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Edited Transcript of EYE.OQ earnings conference call or presentation 7-Nov-19 3:00pm GMT

Q3 2019 National Vision Holdings Inc Earnings Call

Nov 14, 2019 (Thomson StreetEvents) -- Edited Transcript of National Vision Holdings Inc earnings conference call or presentation Thursday, November 7, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Mann

National Vision Holdings, Inc. - VP of IR

* L. Reade Fahs

National Vision Holdings, Inc. - CEO & Director

* Patrick R. Moore

National Vision Holdings, Inc. - Senior VP & CFO

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Conference Call Participants

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* Alexander Rocco Maroccia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Anthony Chinonye Chukumba

Loop Capital Markets LLC, Research Division - SVP

* Dylan Douglas Carden

William Blair & Company L.L.C., Research Division - Analyst

* Eric Michael Cohen

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Joshua Kamboj

Morgan Stanley, Research Division - Research Associate

* Mark David Carden

UBS Investment Bank, Research Division - Associate Director and Associate Analyst

* Paul Lawrence Lejuez

Citigroup Inc, Research Division - MD and Senior Analyst

* Robert Frederick Ohmes

BofA Merrill Lynch, Research Division - MD

* Robert Scott Drbul

Guggenheim Securities, LLC, Research Division - Senior MD

* Stephanie Marie Schiller Wissink

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the National Vision Third Quarter 2019 Earnings Conference Call. (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 speaker for today, Mr. David Mann. Please go ahead, sir.

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David Mann, National Vision Holdings, Inc. - VP of IR [2]

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Thank you, and good morning, everyone. Welcome to National Vision's Third Quarter 2019 Earnings Call. Joining me on the call today are Reade Fahs, Chief Executive Officer; and Patrick Moore, Chief Financial Officer.

Our earnings release issued this morning and the presentation, which will be referenced during the call, are both available on the Investors section of our website, nationalvision.com, and a replay of the audio webcast will be archived on the Investors page after the call.

Before we begin, let me remind you, 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 in 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 presentations for investor reference on our Investors section of our website.

Now let me turn the call over to Reade.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [3]

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Thank you, David. Good morning, everyone. It's a pleasure to be speaking with you today to share our third quarter results.

If you turn to Slide 4. Q3 was a really good quarter for us. We're pleased to report our 71st consecutive quarter of positive comparable store sales growth. That's almost 18 years of consistently healthy quarterly comps. We remain quite proud of the consistency and durability that this track record reflects.

Q3 adjusted comparable store sales growth was up 6.2%. Comps were once again led by our growth brands with a 6.7% comp increase at America's Best and 5.2% comp increase at Eyeglass World, respectively. Also, I'm quite pleased with the improving performance at our Legacy segment, which delivered a 5.7% comp increase.

We opened 17 new stores in Q3 and ended the quarter with 1,145 stores for a 7.3% increase in store count in the past year. The comparable store sales growth and unit growth combined to drive an 11.5% increase in net revenue. Adjusted EBITDA increased nearly 25%, and adjusted net income rose almost 66%.

We closely monitor our Net Promoter Scores as another sign of customer satisfaction and ambassadorship. Our overall NPS increased year-over-year again this quarter. This is a testament to the store level execution of our teams and their commitment to customer service every day and in every store, one patient and one customer at a time.

As we noted on our last call, we improved our balance sheet with the debt refinancing in July that lowered our borrowing costs. Our 14-year tenure of private equity involvement came to an end as KKR completed the sale of its remaining ownership in August. This was the final chapter in our very successful 5.5-year relationship with KKR. Concurrent with the KKR sale, the company purchased $25 million of EYE stock.

And last week, we utilized excess cash to pay down $25 million of our term loan debt. The stock repurchase and debt paydown reflects the strong, stable cash flows generated by our business model and healthy recent trends. Based on our strong year-to-date performance, we are raising our fiscal 2019 outlook. In a few minutes, Patrick will take you through our Q3 results and 2019 outlook in more detail.

Turning to Slide 5. It was another quarter of positive comps, further demonstrating the consistency in store performance and comp store sales gains. The graph here highlights our 71 consecutive quarters of comparable store sales growth. Our comps during this nearly 18-year streak have been consistent over time and across the economic cycle, which we believe is one of the nice benefits of our purchase tied to a medical necessity. People need to see to function in this world, and eyeglasses and contacts remain the primary way to correct their vision loss.

Comps in the quarter were driven by increases in both average ticket and customer transactions. Our comp trend was consistently strong throughout the quarter and, at 6.2%, has accelerated from the first half trend of 5.3%. We experienced continued comp strength at our growth brands and improved momentum at our Legacy segment.

The Legacy segment posted its strongest comp since 2015. We're encouraged by the energy and execution being delivered by the team and believe that our initiatives to engage with the customer are reflected in this performance.

Overall, our consistent positive comp results continue to reflect: the benefits 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 merchandising 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 year-to-date, we believe that we continue to gain share in the fragmented $37 billion optical retail market with our low-cost operating model.

Turning to Slide 6. Our results this quarter were fueled by solid execution across many fronts, including real estate, marketing and store operations. We look to continue to execute on our core growth drivers.

First, new stores are a primary focus as we continue to see a sizable white-space opportunity given our current footprint. We opened another 17 locations this quarter. Year-to-date, we've opened 67 stores and expect to open about 75 stores again this year, following the formulaic approach that has worked so well for us historically. As we look out to 2020, the pipeline of locations look strong.

