National Vision Holdings, Inc. (EYE) Q3 2018 Earnings Conference Call Transcript

National Vision Holdings, Inc. (EYE -5.89%)
Q3 2018 Earnings Conference Call
Nov. 13, 2018, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to National Vision's third quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question/answer session, and our instructions will be given at that time. If during the conference today, you require operator assistance, press * then 0 and our operators will be happy to assist you. As a reminder, this conference call may be recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. David Mann, Vice President, Investor Relations. Sir, you may begin.

David Mann -- Vice President of Investor Relations

Thank you. And good morning, everyone. Welcome to National Vision's third quarter 2018 earnings call. Joining me on the call today are Reade Fahs, Chief Executive Officer, Jeff McAllister, Chief Operating Officer, and Patrick Moore, Chief Financial Officer.

Our earnings release issued this morning and the supplemental presentation, which will be referenced during the call, are both available on the Investors section of our website, nationalvision.com. In addition, a replay of this morning's conference call will be available later today. The replay number as well as access code can be found in the earnings release. A replay of the audio webcast will also be archived on the Investors section of our website.

Before we begin, let me remind you our earnings release and today's presentation include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to the factors identified in the release and in our filings with the Securities and Exchange Commission. The release and today's presentation also include certain non-GAAP measures. Reconciliation of these measures are included in our release and the supplemental presentation, which can be found on our website. 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. In addition, from time to time, National Vision expects to provide certain supplemental materials or presentations for investor reference on our Investors section of our website.

Turning to slide 3, on today's call, Reade and Jeff will discuss recent business highlights and provide a business update. Patrick will then review our third quarter 2018 financial performance and provide insights for the remainder of the year. Following these prepared remarks, we will open the call for questions. Now, let me turn the call over to Reade.

Reade Fahs -- Chief Executive Officer

Thank you, David. Good morning, everyone. It's a pleasure to be speaking with you today to share our third quarter results. Turning to slide 4, Q3 was a real good quarter for us -- a quarter to be proud of. We're pleased to report our 67th consecutive quarter of positive comparable store sales growth. We remain quite happy with the consistency and durability that this track record reflects.

Q3 adjusted comparable store sales growth was up 6.8%. The growth was led by our growth brands, with 8.9% comp at Eyeglass World and an 8.4% comp at America's Best. Comps were once again primarily driven by customer count, not average ticket, which is the way we like it. Another sign of customer satisfaction is net promoter scores. Our net promoter scores improved across all brands year over year. This is a testament to the focus and store-level execution of our teams, every day and in every store, one patient and one customer at a time.

We opened 18 stores this quarter, which brings us to 58 new stores through the third quarter. We ended the quarter with 1,067 locations, for a 7.1% increase in store count over the third quarter last year. The unit growth and comparable store sales growth combined to drive an 11.9% increase in net revenue. Adjusted EBITDA increased 7.3%. And adjusted net income grew 57.7%.

Since our last conference call, we have several noteworthy achievements to share. In September, our AC Lens business significantly expanded its contact lens distribution relationship with Walmart. And we now manage most all contact lens fulfillment for Walmart except store replenishment. We're pleased to further assist Walmart and its customers. Note this is the first expansion of our overall relationship with Walmart since 2013.

In October, we refinanced $200 million of existing debt under our credit agreement to a lower rate of LIBOR plus 175 basis points. Separately, Moody's upgraded the debt credit rating on National Vision to Ba3 in September. These balance sheet enhancements help to lower our borrowing cost.

We strengthened our board of directors with the addition of Tom Taylor, CEO of Floor and Décor. It's nice to have a sitting CEO of a fast-growing, successful public retailer on our board, and the fact that he's based in Atlanta is added value as well.

Finally, we're pleased to announce a multi-year extension of our lens purchasing agreement with Essilor. As you probably know, the recently merged entity is now known as EssilorLuxottica. We're excited to extend this relationship with Essilor with a key long-term partner that allows us to continue to provide our patients and customers with world class quality lenses at the low prices that they've come to expect from us.

In today's earnings release, we provided additional insights regarding the remainder of 2018, which Patrick will take you through in detail. Overall, our third quarter results reflect the ongoing strength of our differentiated, value-focused, and service-based business model and compelling value proposition that continue to resonate with our customers. This further drives market share gain in our very fragmented optical industry.

Turning to slide 5, our business continues to demonstrate consistency in store performance and comp store sales gain. The graph highlights our 67 consecutive quarters of comparable store sales growth across the economic cycle, during both strong and weak economic times. We noted continued strong comparable store sales growth as our third quarter comps increased in line with our year-to-date comp trend of 6.6%. This performance highlights the consistency derived from operating in a category where the purchase is tied to a medical necessity.

