Monro, Inc.

Good morning, ladies and gentlemen, and welcome to Monroe Inc's earnings conference call for the first quarter of fiscal 2023. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance in the call, please press star zero on your touchtone phone. And as a reminder, this conference call is being recorded and may not be reproduced in whole or in part without permission from the company. I would now like to introduce Felix Wechsler, Senior Director of Investor Relations at Monroe. Please go ahead.

Thank you. Hello, everyone, and thank you for joining us on this morning's call. Before we get started, please note that as part of this call, we will be referencing a presentation that is available on the investor section of our website at corporate.monroe.com forward slash investors forward slash investor resources. If I could draw your attention to the safe harbor statement on slide two, I'd like to remind participants that our presentation includes some forward-looking statements about Monroe's future performance. Actual results may differ materially from those suggested by our comments today. The most significant factors that could affect future results are outlined in Monroe's filings with the SEC and in our earnings release. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise except as required by law. Additionally, on today's call, management statements include a discussion of certain non-GAAP financial measures which are intended to supplement and not be substitutes for comparable GAAP measures. Reconciliations of such supplemental information to the comparable GAAP measures will be included as part of today's presentation and in our earnings release. With that, I'd like to turn the call over to Monroe's President and Chief Executive Officer, Michael Broderick.

Thank you, Felix, and good morning, everyone. I'll spend the first part of our call this morning recapping our strategy and the progress we've made, as evidenced by our first quarter's results. I'll then discuss the divestiture of our non-core wholesale and tire distribution assets completed in the quarter as well as provide an update on our capital allocation. We are a leader in the highly resilient and largely non-discretionary auto service aftermarket industry. Given the resiliency of our business model and the robust demand for our products and services, our success remains in our hands. We are intently focused on continuous improvement of in-store execution. Over the last 12 months, we have increased staffing levels in our stores in order to meet the needs of our customers. We are focused on productivity improvement plans to drive more sales and profit at our locations. We are also executing our strategy to improve our underperforming stores, which represent about a quarter of our overall store base. Our first quarter results for this group of stores show that this strategy is working. In the first quarter, our retail comp store sales grew approximately 3%. Comp store sales in our 300 small or underperforming stores increased 15% in the quarter. As a reminder, comp store sales at these stores decreased by 8% in fiscal 2022 compared to fiscal 2020. The acceleration in sales at these 300 stores was the result of improved technician staffing levels and trading to meet customer demand. Comp sales in our remaining stores were approximately flat. These stores experienced softer consumer demand in the quarter. While a number of factors can impact demand, this softness was at least partly due to a broad-based inflationary pressures impacting the consumer, including higher fuel prices and the negative impact on miles driven. We are not satisfied with our top-line results, but we are encouraged that our entire unit market share increased in the quarter. Regarding staffing, we are in the final stages of right-sizing our store labor and believe we have built the labor capacity in our stores to meet customer demand. These investments in additional headcount and inflationary wage pressures increased our technician labor costs as a percentage of sales in the quarter by 200 basis points versus the same period last year. This was a 50 basis points sequential improvement resulting from an increase in sales per tech hour and a 9% reduction in overtime hours. Our first quarter demonstrates clear progress. In order to meet our mid single digit comp store sales growth expectations, we still have important work to do. It is now about properly training our technicians and reallocating resources between the front of shop and back of shop investments to maximize store productivity. We are focused on training our new and existing teammates on the key in-store processes that drive sales and deliver an outstanding guest experience. These include store scheduling, phone skills, courtesy inspections, and becoming our customers' most trusted vehicle advisor. we continue to improve in these operational areas. While comparable store sales in our 300 small or underperforming locations were up nearly 10 percent, continued softness in consumer demand in our remaining locations resulted in a decrease in preliminary comp store sales for fiscal July of less than 1 percent. Now that our staffing initiatives are almost complete, we are carefully managing expenses in the business, which we expect to drive profitably. As we continue to capture productivity improvements from our technician staffing investments, we expect to deliver better sales and gross margin results as fiscal 2023 progresses. Now turning to the divestiture we announced last quarter. In June, we successfully completed the divestiture of our wholesale and tire distribution assets to American tire distributors for a total transaction value of $102 million. We received $62 million at closing and the remaining $40 million will be paid to us quarterly over approximately two years based on our tire purchases from or through ATD in connection with the supply agreement we entered into with them. We are pleased to report that our partnership with ATD is off to a great start. giving us much better availability, quicker delivery, and better pricing. Aside from the cash flow generated from this transaction, it has sharpened our focus on our retail store operations. This is our core strength and where we will concentrate all of our energy and resources. I'd like to thank all of our teammates for their hard work in bringing this transaction over the finish line and for their ongoing dedication to our customers. I'd also like to wish those teammates who transitioned over to our partner at ATD all the best in the future. Lastly, an update on our capital allocation. The proceeds received from the completed divestiture, excess cash being generated by our retail operations, and the strength of our balance sheet allows us to continue to return capital to our shareholders at the same time as we pursue our growth strategy. During the first quarter, we expanded our long-standing policy of sharing our results with our shareholders through an increase in our dividend, and we began executing on our share repurchase program, which authorizes us to repurchase up to $150 million of the company's common stock. As part of our growth strategy, we continue to carefully review value-enhancing acquisitions while maintaining our disciplined approach in evaluating multiples. We believe we have significant capacity to acquire businesses which fit into our overall strategic plan. In summary, as we continue to navigate an uncertain macro environment, there is robust demand for our products and services. In-store execution is our greatest opportunity for improving results and is firmly in our control. Our staffing initiatives and focus on our small or underperforming stores delivered retail comp store sales growth in the first quarter. As our training and productivity initiatives take hold, we expect to deliver continued improvements in sales and earnings. The divestiture of our non-core wholesale entire distribution assets will allow for a sharper focus on our retail operations. Significant cash flow generation will allow us to return capital to shareholders through healthy dividend and share repurchase programs, as well as capitalize on acquisitions. With that, I'll now turn the call over to Brian, who will provide an overview of Monroe's first quarter's performance, strong financial position, and additional color regarding fiscal 2023. Brian?

