National Vision Holdings, Inc. (EYE) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the National Vision Fourth Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference call is being recorded. [Operator Instructions] I would now like to hand the conference over to your host, Mr. David Mann.

Thank you, and good morning, everyone. Welcome to National Vision’s fourth quarter 2019 earnings call. Joining me on the call today are Reade Fahs, Chief Executive Officer; and Patrick Moore, Chief Financial Officer. Earnings release 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 the 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 in our filings with the Securities and Exchange Commission. The release and today’s presentation also includes certain non-GAAP measures. Reconciliation of these measures are included in our release and the supplemental presentation. We also would like to draw your attention to Slide 2 in today’s presentation for additional information about forward-looking statements and non-GAAP measures. As a reminder, National Vision expects to provide certain supplemental materials or presentation for investor reference on the Investors section of our website. Now, let me turn the call over to Reade.

Thank you, David. Good morning, everyone. It’s a pleasure to be sharing our fourth quarter results with you today. If you turn to Slide 4, Q4 was a strong quarter for us, capping up another record year for net revenue and adjusted EBITDA. We are pleased to report our 72nd consecutive quarter of positive comparable store sales growth, that’s 18 years of consistently healthy quarterly comps. We remain pleased with the consistency and durability that this track-record reflects. Q4 adjusted comparable store sales growth was up 8.1%. Comps were once again led by our growth brands with a 9% comp increase at America’s Best and 6.4% comp increase at Eyeglass World. Also, I’m quite pleased with another solid quarter at our Legacy segment, which delivered a 5.1% comp increase for its second consecutive quarterly increase over 5%. Note that our Legacy locations average 24 years of age. So it’s nice to see such strong performance from such established stores. We opened 8 new stores in Q4 and ended the quarter with 1,151 stores, for a 6.4% increase in store-count in the past year. The comparable store sales growth and unit growth combined to drive a 12.9% increase in net revenue. Adjusted EBITDA increased nearly 38% and adjusted EPS increased to $0.11 versus $0.01 last year. An important sign of customer satisfaction and ambassadorship is net promoter scores, which we track closely. Our NPS for each of our brands remained at or near record-levels this year. With our 10K filing today, we’re pleased to share that the previously reported material weakness has been remediated. I appreciate all the hard work from our accounting and finance teams to deliver this accomplishment. Since yearend, we have 2 additional noteworthy achievements to share as a result of expanding partnerships. First, we announced an amendment to our existing contract with Walmart, our strategic partner for the past 30 years. This amendment added 5 additional Vision Centers in Walmart stores to our contract, to bring our total to 231. This marked the first time in 26 years that Walmart gave us more Vision Center locations to operate. We’re excited by this opportunity and are working closely with Walmart regarding the logistics to take over the operations of these Vision Centers as soon as it’s practicable. The amendment also extended our existing contract for 6 months, to February 23, 2021. Overall, this agreement further strengthens our relationship with Walmart and grows our footprint. Given conversations with Walmart are ongoing, we will not be commenting further on the contract or our relationship on this call. Second, our merchandizing team continued to work delivering assortments that exceed customer expectations all at great values. Last month, we expanded our relationship with the affordable celebrity eyewear brand, Privé Revaux, to all our America’s Best locations. The expansion comes after a successful pilot program at select America’s Best stores last year. With our strong Q4 performance, we’re pleased to have exceeded our fiscal 2019 outlook. And enter fiscal 2020 with good operating momentum. In a few minutes, Patrick will take you through our Q4 results and our 2020 outlook in more detail. Turning to Slide 5, 2019 was again filled with a number of highlights at National Vision. We expanded our footprint, increased market share and continued to reinvest in our business towards future growth. The optical retail market remains highly fragmented and we continue to see a large opportunity in front of us. We expanded our centralized lab network and with our new Texas facility, which is ramped on schedule and added capacity to support our growth. Our management team has continued to evolve over the last couple of years. Many of the senior executives that came together to build the company in the early 2000s have reached retirement age. We’re pleased that this transition continues to go smoothly as demonstrated by our consistent performance. We are fortunate to have attracted new executives with strong skill-sets and fresh perspectives, while continuing to foster the same vibrant culture that has served us quite well. We continue to enhance our balance sheet with a successful debt refinancing this summer, followed by a $25 million debt pay-down in Q4. Our 14-year ownership by private equity came to an end as KKR and Berkshire Partners both exited their remaining ownership position by last summer. This concluded the chapter of our very successful relationships with both groups. We wish to thank both Berkshire Partners and KKR for the important role they played in our growth. We strengthened our Board of Directors with the addition of another independent Board member, Heather Cianfrocco, who has provided valuable managed healthcare insights and other stewardship since joining in 2019. Lastly, we also made considerable strides in our social mission at our growth brands. During the months of November and December, our America’s Best teams launched the holiday give-back initiative and donated free eye exams and eyeglasses to over 8,100 children in need. During 2019, Eyeglass World rolled out its Made Locally, Given Globally program and made free prescription eyeglasses that are going to 50,000 underprivileged people around the world. Turning to Slide 6, it was another quarter of positive comps, further demonstrating the consistency in store performance and comp store sales gains. The graph highlights our 72 consecutive quarters of comparable store sales growth. Our comps during this 18-year streak have been consistent over time and across the economic cycle, which we believe is one of the nice benefits of a purchase tied to a medical necessity. People need to see to get through the day, and eyeglasses and contacts remain the primary way to correct for vision loss. Comps in the quarter were driven primarily by increases in customer transactions as traffic trends accelerated from the third quarter. Our comp trend was consistently strong throughout the quarter. We experienced continued comp strength at our growth brands, continued momentum at our Legacy segment, and positive trends at our host brands. The Legacy segment posted its second consecutive quarterly comp increase in