Monro, Inc. (MNRO) Q2 2024 Earnings Call Transcript

Good morning, ladies and gentlemen, and welcome to Monro Incorporated's Earnings Conference Call for the Second Quarter of Fiscal 2024. At this time, all participants are in a listen-only mode. 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'd now like to introduce Felix Veksler, Senior Director of Investor Relations at Monro. 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 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.

Thank you, Felix, and good morning, everyone. I'd like to spend the first part of our call this morning walking through our second quarter performance, which reflected top line results that were challenged. This was due to consumers deferring tire purchases as persistent inflationary pressures impacted purchases of higher ticket items across the retail spectrum. This was clearly evidenced by an industry-wide slowdown in tire unit sales in the regions where a vast majority of our store footprint is concentrated. We mitigated this slowdown with actions to reduce non-productive labor costs, including overtime hours in our stores. Despite a tough macroeconomic environment, the resiliency of our business model allowed us to expand gross margin and maintain our year-over-year profitability even on a lower tire sales volume. I'll also discuss our plans to deliver improved earnings this fiscal year despite some of the consumer-related headwinds that we and others in our industry are experiencing. Before I get into the specifics, I'd be remiss if I didn't take a moment to recognize and thank all of our teammates for their continued dedication to Monro, serving the needs of our customers as well as their positive contributions to the communities where we operate. Now turning to our second quarter results. Our second quarter comparable store sales declined approximately 2%. Comparable store sales were down approximately 1% in our 300 small or underperforming stores, and down approximately 2% in our remaining store locations. As I stated earlier, our sales results in the quarter were challenged by consumer deferrals of tire purchases as evidenced by industry-wide slowdown in tire unit sales in the regions of the country where a vast majority of our store footprint is concentrated. This led to pressured store traffic, which was not supportive to sales of our higher margin service categories in the quarter. While our tire units were down approximately 10%, leveraging the strength of our manufacturer-funded promotions allowed us to optimize our assortment for improved tire profitability in the quarter. And while continued consumer trade-down dynamics led to a higher proportion of lower margin opening price point tires within overall industry unit sales, we remain focused on maintaining a healthy mix of opening price point tires in the quarter. Encouragingly based on the retail sellout data from Torqata, a subsidiary of ATD, we maintained our tire market share in our higher margin tiers. We mitigated this industry-wide slowdown in tires with actions to reduce non-productive labor costs, including overtime hours in our stores, which were down 26% year-over-year and 14% sequentially. This allowed us to expand gross margin and maintain our year-over-year profitability even on lower tire sales volumes. We will continue to closely manage our labor costs and expenses to maximize profitability, now concluding with our plans to deliver improved earnings this fiscal year despite a choppy consumer environment. While our preliminary comparable store sales for fiscal October are down approximately 5%, our stores are properly staffed and ready for the back half of the year. And while we will need to see an improvement in the overall health of the consumer before we can fully capitalize on longer-term industry tailwinds, we have successfully repositioned our cost structure to deliver improved profitability even on lower comparable store sales. We will remain relentlessly focused on achieving comparable-store sales growth through accelerating growth in our 300 small or underperforming stores, maintaining a balanced approach between our tire and service categories with competitive pricing to drive store traffic and continuously improving our customer experience. We'll also strive to expand our gross margins through properly training our teammates to maximize their productivity. However, given the current pressures on the consumer, we are also laser-focused on maximizing profitability through prudent cost control, which includes right-sizing our fixed costs and rationalizing unproductive labor. While we take these actions, we will not cut productive labor at the sacrifice of our standards and to the detriment of our long-term service model. In addition, we will continue to create cash by optimizing inventory and leveraging the strength of our vendor partners for better availability, quality, and cost of parts and tires in our stores. In closing, despite the challenges posed by the current macroeconomic environment, our business continues to be well-positioned and we are confident that we remain on a path to restore our gross margins back to pre-COVID levels with double-digit operating margins over the longer term. With that, I'll now turn the call over to Brian, who will provide an overview of Monro's second quarter performance, strong financial position, and additional color regarding fiscal 2024.