The comp growth this quarter was driven once again primarily by gains in customer count. Our consistent positive comp results highlight the benefits of operating in the growth segment of an attractive industry, having a leadership team of optical experts, new store growth, as well as comparable store sales growth in our more mature stores as customers keep coming back. With our 12% sales growth year to date, we continue to believe that we're gaining market share in the $35 billion optical retail industry with our value-oriented operating model.

I want to say a few words about hurricane disruption this quarter. First, our greatest concern of course has been for the well being of our associates and optometrists, their families, and our customers. Our hearts go out to the communities and people whose lives were so disrupted by Hurricane Florence this quarter and Hurricane Michael in the fourth quarter. From a business perspective, the impact of net revenue and comps was more moderate than we experienced last year. We would expect sales in the affected areas to recover as these markets return to normalcy, similar to our past experience with weather events. This again reflects the resiliency of a business tied to a medical necessity. However, as a result of severe weather activity this year, we currently have five stores that have been closed for an extended period and remain closed today.

Turning to slide 6, we look to continue to execute on our core drivers of growth. New stores are a primary focus given the white space opportunity relative to our current footprint. We opened 18 stores in the third quarter and remain on track to open about 75 stores this year, following the formulaic approach that has worked so well for us historically. As we look out to 2019, the pipeline for locations looks strong.

A key to our ongoing success is our ability to attract and retain optometrists. We are an optometrist-centric company and strive to be the place where optometrists want to practice and stay for their entire career. Optometrist retention remains stable to last year, and we work hard every day to fill our constant need for new optometrists to support our growth.

For 2018, our team expects to continue to drive solid comparable store sales growth, even as we lap strong multi-year comparisons. Our key comp drivers are the comp waterfall for maturing stores, as well as our marketing and vision insurance initiative. Our new stores gain traction as customer awareness grows over the first few years. Given an infrequent purchase cycle for eyeglasses, this averages two to three years. We strive to ensure that our customer gets the best value around and believe that our growth brands offer extreme values that resonate with consumers -- two pairs of eyeglasses for $69.95 including a free comprehensive eye exam at America's Best or two pairs of eyeglasses for $78.00 at Eyeglass World, along with the opportunity of same-day service from our in-store labs. We believe that this combination of incredible value backed by excellent customer service leads to satisfied repeat customers. As we have noted, existing customers represented over 60% of total customers at mature stores in 2017.

We continue to invest in television advertising and digital marketing to attract new customers as well as remind existing customers to come back for another great experience. Our Owl TV campaign at America's Best and the Mr. World campaign at Eyeglass World are helping to drive traffic to our stores. We believe that our investments in marketing are paying off and a factor in our market share gains. Participation in vision insurance programs remains a positive comp driver. Net revenue growth tied to these partnerships continues to advance in the third quarter. We remain underpenetrated relative to the industry for the percentage of our business coming from vision insurance. Let me now turn it over to Jeff, who in Q3 celebrated his one-year anniversary with us, for a few operational updates.

Jeff McAllister -- Chief Operating Officer

Thank you, Reade. We have a low-cost culture here at National Vision, and we know that we can't be everyday low price without being everyday low cost. We are pleased with our progress toward opening our new state of the art lab in Texas, and we remain on schedule to be operational in time for the first quarter next year. We believe our centralized lab network is a world class manufacturing operation that provides a true competitive cost advantage. We continue to make omnichannel investments to improve the customer experience and operating efficiency. We're in the early innings of leveraging our new one view of the customer capability. In addition, online scheduling of the eye exams continues to trend higher. We believe that an omnichannel approach is going to be an ever-more important part of the optical buying process in future years, and we aim to have this be a major competency for National Vision.

I would like to address the topic of tariffs and the potential financial impact to our business. As Reade commented on our last call, eyeglass cases were the only item affected by tariffs imposed earlier this year on imports from China. And these tariffs are not expected to have material impact on our overall product cost. Having said that, this is a fluid situation, and we will continue to monitor the status of trade negotiations. We estimate that less than 15% of our costs applicable to revenue are related to products imported from China and potentially subject to future tariffs. We are currently reviewing our contingency options to mitigate the impact in the event that additional tariffs are enacted. Let me hand the call over to Patrick.

Patrick Moore -- Chief Financial Officer

Thanks, Jeff, and good morning, everyone. As Reade noted, our business continued to perform well in the third quarter. The two fundamental revenue drivers of our business are new store growth and comparable store sales growth. During the quarter, we added 18 new stores and closed one store. Over the last 12 months, we've added 71 net new stores or a 7.1% year-over-year increase with the openings almost entirely in our America's Best and Eyeglass World brands. For these two growth brands combined, unit growth increased 10.5% in the quarter. We're on track for approximately 75 store openings this year, which should be about 65 America's Best locations with the remaining being Eyeglass World stores, similar to the mix of openings between these brands in 2017. Year to date, we have closed four stores. As Reade noted, our total store count is 1,067 locations as of the end of the quarter.