excess of 5%. We are encouraged by the energy and execution being delivered by the team and believe that our patient and customer engagement initiatives are the key factor driving this performance. Overall, our consistent positive comp results continue to reflect the benefit of operating in the growing value segment of an attractive industry, having a leadership team of optical experts focused on customers and patients, marketing operations and merchandizing strength, new store growth, as well as comparable store sales growth in our more mature stores, driven by loyal customers and positive word-of-mouth. With our double-digit net revenue growth in 2019, we believe that we continue to gain share in this highly fragmented $36 billion U.S. optical retail market with our low-cost operating model. Of course, our performance is at its core a testament to the store-level execution of our teams and their commitment to customer service every day and in every store 1 patient and 1 customer at a time. Turning to Slide 7, our strong results were fueled by another quarter of solid operational performance. We look to continue to execute against each of our core growth initiatives. First new stores are our primary focus, as we continue to see a sizable whitespace opportunity. We plan to open approximately 75 stores in 2020, following the formula-based approach that has worked so well for us historically. We have a solid pipeline of specific locations for this year and into 2021. A key to our ongoing success is our ability to attract and retain optometrists. We are an optometrist-centric company and want to be the place of choice for optometrists, whether it be new graduates paying off their student loans or experienced optometrists looking for the ability to focus on pure optometry without the burden of running their own store. As such, we continue to invest in our optometrist recruitment and retention programs. We believe that these investments are paying off as our overall optometrist retention rate remains at record levels. This quarter we believe that our healthy optometrist coverage helped to drive patient traffic as we work to fill the ever growing demand for eye exams in our store. Second, we believe we are well positioned to deliver another year of comparable store sales growth in 2020. Our key comp drivers remain the comp waterfall for maturing new stores, marketing and vision insurance initiatives. Our stores take several years to mature as the patients and customers awareness build. It can take time for potential patients and customers to find a store given an infrequent purchase cycle that averages 2 to 3 years. When our patients and customers are in the market, we strive to deliver incredible values that attract them to our store. We have maintained our introductory offer at America’s Best, 2 pairs of eyeglasses for $69.95, including a free comprehensive eye exam for over a decade. Another great example is our new line a Privé Revaux glasses, which are also available at an attractive value. We’re pleased to offer this fun and stylish celebrity endorsed assortment to our America’s Best customers. And given we have exclusivity for prescription optical products, we are the only U.S. optical retail chain that can offer them. At Eyeglass World, the offer of 2 pairs of glasses for $78 along with the opportunity of same day service from our in-store lab also represents one of the best values in the industry. We believe that the combination of low prices and excellent customer service leads to satisfied repeat customers and positive word-of-mouth as customers tell their friends, how little they spent and the great service they received in our store. In 2019, approximately 65% of customers in mature stores were existing customers. We continue to invest in marketing to attract new customers as well as remind existing customers to come back for another great experience. Television advertising remains our primary marketing vehicle and our marketing team continues to come up with catchy new versions of our Owl and Mr. World advertising campaign. In particular, our Owl campaign has played for years and continues to resonate with customers by humorously reminding them that they paid too much if they didn’t shop the America’s Best. We provided a link to our website at the end of the presentation, where you can watch the newest commercials for our brands. Our marketing efforts also utilize our robust CRM system, and we believe that our CRM initiatives helped to enhance our relationships with existing customers to drive retention. We’re quite pleased with the effectiveness of our marketing campaigns this quarter. Overall, we believe that our investments in marketing are paying off and a factor in our strong gains in customer traffic and market share. Participation in vision insurance programs remains a positive comp driver. Healthy net revenue growth tied to these partnerships continued in the fourth quarter. We believe a factor behind this growth is that vision insurance dollars in general, tend to go further at our stores. We remain underpenetrated relative to the industry for the percentage of our business coming from vision insurance. Net revenue tied to vision insurance, while fast growing remains a minority of our net revenue. Thus, we see continued opportunity for growth. As a value retailer, we promote a low cost culture at National Vision. We know we can’t be everyday low price without everyday low cost. As we’ve noted in the past, our centralized lab network is a key reason that we are everyday low cost. Our newest state-of-the-art lab in Texas continues to ramp its production on schedule, and we’re pleased to have this added capacity to support our future growth. We continue to progress our omnichannel efforts to improve the customer experience and operating efficiency, we appreciate the importance of data science and are focusing on optimizing the usage of our data. Our focuses on all aspects of the customer journey in order to improve engagement and reduced cost. Our patients and customers appreciate such things as the ease of being able to schedule appointments online. I’d like to take a moment to provide a brief update on 2 issues tied to products that we import from China, tariffs and the new coronavirus. Regarding tariff with the Phase 1 trade deal signed in January, the tariffs on List 4A products, which represents most of our exposure were reduced from 15% to 7.5% effective in mid-February. We’re pleased with this development. We continue to monitor ongoing developments as well as continued progress our tariff mitigation efforts. In terms of the coronavirus, we like everyone else are monitoring the ongoing situation closely. Most importantly, I first want to acknowledge our concern for all the people, including employees of our lab partner and suppliers, whose lives are affected by the recent outbreak in China. Our hearts go out to them. To date, we’ve not observed any significant impact to our business and we’re well inventoried for the first half including our peak season. But this is of course a fluid situation, which we will continue to monitor. Overall, we are real pleased with our Q4 and 2019 performance. As we look to 2020, we continue to believe that we are well positioned in a very attractive industry, and are confident in our growth strategy to build the business for the long-term. At this point, I will hand the call over to Patrick.