Optometrists play a key role in our ongoing success and in our mission to deliver improved eye care throughout the U.S. We are an optometrist-centric company and strive to be the place where the best optometrist choose to practice. 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 is at record levels. This quarter, we believe that increased optometrist coverage helped to drive patient traffic as we work to fill the ever-growing demand for eye exams in our stores.

Our team is on track to deliver another year of comparable store sales growth in 2019. Our key comp drivers are the comp waterfall from maturing new stores, marketing and vision insurance initiatives and the positive word of mouth from happy patients and customers. Our stores take several years to mature given an infrequent purchase cycle that averages 2 to 3 years, so it can take time for potential customers to find a store after it opens. This purchase cycle, tied to a low-price offer on a medical necessity, initially attract new customers who then become returning customers in later years, resulting in attractive comp waterfall.

When our customers are in the market, we strive to deliver incredible values that attract them to our stores. Our introductory offer at America's Best, 2 pairs of eyeglasses for $69.95, including a free comprehensive eye exam, hasn't changed in over a decade. At America's Best, this bundle includes hundreds of frames to choose from and is purchased by over 20% of our America's Best customers who do not have vision insurance. Last year, well over 1 million free eye exams were provided to patients as part of a 2-pair bundle. At Eyeglass World, the offer of 2 pairs of glasses for $78, along with the opportunity of same-day service from our in-store labs, also represents one of the best values in the industry.

Each year, millions of patients and customers come to us for affordable eye care and eyewear. 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 at our store. As we have noted, 64% of customers in mature stores are existing customers.

Marketing continues to be a key factor in attracting customers and driving traffic to our stores. Television advertising remains our primary marketing cable, and our Owl and Mr. World marketing campaigns continue to resonate with optical consumers. The Owl is a particular favorite of our customers, humorously reminding them that they paid too much if they didn't shop at America's Best. 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 market share gain.

Participation in vision insurance programs remains a positive comp driver. Healthy net revenue growth tied to these partnerships continued in the third quarter. We believe a factor behind this growth is that vision insurance dollars tend to go further at our store. 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, continues to be a minority of our 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 being everyday low cost. Our centralized lab network is a key reason that we are everyday low cost. Our new state-of-the-art lab in Texas continues to ramp its production and remains on schedule. The new lab is a prime example of growth investments we're making today that we believe will drive future performance.

We continue to progress our omnichannel efforts to improve the customer experience and operating efficiency. Our focus is on all aspects of the customer journey in order to improve engagement and reduce costs. Our patients and customers appreciate such things as the ease of being able to schedule appointments online.

Let me take a moment to provide an update on tariffs. As previously disclosed, we estimate that products imported from China represent less than 16% of costs applicable to revenues. Since September 1, these products have been subject to 15% tariff. We continued our diligent efforts to mitigate the impact of these tariffs. We've been working with our suppliers, looking at all areas of our supply chain as well as reviewing our pricing and cost structures. We remain focused on operating a cost-efficient supply chain and maintaining our commitment to our industry-leading low price strategy. As a result of these initiatives, we are positioned to offset the impact of the 15% tariff this year.

Overall, we're very pleased with our year-to-date performance. The momentum in the business is solid, and we're raising our fiscal 2019 outlook. As we look beyond 2019, we continue to believe that we're well positioned in a very attractive industry and are confident in our growth strategies that build the business for the long term.

At this point, let me hand the call over to Patrick.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [4]

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Thanks, Reade, and good morning, everyone. Turning to Slide 8. As Reade noted, our business performed very well in the third quarter and year-to-date. We are nearly complete with our plan to open approximately 75 new stores in 2019. We've opened 67 stores year-to-date compared to 58 last year at this time. Store openings have been predominantly America's Best locations, with the remainder being Eyeglass World stores. For these 2 growth brands combined, unit growth increased nearly 11% over the last 12 months. We did not close any stores this quarter.

Our 2019 store growth has been skewed towards existing markets as well as further infill in our newer markets. In these 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 pay back 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 comps calculated on a cash basis. Same-store sales increased 6.2% on top of 6.8% increase in the third quarter last year. The comp growth was driven by increases in both average ticket and customer transactions. We experienced comp growth in both the eyeglass and contact lens categories. More importantly, eyeglass comps continue to be primarily driven by increases in customer transactions.

In terms of content lenses, comps were primarily driven by average ticket. Our content lens customers are increasingly migrating towards newer technology lenses that have higher prices. We believe our customers are in the early stages of participation in an industry trend that has been ongoing for several years.

In the third quarter, we generated solid comps in our growth brands as America's Best and Eyeglass World produced gains of 6.7% and 5.2%, respectively. Legacy comps increased 5.7% in the third quarter. Of this growth, we estimate 200 basis points of benefit from incremental eye exam revenues tied to a shift in optometrist from our FirstSight subsidiary to the Legacy segment in the fourth quarter of 2018. As Reade noted, we believe that the strong Legacy performance was driven by improved store-level execution by the team. Overall, we are extremely pleased with the continued top line momentum in our business since our last call.

Turning to the income statement highlights on Slide 9. As a result of the solid comp and unit growth, net revenue increased 11.5%. The growth in net revenue from the AC Lens contact lens distribution business contributed approximately 160 basis points of the increase. As a reminder, we added this incremental AC Lens business in the third quarter last year, so this will be the last quarter in which it will have a material grow-over impact on the income statement.

