National Vision Holdings, Inc. (EYE) Earnings Call Transcript & Summary

We're going to get started in just a minute. Before we get started, I want to remind everybody that we're using app-based technology, where you can go to www.ubs.involved.events.com and submit questions that will come here to the app, and we'll weave those into our conversation. Patrick, can you hear me? This is something new for us. So you have to give us a little bit of a leash. You hear me okay, Patrick?

We're not getting sound from the bridge, guys. Not getting any sound from the bridge now.

It is not from a bridge. It is local to the room. I am just trying to get their volume to work.

We just heard that.

That's the bridge operator. [indiscernible].

Okay. Worst case is, we'll call them.

Please standby. I'm going to try to disconnect and reconnect that remote site.

Thank you.

Hello. This is Patrick.

Hey, Patrick. This is Michael Lasser. How are you guys?

Great. Can you hear us now?

We can hear you great. You are live. We've got -- we actually have a room full of the absolute smartest investors and participants, which you cannot see, so you'll have to trust me on that. It's also probably the best-looking group of investors that we could possibly gather at this conference. So you are in luck. And we can see you clear.

Okay. Great.

We're ready to get -- you're all set?

Okay.

All right.

Yes. I just -- I wanted to show you one thing, and I hate I can't see you. So hate we couldn't be there in person, glad to join virtually. Hope we're breaking some new ice here. I've got my water. I've got a very large container of gel. And then Michael, just for a surprise for you, I wanted to turn that around. And we'll just leave this guy going here while we chat up [indiscernible].

Say, Patrick, you never cease to amaze, that's for sure. Appreciate it. So...

I'm amazed that they'd even let me do that. So...

That's true. Hopefully, that will just be the beginning of many firsts that we have in this conversation. We'll be -- you're amongst a very intimate crowd here. So feel free to share anything and everything. Let me back up and...

[indiscernible] right?

Exactly. Let me back up a step. For those of you who I haven't met, I'm Michael Lasser, the hardline, broadline and food retail analyst at UBS. And we are super excited to have National Vision with us this morning. National Vision is the premier player in the optical retail market in the United States. It operates over 1,100 stores under -- largely under 2 brands, America's Best and Eyeglass World. It's one of the fastest-growing retailers in its segment. And today, we are super fortunate to have not necessarily live in person but in the nice, big, beautiful, clear screen, Patrick Moore, who's the company's Chief Financial Officer. He's been with the company since 2014. And to his left or across from him is David Mann, who runs Investor Relations. So Patrick, I told most folks that my jokes typically need a lot of latency as it stands, so you'll have to bear with me for the surprise during our conversation.

An area I want to start is that National Vision has been the model of consistency within the retail sector. It's generated 72 consecutive quarters of positive same-store sales growth, which is a true rarity. So can you give us a sense of what's driving that? And how should we think about that persisting from here?

Yes. That's a great place to start. Thanks, Michael, and we appreciate being able to participate in the conference today remotely. Although off camera, David Mann, our VP of IR, is here with me as well. So kind of just starting on the comp side. There's not a factor, there's multiple factors that have led to our consistent, predictable performance around comps. And so I'll just unpack a few of those. I think it starts with a low-cost, low-price operating model in today's environment. It starts with good industry tailwinds. The overall optical industry is growing in the low single digits in the value, and it's growing even higher than that. So it never hurts to be in the right industry, and this is a good industry for continued growth. I like our marketing and advertising for America's Best. And secondarily, EGW as much as any -- probably better than any, optical advertising out there, I think that we've done some really interesting, creative things with the how, in building our -- in our AB brand. The other thing I would just mention is 2/3-ish of our customers in any mature store are repeat customers. So you can have industry tailwinds. You can have good advertising. And if you don't take care of those customers when they're there, then they're not going to come back. So I also think effective store execution has been a component of it. And the 2 other key factors: Managed care. At the time of the IPO, Michael, I think I've already shared that we were in the 25% to 30% penetration range for managed care. We're now north of that range slightly. We're still well in -- under-indexed to U.S. averages at around 50% to 55% and even higher for glasses. And then I would say structurally, our buying cycle is 2 or so years for glasses, the U.S. average. And so that makes our stores take a little longer to ramp. The silver lining inside those longer ramps is the comp waterfall. So if our stores are taking 5 years to get to a reasonable level of maturity, we pick those up in the comp waterfall beginning in year 2. And so that's also a factor. So it's not one thing. It's not 2 things. It's multiple things that have led to those consistent results over a long period of time.