Thanks, Reade, and good morning, everyone. Turning to Slide 9. As Reade noted our business performed very well in the fourth quarter and full year of 2019. During the quarter, we opened 8 stores and closed 2 stores. For the year, we successfully achieved our plan to open 75 stores, while closing 6 locations. Store openings have been predominately America’s Best locations with the remainder being Eyeglass World stores. For these 2 growth brands combined, unit growth increased 9.1% over the last 12 months. We are pleased with our 2019 store additions; these stores were both in existing markets as well as infill in newer markets. In our newer markets, we continue to expand our store base and invest, where our new stores are ramping and building awareness. We note that the majority of our new stores have historically taken approximately 3 to 5 years to mature, and payback invested capital. We remain positive about these newer markets and see a lot of our potential customers there. The chart of adjusted comparable store sales growth presents our comp calculated on a cash basis. Same store sales increased 8.1% during the quarter. Once again, we experienced comp growth in both eyeglass and contact lens categories. The comp growth was driven primarily by an increase in customer transactions, more importantly eyeglass comps were driven entirely by the increase in customer transactions. In terms of contact lenses, comps were primarily driven by average ticket as our contact lens customers are increasingly adopting newer technology lenses that have higher prices, which is a trend that we expect will continue. In the fourth quarter, we generated robust comps and our growth brands as America’s Best and Eyeglass World produced gains of 9% and 6.4%, respectively. Legacy comps increased 5.1% in the fourth quarter. Of this growth, we estimate 140 basis points of benefit from incremental eye exam revenues tied to a shift in optometrist from our FirstSight subsidiary to the Legacy segment. As a reminder, this will be the final quarter in which this shift will have an impact on legacy comps as it was completed in the fourth quarter of 2018. Overall, we are extremely pleased with the continued top-line momentum in our business. Turning to the income statement highlights on Slide 10. As a result of the solid comp and unit growth, net revenue increased 12.9%. Cost applicable to revenue increased 8.1% or a decrease of 200 basis points as a percentage of net revenue versus last year, which was favorable as compared to the range we provided last quarter. The improvement primarily reflected higher eyeglass margin, a higher mix of reimbursed eye exam sales, and lower growth in optometrists related costs despite increases in store coverage levels. SG&A expenses increased 7.2% or a decrease of 240 basis points as a percentage of net revenue versus last year. Adjusted SG&A expenses increased 12.1% in the fourth quarter versus last year or a decrease of 30 basis points as a percentage of net revenue. We are pleased with the leverage of store payroll that we achieved this quarter, which was partially offset by higher performance based incentive compensation. Adjusted EBITDA increased 37.9% and adjusted EBITDA margin increased 180 basis points to 9.9% in the quarter. The increase in adjusted EBITDA margin was primarily due to our higher eyeglass margin, store payroll expense leverage, and the net change in margin on unearned revenue. The net change in margin on unearned revenue lifted adjusted EBITDA growth by 14.6%, and we would expect that this timing benefit will reverse to some extent in the first quarter of 2020. Adjusted net income increased to $8.7 million in the quarter. Adjusted diluted EPS increased to $0.11 versus $0.01 last year. Bottom line, we achieved solid flow through again this quarter, as we generated strong incremental margin on higher sales. In addition, while the fourth quarter is our seasonally low period for sales and profitability, we are very pleased by the strong level of earnings that were generated. Turning to Slide 11 and 2019 results. Our full year 2019 results reflect the consistency and predictability of our business model with adjusted comparable store sales growth up 6.2%, net revenue up over 12%, and adjusted EBITDA growth up 15%. Adjusted EBITDA growth was negatively impacted by 0.5% due to net change in margin from unearned revenue. Adjusted EBITDA margin increased 30 basis points to 11.6% and improved despite 2 factors. First, the incremental AC Lens contact lens distribution business growth resulted in an approximate 30 basis point headwind. In addition, adjusted EBITDA margin included a 25 basis point impact from the significant cyber-security investments we made. National Vision has now completed its second full year as a public company. Compared to our 2017 results, net revenue and adjusted EBITDA have risen at a compound average growth rate of 12% and 12.5%, respectively. As we have said, our business has performed consistently over time. Before shifting to the balance sheet, please note that we have again included an explanatory slide on unearned revenue in the appendix section. This illustration is intended to help unpack; how unearned revenue is somewhat unique to our service based business model versus more traditional retailers as well as the typical seasonal impact on our income statement. Now turning to Slide 12. At the end of the fourth quarter, our total debt was $570 million. Our cash balance was $39 million or up over $22 million year-over-year. During the quarter, we used cash on hand to make a voluntary $25 million prepayment on our term loan. Net debt to adjusted EBITDA was 2.6 times, an improvement from 3.2 times in the fourth quarter last year, and our pre-IPO ratio of approximately 6 times. We remain committed to further deleveraging our balance sheet and are targeting the 2.0 times range over time organically and with future potential debt repayments. In 2019, we invested $101 million in capital expenditures, slightly below the 2018 level. The majority of the CapEx was focused on growth initiatives, with our 12% top-line growth and stable CapEx. We reduced our capital intensity to 5.9% in 2019 from 6.8% during 2018, which remains an ongoing strategic focus. Another 2019 highlight was the accelerating free cash flow characteristics of our business, which reflect our consistent performance and reduced capital intensity. Cash flow provided by operating activities increased $58 million versus last year. During the year, we deployed $50 million in cash toward stock repurchase and debt pay down, while ending the year with a higher cash balance versus the prior year. Overall, we made tremendous progress in enhancing our balance sheet and debt profile this year, including the term loan refinancing in July, which lowered our borrowing costs. While we look to achieve continued improvements in our leverage ratios, we remain comfortable with our leverage levels today given our health services business tends to perform well across the economic cycle. Before I discuss 2020 outlook, please turn to Slide 13. As noted in today’s earnings release, we’re making several changes to our key non-GAAP financial measures that are incorporated in our 2020 outlook and will be effective in our reporting during the first quarter of 2020. Let me take just a moment to unpack these changes. First, we’re introducing 2 new non-GAAP measures, adjusted operating income and adjusted operating margin. You can see that adjusted operating income is included in our 2020 outlook, as we continue our evolution as a public company, we will be transitioning in 2020 to place more emphasis on adjusted operating income in lieu of adjusted EBITDA, with adjusted EBITDA being a measure that is more commonly used in the private equity sector. For consistency and transparency, we will continue to provide adjusted EBITDA as a reported measure and in our 2020 outlook. Similarly, we are also transitioned this year to emphasize adjusted diluted EPS in lieu of adjusted net income. Second, we are presenting new definitions of certain non-GAAP measures that include fewer adjustments. Specifically, in 2020, we will no longer adjust for new store pre-opening expense and non-cash rent and adjusted EBITDA or adjusted diluted EPS. These changes are being implemented as a result of our ongoing review of our reporting measures as well as to enhance comparability with our peers. Finally, to assist for modeling purposes, we have included supplemental tables that provide historical reconciliations of these measures to the 2020 definition for the last 8 quarters in the appendix of today’s presentation. This supplemental information was included in the 8-K filed this morning, and is also available on our website. Turning now to our 2020 outlook on Slide 14. Let me begin by pointing out that fiscal 2020 is a 53-week year for National Vision. We estimate that the 53rd week will add approximately $35 million to net revenue, with an approximately breakeven impact to adjusted diluted EPS. The projected minimal profitability is due to the expected net change in margin on unearned revenue in the 53rd week. As we included in today’s earnings release, our 2020 outlook is as follows: net revenue of $1.875 billion to $1.905 billion; adjusted comparable store sales growth in the range of 3% to 5%, opening approximately 75 new stores; adjusted EBITDA between $210 million and $215 million; adjusted operating income between $120 million and $125 million; and adjusted diluted EPS between $0.80 and $0.85, assuming a diluted share count of approximately 82.4 million shares. We project another year, our 19th consecutive year of positive same store sales growth in 2020. It is important to remember that while we expect our growth brands to continue to perform well, we will be facing challenging comparisons from the strong comp trend for the last 5 years, especially for our growth brands. As a result, we believe it is responsible to plan a business in the 3% to 5% comp range as reflected in our outlook. Store openings this year will continue to be predominately America’s Best locations with the remainder being Eyeglass World stores. Most of our store growth will be in existing markets and continued infill in newer markets. Similar to last year, openings are also expected to be skewed towards the first half of the year. We project a few closings as is typical each year. We estimate a slight decline in adjusted operating margin at the midpoint of our guidance range. For full year 2020 as a percentage of net revenue, we expect cost applicable to revenue to increase 20 to 40 basis points as compared to fiscal 2019. For Q1, we expect cost applicable to revenue to be flat to down 10 basis points. As Reade noted, products that we import from China are now subject to the 7.5% tariffs. Our 2020 outlook takes into account these tariffs. We would expect adjusted SG&A to be relatively flat to slightly leveraged as a percentage of net revenue in our outlook. We expect continued wage inflation as well as investments in marketing this year while looking to tightly manage growth in corporate expenses. We project depreciation and amortization in the range of $97 million to $98 million, including amortization of acquisition intangibles of approximately $7.5 million. Depreciation and amortization in 2020 is expected to grow more in line with the rate of revenue growth, unlike recent years, as capital intensity has improved in recent years. Finally, we estimate annual interest expense of $29 million to $30 million, and 2020 capital expenditures in the range of $100 million to $105 million. Regarding the coronavirus, we have not included any impact in our 2020 outlook. As a reminder, as we enter our peak selling season, the timing of tax refunds is a variable that can affect our performance between our first and second quarters. Consequently, we like to look at our business on a semiannual and annual basis. We would also remind everyone that unearned revenue can affect our quarter-to-quarter comparisons. Unearned revenue had a favorable benefit to the fourth quarter results and we expect the favorable shift to reverse in the first quarter. While the net change in unearned revenue is typically a headwind in the first quarter, we estimate a greater impact this year with net change in margin on unearned revenue projected to impact Q1 adjusted operating income by approximately $3 million or $0.03 in adjusted diluted EPS. Turning to Slide 15, we have included a supplemental table that allows investors to see our 2020 adjusted EBITDA guidance and 2019 results on a comparable basis under the 2020 definition. Adjusted EBITDA of $200.7 million in 2019, that we reported today would have been $194 million, under the new 2020 definition. Thus, our outlook projects 2020 adjusted EBITDA to grow between 8% and 11% on a comparable basis. In summary, we are extremely pleased with our consistent performance in 2019. We are focused on executing our 2020 strategic growth initiatives and look forward to delivering another year of consistent growth. At this point, I’ll turn the call back over to Reade.