Cost applicable to revenue increased 12% or an increase of 20 basis points as a percentage of net revenue versus last year, which was better than the range of expectations that we provided last quarter. The contact lens distribution business growth negatively impacted cost applicable to revenue by 70 basis points. The remainder of our business generated a 50 basis point improvement in cost applicable to revenue, which primarily reflected higher eyeglass margin and a higher mix of reimbursed eye exam sales that were partially offset by higher optometrist costs. The higher optometrist costs resulted from planned increases in store coverage and, to a lesser extent, wage inflation in certain markets.

SG&A expenses increased 2.8% or a decrease of 370 basis points as a percentage of net revenue versus last year. Adjusted SG&A expenses increased 7.7% in the third quarter versus last year or a decrease of 140 basis points as a percentage of net revenue. We're pleased with the leverage of store payroll and advertising expenses that we achieved this quarter.

Adjusted EBITDA increased nearly 25%, and adjusted EBITDA margin increased 120 basis points to 11.1% in the quarter. The increase in adjusted EBITDA margin was primarily due to our improved eyeglass margins and expense leveraging partially offset by the impact from the contact lens distribution growth and the net change in margin on unearned revenue. The change in unearned revenue negatively impacted adjusted EBITDA growth by 650 basis points in the quarter.

Adjusted net income increased almost 66% in the quarter. Adjusted diluted EPS increased 62% to $0.18 versus $0.11 last year. The flow-through this quarter was excellent as we generated strong incremental margins on higher sales. Overall, we are very pleased to have delivered more to the bottom line from our solid top line growth while still investing in the business for the future.

Turning to Slide 10 and year-to-date results. Our year-to-date results reflect the consistency and predictability of our business model, with adjusted comparable store sales growth up 5.6%, net revenues up 12% and adjusted EBITDA growth up about 11%. Adjusted EBITDA growth was negatively impacted by 350 basis points due to the net change in margin on unearned revenue.

Adjusted EBITDA margin slightly declined by 10 basis points to 12.2%. Our adjusted EBITDA grew at a slower rate than net revenue due to the impact from the contact lens distribution business growth and the net change in margin on unearned revenue. In addition, adjusted EBITDA margin includes a 20 basis point headwind from an approximately $3 million plan increase in cybersecurity investment year-to-date.

Similar to recent quarters, we have again included an explanatory slide on unearned revenue, which you will find 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.

I also want to take a moment to comment on our adjusted comparable store sales growth metric, which is connected to the topic of unearned revenue. This quarter, we've added an additional explanatory slide about this metric in the Appendix section.

Adjusted comps reflect our same-store sales growth on a cash basis, which adjusts for the impact of unearned and deferred revenues. This is how the management team has always reviewed business performance, and our comp methodology has been consistently applied.

In most quarters, adjusted comps will be less than GAAP comps as it has been lower or equal for 10 of our 13 reported quarters. In the third quarter, adjusted comps were higher than GAAP comps primarily due to the year-over-year change in unearned revenue that I referenced earlier as well as continued growth in our business.

Turning to Slide 11. At the end of the third quarter, our total debt was $598 million. Our cash balance was $94 million or up over $45 million year-over-year. Net debt-to-adjusted EBITDA was 2.6x, an improvement from 3.1x in the third quarter last year. With our pre-IPO ratio at 6x, the substantial progress in the last few years indicates our commitment to deleveraging our balance sheet.

Year-to-date, we invested $76 million in capital expenditures with the majority of the CapEx focused on growth initiatives. We've tightened our 2019 CapEx plan to the high end of our previous range or $102 million to $105 million, which would be equal to or below our 2018 capital investment level of $104.5 million. With our current outlook for top line growth and relatively stable CapEx, we will reduce our capital intensity in 2019, which is an ongoing strategic focus.

We are encouraged with the improving cash flow characteristics of our business. Cash flow provided by operating activities increased $55 million versus last year. During the quarter, we repurchased $25 million in stock, concurrent with the final secondary offering.

Also, as Reade noted, we made a voluntary $25 million prepayment on our term loan last week. In total, we have redeployed $50 million in cash towards stock repurchase and debt paydown during 2019. Even following these actions, we expect to end the year with ample cash balance.

As a reminder from our last call and noted on Slide 12, we completed a refinancing of our debt in July, which lowered our borrowing costs on approximately $360 million in debt by 100 basis points and increased our overall borrowing capacity by approximately $60 million.

We are pleased with our continued efforts to enhance and strengthen our capital structure. While we will look to achieve continued improvements in our leverage ratios, we remain very comfortable with our leverage levels given our health services business tends to perform well across the economic cycle.

Turning now to our outlook on Slide 13. Based on our year-to-date performance and our expectations for the fourth quarter, we're raising our fiscal 2019 outlook. As you saw from our press release, we now expect adjusted same-store sales growth in the range of 5% to 5.5%. Consistent with prior guidance, we believe it is prudent to continue to plan the business in the 3% to 5% range for the fourth quarter.

One factor to consider relates to the final week of the year, which is a high-volume period for optical shoppers who rush to use expiring benefits. The final week of the fiscal 2019 calendar has 1 less day between Christmas and year-end, and this calendar shift historically has had a negative impact on comps and net revenue growth. We now expect net revenue of $1.705 billion to $1.712 billion. We are increasing our expectations for adjusted EBITDA to a range of $189 million to $192 million and adjusted net income to $56.5 million to $58.5 million. We also expect a slightly lower range for depreciation of $87 million to $88 million.