And can you give -- that's helpful, Patrick. Can you give us a sense of what the core customer demographic is, both in America's Best and Eyeglass World? And maybe you can give us a sense, has that demographic remained relatively stable? Or as the business has grown, you've been able to attract new types of demographics over time?

Yes. That's another great question. I would say the demographics are fairly similar for those brands. And I also think they've been consistent probably post the 2008, 2009 recession, and I'll come back to that. In our America's Best brand, that's our most value-seeking customer. They're willing to have a slight delay as they pick up their glasses. Those are all made in centralized labs to help achieve that degree of cost-effectiveness. Those customers are often working-class folks. There's kind of blue-collar, white-, blue-collar. In our EGW brand, still value-seeking customers, a lot of commonality. But we often see education levels and professional levels a little higher, which is consistent with the value proposition of more options on frames, quicker service for those that need their glasses soon in an hour or that day. So there's probably more commonality between those 2 brands than being dissimilar, but there are some nuances between the 2.

And how have the demographics changed? Over time, as both chains have expanded and added physical locations, going into more mainstream real estate versus maybe being closer to that -- to the more value-oriented customer in the past, have you seen a rise in the middle demographic for your growth? Or is it still the core customers come in from the more value-oriented end of the market?

I think we have seen a slight migration, and I think that's correlated with our managed care penetration increasing. The customer that walks in that has insurance that helps them pay for eye care and eyewear has a good paying job. They come in with the lower and different socioeconomic set and save people without potentially without insurance. And so that's migrated slightly but not anything substantial. The other point I'd just make is, I think that -- and I wasn't around here then, but a lot of folks that are here now were. In 2008 and '09 time frame, our store managers reported expressions like the nicer cars in the parking lot. We saw consumers that maybe had been shopping in more premium outlets or independents being willing to trade to America's Best. And again, with retention levels of having repeat customers constitute 2/3 of our traffic in mature stores, we think we held on to a lot of those customers. So yes, some slight evolution in customer mix overtime, dependent on -- primarily driven by those 2 things, Michael.

And Patrick, you're adding 75 stores a year between both America's Best and Eyeglass World. Why is that the right number? Particularly as the organization grows bigger, has more resources, then mathematically, your growth in new space is going to slow. Why would you not push that up? And then I have a follow-up on that.

Okay. Great. 75 fits us very well. We're formula people. We know where our wheelhouse is, and we'd like to stay in it. In 2014 to '15, we stepped up from opening 45 to 50 stores to 75 and got -- we've been very good at that, and we like where we are. The doctor component is a critical element of this as well, probably more so than any other component. And at 75 a year, we've likewise been successful in making sure we were opening the overwhelming majority of those new stores with optometrists in place at the outset. It's less about is there -- could we get more real estate? Absolutely. Could we invest more capital? Absolutely. We like the 75 and its rhythm and cadence, and we like that in terms of our professional services staffing as well. So that number has seemed to fit us. And there have been a couple of times where we've contemplated bumping that up a tad. But again, we're -- we tend to like to do things consistently and definitively. And that 75 figure is a part of the core fabric of the company now.

And we'll talk a little bit more about the competitive landscape. But is there a land grab going on in the optical retail market? You've got online competitors. You've got off-line competitors who are expanding aggressively. So is there a risk where if you don't accelerate your square footage growth, places that would have been fertile opportunities to have a store may no longer be available because you'll have a competitor now in one of those locations?