Thank you, Patrick. Turning to Slide 16 and our Moments of Mission, let me introduce Dr. Frank Ptak, an optometrist who practices inside the America’s Best in Fort Worth, Texas. Dr. Ptak recently saw a male patient who had been released from the hospital 2 days earlier with a diagnosis of a concussion and high blood pressure. The patient and his sister came to Dr. Ptak’s office, straight from a 3-hour visit with his primary care physician, so confirmed the concussion and high blood pressure diagnosis. And said the patient’s dizziness was because he had for some reason been wearing his sister’s glasses. During the eye exam, Dr. Ptak informed the patient that he had or was having a stroke in the back of the left side of his brain. Dr. Ptak immediately referred them to the emergency room and made the sister sign the referral form to show the importance of going. Six days later, the patient and the sister returned to thank Dr. Ptak. They did go to the emergency room. And MRI results confirmed the stroke was happening at that moment. The sister expressed that if Dr. Ptak had not had her sign the referral, they would not have gone and her brother would have died. As we have said many times, a routine eye is routine until it isn’t. And Dr. Ptak saved a life that day. While it’s easy to focus on our sales of eyeglasses and contacts, do know that in each of our stores every day, thousands of patients, primarily uninsured, are receiving site savings and even lifesaving healthcare from optometrist like Dr. Ptak. In summary, we are extremely pleased with our fourth quarter and 2019 results, as well as our outlook for another year of consistent growth in 2020. I want to thank our entire team at National Vision, including the over 2,000 optometrists like Dr. Ptak, who provide much needed medical services to patients and our over 1,100 store fronts every day. Each year millions of patients and customers come to us for affordable eye-care and eyewear. We continue to strive to be the best at providing low-price exams, glasses and contact lenses, while both at home and abroad, we worked to bring glasses and consequently sight and improved quality of life to those who would not be able to see well otherwise. This is why we believe optical retailing is a noble profession. With that, I’d like to turn the call back to the operator to start the question-and-answer portion of the call.