Our 2018 openings have been balanced between newer and existing markets. In our newer markets, we continue to expand our store base and invest where our new stores are still ramping and building awareness. We have noted that new stores have historically taken approximately three to five years to mature. We're excited about these 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 growth increased 6.8% versus the 7% increase in the third quarter of last year. This comp growth was driven primarily by increases in customer transactions. During the third quarter, we generated strong comps in our growth brands. America's Best and Eyeglass World drove the growth, with gains of 8.4% and 8.9% respectively. Legacy comps were flat in the third quarter. The comps to our legacy stores were impacted by approximately 100 basis points by Hurricane Florence given the segment's store concentration in the Carolinas.

Turning to income statement highlights on slide 9. As a result of the solid comp in new growth net revenue increased 11.9% to $387.4 million. Revenue growth was negatively impacted by about 40 basis points by the timing of unearned revenue. Finally, as a reminder, year to date, the company has experienced the elimination of approximately $5.4 million and revenue and cost associated with FirstSight operational changes that occurred in 2017. In the third quarter, which is the final quarter in which we experience this grow-over, the impact was a reduction to net revenue of 1.8 million, which had the effect of lower revenue growth by 50 basis points but with no material impact on profitability.

Net revenue included approximately $3 million from the new contact lens distribution relationship with Walmart that begin in September. This expanded role involves contact lens orders that are shipped to Walmart corporate stores for customer pickup. Similar to other contact lens distribution that our AC Lens business provides for Walmart, this agreement is accounted for on a retail basis, though National Vision earns a modest packing and shipping fee. As a result, this business is expected to provide minimal contribution to overall profitability.

Regarding the storm impacts this quarter from Hurricane Florence and other weather events, we estimate that over 37 stores were affected, for an overall impact on net revenue of approximately $1.3 million. As Reade mentioned, we have five stores that remain closed as of today's call.

Cost applicable to revenue increased 12.5%, or an increase of 20 basis points as a percentage of net revenue versus last year. The increase was primarily driven by higher optometrist costs and the impact from the expanded contact lens distribution relationship with Walmart, with a partial offset from a higher mix of eye exam sales as a result of our growing managed care business, as well as vendor rebates driven by volume growth. Cost applicable to revenue before the impact of the new Walmart business increased 10.5%, or a decrease of 20 basis points as a percentage of net revenue versus last year.

Optometrist-related expenses reflect expanded coverage as well as wage inflation in certain geographic markets. As Reade noted, we work very hard to attract and retain optometrists and compensation is an important part of this equation.

SG&A expenses increased 21.9%, or an increase of 390 basis points as a percentage of net revenue versus last year. This increase was driven by stock compensation expense, cash expenses related to a long-term incentive plan for non-executive employees, our investment in advertising, and the continuing year-over-year impact of public company cost. These factors were partially offset by the impact of our expanded contact lens distribution relationship. The stock compensation and long-term incentive plan expenses represented approximately 360 basis points of the total 390 basis point increase. The expanded contact lens distribution relationship aided expense leveraging by approximately 40 basis points. The long-term incentive plan applied to non-executive employees who were not part of our management equity plan. The plan was put in place with the KKR acquisition in 2014, and the cash payments were triggered by the reduction in KKR ownership below 50%.

We have made investments for growth and encouraged some incremental expenses that were not contemplated when we provided our 2018 outlook back in March, which I'll cover in more detail at the end of my remarks. I do want to mention that one such investment related to a citizens' initiative in Oklahoma. We invested a total of $1 million in support of this initiative, with half occurring in this quarter and half in the fourth quarter. This one-time expense was an investment in growth potential in Oklahoma where we currently have no store presence. The initiative would have allowed the provision of optical services and eye exams in big box retail locations. Unfortunately, the initiative failed to be approved by a narrow margin.

Adjusted EBITDA increased 7.3% and adjusted EBITDA margin fell 40 basis points to 10% in the quarter. As expected, adjusted EBITDA growth was negatively impacted by 280 basis points from the net change in margin on unearned revenue. Depreciation and amortization expense increased 3.7 million compared to the third quarter last year. The growth primarily reflects our ongoing investment in new stores, our network of optical laboratories, and our omnichannel-related investments. Interest expense decreased 5.4 million versus the third quarter of last year, primarily due to lower debt levels driven by the 360 million IPO debt paydown in the fourth quarter of last year.