Inside the optical industry, Michael, I'm not seeing a land grab. We -- the only thing I would say, in the last few years, history-wise, is the regulatory laws in California were somewhat confusing and not defined well for a long period of time, and that market opened up several years ago. And we went in there. I really wouldn't call that a land grab. But in general, I would say the only grab has been more on the ownership side. A lot of the optical assets have changed ownership. Private equity is involved a little more on the roll-up side for independents. So in terms of ownership, there's been more turnover competitively. The competitive market feels pretty consistent to Reade and I right now, as it has over the last year or so and that includes the online-only people, the used to be online-only now building stores folks. So competitive environment feels pretty consistent with where it was. And I don't really see a real estate land grab. We're still able to get spaces in those value centers that we like.

And as we're touching on the competitive landscape, do you see these online-only players? You mentioned those that are adding stores like Warby Parker. There's others like Stanton Optical and Zenni, who are upstarts but are expanding fast. Do you think they pose some long-term risks for the market? Do they evolve the market and make it such that America's Best and Eyeglass World are actually better positioned because they're going to push more of the volume overall in the industry towards the more value-oriented end of the market?

I think you've almost answered the question for me. I'd start with the overall market, which is still highly, highly fragmented and in a concentrated way inside of that fragmentation, still heavily independent. So as share moves from the kind of pure-play mainstream independent, there's multiple players taking that share. We are obviously one of those. We've had online competition for quite a while. We offer online contact lens and glasses as well but, again, are wheelhouse stores. We believe that there is still an important physical presence element of this, of eye care and eyewear that will be with us for quite a while. So while we do see high competitive levels, and we've looked in those for quite a while from both brick-and-mortar as well as online players, I wouldn't say that that has had any form of a step-function change. And to the point you were making, all of those players, if they're true value players, they further legitimize the entire space for all of the value players. And this gets back to, if you're someone who's been accustomed to paying $600, $800, $1,000 for your progressive glasses and you come to a value player and maybe you don't pay less than $100, but you still get really good value, the odds of you going back and spending $800, $1,000 in the future is very low. So there is some benefit to the competition in the value end, which is legitimizing it for all players in the value space.

Yes. That's helpful, Patrick. I want to introduce the idea of the coronavirus in this part of the conversation in a few different ways. And this is just because we've been getting a lot of questions on it, and the audience seems to be interested on it. The first angle I'll ask you is, in a perverse way, might this actually be a benefit for National Vision? I mean take a competitor like Zenni. All of its glasses are sourced in China, or a majority of its glasses are sourced in China. And so if a customer -- it's a very low-cost frame. If a customer comes to Zenni, and now they're experiencing such long delays, doesn't that push more volume to more traditional players? And isn't that helpful for a player like National Vision?

I'll come to our side of the fence and answer that question. I've heard some of the things in terms of supply chain, but we'll probably stay away from making direct comparisons. It is helpful. We find ourselves in a decent position on the inventory. On our call last week, Michael, we stated that even through our peak selling season, which is typically February, March and April, we feel comfortable with our inventory levels through midyear. You probably can do the analyst research and tell me of what other folks are saying about that. But I think, we are in a position of strength right now that -- or are happy to take advantage of, assuming this remains mainly a supply side challenge. So we're happy about where we are with inventory and don't expect any forms of inventory disruption should this thing play out between now and midyear.

And as a company that operates in the health care space, what precautions are you taking to be best positioned to mitigate any risk to your employee base, to consumers and patients who come in to experience your service?

Yes. That's a really large focus area for management, as you would expect. Like most companies, we're having daily status meetings. We're simply deploying CDC guidelines. And we're also letting our associates and doctors work within their own guardrails of comfort and make any local customizations that they prefer. We have -- we are probably not deep enough into this to have complete policies laid out, but we are very focused on maintaining and protecting the health of our associates, doctors and customers and working through that now. We have over 1,100 stores, and we're busy. So there's a lot of foot traffic and people in our stores, and this is on the forefront of our minds. And it's obviously evolving. But we're fairly prudent, conservative folks, and we're doing everything we know to do to take care of all of those stakeholders.

And as you and Reade, National Vision's CEO, constantly point out, eyeglasses are a medical necessity. This is a purchase that's done because you need it. So it could be potentially deferred, but it doesn't go away. So is that the right way to think about, if there is an extended period of consumer hibernation, the impact on National Vision would really be temporary, unlike maybe some other consumer services, a restaurant, an amusement park that would lose out over an entire trip?

