Monro, Inc. (NASDAQ:MNRO) Q3 2023 Earnings Call Transcript

Monro, Inc. (NASDAQ:MNRO) Q3 2023 Earnings Call Transcript January 25, 2023

Operator: Good morning, ladies and gentlemen, and welcome to Monro, Inc’s Earnings Conference Call for the Third 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. 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 Veksler, Senior Director of Investor Relations at Monro. Please go ahead.

Felix Veksler: Thank you. Hello, everyone, and thank you for joining us on this morning’s call. Before we get Before we get started, please note that as part of this call, we will be referencing a presentation that is available on the Investors section of our website at corporate.monro.com/investors. 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 Monro’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 Monro’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’s 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 Monro’s President and Chief Executive Officer, Michael Broderick.

Michael Broderick: Thank you, Felix, and good morning, everyone. I’ll spend the first part of our call this morning outlining a series of customer focused initiatives we recently implemented across our store base. These initiatives will enable us to drive additional sales of our higher margin service categories and position us as an even stronger competitor in every market we serve. After that, I’ll walk through our third quarter results and the continued progress we’ve made despite inflationary pressures impacting the consumer and our business. I’ll then conclude with an update on our cash creation and capital allocation. Before I get started, I would be remiss if I didn’t recognize and thank all of our teammates for their tremendous efforts in serving the needs of our customers in the communities where we operate.

Now starting with a series of customer focused initiatives we recently implemented across our store base. While batteries currently represent a small fraction of our overall sales, the battery market is large and growing. In response to this, we have made changes in the way we sell and service batteries. We now offer free battery checks and in departure from industry standards, we are waiving installation charges for most batteries. Our customer safety is our primary concern and when we install the battery, it gives us an opportunity to assess a vehicle’s entire electrical system through a free quality courtesy inspection to ensure that everything is in good working order. We know that our customers are busy and they value convenience, personal service and purchasing options tailored to their needs.

To meet these demands, we’ve rolled out several enhanced offerings, including a walk in oil service option to provide hassle free service, which is in addition to our existing online employment system. Number two, a good, better, best oil service package updates to give customers competitively priced options that meet their budgets. Number 3, a callback program to personally remind customers when their next oil service is due. And finally, a new integration with CARFAX to provide customers with their vehicle service history and manufacture recalls while in-store with service recommendations to enable more informed decision making. Additionally, we started offering combined tire and service packages to better connect activity and momentum in tire sales to our service categories.

While these initiatives are aligned with delivering an outstanding guest experience, they have been strategically designed to boost customer traffic at our locations, enable us to drive additional sales of our higher margin service categories and fulfill our commitment to maintain a balanced approach between tire and service categories to deliver enhanced profitability at our stores, grow market share and position us as an even stronger competitor in every market we serve. While these initiatives are still in their early days, we will be sure to provide updates on our progress in the quarters to come. Now, turning to our third quarter results and how inflation pressures are impacting the consumer and our business. Driven by strength in tires, we delivered mid-single digit comp store sales growth in the third quarter of approximately 6%.

We continue to execute on our strategy to improve our 300 small or underperforming stores. Which represent about a quarter of our overall store base. These stores delivered comp store sales growth of approximately 12% in the third quarter, which is on top of the double digit comp growth in the first half of this fiscal year. Our sales results for the group of stores through the first three quarters shows that our strategy is working. As a reminder, comp store sales at these stores decreased 8% in fiscal 2022 compared to fiscal 2020. The continued acceleration in sales at these locations is a direct result of our strategy to improve technician staffing levels as well as our training initiatives that allow us to better meet customer demand. Comp store sales in our remaining stores were up approximately 5%.