In terms of taxes, we recorded a 16.4 million income tax benefit this quarter, compared to a 200,000 tax provision in the third quarter of 2017, reflecting a benefit from pre-tax losses at our statutory tax rate and a 13.9 million income tax benefit from stock option exercises. We expect our full-year 2018 tax rate to be approximately 48%, excluding the impact of stock option exercises, which primarily reflects the non-deductibility of certain items, including the investment to support the citizens' initiative in Oklahoma. Adjusted net income increased 58% to 9.2 million and excluded the income tax benefit from option exercises. Adjusted diluted EPS increased 16% to $0.12 compared to $0.10 last year.

Turning to slide 10 in our year-to-date results, through nine months, our adjusted comparable sales growth was 6.6%, net revenues were up 12%, and adjusted EBITDA was up about 9%. Our performance highlights the consistency of our business over time. Adjusted EBITDA margin decreased 40 basis points to 12.4%, primarily due to higher optometrist costs, investments in advertising, managed care, and support of the Oklahoma citizens' initiative, as well as higher public company expenses.

On slide 11, at the end of the third quarter, our total debt was 574.8 million, and our cash balance was 48.9 million. Net debt to adjusted EBITDA improved to 3.1x, down from 3.2 at the end of the second quarter. Year to date, we have invested 78.8 million in capital expenditures, with the majority of CapEx focused on growth initiatives. Cash flow provided by operating activities increased almost 20 million.

In terms of our capital structure, we completed a 200 million term loan A refinancing in October, which lowered the interest rate on that tronch by 75 basis points for the existing loan rate. In addition, we were pleased to receive a Corporate Credit Rating upgrade to Ba3 from Moody's, which triggered a provision in our credit agreement that lowered the interest rate on our term loan debt by 25 basis points. Overall, we're very pleased with these improvements in our borrowing cost.

Turning to slide 12, as you saw from our press release, we're providing the following insights for the remainder of fiscal 2018. We expect adjusted same store sales growth to be at or above the top end of the range of 3% to 5% in our previously provided 2018 outlook. While we're pleased with our year-to-date adjusted comps of 6.6%, we are facing our most difficult quarterly comp comparison of 10.4% in the fourth quarter, which benefited from storm recovery last year. In addition, our AC Lens business is generating higher net revenue, including the expanded contact lens distribution relationship with Walmart that is estimated to add at least 10 million to 2018 net revenue. As a result, we expect net revenue to be above the range our previously provided 2018 outlook. As noted, the expanded Walmart relationship is expected to provide minimal contribution to profitability and no impact on same store sales growth.

We expect to incur during the year approximately 4 to 5 million for certain growth investments and incremental operating expenses by the end of 2018 that were not contemplated in our original 2018 outlook. These items primarily include investments to support our strong managed care growth, the Oklahoma citizens' initiative, and cybersecurity upgrades. Also, as noted last quarter, public company expenses have been running higher than initially expected as we work toward [inaudible] this year. As a result, we expect both adjusted EBITDA and adjusted net income to be in the lower half of their respective ranges in our previously provided 2018 outlook. We expect capital expenditures to be near the high end of the range in our previously provided outlook, driven by growth investments.

On several previous calls, we've noted that unearned revenue can cause material swings in quarterly results. Unearned revenue is associated with purchases in the last week of a reporting period and can be difficult to predict. Historically, due to the significant revenue in the last week of the fourth quarter, the net change in unearned revenue is largest in this quarter and is seasonally negative.

We are currently in the planning process for 2019. Consistent with last year, we look forward to providing fiscal 2019 outlook on our year-end conference call in late February. This concludes my remarks. I will turn the call back to Reade.

Reade Fahs -- Chief Executive Officer

Thank you, Patrick. Turning to slide 13, in honor of Veterans Day on Sunday, we thank veterans for their service. At National Vision, we've developed an active veterans recruiting effort and now employ nearly a thousand veterans and veteran spouses. We work hard to honor them in every way we can. For our moment of mission, let me introduce Dr. Dan Knepper, an optometrist at one of our America's Best store in Nashville. Dr. Knepper recently saw a male patient who presented with numerous retinal hemorrhages. With some convincing from Dr. Knepper, the patient went straight to the emergency room where, while he was waiting to be seen, he suffered a heart attack. As I said, a routine eye exam is routine until it isn't, and Dr. Knepper saved a life that day. This moment of mission does not end there. Less than two weeks later, Dr. Knepper saw a female patient with sudden vision loss and retinal hemorrhages and sent her straight to the emergency room too and probably saved her life as well.