Our fiscal 2019 outlook for store openings, interest and effective tax rate remains unchanged. As a reminder, our outlook includes the impact from several items that we've outlined previously. First, we have now lapped the addition of the incremental AC Lens contact lens distribution business. The impact of this business growth dampened our adjusted EBITDA margin by increasing our cost applicable to revenue and leveraging our SG&A expenses. For fiscal 2019, we now expect our GAAP cost applicable to revenue to increase 90 to 100 basis points compared to fiscal 2018, a slight tightening of the range that we provided last quarter. For Q4, we expect costs applicable to revenue to increase about 30 to 40 basis points. Second, we continue to expect to spend approximately $4 million in incremental investment in cybersecurity this year.

Lastly, let me briefly revisit the China tariffs in the context of our 2019 outlook. Products that we import from China are now subject to 15% tariffs versus the 10% tariffs that we expected when we last spoke in August. Our increased 2019 outlook takes into account the incremental headwinds of these 15% tariffs. As Reade highlighted, we have been working diligently on initiatives to mitigate the impact of tariff. We are focused on executing our 2019 strategic growth initiatives to finish the year and look forward to delivering another year of consistent growth.

In terms of 2020, we are currently in the planning process. Consistent with last year, we look forward to providing a full fiscal 2020 outlook on our year-end conference call in late February.

At this point, I'll turn the call back to Reade.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [5]

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Thank you, Patrick. Turning to Slide 13. In closing, I'd like to share some of the efforts we've been involved in, in just the last couple of weeks, regarding helping to get exams and glasses to lower-income kids as part of National Vision's active social mission. Two weeks ago, a group of us joined our partners at Essilor, Transitions and the Essilor Vision Foundation in Dallas to provide eye exams and free eyeglasses to elementary and middle school kids in need. It was a great day of industry partnership in support of a worthy cause that I'm confident had a trajectory-setting impact on a great many young people's lives.

This past weekend, we are the lead sponsor of an annual fundraiser for Salus University, a graduate health sciences school that grew out of the Pennsylvania College of Optometry. The fundraiser is in support of the school's vision band that provides screenings, eye exams and eyeglasses to thousands of kids in the Philadelphia public schools as well as other school districts in the Philadelphia environment.

And finally, going on as we speak, nearly 40 America's Best and National Vision associates and 6 optometrists, in partnership with Atlanta's Westside Future Fund, are on site at the Hollis Innovation Academy, an elementary and middle school in downtown Atlanta. We're providing free vision screenings, eye exams and glasses to all Hollis students and expect to help more than 500 people at this event. These are just a few of our most recent efforts to make eye care and eyewear accessible for all.

In summary, I'm extremely pleased with our third quarter results and increased guidance. I want to thank our entire team at National Vision, including the over 2,000 optometrists who provide much-needed medical services to patients at our over 1,100 storefronts every day.

We continue to strive to be the best at providing low-priced exams, glasses and contact lenses while both at home and abroad. And this week, in our hometown of Atlanta, we work to bring glasses and, consequently, sight and improved quality of life to those who would be unable to see well otherwise. As I've noted in the past, 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Robert Ohmes of Bank of America.

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Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [2]

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Congrats on a great quarter. I have actually 2 questions. The first is can you remind us or maybe help us understand the -- how much the average ticket growth is benefiting from contacts. And maybe how much that is helping the comps and the -- maybe some help on penetration of contact lenses versus eyeglasses, just -- and why this is not sort of a onetime ticket benefit. And just maybe a little math to help us understand how sustainable that is.

And then the other question is just remind us what's driving the higher eyeglass margins and how sustainable that is as well.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [3]

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Thank you, Robby. Appreciate that. And yes, we're pleased with both the ticket and the transaction growth overall. Transaction count overall of the company was up 3.9% and ticket growth, 1.9%.

And so on the contact lens side, you got to remember, contact lenses are about 20% of our business overall. And so although they are growing ticket-wise and growing transaction-wise, that's more sort of doctor- and customer-driven. It's not something we drive. It's not something that -- that's more sort of what the doctor feels is in the best interest of the patient and what sort of modality the patient wants. But really, our comps are related to the growth in our eyeglass business, not our contact lens business. And again, transactions were up for eyeglasses 3% and growing faster than ticket, which is the way we like it and have done it historically.

And Patrick, do you want to talk about the margin piece of that?

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [4]

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Yes. I'll follow on the eyeglass margins. Robby, there's a few things going -- coming into play there. I think we've mentioned a couple of quarters this year that we had a new lens contract going into effect at midyear, and that has obviously occurred.

Second, we also mentioned some peripheral pricing action that would have also affected kind of our frame mix, our frame board mix. So both of those are factors in helping the eyeglass margins a bit at this time.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [5]

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Again, sort of when I look at the transaction and ticket, I see it as just part of the consistent story that we've been talking about for a real long time. It's in line with how we like it, and it feels very similar to what we've been talking about even since our road show.

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Robert Frederick Ohmes, BofA Merrill Lynch, Research Division - MD [6]

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And just one follow-up, if I may. Just the improvement in the Legacy business comp. Any -- anything you can highlight? What happened there? And is that sustainable?

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [7]

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Yes. So we're pleased with that as well. Again, that was -- yes, that's -- there's nice momentum that we're seeing in that business. We have sort of a new leadership team, key people in place there. And we're feeling like our Legacy division really has its mojo going there. So I think it's leadership, focus, energy. Yes, we're feeling good about that.