Thank you. [Operator Instructions] Our first question comes from Simeon Gutman of Morgan Stanley. Your line is open.

Hey, good morning, everyone. I have one for Patrick. One for Reade. First on the fourth quarter, can you separate out how much operating margins improved, if you want to focus, or the new adjusted margins, if you remove the benefit from unearned revenue, how much the core underlying? And just to clarify, you said that your adjusted EBIT margin for 2020 is slightly or I think it’s flat or slightly down as implied for next year.

Hi, Simeon, good morning. I’ll answer the second question first. As we as we look at margins in the guidance and we were pleased to lay out guidance that shows another good year of consistent growth. At the operating margin level there, they are down 10 to 20 bps in terms of middle of the range. Do note that they’re approximately flat at the high-end of outlook. These are based on 3% to 5% comps and, obviously, would look to leverage and our results be above that range. I would note that there is 10 to 15 basis points of negative impact in those margins relative to the unearned revenue that we’ll see next year, in the 53rd week, we’ll have – none of that revenue, will defer a lot of that. And we’ll have some of the fixed cost, so that’s certainly a factor. But again, at the upper end of the range, we do expect to see flat margins. In terms of the impact on the growth, I think I noted of the EBITDA growth of 37 or so percent, about 14%, 15% or, I guess, 1460 basis points was due to the unearned. We saw similar occurrence last year and we’ll see that turn to a degree in Q1 of 2020.

Thanks for that. May follow-up maybe for Reade, if you look at Q4 it was a strong quarter. The stacks looked pretty good and definitely a sequential acceleration. Can you talk about the impact of flexible spending, people rushing to use whatever insurance money you’re in? When you do this well in the 4th quarter, does it rob anything from Q1? And then, wrapped into that, you must be tracking tax refunds, is that going to dictate the cadence of Q1?

So let’s see a few parts. We do benefit from – the 4th quarter does benefit from flex spending accounts and people using their insurance. And that generally starts towards the day after Christmas and that’s been a factor in optical retailing for years and years now. So that is real. We don’t necessarily see that as something that steals from Q1, because Q1 people sort of to re-up and a lot of people who had already used their accounts, or whatever, get new insurance benefits. And so, it’s not really – so the answer is no for that. And what was the second part again? Oh, the refund?

Yes.

We are always impacted by tax refunds. That’s sort of the timing of them and the extent of them is a factor in our business and we monitor that on an ongoing basis. But we like to – that this is why we always like to focus people on half as well as quarters, because those things spread out over time. And in the past few years, we talked about, yeah, please, please don’t look at end of Q1, early Q2, tax refund timing affects that. And you look at us over half, it all sort of washes out.

Thanks for the color.

Thank you, Simeon.

Thanks, Simeon.

Thank you. Our next question comes from Michael Lasser of UBS. Your line is open.

Good morning. Thanks a lot for taking my question. Patrick you mentioned in your prepared remarks that you will be facing difficult comparisons and that’s one of the reasons why you guided 3% to 5% comp growth for this year. But you’ve really been facing difficult comparisons for the last few years. So was your comment intended to signal that there’s anything different on the horizon?

Good morning, Michael. The short answer is no. We’ve been pretty consistent about guiding in the 3% to 5% comp range. And that’s also where we set, frankly, operating plan expense targets. We think that’s kind of a nice conservative approach and had enjoyed seeing what happens with leverage beyond that, so not intending to signal anything different. I’ll tell you, we have had a nice 5-year run of AB comps that were very strong in Q1. That was only the point I was trying to do – make is remind folks that AB has been strong every quarter, so it’s early in the year. We are right out of the gate. We’re excited about 2020, really pleased with what we delivered in 2019 and as well as 2018, and have a tendency to take a prudent posture early in the year. And just to add on to that, I mean, if you look at our last 18 years, we’ve averaged about a 5% comp. So, again, we’ve been saying for a long time, we’re consistent predictable business and over time and through all the economic cycles. But that’s how we get to that range.

Thank you very much and my follow up is, you mentioned that the cost of applicable revenue improved in part driven by higher eyeglass margin and lower growth in optometrist related costs in the fourth quarter. So can you explain what drove those improvements and why would that not continue into 2020?

Okay. Sure. In terms of the gross margin in the quarter, we did experience higher eyeglass margins. Recall back that we had a new lens contract go into effect at about mid-year, and also recall that we had some telegraphed dilution in terms of our new Texas lab ramping, so both of those were helpful to margins in fourth quarter as we saw the results come in. In terms of the margins for 2020 and Q1, we certainly provided some guidance around that. We do expect to have the full impact of the 15% tariffs, which is kind of the level where we were buying inventories for our peak season for a little while longer. But certainly do expect to see gross margins on the year slightly lower, but in the first quarter a little higher.