I want to thank our entire team at National Vision. The 11,000-plus associates, including the 2,000 optometrists, including Dr. Knepper, who provide much needed medical services to patients at our over 1,000 storefronts every day. We strive to be the best at providing low-price exams, glasses, and contact lenses, while both at home and abroad we work to bring glasses and consequently sight and improved quality of life to those who would be unable to see well otherwise. We are helped to fulfill this mission by our long-term relationships with others in the optical ecosystem. Essilor is one of those relationships. Essilor has been a great business partner for us for over a decade, as well as a great philanthropic partner on a variety of fronts. Together, we share a common value of trying to bring improved sight to all, especially the low income and disadvantaged, as a business and through philanthropic efforts and partnerships, both in the US and throughout the developing world. These efforts and these partnerships are part of the beauty of the work we do. Many of you have heard me say this before, but this is why we believe optical retailing is a noble profession.

...

This concludes our prepared remarks, and at this time I will turn the call back to the operator to start our Q&A session.

Questions and Answers:

Operator

Thank you, sir. Ladies and gentlemen, at this time, if you'd like to as a question over the phone, press * and then 1 on your telephone keypad. If your questions have been answered or you wish to remove yourself from the queue, simply press the pound key. Once again, ladies and gentlemen, if you would like to ask a question over the phone at this time, please press * and then 1 on your telephone keypad.

And our first question will come from the line of Simeon Gutman with Morgan Stanley. Your line is now open.

Simeon Gutman -- Morgan Stanley -- Analyst

Good morning. It's Simeon Gutman. I wanted to ask first about some of the added investments for the back half of the year. Can you talk about the planned payback, either sales to margins and their timing as we think about it into 2019? Thanks.

Patrick Moore -- Chief Financial Officer

Hey, Simeon. It's Patrick. Thanks for the question. Yeah, I would just start off by saying on a note that we set a fairly tight range for EBITDA back in March and we're still in that range. We have got it a little lower. As we kind of thought about those factors, we did call out 4 to 5 million. And I put those in a couple of categories. The managed care incremental investments -- we're very happy with our managed care growth, and we're simply making incremental investments to continue that. The Oklahoma initiative was -- effectively we took a one-time shot. Cost us about $1 million. Unfortunately, it didn't work. That's a non-recurring component. And then we've also got some of the public company costs. As we think about the investments -- advertising, the managed care -- we do expect that to continue to drive revenue. I don't have specific return metrics to provide today, but we wouldn't be making those investments if we felt like those wouldn't pay off.

Simeon Gutman -- Morgan Stanley -- Analyst

Okay. And then a follow-up on the Essilor contract you signed. I think you've teed it up to tell us that it was coming due at some point. Just wanted to check -- the expiration I think was June of next year. So this is sort of normal course to renegotiate at this point. That's my first part of the question. And then, any changes to consider? Are you giving up anything now that you have an extra five years? Or it's normal course and steady as she goes?

Reade Fahs -- Chief Executive Officer

So the timing is normal course and this is an extension agreement on favorable terms that we're happy with.

Simeon Gutman -- Morgan Stanley -- Analyst

Great. Okay, thanks.

Patrick Moore -- Chief Financial Officer

And Simeon -- it's Patrick. I think we missed one part of your question that I wanted to circle back to. We did guide, back in August, that we expected our pub co cost to be a little higher this year. I do think this should be the peak year assuming things go fairly well for us [inaudible] nicely. So those costs will obviously continue, but I think at a little more moderated level as we move beyond this critical first year.

Simeon Gutman -- Morgan Stanley -- Analyst

Okay, thanks.

Operator

Thank you. And our next question will come from the line of Bob Drbul with Guggenheim Securities. Your line is now open.

Bob Drbul -- Guggenheim Securities -- Analyst

Hi, guys. Good morning. Couple questions from me. The first one's just -- on the Eyeglass World business continued strength, can you just give us any update on the new marketing campaign -- what's working there. And then the other question I have is can you talk about the Sears bankruptcy and the opportunity or market share you think is available with what's going on there from your perspective?

Reade Fahs -- Chief Executive Officer

Thank you, Bob. It's Reade here. Yeah, we're pleased with the performance for Eyeglass World. 8.2% comp, that's real nice, and we think the marketing was a factor in that. We do face a tough Q4 comp comparison. [Inaudible] 11.6% last year due to our hurricane benefit, but we think that -- we're pleased with the formula, we think the new ad campaign is helping us a lot, and operationally we've got fresh energy in the group there. So that is first question. In terms of Sears, there are a little over 200 Sears stores with optical in them. Of course, that there's bankruptcy is not very encouraging for their future. There's disruption there that provides market share, that provides doctors for us and so, yeah, we see this as being a nice help to our growth and help to market share gain.

Bob Drbul -- Guggenheim Securities -- Analyst

Great. And I guess just one last question. Can you talk a little bit about, as you continue to expand stores, store employee availability and optometrist availability? Can you just talk about the trends you're seeing in both of those areas?