Similar to last quarter, broad based inflationary pressures on the consumer continued to affect customer purchasing behavior in the third quarter. We saw customers trading down to lower priced tire options. We actively repositioned our tire assortment to give our customers the right tire at the right price. We are staying relevant on opening price points to provide customers with more choice and greater value. In preparation for the winter selling season, we raised in stock levels in our stores with an expanded snow tier offering, a more established regional inventory for opening price point and altering tires and an upgraded inventory system to allow daily review and replenishment. We drove additional customer traffic to our store through manufacturer rebates on six tire brands and a free lifetime tire installation package.

Encouragingly, our tire units were positive in the third quarter with tire comp store sales up high single digits. Based on third party syndicated U.S. replacement tire data, all of this contributed to our outperformance in tire units versus the industry in the third quarter. We also saw stretch consumers continue making decisions to defer vehicle maintenance, which put pressure on sales in some of our key service categories. As a result, we chose to not fully pass through inflationary cost increases to an already stretched consumer. The voice of our customer has indicated that raising price is at a time when they’re struggling to accept them would likely result in the immediate loss of a sale and has the potential to jeopardize a longer term relationship.

And as a reminder, developing this longer term relationship with our customers is a key element of our strategy. While our higher sales mix of tires versus service, customer trade down to opening price point tires. Our investment in price and our continued labor cost pressures impacted our gross margin. Prudent cost control in the third quarter allowed us to leverage operating expenses on a mid-single digit comp. As we continue to drive our business stores consistently delivering mid-single digit comp store sales growth, we also remain committed to a more balanced approach between the tire and service categories. That will deliver enhanced profitability of our stores. The series of initiatives that I outlined at the outset of our call this morning will allow us to achieve these expectations.

Our business is well positioned with the right strategy in place to take advantage of longer term industry challenges. While the current macro environment remains challenging, we continue to gain market share in our tire category with a keen focus on driving traffic to our stores and serving the car care needs of our customers. The largely nondiscretionary nature of our business gives us confidence that as long as our stores are properly staffed, our pricing is competitive with the right assortment and we continue to improve our in store execution, we’ll be able to capture market share gains in both our tire and service categories. And encouragingly, sales momentum has continued into fiscal January with our preliminary comp store sales up approximately 8%.

Lastly, an update on our cash creation and capital allocation. The strength of our financial position and cash flow is a competitive advantage which enables us to make investments in price and labor to grow market share and capture new customers for the long term. As a reminder, an important focus of our strategy is cash creation. We are continuing to unlock cash by optimizing inventory and leveraging the strength of our vendor partners for better availability, quality and cost of tires and parts in our stores. And then in the third quarter, we continued to generate strong operating cash flow led by reductions in our working capital. Excess cash being generated by our operations and the strength of our balance sheet allowed us to continue returning capital to our shareholders in parallel to pursuing our growth strategy.

During the third quarter, we continued our long standing policy of sharing our results with our shareholders through our dividend and we continue deploying cash on our share repurchase program, which authorizes us to repurchase up to $150 million of the company’s common stock. After a careful review, which included our disciplined approach in evaluating multiples, we executed a definitive asset purchase agreement to acquire four additional stores in Iowa and one additional store in Illinois. This acquisition is expected to close in the fourth quarter and is expected to add annualized sales of approximately $6 million. As part of our growth strategy, we continue to have significant capacity to acquire businesses which fit into our overall strategic plan.

In summary, we have implemented a series of customer focused initiatives that will benefit our business. We delivered mid-single digit comp store sales growth in the third quarter, our strategy to improve our small or underperforming stores through our staffing and training initiatives is working. We will continue to drive our business towards consistently delivering mid-single digit comp growth with a commitment to a more balanced approach between tire and service categories that will allow us to leverage our cost structure to deliver enhanced profitability. Although we continue to navigate an uncertain macro environment, we have the right strategy in place to take advantage of the longer term industry tailwinds. We are focused on gaining market share and driving traffic to our stores through competitive pricing and the right assortment to meet the needs of our customers.