Do you think you’ve reached this inflection point, where optometrists wage pressure is starting to abate?

Yes. So second part of your question, optometrist wage pressure, in the quarter we saw a little lower benefit cost per optometrist and we benefited from that in the quarter. I would really point you more to the full year numbers for optometrists. And in the quarter, revenue growth outpaced optometrist cost. For the full year those were much closer. I think the costs were just a shave higher than the annual rate of revenue. I am not ready to signal an inflection point, but we have seen some stabilization in that. We do expect – our guidance assumes that there’s continued inflation for wages, for optometrist and associates, but again, in a more stabilized cut.

And we are very encouraged by our record levels of OD retention. That says a lot, and it’s a real positive sign for us.

Thanks a lot and good luck.

Thank you, Michael.

Thank you.

Thank you. Our next question comes from Kate McShane of Goldman Sachs. Your line is open.

Hi, thank you. Good morning. With regards to the contact growth that you saw during the quarter, I think, you said a lot of it had been driven by ticket. But I wondered, if there was any traffic commentary that you can point to that’s going on in contacts and if it differed much from what you saw earlier in the year versus Q4?

Yeah, in general, in the quarter we saw overall comps traffic driving, outpacing ticket and in eyeglasses it was pretty much a total traffic story. For contact lens, we saw a good growth there, it was more balanced I don’t think I have a ratio off the cut to provide. But there was a little more ticket than traffic. And again, that’s principally driven by what our consumer patients selecting. And in general, there has been an overall trend in the industry, where consumers are picking better technology, more daily lens, and certainly the prices are reflecting that. We obviously can’t – it’s an area that we monitor closely in terms of pricing, because in general contact lens are fairly commoditized product, you can get them online as well as in-store, and we want to make sure our prices are competitive. So the price impact of the contact lens is more about what are patients choosing versus what are we selling and at what price.

But it was nice that we saw traffic growth on contact lenses as well as ticket growth.

Okay. Great. And then my follow-up question is, you’ve talked about the opportunity of getting more growth from being cited in insurance plans, et cetera. I just wondered, how we should think about the contribution of this possible growth opportunity at 2020 and its contribution to comp.

We think that managed care will continue to grow, it’s been steadily growing over the years. And as we’ve always said, we’re underpenetrated in the area of managed care. We – our customers that were underpenetrated for 2 reasons. One, sort of America’s Best got a late start. When we took over America’s best, they didn’t even accept insurance, so we’re starting from a dead start there. But also our consumer base is underpenetrated relative to insurance, when it’s your own money, you go and seek out true value, so that’s always strong but that’s why the majority of our customers still are non-insurance customers, but it’s steadily growing. And I think, it grows because people have figured out your dollars go further, when you use your managed care benefits at National Vision brands. Our low prices mean you get more for your money and more for your insurance benefits from us.

Thank you.

Thank you, Kate.

Thank you. Our next question comes from Adrienne Yih of Barclays. Your line is open.

Good morning, everybody. Congratulations on a great quarter.

Thank you.

Patrick, my first question is for you, can you talk about – you had mentioned 30 basis points of cyber-security investment throughout FY 2019. How should we think about that line item either that specifically or really SG&A dollar growth into FY 2020? Should we think that kind of maintains as a percent of sales or actually gains leverage? And then for Reade, can you talk about the newer markets, where you’re opening stores? How far apart are the different stores and do you see any impact to the nearest store? And then remind us is what the ultimate potential for each of AB and Eyeglass World? Thank you very much.

Sure thing, I’ll start with the cyber and SG&A leverage. Overall, as we look at 2020, we do expect the flat to slight leverage in SG&A cost. On the headwind side, we – as I said earlier, we still are planning to see some degree of wage inflation for both doctors as well as associates. We are planning to continue to invest in advertising as we are a growth company that is certainly intending to continue to take share. I do expect to see us leverage corporate cost a little more. So that will be offsetting to get to that slight to – flat to slightly leverage. As it relates to cyber that was an important effort last year, we feel like we have done the things that we needed to do. I think, we guided that we would spend about $4 million last year and pretty close to that. I wouldn’t see that cost being ever mentioned as a grow over pressure as long as things are going smoothly. So I don’t think you’ll hear me talking about that. And in fact, we may even see that dial back just a slight amount coming out of the build year and now we’re in more run mode. So overall, we’re expecting to see flat to slight leverage in the SG&A.

Great.

And on the store count front, we still believe that America needs at least 1,000 America’s Best stores and 850 Eyeglass World stores. We continue to focus on America’s Best, because the ROIC is a little better, and because we have the network effect now of network television, and just the more stores you have the more awareness people have of your stores and when they move to new places and they see you again, it’s reinforces that you’re a strong national brand. In terms of stores near one another, it’s sort of – we factor in cannibalization into our models and into our pro formas, when we built the stores. And so that is something that we have already taken into account when we select where to open our stores.

Okay. And then my last final question is on Privé Revaux. I assume, how long is the length of the exclusivity and how much of the comp was driven? But did you do – I know you did advertising specifically for that, because I saw that throughout the fourth quarter. Was there anything that you did that was over indexing to highlighting Privé Revaux?

In terms of our advertising, sort of in – we – this year not in 2019, but this year we started the year with a strong advertising focus on it. So in terms of that was the key communication. I think those ads has been posted, so you can see them. I hope you like them. I think they’re great.

Great. Great.