Thank you, Mike, and good morning, everyone. Before getting into the specific details of the quarter, note that the discussion of our first quarter financial performance includes the results of the divested wholesale tire and distribution assets through June 16th. Turning to slide 8, sales increased 2.3% year-over-year to $349.5 million in the first quarter. Total comparable store sales increased 0.4%, while sales from new stores increased $11 million. Excluding the divested assets, retail comparable store sales increased 2.8%. Gross margin decreased 180 basis points from the prior year to 35%. The year-over-year decrease was primarily due to an incremental investment in technician headcount and wages to support current and future topline growth. We estimate that this incremental investment impacted gross margin by 200 basis points in the quarter. Lower than expected comparable store sales growth also resulted in higher fixed distribution and occupancy costs as a percentage of sales. Material costs as a percentage of sales improved year-over-year. driven by higher selling prices and a mixed shift towards our higher margin service categories. Total operating expenses were $95.9 million or 27.4% of sales as compared to $98 million or 28.7% of sales in the prior year period. The decrease was principally due to a $1.2 million gain on the sale of our wholesale tire locations and distribution assets. Net of closing costs as well as costs associated with the closing of a related warehouse in the quarter, and $3.9 million in one-time litigation settlement costs in the prior year period. Operating income for the first quarter declined to $26.3 million, or 7.5% of sales. This is compared to $27.9 million, or 8.2% of sales in the prior year period. Net interest expense decreased to $5.7 million as compared to $6.9 million in the same period last year. This was principally due to a decrease in weighted average debt. Income tax expense was $8.1 million, or an effective tax rate of 39.6%, compared to $5.3 million, or an effective tax rate of 25.4% in the prior year period. The increase in the effective tax rate was due to the tax impacts related to the divestiture of our wholesale tire locations and tire distribution operations, as well as the revaluation of deferred tax balances due to changes in mix of pre-tax income in various U.S. state jurisdictions because of the divestiture. Net income was $12.5 million as compared to $15.7 million in the same period last year. Diluted earnings per share was 37 cents compared to 46 cents for the same period last year. Adjusted diluted earnings per share, a non-GAAP measure, was 42 cents in the quarter and excluded 3 cents per share of gain on the sale of our wholesale tire locations and tire distribution assets, net of closing costs, and costs associated with the closing of a related warehouse, and excluded 8 cents per share of certain discrete tax items related to the sale, as well as the revaluation of deferred tax balances due to changes in the mix of pre-tax income in various US state jurisdictions, again because of their divestiture. This compares to adjusted diluted earnings per share of $0.55 for the same period last year, which excluded $0.09 per share of costs related to one-time litigation settlement costs, $0.01 per share of acquisition due diligence and integration costs, and $0.01 per share of benefit from an adjustment to the estimate for prior year store closing costs. As highlighted on slide 9, We continue to maintain a very solid financial position. We generated a record $77 million of cash from operations during the first quarter, including $48 million in working capital reductions. We received $62 million in divestiture proceeds, of which $5 million are currently being held in escrow. We invested $8 million in capital expenditures, spent $10 million in principal payments for financing leases, and distributed $9 million in dividends. Lastly, under our board authorized share repurchase program, we repurchased approximately $17 million of our common stock. At the end of the first quarter, we had bank debt of $110 million, cash and cash equivalents of $31 million, and a net bank debt to EBITDA ratio of 0.4 times. While we are not providing guidance for fiscal 2023, we are providing color to assist in your modeling. Note that our comments for the remainder of fiscal 2023 factor in the divestiture, which generated about $115 million in sales in fiscal 2022. We expect the ongoing impact from the divestiture to be accretive to overall gross and operating margins and neutral to earnings per share. As we have made investments in store labor to drive higher year-over-year sales, This will continue to put pressure on our gross margins in fiscal 2023, which should be more than offset by the divestiture of our lower margin wholesale tire locations, a higher percentage of service sales in our retail locations, and pricing actions. Total operating expenses are expected to be slightly higher as a percentage of sales on a year-over-year basis as a result of that divestiture of the wholesale tire locations. Our tax rate should be approximately 25% for the remainder of fiscal 2023. Regarding our capital expenditures, we expect to spend approximately $40 million to $50 million in fiscal 2023. In addition to the operational improvements that we expect to benefit our sales and earnings, we also expect an improvement in our operating cash flow generation. This improvement will be driven by improved profitability, as well as continued working capital reductions. We believe that our balanced approach of returning capital to shareholders as well as completing value-enhancing acquisitions will meaningfully increase our return on invested capital. And with that, I will now turn the call back over to Mike for some closing remarks. Thanks, Brian.

