a great place to use your managed care benefits. And of course, there's also the word-of-mouth side of that; you're the same age care as your co-workers, and you tell them about your good experience and that snowballs from there. But I'm not sure there is a high watermark; I think it will continue to grow. I think we are on a roll here. And so, I don't, I think when we publish our number at the end of the year, it's going to be up nicely, and I would expect that to continue.

Thank you. Our next question we have line of Simeon Gutman from Morgan Stanley. Your line is open.

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

Hey, Simeon, good morning this is Patrick. Hitting on new stores, I do want to add that assuming the year-end timing works out well, we do expect to be at the top of that 65 to 70 range for 2023. So, we're happy, really happy with what we've accomplished over the last two years for our real estate and store teams in terms of continuing the unit growth. In terms of how we're thinking about next year, look, we're in the midst of planning. I will tell you that there are a lot of factors that come into that every year. State site brands, doctor recruiting optionality remote has become a significant factor. As it is not plan A, but it is a really nice plan B. We're looking at all that very carefully right now and expect to be able to share those details with you as we close the quarter and fourth quarter. But rest assured, we're still focused on taking advantage of the whitespace opportunity that remains in front of us while carefully balancing the other dynamics that we mentioned.

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

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

Yeah, so with advertising, we do see a little bit of advertising leverage as we move into the fourth quarter. And that's just due to more productive advertising that we're expecting to have SG&A overall. Yes, we will expect to be leveraged for the full year. And that is largely related to the incentive compensation reset that we spoke about initially with our year-end release.

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

Thank you. Just curious what percent of your stores are dim? Sorry if I missed that, and your counter stores dim if it's got remote capacity. And maybe how that's trended over time?

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

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

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

And our last question for today will come from the line of Molly Baum from Bank of America. Your line is open.

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

Good. So overall, we haven't seen significant changes in the competitive landscape. Yes, I am aware that one competitor did announce more aggressive marketing effort; you just have to think about market share in this category, because it's just a highly fragmented category. So, an increase in marketing spending from one competitor doesn't drive massive pieces. And especially, sort of different competitors attract different customer bases. Ours is a more low-income budget conscious, less high-end consumer. And so oftentimes, we're talking to different consumers in our marketing. And while Walmart is taking the 227 stores, we're not expecting them to be a more aggressive competitor, as they do not historically do marketing of their Vision Center business. In general, the competitive landscape I think is pretty similar to the last call we did, and ecommerce has stayed very stable for a long time as a percentage of the business of the category.

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

Yeah, but I would like to just point out one other thing is that your first piece, even in light of some competitive marketing increases, positive comp transactions for Q3 are still coming in.

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

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

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