That has been the case with disruptions like old concern over government shutdown in 2011 for a hurricane. We've seen short-term demand impacts and then typically a full or near full recovery cycle. Because as those events are playing out, people's eyes were getting worse. They're scratchy, broken glasses, are still scratchy and broken. And it is not like the meal that you're never going to eat if you missed it. It is a necessity that people are going to find a way to come back into, and that's what we've seen over time. At the table earlier this week, we had our entire management team in, and we were kind of seeking to talk about things that have happened in the past that felt a little like this. And we brought up SARS and one other global pandemic scare, and there was a little impact to the business as a result of that. That's not a promise for now because I don't know what now looks like in a week or a month. But I do think the fact that this is a medical necessity and a very affordable medical necessity inside of an industry that typically takes prices up, I think we could be in a decent position to weather this should it get to a point that it needs to be weathered.

From that conversation and from those experiences, were there any learnings that now can be applied? You can flex your workforce and your hours up and down if traffic is impacted. Or are there facets of the organization that could be temporarily altered in the event there is a consumer impact to this?

We're working through contingency plans that would contemplate almost every scenario that one could imagine. And to the degree, you certainly like to pull the variable levers first. But we also I think rightly so have a good reputation for trying to do things that make good sense for associates as well as customers. And so I don't have anything specific. Again, the scenarios are rather infinite. But we're -- I think we're spending an appropriate amount of leadership time thinking through that, being prepared, keeping folks informed, which is really probably the headline. It's just communicating with people so that they understand how we're thinking about dealing with these various scenarios.

And you mentioned in one of your previous remarks about pricing power, you have abilities to push levers to navigate through this. How does pricing power come into play in the optical market? When do you feel you need to use that? Or have prices gone up over time? Or is that not a lever that typically National Vision uses?

So before I answer that question, I want to go back because I forgot one thing that I thought would be important to say.

Oh, your quarter-to-date sales? I told you there's latency in my jokes.

Let's get back -- I've got a few more seconds to come through. In the 2008 downturn, and I'm not comparing that to this because it's not, but I'm giving you an example of taking advantage of certain things that were going on then, we found more affordable real estate. We found better advertising rates. And so there was a period of time as our comps remained positive, that we actually were accelerating somewhat based on favorable cost positions in the market. Again, none of us want to think about lasting anytime. But I guess my point there is, we'll monitor this very carefully. And if there's opportunity in this to grab, we'll look to grab it. In terms of pricing power, we remember first that we're -- we strive to be the low-cost provider of medical necessity. So once you put yourself in that sandbox, there's only so much you can do with price. We've not changed our headline pricing since, I think, 2004 for America's Best and since we bought Eyeglass World in 2009, I think. We have tried very hard and have been successful at not touching headline pricing. We have taken some peripheral pricing actions from time to time. In my tenure here, I've seen that a couple of times over 5.5 years. So it's -- we don't have a strategic pricing growth. We don't have a tactical pricing growth. We are not always looking to see exactly where we can get juiced out of pricing. But from time to time, we take that into account. But it's essential. If we're going to keep being the low-cost provider of a medical necessity and beating others on price, we can only raise it so much. So there is some elasticity in pricing for us, but we engineer it so that we try to keep that as low as possible. What we have found some of industry do by mistake is replace traffic-driven comps with price-driven comps. And when you do that, you have all goodness in the short term. You feel the benefit of that. But 2 years later, when the buying cycle comes back, that customer may not remember that as a pleasant experience, where they paid a lot more than they expected to pay. So we watch our average price per payer and price per contact lens unit carefully, and we're not watching and hoping it increases. We're watching it to make sure it stays steady because that's absolutely correlated with retention.

Sure. And are you seeing the marketplace continued to push up prices, particularly in response to some of the tariffs? So such that the gap between the offer and National Vision, America's Best and Eyeglass World, the -- that gap between the company and the competition is widening?