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Operator [8]

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And our next question comes from Simeon Gutman of Morgan Stanley.

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Joshua Kamboj, Morgan Stanley, Research Division - Research Associate [9]

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This is Josh Kamboj on for Simeon. As you look towards 2020, can you maybe remind us what some of the key margin buckets that will help and hurt your expense structure? Like, for example, you've spoken about optometrist wage headwinds for a long time. There's a lot of talk about broader wage inflation. Are you worrying about the potential for your store associate wages to rise? And is advertising going to become a tailwind? Just, in general, some of the buckets that we should think about.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [10]

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Josh, it's Patrick. I'll take that one. In terms of 2020, I'd say at the outset, we're still working diligently on that plan. We look to share specific outlook in February. Tariffs kind of come into play, and we continue to make great strides towards being prepared for those, however that may fall.

There's some key items that have affected us in '19 that it will not continue: the cyber investment of $4 million on the year, the Plano lab drag. I think we disclosed about 1 to 1.5 of EBITDA and about the same amount on depreciation. And then, obviously, we've now lapped the AC Lens contact lens distribution bolt-on that we talked about over the past 12 months.

As I kind of look out and think about overall margin expansion and not just for 2020, but in general, we've had these factors that I've just discussed. And then, yes, we expect to see some continued wage inflation. I think we're managing through that very well in our stores as evidenced by leveraging associate wages in the quarter. We continue to support managed care growth and look at some other key investments that we think drive market share gains. Next year, we should see some lab productivity improvements, and we're also working to leverage those fixed costs in the business that can be leveraged.

So today, I'm not ready to kind of call it in terms of which way that goes for 2020. Our intent is to remain a very consistent grower and continue to deliver what you all have been accustomed to. And obviously, we'll go into much more specificity on our next call.

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Joshua Kamboj, Morgan Stanley, Research Division - Research Associate [11]

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And then just as a quick follow-up. Can you remind us maybe what your overall business leverage point is for comps? Is it the 5% level? Is it the 6% level because of wage inflation now? Just any color on that would be helpful.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [12]

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Yes. I think we've kind of said something in that 4% to 5% range. And we have -- we're working very hard to do what we can with fixed costs to continue to improve that.

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Operator [13]

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And our next question comes from Bob Drbul of Guggenheim Securities.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [14]

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Just 2 questions from me. The first one is, I guess, 2 years now into being a public company, could you just maybe talk about the environment, sort of how it's changed over the last couple years and sort of how you see it changing and then just sort of tying that one together? Can you just give us an update on the Walmart relationship? I think you have a renewal coming up and just sort of how we should think about where that relationship is and the future prospects there.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [15]

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Yes. Bob, I'm happy to do this. So yes, we just had our 2-year anniversary a few weeks ago as a public company, and I would say the trends we laid out on our road show have continued. There's ongoing consolidation in the industry. There seems to be an ongoing shift to the value segment that we are benefiting from. The consolidation is making it, I think, ever more challenging to be an independent doctor. And doctors are still 40% of the industry. And we're finding a lot of doctors are saying, "Yes, I think I'd rather be in your employed model than in the independent model." So we have folks coming to us like that. But they're, I guess, sort of the EssilorLuxottica thing came together in the past 2 years, but that really hasn't affected us a great deal. But we're always saying that category's growing a bit, and it's continued to do that. But the chains are growing at the expense of the independent, we see that continuing. And the value segment is growing at the expense of a lot of the traditional, more expensive sides of the chain. So that's all continuing and consistent with the vision we had 2 years ago and what we expected there.

On the Walmart side, first of all, we're really pleased with our Walmart results there. And we've always considered it a great honor to get to operate within Walmart. We've now -- as we're just ending our 29th year, so next year will be our 30th year of partnership with Walmart. We feel that the relationship remains quite strong, and we're sort of in touch with them on a frequent basis on a variety of topics. We talk to them about all sorts of things all the time as we have, so things are good there. And we don't have anything to report right now relative to that. But when we do, we'll let you know.

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Robert Scott Drbul, Guggenheim Securities, LLC, Research Division - Senior MD [16]

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Got it. And if I'm -- can I just sneak in one more? When you look at the inventory levels throughout this year, I was just wondering, can you just tell us how you think you'll enter 2020 from an inventory perspective?

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [17]

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Bob, it's Patrick. Yes, inventory levels are probably conditional on where things are currently trending on tariffs. There are [something] to get opportunities to do forward buys, and you've probably seen us do that a couple of times in the fourth quarter. I think levels have worked down to a reasonable level now. And I think we're just going to have to stay tuned to various tweaks to kind of see how that's looking, and we'll adjust the inventories accordingly.

But turns are fairly consistent for us. There's -- very high in contact lens business and reasonable on glasses and frames as well. So we'll be monitoring that over the next 1.5 months or so and take as wise an action as we can.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [18]

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Broadly, inventory increases relate to things that are opportunistic and favorable for us.

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Operator [19]

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And our next question comes from Michael Lasser of UBS.

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Mark David Carden, UBS Investment Bank, Research Division - Associate Director and Associate Analyst [20]

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It's Mark Carden for Michael today. When you think about the Walmart business, if Walmart did ultimately, for any reason, decide they would prefer to bring in eye care operations in-house, how would it impact your free cash flow?