We're optimistic about our outlook for the remainder of fiscal 2023 and beyond. Although we still have important work to do, we strongly believe that we remain well positioned to execute our growth strategy and deliver long-term value creation for our shareholders. Before we move to questions, two topics I wanted to briefly address. First, our governance structure. We have been consistent in our disclosures regarding the company's dual-class capital structure and the fact that the company does not have the right nor power to unilaterally recapitalize its equity capital structure. Second, I want to be clear that the Board is more than aware of its fiduciary duties, is well advised, and will continue to act in the best interest of all shareholders and in compliance with securities laws. With that, I will now turn it over to the operator for questions on their quarter.

Thank you. If you'd like to ask a question, you can press star 1 on your telephone keypad. If you'd like to withdraw your question, you may press star two. Please ensure you're unmuted locally when asking your question. And please note, we'll be limiting each analyst to one question and one follow-up question only. Thank you. Our first question for today comes from Daniel Inbro from Stevens Inc. Daniel, your line is now open.

Yeah. Hey, good morning, guys. Thanks for taking our question. Good morning. Good morning. Mike, I want to start actually on the tire category. You saw a nice acceleration on a one- and two-year stack, and I think in the prepared remarks you mentioned that unit market share increased. Could you break down that comp increase and talk about how much of that was ticket versus price inflation? And on share, how are your strongest markets doing? Are unit share increasing in all your markets? Or I'm just curious kind of how ubiquitous that unit market share growth has been across the country.