Reade Fahs -- Chief Executive Officer

We are finding availability even in a tight marketplace. As you know, optics is a quirky little field and a lot of people who work in optics like us say, hey, this is our field. This is what we're going to do. And don't sort of look other places. So we're finding both both in terms of optical people and frankly -- you know, I was talking to a store manager the other day who had started as a receptionist and worked her way up. And that's a great part about being a growing company -- you are able to provide those sorts of career growth opportunities and people see that with us. So that's encouraging. With optometrists, we are always out there recruiting optometrists. With our growth, optometrists feed our growth, but we're not seeing any change in trends in that area. But we're always recruiting, and that's just part of being an optical retailer that's growing lots of stores every year.

Bob Drbul -- Guggenheim Securities -- Analyst

Great. Thank you very much.

Operator

Thank you. And our next question will come from the line of Paul Lejuez with Citigroup. Your line is now open.

Paul Lejuez -- Citigroup -- Analyst

Hey, thanks, guys. Just curious on that $4 to $5 million -- how much is that -- the incremental cost there was third quarter versus fourth quarter -- if there are any specifics you can provide in terms of what incremental investments are necessary to support that managed care business. And if you can give us an update on where managed care revenues were this quarter versus last year -- where you expect 2018 to come out versus 2017, and what's the right number long term? Thanks.

Patrick Moore -- Chief Financial Officer

Yeah, hey, Paul. It's Patrick. The 4 to 5 million is generally balanced across third and fourth quarter, so [inaudible]. In terms of the incremental cost, as we think about managed care, again, been a very important growth driver. We want to continue that growth. There are both internal and external types of costs. Internally, you've got billing and system support. And externally, you've got reimbursement rates and fees. So there's a whole portfolio of things that kind of come into that expense bucket necessary to drive it -- to manage it and drive it. So I hope that gives you a little more color there. And then finally, in the third quarter, we continued to see our penetration increase. We are still well under index to US national averages, though we don't disclose specifics anymore. But we did see penetration continue to pick up.

Reade Fahs -- Chief Executive Officer

Continues to be a nice part of our growth. Expect that to continue.

Paul Lejuez -- Citigroup -- Analyst

Thanks. Good luck, guys.

Reade Fahs -- Chief Executive Officer

Thank you.

Operator

Thank you. And our next question will come from the line of Zach Fadem with Wells Fargo. Your line is now open.

Zach Fadem -- Wells Fargo -- Analyst

Hey. Good morning, guys. Could you talk about the moving parts on the gross margin line? It looks like both your product and services margins were positive, but total gross margins down about 20 basis points. How much of this is the impact of unearned revenue? And if it is, should we expect the impact to reverse out in Q4 and turn positive again?

Patrick Moore -- Chief Financial Officer

Yeah, so in terms of the gross margins, yeah, you're right. The cost applicable to revenue went up about 20 BPS. And if I normalize that for this new Walmart business that we talked about and AC Lens, that would be down around 20 BPS. So generally, I would characterize our margins as relatively stable. We continue to see a little OD cost pressure, although most of that in the quarter was really more concentrated in our legacy segment. I saw a little bit of moderation in the OD cost pressure in our owned and host segment. The [inaudible] unearned revenue was essentially flat on a year-over-year basis for the year to date. So [inaudible] --

Zach Fadem -- Wells Fargo -- Analyst

So Patrick, did --

Patrick Moore -- Chief Financial Officer

-- and it was about $1 million hurt in 3Q.

Zach Fadem -- Wells Fargo -- Analyst

Got it. So Patrick, is that 20 BPS impact from Walmart -- should we expect that to carry forward over the next, you know, three, four quarters until it anniversaries?

Patrick Moore -- Chief Financial Officer

Yeah, and actually I think what I provided in our insights related to outlook was we expect at least 10 million in revenue there. And it will probably be a little bit higher than that. And I think we actually [inaudible] few million dollars in the quarter. So you'll probably see that grow a little bit as you model in those revenues approaching 10-plus million with frankly low profitability, but that should get you in the ballpark. I will mention a couple clauses on gross margins. As a consequence of our increasing managed care growth, we actually have more eye exams that are reimbursed. I mean that's -- when managed care patients come in they're not able to generally take advantage of our two pair offers with free eye exam, so we're seeing higher levels of eye exams reimbursed. And then frankly, we have very good long-term relationships with vendors, and we have broken through a couple of new volume levels this year and that's helped with some of the product rebates. So I wanted to paint the full picture for you in terms of the levers and swing factors that I see in gross margins. But my headline is generally stable.