I think the industry for optical retailing, especially in the U.S., has declared a side. I think there's certainly value players like us. There's the more premium, more expensive players, and I don't see a lot of -- I don't see really any movement in those opposite ends moving toward one another. There's been a few players in the middle. The middle is often never a really easy place to be, but I think the folks are in their respective corners and are trying to win in their corners. I've not seen a lot of premium downmarket encroachment.

A couple of areas of debate -- yes, please.

One more thing, Michael. One more thing to mention there. Pricing is so hard to analyze in this industry. You look at the 2 offers, the one offers, the online offers, the [ $6.95 ], the [ $38.75 ], but you can look at all of these offers and then give you a glimpse of pricing. But you -- honestly, to do a pricing analysis, we find that we have to go shop.

Yes.

We have to go -- we have this thing, send secret shoppers in and figure out what's the real walk-out price because you can -- the consumer can get duped there. In our America's Best brand, about 1 in 5 customers walk in and say, "I want the base offer. I have this much to spend. Don't show me anything else." And they take the base offer. A much larger percentage take that base offer and add like one thing to it. Maybe it's anti-reflective coating. Maybe it's a polarization. Maybe it's a little thinner lens. So we try very hard to keep our stores from pushing them up and helping customers get exactly what they need. But the main point there is -- I think, I even recently saw an analyst report where they were comparing pricing, and they were using headline pricing. And it's not an industry where that works.

Do you have resources that you dedicate to do the mystery shop and to have a good assessment of what prices are in the marketplace?

From time to time, we actually either work with a third-party, and that third-party finds people that are willing to take good direction and go do the secret shopping. And frankly, our district managers, our regional vice presidents, our brand leaders, they -- and Reade are constantly shopping other players. So I would say, formally, we use a third-party on that time to time. Informally, we do this nonstop.

Sure. I want to switch gears a little bit to a couple of areas of debate on this -- the investment case for National Vision. One is, National Vision's history has gone from being a privately held, private equity-backed company to a publicly traded corporation. And during that time, there's been a little bit of an evolution in the demands from the owners, which are now private equity, public equity investors. There's more of a focus on improving margins, improving the free cash flow generation. Are there opportunities to pivot to now generate these 2 areas of focus that the public equity markets are demanding?

I think so. I'm happy with where we are after 10 quarters of being public. We -- for those folks that got our model a long time ago, it's proven to be pretty accurate. We met our annual guidance to The Street in '18 and in '19 and are obviously focused on doing that in '20. If you talk about free cash flow, I would say we just demonstrated some recent substantial improvement. Free cash flow from operations was $60 million, $65 million last year. We redeployed $50 million of cash into one voluntary debt paydown of $25 million and another stock repurchase. So I think we have hit a point where I'm seeing free cash flow improve. And obviously, look at CapEx, we are guiding towards another year of CapEx within $1 million or $2 million or $3 million of the previous year. So that feels like it's getting better. And that's obviously a management goal. As it relates to margins, fourth quarter was a great example of leveraging the fixed costs in the business. We did, I think, an 8% comp and saw really nice margin improvement in the fourth quarter. It parlayed us into margin improvement on the entire year. And so to the degree that we can get those comps north of that 3% to 5% range, I think we will continue to see that. The last couple of years, Michael, has had frankly cost structure noise with pubco costs, with cyber. I am elated that that is behind us, and the cost structure now is effectively what it is. We continue to look for ways to [ realize ] labor on the retail side of the business, but we also have to be careful of that because our employees and associates need to -- there's stuff they need to know to help customers, pick what they need to pick. So overall, I think we're in a better foundation right now for potential margin expansion. At the top end of guidance, we're about flat in 2020. Should we get comps in north of that guided range, I think we have a good shot at it. And I think the puts and takes are more emphasis now on leveraging corporate expense. At some point, I do expect more -- leverage our TV national advertising a tad more. And then that's offset to some degree with some continued assumption for associate wage pressure and even optometrist wage pressure. We don't have the Texas lab drag this year to any extent that we felt last year. So I feel better about where we are foundationally, but you've probably found me pretty consistent. I don't promise a lot of margin expansion until we know we're there. And -- but it's a focus of management. And then I'll take that right into returns on invested capital. As a private equity company 5 years ago, the emphasis was drive sales, get customers back in, get repeat customers, drive cash profits, EBITDA profits. And that's still important. Those objectives led to some really good outcomes. But it's an and equation for us now and make sure that what we're doing is prudent from an ROIC perspective to grow in a way that investors want us to grow.