Our in store execution is firmly in our control and remains our greatest opportunity for improving our results. As our training and productivity initiatives continue to take hold, we expect to deliver improvements in sales and earnings. Significant cash flow generation through operational improvements and working capital reductions will allow us to continue returning 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 Monro’s third quarter performance, strong financial position and additional color regarding the remainder of fiscal 2023. Brian?

Brian D’Ambrosia: Thank you, Mike, and good morning, everyone. Turning to slide eight, sales decreased 1.9% year-over-year to $335.2 million in the third quarter, which was due to the divestiture of our wholesale tire and distribution assets in the first quarter of fiscal 2023. Sales for these divested assets were approximately $28 million in the prior year third quarter. Comparable store sales increased 5.6% and sales from new stores increased $6 million. When adjusted for one additional selling day in the current year quarter due to a shift in the timing of the Christmas holiday from the third quarter in fiscal 2022 to the fourth quarter in fiscal 2023, comparable store sales increased 4.4%. Gross margin decreased 150 basis points from the prior year to 33.8%.

A higher mix of tire sales in our retail locations, customer trade down to opening price point tires, as well as parts inflation that we intentionally did not fully pass through to the consumer increased material cost as a percentage of sales from the prior year. In addition, incremental investments in technician, labor and wages to support current and future top line growth increased labor costs 80 basis points from the prior year. These increases more than offset the benefits to gross margin from the divestiture of our wholesale tire and distribution assets. Total operating expenses were $89.6 million or 26.7% of sales as compared to $93.1 million or 27.3% of sales in the prior year period. The decrease as a percentage of sales was principally due to prudent cost control, which allowed us to leverage operating expenses on mid-single digit comparable store sales growth.

Operating income for the third quarter declined to $23.8 million or 7.1% of sales. This is compared to $27.4 million or 8% of sales in the prior year period. Net interest expense increased to $5.9 million as compared to $5.7 million in the same period last year. This was principally due to higher year-over-year interest rate. Income tax expense was $5 million or an effective tax rate of 27.6% compared to $5.5 million or an effective tax rate of 25.3% in the prior year period. The increase in effective tax rate was due to a higher discrete tax impact related to share based awards, as well as other state income tax impacts from the divestiture of our wholesale and tire distribution assets. Net income was $13 million as compared to $16.3 million in the same period last year.

Diluted earnings per share was $0.41 compared to $0.48 for the same period last year. Adjusted diluted earnings per share, a non GAAP measure, was $0.43. This compared to adjusted diluted earnings per share of $0.49 in the third quarter of fiscal 2022. Please refer to our reconciliation of adjusted diluted EPS in this morning’s earnings press release and on slide eight in our earnings presentation for further details regarding excluded costs in the third quarter of both fiscal years. As highlighted on slide nine, we continue to maintain a very solid financial position. We generated a record $171 million of cash from operations during the first nine months of fiscal 2023, including $71 million in working capital reductions. This has reduced our cash conversion cycle by approximately 35 days at the end of the third quarter compared to the prior year period.

Our AP to inventory ratio at the end of the fiscal third quarter was 162% versus 79% at the end of fiscal 2022. We received $66 million in divestiture proceeds, of which $5 million are currently being held in escrow. We invested $29 million in capital expenditures, spent $30 million in principal payments for financing leases and distributed $27 million in dividends. Lastly, cumulative repurchases of our common stock were approximately $97 million under our board authorized share repurchase program. We have used our significant cash flow to reduce invested capital by $180 million during the first nine months of fiscal 2023. At the end of the third quarter, we had bank debt of $130 million, cash and cash equivalents of $13 million and a net bank debt to EBITDA ratio of $0.7 times.