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [21]

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Mark, thanks for the question. So you can look at our Legacy segment. Our Legacy segment is the store level P&L for those 226 Walmart stores. So that kind of gives you our profitability at the store level.

There are some other costs that are in our corporate and other related to all the field management personnel, the district managers, the regional VP, brand leadership as well as corporate support. And so you have to be a little careful with that segment number in terms of translating it down to a true free cash flow.

We've not provided that kind of extended segment. But as you think about moving down from the 20-something percent for owned and host and Walmart combined to lower teens, 11%, 12% for EBITDA, there's going to be a similar margin there. So it would be something far less than segment, and we obviously -- our intent is to not have to think about that. We continue to do our best to be the best partner that they have. But if that were to occur, I think, frankly, we could manage through it and -- it'd be an impact, but I think we could manage through it and grow through it within a short period of time. But again, we're not ready to really make that a project.

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Mark David Carden, UBS Investment Bank, Research Division - Associate Director and Associate Analyst [22]

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Okay. That's helpful. And then you mentioned that managed care continues to be an opportunity. Can you help quantify where your current penetration is relative to overall industry levels and then how much that's changed over the past few years?

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [23]

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Yes. So we don't give an exact number. I think when we went public 2 years ago, we were saying it was between 25% and 30%. And we were saying it was growing a bit faster than the rest of the business, so that could give you a sense of dimension. And we continue to say that it is less than half of our business and that we are and remain underdeveloped relative to the category overall.

We think that we're underdeveloped for a couple of reasons. One, when we bought America's Best back in '05, they didn't accept any managed care. So we're starting at 0. They were -- they had no plans. There was -- we started at 0, so we're playing a bit of a catch-up game there. But alternatively, if you don't have vision insurance, you're more likely to come to us. So when it's all your money and you're not factoring in the various factors that go into the decision if you're a managed care buyer, it's all your money, and you're seeking out true value, you generally find us. And so I think we'll always be a bit overdeveloped in the nonmanaged care business for that reason, but it continues to grow nicely as a piece of our business. And we're happy with it and spend time cultivating it.

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Operator [24]

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And our next question comes from Steph Wissink of Jefferies.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [25]

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Most of our questions have been asked. But one thing I wanted to just break down, maybe, Reade, this is a question for you. In your prepared remarks, you mentioned that you had stronger optometrist coverage, which you used as a way to drive some incremental utilization and comp. Can you talk a little bit about how you think about investing in optometrists to make available appointments or availability of appointment improved and ultimately benefiting the overall sales take rate? Just break that piece of the business down, that would be helpful.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [26]

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Good. That's one of my favorite topics. It's something I spend a lot of time on. As I said in the prepared remarks, we are an optometrist-centric organization. One of the phrases I repeat most frequently is that we are creating environments where optometrists will want to spend their entire career. And I say environments, both because we have multiple brands and we have multiple different relationships with optometrists in terms of how we interact with them. Some lease from us, some are employed by us, some work for professional corporations, some work for our California HMO. I broadly say that if there's a relationship one can have with an OD in America, we have it. And frankly, that's a barrier to entry the -- in our favor, the fact that, that is one of our competencies.

Key is we see very strong demand for our services, and the ODs in our stores help us to be able to serve this ever-growing demand. So when we have more OD coverage, it tends to correspond to higher sales. And that's why when we refer to the fact that our retention of optometrists is at an all-time high, it really is a key barometer of the health of our business.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [27]

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Great. Just one follow-up on marketing. I think you mentioned that you did lever advertising in the quarter. I'm wondering if you can talk a little bit about what we should look for over the course of the next 1 to 2 years in terms of your marketing investment. You've had great success with some of your campaigns. What are you looking forward to in terms of either further activating some of those assets or adding on new mediums or ways to reach the consumer?

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [28]

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We're always looking for ways to make our marketing more efficient, and I believe we get ever smarter with the years. We're both traditional marketer and spend a lot of -- on TV, and we do a variety of different digital marketing programs that we're always testing and quantifying and learning about. The media markets in America, both on the television side of things and on the digital side of things, is ever changing so you're foolish if you're not always testing and learning. And the great thing about the digital means is it's very quantifiable as opposed to the traditional way. So we believe we're going to be a consistent marketer for a long time, and we think that it's a key way to help us grow our share and sort of seize the opportunity and continue the demand for our products.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [29]

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I would just add -- it's Patrick. Reade did a great job of talking through both being traditional and digital. I think that as this continues to equalize some shift, we also have an opportunity to see some degree of advertising leverage over time. We've not kind of made that call yet. But I do think in today's world, we're really having to invest in both sides. And I do expect that transition a little more over time and give us a better opportunity for leverage, yes.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [30]

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We get smarter as we go.

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Operator [31]

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And our next question comes from Paul Lejuez of Citi.

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Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [32]

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You mentioned offsetting tariffs this year. I was curious if that happened strictly on the cost side, just negotiating better price. Or did you also take prices up anywhere? Also curious if you believe you'll be able to offset the impact from tariffs next year as well.

And then secondly, I was just -- wanted to talk a little bit more about the optometrist costs. The drag that you saw this quarter, maybe if you can quantify it compared to prior quarters and what you expect in 4Q. And any early thoughts about next year on that side of the gross margin equation?

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [33]

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Paul, thank you. Yes, and by the way, we're very encouraged by the news this morning. We'll see if it definitive or not but it sure was encouraging, the tariffs side this morning. There are a variety of different levers that one can pull to help mitigate these things, and we look at all of them. We study all them. We don't provide too much guidance overall for competitive reasons. We're the only public company really pure-play in our category, so we'd like to not share in detail exactly how we're doing this.