Zach Fadem -- Wells Fargo -- Analyst

Got it. That's really helpful. And then briefly, you're now more than a full year in on some of your newer California markets. I'm curious if you could just talk about how those stores have performed in year one relative to your internal expectations. And now, as these stores begin to enter the comp base, could you talk about the tailwind that it's expected to have on your comp performance.

Reade Fahs -- Chief Executive Officer

Yeah, we don't like to comment about specific markets due to competitive reasons. Each market has its own competitive ecosystem, and certainly California, it's still early in the lifecycle there. Our stores are continuing to ramp there as we build awareness. Our store ramp has historically been about three to five years to get to maturity. But we're excited about these markets and there are just lots of potential customers for us in these markets.

Zach Fadem -- Wells Fargo -- Analyst

Fair enough. Thanks, Reade. Appreciate the time.

Patrick Moore -- Chief Financial Officer

Thank you.

Operator

Thank you. And our next question will come from the line of Michael Lasser with UBS. Your line is now open.

Michael Lasser -- UBS -- Analyst

Good morning. Thanks a lot for taking my question. In light of your expanded contact lens relationship with Walmart, should we consider that to be a prelude of an expansion of the overall business that you're doing with Walmart -- perhaps getting more stores [inaudible]future?

Reade Fahs -- Chief Executive Officer

Well, we are pleased to expand the contact lens distribution business with Walmart. It's the first expansion of the relationship since 2003. And what this is it's shipping to store for contact lens orders for Walmart -- a nice chunk there. You know, we focus every day on our relationship with them. We've been saying for well over a decade that we want to be a great partner to them. And we've been their partner for 27 years, but in terms of their future decisions, you've got to ask them that.

Michael Lasser -- UBS -- Analyst

And as a follow-up to that, the ballot measure in Oklahoma -- how has that --

Reade Fahs -- Chief Executive Officer

Well, actually -- sorry. Just want to say I think I misspoke. It's been the first expansion of the relationship since 2013. My friends here told me I said 2003. Sorry about that.

Michael Lasser -- UBS -- Analyst

No problem.

Reade Fahs -- Chief Executive Officer

And your question?

Michael Lasser -- UBS -- Analyst

Yeah, the ballot measure in Oklahoma -- trying to expand the availability of eyeglass locations in big boxes -- how does that play into it, the fact that that did not go through? Did that just affect the Oklahoma --

Reade Fahs -- Chief Executive Officer

Well, the initiative was all about allowing optical stores and eye exams in big box locations. Currently the laws say that you can't have optical stores in big box locations. It was narrowly defeated. My opinion's people of Oklahoma lost out for broader access and lower prices. It doesn't materially impact the white space for our growth brands. It was really only just about big box retail, but we're always looking for opportunities to invest in [inaudible] that are favorable to consumers and favorable to expanding value.

Michael Lasser -- UBS -- Analyst

And then my follow-up question is on the Eyeglass World stores. In light of the [inaudible] compare you have in the fourth quarter but recognizing the strong performance that that business has achieved in the last couple of quarters, should we be modeling a negative comp for Eyeglass World in the fourth quarter?

Patrick Moore -- Chief Financial Officer

It's Patrick. I'll take that. We don't really comment at the brand level in terms of our forward-looking guidance. I can't help you there. Regarding the overall comps, it's this management team's impact to continue that winning streak of consecutive quarters of positive comp and look forward to discussing what we see in those specific brands as we cover Q4 in February.

Michael Lasser -- UBS -- Analyst

Okay. Thank you.

Operator

Thank you. And our next question will come from the line of Robby Ohmes with Bank of America Merrill Lynch. Your line is now open.

Marisa Sullivan -- Bank of America Merrill Lynch -- Analyst

Hi. This is Marisa Sullivan on for Robby Ohmes. Thanks for taking the question. I just want to pick up on the last question regarding the same store sales outlook. The updated guidance implies that you would see a slowdown in 4Q on a one and two year stack and potentially even negative. So is that just conservatism around the tough compares, or are there other factors that might be driving that implied outlook? Thank you.

Patrick Moore -- Chief Financial Officer

Sure. It's Patrick. Thanks for the question. So we're being careful this year. We are providing annual guidance and trying to get into a rhythm being a longer term focused growth company to not go too specific on the quarters. We haven't really got it at the quarter level. We do manage this on a long-term basis. We did say about 2018 that we expect the comps to be at or above the top end of that 3 to 5 range. So I realize that if you kind of do the math at the bottom end, it can swing to flat or negative. We're not guiding at that point. Again, our intention is to continue that healthy streak of consecutive positive comp quarters.

There are a couple callouts, and if this is redundant, I apologize. But we did a 10.4 last year and it was significant storm recovery that we felt particularly in EGW, but we really felt it in a couple of the other brands as well. Reade mentioned in his remarks and I may have reiterated that we do currently have five stores that are closed. We're not exactly sure of the timing of when those will reopen. If those were to remain closed for the entire quarter, you're looking at probably half a point of comp impact there.