Yeah, right. They are a lot of fun. In fact, we’re just having a lot of fun with this. We’ve had movie stars show up at our stores and we get nice crowds and they’re sort of – these people have very large Instagram followers. So that’s very – for competitive reasons, we aren’t going into a lot of specifics. By the way, you should check them out. I wear them and they’re just fun styles too, and they’re very enjoyable in that way. But we don’t like to get into the details of the exclusivity or the exact part of the business attributable to this, but it’s a nice relationship, and we’re real happy, and we’re having a lot of fun with it.

Thank you. Our next question comes from Paul Lejuez of Citigroup. Your line is open.

Thanks, guys. I’m just going back to Kate’s question, and your answer, Reade. I’m just curious, how much of the higher mix of exam sales are being driven by those customers using insurance versus whether or not you’re seeing exam sales increase for cash paying customers? And then second, I’m curious, if you could talk about the performance of mature stores, how that shook out in 2019, but also curious about the 2018 store class, how they comped in their first year? And then just last one for me is, on the Walmart conversions, just curious what changes need to be made on the backend from what you need to do from the systems perspective versus what changes will the customer see if any? Thanks.

I’ll just – let me start with the Walmart question, and then Patrick will follow on with the other piece. So actually that’s the key point is the long lead time item and taking over one of these Walmart stores is inputting or putting in our POS system, and our sort of IT infrastructure, and getting sort of all the – everything in place to do that in ways that provide all the right security for us and for Walmart. So that is the long lead time and then sort of we put in our approach to managing the stores in terms of all the operational pieces, the product pieces and the like. So – although, we’re granted the 5 stores a few weeks ago, it’s going to be a little while before we take them over and we sort of do it in phases. We will probably take over one, and then sort of see what we learned there and take over the other 4 soon thereafter.

Hi, Paul. So following up on the other 2 questions, the real driver in the exam growth is managed care. And the reason there is – when cash pay patients come in, those patients are more applicable or more likely to take our 2-pair offer. And those that come in with a managed care insurance card, they are fitting into whatever provider schedule, which has exams separate from frames and lenses. And so it’s simply a function of we’re growing managed care penetration. We still feel like we’ve got great runway left there, but that’s the bulk of that dynamic. And then in terms of store performance, we’re happy with what we’re seeing across years in cohorts. We – there’s not a lot – we have mature stores comping probably on average across multiple quarters at the lower end of that 3% to 5% range. There are quarters like Q4, where that was also a larger number for mature stores. So as you think about, we are increasing managed care penetration that doesn’t really toggle between existing and new, it’s more ubiquitous across the entire classes. 2018, I don’t have any specific comments to offer up there. We’re a little careful with geographies in years specifically. But I can tell you, 2018 with one of those classes where we were entering new markets and we feel like we continue to take share in those new markets and see a lot of our potential customers there.

Thank you. Our next question comes from Robbie Ohmes of BofA Global Research. Your line is open.

Hey, guys. Thanks for taking my question, and congrats on a great quarter. Actually 2 questions. The first, Reade, I constantly get questions about the changing competitive environment and what’s going on out there and maybe could you just speak to any thing you’re seeing any changes and maybe work into that America’s Best positioning versus Eyeglass World. And – what would it take to get Eyeglass World comps to be more in line with what America’s Best has been able to achieve?

Yeah. So you know the optical industry continues to shift to the value segments. We – when we went public, we talked about we’re a rising tide in a rising tide in a rising tide. The market is growing. There’s a shift to change and within the shift to change, there’s a shift to the value, and we’re the key beneficiary of it. I think the most interesting competitive change of the past few months has been that Sears Optical has closed all its remaining locations. So they, in essence, are – there’s no more Sears Optical, so that has happened, it’s been happening gradually over the years. We do think that that our key brands are gaining market share and America’s Best especially, but America’s Best and Eyeglass World are both gaining market share. And we’re working on ways to continue to get the Eyeglass World comps a little closer to the America’s Best comps, but there are a lot of retailers out there in the world who’d be pretty darn pleased with the 6.4% comp for Q4. And the Eyeglass World team though there were little in the America’s Best shadow is still or rather proud to have delivered 6.4% comp.

That’s a very good point. Just one follow-up question, just on coronavirus, what – can you give us any kind of thought on what your exposure might be under scenarios where there’s a lot of bottlenecks coming out of China, how exposed would you be to that or not be to that?

Well, Robbie, I was waiting for that question that I’m surprised that hasn’t come up so far. So, yeah, is that given how much this is a topic go throughout the world. To date, we have had no significant impact on our on our supply chain. We are well inventory for the first half of the year and that includes our peak season, our China lab is up and going after Chinese New Year and delivering to our needs and expectations, of course, this is an ever evolving situation. So we’re monitoring it closely, but we’re very pleased with our inventory levels and with the continuation of our supply chain via The Chinese lab, which is of course, one of our fixed labs out there and the only one in China. So, of course, we have 4 domestic labs: 1 lab in Mexico, and then 1 in China.

Great. Reade, that’s really helpful. Thanks so much.

Yeah.

Thank you. Our next question comes from Zach Fadem of Wells Fargo. Your line is open.

Hi, this is Eric on for Zach. Thanks for taking the question. You have set another quarter of 5% comps on Walmart. If you look at on a 2-year stack, it actually slowed notably. So just curious when maybe that comp, which should have been higher, and as you look into fiscal 2020, what we should expect, given that comps in that segment are going to get tougher?

Okay. So again, we had a 5% comp in Q4. And that’s our second consecutive quarter of over 5%. We have sort of our execution we think is getting tighter and better, and we’re pleased that we’ve got sort of a fresh new leadership team that started in Q4 of 2018. And we saw it sort of jump starting of the business there. So we feel like there’s good momentum there. And…

I would say we’re also – if you look at the 3-year stack, it’s a little better. We saw like 5.5% in Q4 of 2017.