I will say that over the years, we have periodically and episodically taken peripheral pricing action. We never -- we don't change our core offer of -- our banner offer. But we have, over the years, done that here and there, and that is one of the levers that is available.

And the second question about OD -- could you repeat the question you had on OD?

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Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [34]

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Sure. Just the drag this quarter versus previous quarters, what you expect in 4Q of next year, outlook.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [35]

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I'll take that. As we think about coming out of the year and into fourth quarter, overall, we're expecting gross margin to have probably 30 basis points of pressure. And we expect that to be impacted by tariffs, assuming that's continuing, our lab drag as well as a little bit of OD wage inflation. Not ready to make a statement on that for 2020 because we're still very focused on putting together a great plan that continues the consistent growth momentum that we've established. But we're really not seeing that get worse.

And the other thing I'd come back and mention, Paul, when we say -- when we talk about early inflation, there's really couple things going there. One is the coverage topic that, I think it was a Steph that kind of brought up with Reade earlier. That's a factor of kind of wage as well as just we occasionally get markets where there's a supply/demand imbalance and we have to respond there. But that should give you a little color on how I'm thinking about gross margin in Q4. And then in February, I'll give you lots of color on 2020.

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Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [36]

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Patrick, just one follow-up. This quarter, I think gross margins you said were up, excluding the AC Lens drag. That goes away in 4Q. So just curious what changes that would hurt your margins in 4Q compared to the underlying in 3Q.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [37]

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Yes. So you're right, Q3 growth was up about 50% if you put the AC Lens business aside, and that was better eyeglass margin, reimbursed exams, offset by higher OD cost -- little higher OD cost. I think the biggest change going into 4Q is the kind of timing of the inventory and the tariff assumptions as they exist today.

So Paul, we -- before the tariffs went into effect, we had some existing inventory at pre-tariff cost. Those -- we are working those down as time progresses, so I do expect to feel a little more of that impact in Q4. And that's the -- that's kind of the main reason on the guide there. And again, for 2020, we're still very focused on coming up with this -- as much mitigation as possible should they remain in place.

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Operator [38]

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And our next question comes from Anthony Chukumba, Loop Capital Markets.

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Anthony Chinonye Chukumba, Loop Capital Markets LLC, Research Division - SVP [39]

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Congrats on the strong quarter. So my first question, is there anything noteworthy that you would point out in terms of the competitive landscape? I mean any changes with the independents or some of the bigger chains or some of the online-only retailers? Just anything that you might want to point out there.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [40]

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Overall, I'm finding it pretty consistent. And it still proves the value segment is growing, and we think that's part of our momentum. We think that -- yes, so we're not seeing dramatic things out there that are changes versus either our expectations or what we've been seeing on an ongoing basis in terms of offerings -- the consumer offerings.

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Anthony Chinonye Chukumba, Loop Capital Markets LLC, Research Division - SVP [41]

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Got it. That's helpful. And then just my follow-up, I'm going to apologize in advance because this really shouldn't be asked on a call like this because it's sort of foolish but it's been written about so just wanted to see if you would address it. There's been a couple of sell-side reports that have basically said that the FTC is going to come after you guys because of your 2 for $69.95 with free eye exam offer at America's Best. I mean that's patently ridiculous, but I just wanted to see if you would address that at all. Or maybe they're right, and the FTC's knocking at your door right now.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [42]

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I'm happy to address that. I feel that's totally appropriate and actually appreciate that you asked. We have had never had an interaction with the FTC on this topic at all that there is -- so that is -- it is not a topic area. It is not a conversation. We are a company that takes -- abiding by all laws very seriously. And the key is that as people are getting the offer that you are communicating and -- then it is a legitimate offer. And large numbers of people get our offer, and we actively encourage it.

We have hundreds of frames available at that and of noninsured customers and insured customers that come in, they have whatever their insurance has. But the majority of our customers, 20% take the offer. And we've given away well over 1 million pairs of -- well over 1 million exams at no cost in the past year. And no, it's an offer we hang our hat on. So no FTC dramas out there occurring. Never had an interaction on the topic and would be surprised by it given the legitimacy of the offer.

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Operator [43]

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And our next question comes from Zack Fadem of Wells Fargo.

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Eric Michael Cohen, Wells Fargo Securities, LLC, Research Division - Associate Analyst [44]

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This is Eric Cohen on for Zack. You guys showed a really nice EBITDA margin expansion in Q3. I was just wondering how that compared to your expectations and sort of what the puts and takes were and if there are any timing and shifting of expenses between Q3 and Q4 that we should be aware of.

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [45]

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Eric, thanks for the question. We were very pleased with gross margin and as well as SG&A leverage and resulting EBITDA and EBIT margin expansion in the quarter. Started with good top line comp performance. We did only have 2 months of the AC Lens contact lens distribution, so we started -- we move beyond the lapping of that. As we've talked on the call, we had really good eyeglass margins. We have more exams being reimbursed now. Those were all helps to margins. And frankly, we leveraged both advertising and store associate payroll. So -- and that was a function of just really good focus on execution.

I am not aware of any kind of timing things that benefited 3Q or that I need to talk about in Q4 or beyond my comments regarding that last week of the year having 1 less day for us between Christmas holiday and Saturday, the 28th, when we end our fiscal year. So I -- you can kind of see our guidance, and we talked a little about gross margins earlier. But there's nothing significant to kind of call out as we head out of Q3 into Q4, excluding those couple of things.