And then finally, I would just reiterate that last week of the year is a really big year -- super critical. Patients and customers are trying to exhaust any benefits that remain. And so those last waning four to five days of the year are really large days. That can be impacted by this pesky GAAP unearned revenue timing. And so I don't know if you would call that conservatism, but we did take all of that into consideration as we provided the annual guidance ranges that you can do to interpolate fourth quarter. But again, I'll end by saying we intend to continue to drive positive comps and do [inaudible].

Marisa Sullivan -- Bank of America Merrill Lynch -- Analyst

That's really helpful. And then just as a quick follow-up -- you had very strong comps year to date. I'm just wondering if you can comment on the health of your customer and whether you're seeing any increases in their spending of existing customers, maybe the more budget-conscious customers, and whether with your initiatives and what you're doing around the vision insurance you're seeing new customers coming in the door, and has that accelerated? Thank you.

Reade Fahs -- Chief Executive Officer

We're seeing new customers come in the door, yeah. And we find it hard to extrapolate on sort of broader consumer trends in the marketplace, but we continue to believe that we're building market share.

Marisa Sullivan -- Bank of America Merrill Lynch -- Analyst

Gotcha. Thank you.

Patrick Moore -- Chief Financial Officer

Thanks Marisa.

Operator

Thank you. And just as a reminder, ladies and gentlemen, if you would like to ask a question over the phone at this time, press * and then 1 on your telephone keypad. And our next question will come from the line of Matthew McClintock with Barclays. Your line is now open.

Matthew McClintock -- Barclays -- Analyst

Hi, yes. Good morning, everyone. Reade, congratulations on the new Walmart deal. I was wondering if you could provide a little bit more context into how that deal got put into place. Was that something that you chipped away at and worked with them over a long period of time? Was that something that they just made a strategic decision all of a sudden? And what do you think actually put you over the top for them to go with this new direction? Thank you.

Reade Fahs -- Chief Executive Officer

Our AC Lens division has had a good relationship with Walmart for a great many years and has done really good work for them and provides really good service to them. And we're always saying, hey, if you want, we could do this for you, we could do this for you, we could do this for you, and we just always like to be available if they need a partner in any aspect of optics. And so at one point they said, well, this is a chunk that is being done elsewhere. We'd like you to do it.

Matthew McClintock -- Barclays -- Analyst

Thank you. And then just as we think through the tariff issue and we think through potentially other inflationary cost pressures -- you know, you've been very consistent with your pricing strategy over a very long period of time and provided exceptional value to the consumer. And I was just wondering, is that something that you would ever be open to thinking about, or is that something that's set in stone and you would try to always find other offsets? Thank you.

Jeff McAllister -- Chief Operating Officer

Hi. This is Jeff. I'll take that question relative to pricing and anything related to tariffs if you will. You know, as you spoke to the fact that we are an everyday low price model, we think that that's really the service that we provide and certainly what our customers and patients have come to expect from us. We'll never say never, given the situation continues to be fluid and tariffs, but it's something that certainly we're going to do everything we can to maintain our price competitive nature and to ensure that we're providing the best value for our customer. So again, we're keeping our eye on all this and we're modeling different outcomes, and we'll make the right call at the point that we have more information.

Matthew McClintock -- Barclays -- Analyst

Thank you for the color. I appreciate it.

Operator

Thank you. And I am showing no further questions in the queue at this time, so now it is my pleasure to turn the conference back over to Mr. Reade Fahs, Chief Executive Officer, for any closing comments and remarks. Please proceed, sir.

Reade Fahs -- Chief Executive Officer

Thank you, Brian. We want to thank you all for joining us today and for your continued interest in National Vision. For those of you who have not seen our current television ads for America's Best or Eyeglass World, we invite you to go online and they're included in a link on page 22 of our presentation. We look forward to speaking to you again in early 2019 when we report our fourth quarter results. Thank you all very much.

...

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program, and we may all disconnect. Everybody have a wonderful day.

Duration: 49 minutes

Call participants:

David Mann -- Vice President of Investor Relations

Reade Fahs -- Chief Executive Officer

Jeff McAllister -- Chief Operating Officer

Patrick Moore -- Chief Financial Officer

Simeon Gutman -- Morgan Stanley -- Analyst

Bob Drbul -- Guggenheim Securities -- Analyst

Paul Lejuez -- Citigroup -- Analyst

Zach Fadem -- Wells Fargo -- Analyst

Michael Lasser -- UBS -- Analyst

Marisa Sullivan -- Bank of America Merrill Lynch -- Analyst

Matthew McClintock -- Barclays -- Analyst

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