Yeah, thanks, Daniel. Let me... On the market share, and I'll speak specifically around tires, but I also would like to introduce parts at the same time because there might be other follow-up questions on market share. So I separate market share. We have good data, industry data, all about tires. So I have a good idea of how we're doing with tires. We don't have that same view with parts and service categories. But to be going and trying to answer all your questions around tire category, we saw growth across the market, across the country, but we really saw a nice increase I would say significant change in the south, southeast, and also the northeast. They really had a nice first quarter. So now looking at overall market share, the industry units-wise were significantly down in the first quarter. We were down also. We were able to optimize with price. We don't want to get into the specifics, but it was all driven through price. So when I look at the 5% comp, Although I'm happy with the 5% comp, I was expecting much better numbers. It seemed like we were moving through the month of May in a good way, and then all of a sudden things slowed down, and I feel like the customer was definitely affected starting in the early parts of June. I do believe that's deferred maintenance in very much way. I mean, we started seeing customers trade down from four tires to two tires to one tire. I do believe that just like on service carriers, all that's going to be deferred. And I look forward to those customers coming back because those services still need to be provided.

That's really helpful. And then on the kind of initiatives and staffing, you mentioned you're towards the tail end of staffing. But then, Mike, you talked a little bit about employee training. You guys are working on kind of in-store training. Curious where we're at in that initiative. And then what are the margin implications we should think about? As you guys rolled that out, how is the team responding? How are the teammates responding to being asked to do more or change their day-to-day operations in the stores? Thanks so much.

That's a really good question because it's a big portion of what we're trying to do here is really be a best-in-class service retailer. It's all about having trained associates be able to take care of our customers the first time properly. So just like any retailer, that's a challenge to make people do different things and actually expand something out of their comfort level. It's been part of our agenda for a long time. I would say it's really coming to life recently. Everybody on one consistent way of how we greet a customer, how we answer the phone, how we service a vehicle. I've talked about in the past a courtesy inspection. How do we perform a courtesy inspection on every vehicle? I don't think we're there. I mean, we have a lot more work to do there. We really do. I would say that's a significant opportunity for us. We're investing in technology to help augment that. We're going to really start focusing on people who are not following the Monroe West. The good news is I would say that the majority of our teams see where we're going. They're actually benefiting from the training. They're actually doing additional services like check engine lights. Monroe has not been a destination in the past, but it's coming to life in a better way. And anything that we touch with regards to service categories has a significant positive improvement in our gross profit. And it flows right through the bottom line. So that is our focus, having a nice balanced approach, really focusing on new categories. And it all comes to life with our training initiatives.

Great. Well, best of luck. Thanks for the question, Daniel.

Thank you. Our next question comes from Brian Nagel from Oppenheimer. Brian, your line is now open.

Hi, good morning. Good morning, Brian. I have a few questions on top line. I'll kind of maybe merge them together if I can. So first, going back to the prepared comments and talking about the initiatives, I just want to make sure I kind of understand correctly. So what I think I hear you saying is that the historically underperforming stores where you put these labor initiatives in. I mean, there you've seen a nice response and sales performing well, but the laggards are now the historically better performing stores. So I just want to make sure I understand that dynamic correctly. And then my question on that would be then is that, so as you look at that, are there initiatives you can put in place in these stores that had historically been better performing to drive a better performance there?

Yeah, no, you got it, Brian. So All our stores actually saw a deceleration. We were coming off a strong growth in May, and I was really optimistic about where the customer, where the company was going. So we saw a lot of these come to life, led by our small stores. And it's all about the small stores really changing year-over-year declines. And we talked about staffing, and we talked about training, really emphasizing that these stores are good stores. They just have, they need more attention. So we put more attention, and they responded, and our customers responded immediately. Now, coming into June, I would say it's just the challenge that we're with the consumer base. When we looked at vehicle miles traveled, I think the consumer, in my prepared remarks, I do reflect back on, I mean, the consumer definitely started changing their buying behaviors from May to June and then into July. I do believe all that's going to come back. The good news about the automotive aftermarket, you're still going to have to service your vehicle. So that's all going to be deferred. And we're very much prepared and focused on getting ready for that. We're putting a marketing initiative together. We're focusing on training. We're focusing on properly staffing our stores. And we wanted to take advantage of when that customer comes back in all of our stores.