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Eric Michael Cohen, Wells Fargo Securities, LLC, Research Division - Associate Analyst [46]

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Great. And just looking at cash flow. You guys have -- enjoying nice cash flow this year. And now with the processing lab now behind you, sort of how are you prioritizing the uses of cash between opening stores, investing in the business and paying down debt?

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [47]

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One of the benefits of this business model is that it gives us ample cash flows to use to do all of that. We have been building 75 stores per year and the associated lab distribution center and infrastructure, capacity to do that for quite a while. We feel like we've got a nice machine there that works really well, and we're happy about the white space.

In terms of the cash flow for that, that's kind of a given. This year, we have redeployed $50 million of cash, $25 million in the stock repurchase, commensurate with the last secondary in August and then last week, a voluntary debt paydown.

So in the past, I've talked about directing cash towards improving balance sheet. Was really happy to put some action in place last week to do that. And so we'll continue to -- I think you can expect us to continue to deploy cash to growth and, as cash flows are increasing now, continue to improve the balance sheet. We grew from a high number at IPO to down to 2.6 as we come out of third quarter, and we're very pleased with that. I'd like to see that number get down to that 2.0 range organically and with future potential debt paydowns.

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Operator [48]

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And our next question comes from Alex Maroccia of Berenberg.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [49]

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So my first question is on the managed care business and its impact on sales and margins. It looked like you had some growth there in the owned and host segment, but there was a decline in Legacy. Can you just expand on how these managed care trends affecting average ticket prices and optometrist utilization as it relates to margins?

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [50]

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I'll talk a little bit about margins, and then Reade can chime in on kind of our professional optometrist utilization. So from a margin standpoint, they're a little different in terms of whether a patient using insurance or a patient using cash and without insurance comes in. We are absolutely indifferent to that. We -- we're happy that these patients showed up and take advantage of our health care services and offers. So from a margin standpoint, there's not a huge difference there.

The customers with insurance do have a tendency to spend a little more in terms of average ticket because they're leveraging what they view as other people's money, which is really theirs, as well as their own. So we see a little ticket lift there. But again, our store associates, there's no coaching whatsoever other than trying to help maximize those insurance benefits.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [51]

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Yes. I guess I'd just add that lots of managed care customers is -- see that their managed care benefits go a little farther with us. So they come in, and sometimes -- they often buy better things, those they can and they have the help from the insurance offset.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [52]

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Okay. Got it. And then just a quick clarification point on the previous question. You said that 2x leverage ratio. Is that a long-term target or for end of this year?

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Patrick R. Moore, National Vision Holdings, Inc. - Senior VP & CFO [53]

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Oh, I don't want to put a time line on that. You could probably take a look at a line of what we've been accomplishing organically since the IPO and come up with a reasonable guess on that. We haven't announced specific future debt paydowns. But again, our intent is to get this company to a really good stable position in terms of its capital structure as compared to other more traditional retailers.

I would also say I've been comfortable all along the way with the predictability and dependability of the business. The fact that it's tied to health services and a medical necessity gives us a lot of confidence to operate even at higher leverages. But just because I'm a really conservative guy, I do like the notion that we'll get that down even closer to 2.

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Operator [54]

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And our next question comes from Dylan Carden at William Blair.

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Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [55]

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Just curious, sort of looking at the 2 primary banners and sort of further store expansion, wonder what the infill opportunity or the infill breakdown will be for America's Best. And then sort of expectations in and around maybe accelerated or a little bit faster rollout of Eyeglass World, whether or not there's an infill opportunity there to kind of make that a more profitable endeavor.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [56]

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We think there's lots of opportunity for both those brands. So as you can see from our comps, they both generate really nice consumer traction. So we're still -- yes, so we think there's great opportunities for both. We have not updated our white space guidance since we did the IPO of believing that there's a place for over 1,000 America's Best stores and over 850 Eyeglass World stores. The ROIC is stronger on America's Best, so that's why we've been focusing on that first. And because we've got network TV, we're getting sort of a network effect of more you see the stores, the more the brand and more you see these national advertising, it sort of -- it builds on itself, the network effect there.

And to your question, yes, we actually think there's probably opportunity to improve the ROIC on Eyeglass World, and we are paying attention to that also. So all good, still up both those growth brands.

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Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [57]

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Okay. And sort of a smaller point, I was just curious sort of on the Spanish language advertising. I know that's sort of a relatively newer endeavor. Any sort of -- anything to add there as far as newer customer or traction maybe in some markets you otherwise sort of weren't penetrating?

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [58]

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We have nice development amongst the Hispanic consumer. Our offerings are appealing. We have a Hispanic ad agency and are working on different ways of building that customer segment. It's sort of you build on the strength you already have. When we have strength there and all the other consumers like that will only make us stronger.

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Operator [59]

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Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Reade for any closing remarks.

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L. Reade Fahs, National Vision Holdings, Inc. - CEO & Director [60]

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Good. Thank you very much. In closing, I'd like to congratulate our entire team on the milestone of 71 consecutive positive comp quarters. We're feeling solid momentum in our business, and we are pleased to be raising our 2019 outlook. We'd like to thank you all for joining us today and for your continued interest in and support of National Vision. And we look forward to speaking with you again in February when we report our fourth quarter results. Thank you all very much.

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Operator [61]

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