Yeah. And the average of our 226 open Walmart stores, the average age is 24 years. I mean, these are these are hyper mature stores. So I think positive trends in this way say a lot.

And then, just as we look, last year you lapped – you’re lapping in the cyber-security and the new processing lab, is it fair to think that fiscal 2020 will sort of be the bottoming of EBIT margins?

Well, you can – we’ve certainly laid out our guidance there. And in terms of EBIT, we’re guiding down just 10 to 20 bps in the middle point of the range. Well, obviously, that looks more like flat at the top-end of the range. And frankly, we think that if comps come in higher than our leverage point, which is in that kind of 4% to 5% range, well, we should see some continuation of margin improvement. I’m not saying that out as a given. But in general, the puts and takes we are – to your point, the Texas lab will not be a drag. We will see – we took some peripheral pricing actions in 2019. On the headwind side, we’re going to see a little bit of inflation. In terms of wages, we’ve still got tariffs baked in. So I think that we did a pretty good job in leveraging, especially in the second half of the year in 2019. And for 2020, we’re guiding at flattish margins, and hope to do better.

Thank you. Our next question comes from Steph Wissink of Jefferies. Your line is open.

Thanks, good morning, everyone. Most of our questions have been asked, but I wanted to unpack 3 things that you commented on in your prepared remarks, and maybe 2 of these are for Reade and one is for Patrick. The first, Reade, is just on the success you’ve had with your marketing campaign in recruiting new customers. I think over the last couple of years about 35% of your customer count have come from new customers. Talk a little bit about the CRM system in combination with the marketing agenda? And what KPIs do you use internally to kind of benchmark the success of that marketing investment? And then, secondly, you mentioned lower optometrists cost despite better coverage. So I’m wondering if you can also talk a little bit about your labor model, if that has changed over the course of the last 6 to 12 months, where you’re getting better efficiency out of that optometrists cost investment. And then, just last really quick one, Patrick, for you is on working capital efficiency, had a nice benefit to cash flow this year. Is that something we should continue to expect from you, just greater discipline around inventory and working capital? Thank you.

Good. Thanks so much. So let me start with your comment of the 35% coming from new customers. And again, I think it’s important to just view this in context. We’re the low cost provider of a medical necessity. We’re in a great and growing industry, where chains are growing and value chains are growing in particular. We have a great formula and we’re very careful to guard our formulas and have had good momentum as you can see over the past several years. Also OD coverage being strong at the record retention level means that we can deal with the volume of people who want to come to us. That’s what happens when you have strong OD retention and good, good coverage level. I do think our marketing is getting ever smarter, more and more sophisticated. And that combined with the continued managed growth in many ways impacting it, helps to drive the new customer count. And there is also just – the wonderful thing that comes with positive word of mouth, you’ve heard me say that this is a fair game. And those who take the best care of the patients and customers generate positive word of mouth that brings in more customers on an ongoing basis. In terms of the detail of the CRM system and the KPI, that’s a little bit of the secret sauce that we have. I’ll just say that there is an integration of traditional and digital and new customer communications vehicles that I think we get ever better at an ever more sophisticated at. And we pay tremendous attention to it and marketing is a key part of what we do. In terms of getting into the specifics of the KPIs, I think that is part of our secret sauce that helps us to be so successful, so I’m hesitant to – we’re the only public optical retailer out there. And I’m hesitant to share too much of that, because it’s part of what makes us so successful.

Yeah. And in terms of the lower doctor cost in the quarter, I would say look a little closer at the year, which was much better aligned with revenue growth. We’ve not seen a tipping point in terms of optometrists-related costs. But we have seen good stabilization. And honestly, this is the fulcrum point of the model. We’re a patient-focused company. We’re a doctor-focused company. The doctor component of the labor structure is pivotal. We put a lot of emphasis there in terms of acquiring and retaining, and it’s an area where we occasionally make investments. But we did have – we did see some leverage in the quarter. In terms of working capital benefit, I guess, the way I would say it is, we delivered I think about $60 million in operating cash flow this year. Let’s just say that a third of that was favorable working capital timing. And so, that just moves around. In general, we were doing a lot of forward buying at the end of 2018. We think smartly so, because of potential tariff impact. So we didn’t have as much of that this year at the end of 2019, but our working capital is, generally, for a lot of periods it will even be negative. We’ve not made any strides to change that. We like where our inventory levels are especially now staring potentially at this coronavirus situation.

Thank you. Our last question comes from Anthony Chukumba of Loop Capital Markets. Your line is open.

Thanks for taking my question and congrats on another very strong year. Most of my questions have been answered. I just wanted to get a quick update. I mean, I know it’s not a significant portion of your business, but I’d love to get an update just in terms of e-commerce, what the penetration rate was for sales for maybe for the full year. And anything, are you seeing any changes, from that perspective? That would be helpful. Thank you.

Yeah, our online sales for the year was 4% and we’re pleased with that. And we’re always working on different ways of providing meaningful consumer – meaningful omni-channel options to our customers. Category-wise contact lenses has heavier penetration than eyeglasses. And that’s the same for us as well.

Thank you. Now, I’d like to turn the call back over to our CEO, Reade Fahs, for any closing remarks.

Thank you very much, Valerie. I appreciate your help with the call today. In closing, I’d like to congratulate the 13,000 members of the National Vision team on the milestone of 72 consecutive positive comp quarters, where we’re extremely pleased with both our Q4 performance and our 2019 performance and look forward towards building on that performance into 2020. We’d like to thank you all for joining us today and for your continued interest in and support of National Vision. We look forward to speaking with you again, when we report our first quarter results. Thank you all very much.

Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.