While we are not providing guidance for the remainder of fiscal 2023, we are providing color to assist in your modeling. Note that our comments for the remainder of fiscal 2023 continue to factor in the divestiture, which generated about $115 million in sales in fiscal 2022. As we continue to focus on gaining market share and driving traffic, we expect to continue maintaining appropriate staffing levels as well as competitive pricing to attract customers to our stores. This will likely continue to put pressure on gross margin in the fourth quarter of fiscal 2023. In order to mitigate that, we will be focused on driving sales in our higher margin service categories, managing mix within our product categories to improve profitability and taking opportunistic pricing actions.

Total operating expenses in the fourth quarter are expected to be consistent as a percentage of sales on a year-over-year basis. Our tax rate should be approximately 25% for fiscal 2023. Regarding our capital expenditures, we expect to spend approximately $35 million to $45 million in fiscal 2023. We also expect to continue improving our operating cash flow, driven by continued working capital reductions, 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’ll now turn the call back over to Mike for some closing remarks.

Michael Broderick: 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 remain well positioned to execute our growth strategy and deliver long term value creation for our shareholders. With that, I’ll now turn it over to the operator for questions.

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Q&A Session

Operator: Thank you. Thank you. Our first question for today comes from Brian Nagel Oppenheimer. Brian, your line is now open. Please go ahead.

Brian Nagel: Hi, good morning.

Michael Broderick: Good morning, Brian.

Brian D’Ambrosia: Good morning, Brian.

Brian Nagel: Thanks for all the color. So, a couple of questions. I mean, first off, just with respect to the underperforming stores and now we’ve seen some — for a trend in improving performance. How much potential is left in those stores for the outsized comp growth we’ve seen?

Michael Broderick: Brian, good morning. It’s Mike. I would say that it’s part of our strategy. Just to remind everybody that was year-over-year-over-year declines that we are now starting to reverse. So I would look at the strategy as the exact opposite. We’re actually walking these stores back year-over-year-over-year. So my expectation and I know my field team understands the expectation that we’re expecting double digit comps to really start reversing. And we expect this type of growth for our, I would say, the next one to two years going forward.

Brian Nagel: Got it. That’s helpful. And then my second question — Mike, it is my follow-up question. Maybe I’ll merge a couple together, but — so as you look at the results today, you’re calling out this kind of shift in buying patterns as a result of, to some extent, consumers trade down amid economic pressures. So the question I have is, as you look at that, a better demand for to gets these more opening price tires, what gives you the confidence that this does in fact reflect market share gains as opposed to potentially existing customers now just reacting to a more expanded product offering as part of Monro?

Michael Broderick: First of all, we look at syndicated data and we actually can see the breakdown based on Tier 1 through Tier 4 performance based on tires, opening price point being Tier 4, premium tires being Tier 1. So I can actually see our performance by tier. Now when I look at our performance right now, Brian, this is what we’re focused on from the day we’ve been on this call together is, sales margin and cash creation. We are now finally seeing with our — really with our partnership with ATD we’re actually seeing real tire unit creation. And it’s not just because we’re — I think we have a better assortment for our customers. And that started with really activating on opening price point. But our greatest opportunity that we have is, obviously, through field execution and part of field execution’s job is to really take that opening price point opportunity and sell up through the screen based on the features, benefits and advantages.

But ultimately, what drives us is market share. We can see the activities that we’re deploying the stocking decision, the assortment, the pricing decisions and it’s coming to life in unit gain in the markets that we serve. And I think that is the successful for years to come.

Brian Nagel: That’s very helpful. I appreciate it. Thank you.

Michael Broderick: Thank you, Brian.

Operator: Thank you. Our next question comes from Daniel Imbro of Stephens Inc. Daniel, your line is now open.

Joe Enderlin: Hi guys. This is Joe Enderlin on for Daniel. Thanks for taking our question.

Michael Broderick: Of course. Good morning, Joe.

Joe Enderlin: So it looks like the three year stack from monthly comps accelerated sequentially from December to January pretty meaningfully. Could you maybe provide some color on how you think the consumer is receiving the increased promotional activity right now and maybe how that trended through the quarter