We've got just a couple of more minutes, Patrick, which I'm sure you're pleased to get off the hot seat. But I want to have a follow-up there and then talk a little bit about Walmart to end. On the follow-up, are we at the point at which we've hit an inflection and optometrist wage pressure is just more manageable now? Or is this going to continue to be an extended burden on the business because of the supply-demand conditions within the optometrist labor market?

You know, Michael, since going public in '17, we've experienced optometrist wage inflation. It's the fulcrum form of our business. We are certainly willing to invest in those people because they're critical. I didn't think we had seen a stabilization. That doesn't mean that wages are not increasing. It seems to have hit a level that's frankly moderated and a little more predictable. When you think about that, you think of both what is the market rate to employ an optometrist to work for us, and then you think about to what degree can we make sure that that very important person is well utilized, so that they can see as many patients in a high-quality manner as possible. So all of those things come into play with optometrist wages, costs and even coverage levels. But we have seen some slight stabilization.

That's helpful. And the last area I want to focus in on is your relationship with Walmart because National Vision runs about 250 eye care centers within Walmart's stores. Importantly, and for the first time in a while, National Vision has just been given the opportunity to run 5 more stores. Up until this point, the number had been dwindling. So what are the factors do you think motivated Walmart to allow you to run more stores? What enabled you to get more stores from Walmart?

Well, what we did with the contract, there was a deadline in mid-January that we were staring down. Both sides said, "Hey, this is an arbitrary deadline. Let's keep talking with each other about ways that we can run this business more effectively and get more value-added business for customers and the companies that own these businesses." So we had simply extended our discussion times 6 months. As a part of that, and I don't remember which side started it, we thought it'd be great to demonstrate what we could do. We also want to learn about store conversions. Michael, every store of the 226 that we currently operate for Walmart is a store that we opened for them a long, long time ago. Way back, they would open 10. They would give us 10. And so every one that we have left was one of ones that has always been National Vision. I don't think we've ever converted a Walmart corporate vision center into a National Vision-managed Walmart Vision Center. And so my -- the part that I'm most excited about, these 5 stores, they're not too far from our corporate offices. There's one that's a little further. But it lets us learn and it lets us deploy everything that we can bring to bear to convert those stores, understand what that means, how long does it take to get a circuit, how is it going to cost, and really have 5 good practical examples such that we can continue to hopefully make good recommendations to Walmart. We obviously would love to win and earn more of their business. And while I don't really view these 5 stores as a test per se, it is a great learning opportunity. But you also just have to know that Reade would like nothing else and to be able to point to some nice success stories.

That makes sense. My last question is, Walmart clearly has...

I thought that was...

No, that was part of it. That was part of it. That was only part of it. Walmart, clearly, has large aspirations in health care. They're opening stand-alone health care clinics. How do you think these aspirations will impact National Vision and its relationship with Walmart over the long run? And then we're done.

At the end of the day -- we don't have to be done. At the end of the day, our interest and our mission -- our missions are aligned. They are after giving great value to a population that needs great value. We're doing the same thing. As it relates to health and specifically optical, we're coming at this from the same dimension. So I don't see -- I see Walmart's emphasis on health as a positive, and I hope that some things come to fruition that can put an exclamation point on that at some point. So I think our interests remain aligned. They were always aligned, and they might even be further aligned now. But again, we're still in negotiations, discussions, contemplations. Hope to be in a position later this year to disclose more information. And again, it's Reade and my intent to continue to be an awesome partner for them.

Well, we appreciate your perspective, Patrick. And thank you, David. There's a lot of light bulbs that have gone on in this room, a lot of smiles. Seems like a lot of potential investors. So please join me in thanking Patrick and David for their insightful comments today.