Got it. Okay. So with regard to inflation, and clearly that's a topic that we're discussing across consumer at this point. As you look at maybe the impacts you're starting to see more or the intensifying impacts you're seeing on your business, do you think it's more the consumer reacting to broad-based inflation or is it inflation specifically within your category, your pricing? And I guess the question would be, are there actions you could take to help offset that?

Yeah, no, I absolutely believe it's broad-based inflation. Because in our purchasing actions, we've actually gone the opposite direction. We're actually offering, and I've talked about this in the past, offering good, better, best, introducing value where we didn't have before. So I actually am trying to meet the customer where they are. 40% of the customer base that we have could be really affected by an increase in gas. They're a very similar customer to most of the retailers that are going publicly right now. So we are very focused on driving value and making sure that we have a value offering for all of our categories. Tires, brakes, B, oil would be the three that I could easily talk about. But what we're looking at really is, I would say, especially with the syndicated data we have on tires, things changed around the tire category, and I think that is very much in parallel to service categories.

Okay, one final question. I'll keep it quick. I appreciate all the colors apart. Look, I know we're watching this in painful real-time, frankly. But with regard to gas prices, gas prices have started to moderate off recent peaks. As that's happening, are you seeing any type of, so to say, improvement, or has it been steady?

Brian, maybe I can ask you. Maybe you can jump in on this one.

Yeah, I would say, Brian, that we are certainly – I think you can see vehicle miles traveled responding generally to gas prices. We've seen that kind of along the way. But as Mike said, there's general inflationary pressures on the consumer. More share of their wallet is going to food, to shelter, and certainly still year over year gas, even though it's come down sequentially. So those, I think, have created some pressure, as Mike said, on some of our larger ticket categories, certainly tire being the largest.

Got it. Thanks, guys. I appreciate all the color. Brian, thank you.

Thank you. As a reminder, if you'd like to ask a question, that's star one on your telephone keypad. Our next question comes from Brett Jordan of Jefferies. Brett, your line is now open.

Hey, good morning, guys. Hi, Brett. Good morning. Good morning. You commented about tire share gain in that comp. Could you talk about, I guess, within the broader comp, other categories, how you see yourselves from a market share standpoint?

Yeah, that's the only, just like I responded, I'm happy that we took comp. I'm not happy with our overall number. So even though we definitely had higher expectations. I don't really have any strong comp, anything to look at market share on the other service categories. Brett, so I can only say that we're not happy with our results. And we're very much focused on mid-single digits. So anything less than mid-single digits, I'm not happy. And I look at that for basically across all my major categories, including batteries, including brakes, including oil change. I mean, that's what we're focused on. And last but not least, it needs to be a balanced approach. I want more ticket, like ticket, but I also want a balanced approach with customers. And I really do think we have an opportunity at Monroe to get a consistent growth in customer and ticket at the same time. And I look forward to sharing that with you in the future.

How was that 2.8 stacked ticket versus 2.8? versus traffic count?

Without getting into specifics, it was led by an increase in ticket and a decrease in traffic.

Okay. And then I guess a question on the working capital reduction. You picked up $48 million in working capital. You talked about more. Could you sort of give us a ballpark size of what's left in working capital that we could see in cash flow this year?

Yeah. a lot of work there in order to capture additional working capital improvements, and we're certainly committed to driving that and expect to do it, but I'm not going to provide a range or a guide on that, but what I would say is, you know, we saw record cash flow in Q1, record operating cash flow, driven by that working capital reduction, and we expect that, you know, continued improvements there will continue to benefit, and we would expect to put up near or record cash flow numbers as we move through fiscal 2023.

Okay. And Brian, can I get the housekeeping question, the quarterly, I'm sorry, the monthly comps in the quarter?

Yeah, it was about flat in April, almost six in May, and two in June. Okay, great. Thank you.

Thanks, Brian.

Thank you. We have no further questions for today, so I'll hand back to the management team for any further remarks.

Thank you for joining us today. This continues to be an exciting time to be part of Monroe. We have a strong foundation to build upon to create long-term value for all our stakeholders. I look forward to keeping you updated on our progress. Have a great day.

Thank you for joining today's call. You may now disconnect your lines.