Thank you, Mike and good morning, everyone. Turning to slide eight, sales decreased 2.3% year-over-year to $322.1 million in the second quarter, which was primarily due to lower tire unit sales. Comparable store sales decreased 2.3%, and sales from new stores increased approximately $1.2 million. Gross margin increased 30 basis points compared to the prior year, primarily resulting from lower material costs as a percentage of sales, which were partially offset by higher distribution and occupancy costs as a percentage of sales, as well as higher technician labor costs as a percentage of sales due to wage inflation. Total operating expenses were $92.6 million or 28.8% of sales as compared to $93.3 million or 28.3% of sales in the prior year period. The increase as a percentage of sales was principally due to lower year-over-year comparable store sales. Operating income for the second quarter declined to $22.4 million or 6.9% of sales. This is compared to $23.5 million or 7.1% of sales in the prior year period. Net interest expense decreased to $4.8 million as compared to $5.7 million in the same period last year. This was principally due to a decrease in weighted average debt. Income tax expense was approximately $4.7 million or an effective tax rate of 26.8%, which is compared to $4.7 million or an effective tax rate of 26.6% in the prior year period. Net income was approximately $12.9 million as compared to $13.1 million in the same period last year. Diluted earnings per share was $0.40 compared to $0.40 for the same period last year. Adjusted diluted earnings per share, a non-GAAP measure, was $0.41. This is compared to adjusted diluted earnings per share of $0.43 in the second quarter of fiscal 2023. 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 items in the second quarter of both fiscal years. As highlighted on slide nine, we continue to maintain a very solid financial position. We generated $98 million of cash from operations during the first half of fiscal 2024, including $36 million in working capital reductions. This has reduced our cash conversion cycle by approximately 72 days at the end of the second quarter compared to the prior year period. Our accounts payable to inventory ratio at the end of the second quarter was 191% versus 178% at the end of fiscal 2023. We received $7 million in the divestiture proceeds. We invested $16 million in capital expenditures, spent $20 million in principal payments for financing leases, and distributed $18 million in dividends. Lastly, given the higher interest rate environment, we opted to pay down some of our debt in the second quarter to reduce interest expense versus repurchasing shares under our program, which authorizes us to repurchase up to $150 million of the company's common stock. We have used our significant cash flow to reduce invested capital by $71 million during the first half of fiscal 2024. At the end of the second quarter, we had bank debt of $55 million, cash and cash equivalents of $9 million, and a net bank debt to EBITDA ratio of 0.3 times. While we're not providing full year guidance, we are providing color to assist in your modeling. We expect to drive higher year-over-year sales through comparable store sales growth and outsized performance in our 300 small or underperforming stores. This is inclusive of an extra week of sales in our fiscal fourth quarter. We expect to drive year-over-year improvements in our gross margin through pricing actions, lower fixed distribution and occupancy costs as a percentage of sales due to a higher sales base and productivity improvements from our labor investments and reductions from non-productive payroll, which will be partially offset by continued wage inflation. Total operating expenses as a percentage of sales are expected to be higher year-over-year due to increases in direct and departmental costs to support our store base, as well as the impact of inflation. Our tax rate should be approximately 26% for fiscal 2024. Regarding our capital expenditures, we expect to spend approximately $35 million to $45 million in fiscal 2024. We also expect to continue improving our operating cash flow driven by continued working capital reductions, our balanced approach of returning capital to shareholders through dividends and share repurchases, as well as opportunistically completing value-enhancing acquisitions as expected to 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 fiscal 2024 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.

Thank you. Our first question today is from David Lantz of Wells Fargo. David, your line is open. Please proceed.

Hey, good morning, guys, and thanks for taking my questions. So you're guiding the comparable sales growth in fiscal 2024 and in the context of October comps being down 5%, curious if you can talk about your expectations for the balance of the year, and if any of that improvement assumes an overall improvement in the macro.

Thanks for the question, David. This is Brian. If you look at our back half, I just want to remind everyone we've got an extra week in our fourth quarter; that extra week is about 2% on the annual comp. So that is factored into that commentary around comparable store sales growth for the year. But we do expect, and it is factored into that comparable store sales growth, improvement off of the down five trend we talked about in October. And I think that's driven by what we hope will be better consumer dynamics in our tier one through three tires, which we expect that weather, and that supports a tire selling season in the back half will help to drive that inflection.

Got it. That's helpful. And then just a longer term question. On getting back to the low double-digit EBIT margins, can you provide a glide path on what sort of improvement could be driven by gross margins and what else could come from SG&A?

I'll start with the margin, David. Even in this quarter, despite the decline in sales, we were able to demonstrate margin improvement. We believe this will continue to improve through our assortment decisions and the appropriate tire and service mix in our business. Over the last 12 to 15 months, we've made significant efforts to position ourselves to clearly understand what margin improvement means as we aim to return to pre-COVID margin levels, and we have effectively managed our payroll. The team has done well in adapting to the environment, whether it increases or decreases, and has mitigated some of the wage investments necessary over the past two to three years.

And just to add to that, David, if you think about the margin at 35.7 for our second quarter that was driven year-over-year by 120 basis points of improvement in material costs as a percent of sales, and then offset by about 90 basis points of a combination of our distribution and occupancy and labor costs, largely calling that 90 basis points deleverage on the lower sales. So if our planning assumptions around the top line to flat come true, then you look at that labor and distribution and occupancy deleverage dissipating. You put 90 basis points on top of the 35.7 and you start to achieve some meaningful gross margin improvement on the path to double-digit operating margins. But G&A has been a focus, and if you look at our G&A in the quarter, it was flat year-over-year from a dollar standpoint. It deleveraged a little bit because of the lower sales, but our focus is to continue to drive flat G&A year-over-year in order to gain as much flow-through on the sales we are delivering. That's obviously our goal. And so far we've been able to offset a lot of the year-over-year inflation with efficiency gains in G&A.

Got it. That's super helpful. Thank you.

Thank you, David.

Our next question today is from the line of Bret Jordan of Jefferies. Bret, your line is now open. Please proceed.

Hey, good morning, guys.

Morning, Bret.

Good morning.

Could you give us a little detail on car count, I guess ticket versus traffic in the comparable sales and then I guess Brian, the usual, the monthly comparable sales breakout?

I'll start with the traffic. Traffic was down in the mid-single digits, and the ticket was up in the low single digits. However, despite a decrease, we saw significant performance from tires. To clarify regarding the opening price point, this was indeed a solid quarter for tires. We experienced a mix shift that we enjoy, moving from tier one to tier three, which boosts profit. Due to the drop in tire count, we also saw a loss in the attachment rate. We are optimistic about the consumer returning this quarter. We're currently anticipating a weather event in November that should encourage customers to return, which will help us improve transactions and increase attachment rates as well.

Okay.

And then regarding the cadence in the quarter, July was up 0.5%, August was down 2.5%, September down five. And those trends all really, like Mike said, were driven by tire unit declines as the quarter went on and also consistent with the industry data that we mentioned in the prepared remarks that we were comparing ourselves against.

Was there much regional dispersion? I guess you guys kind of called out that your primary markets saw a lot of pressure from the consumer. Was the West better?

The West was better, but I would say it's marginally better. But to our prepared remarks, a lot of the pressure was definitely on the East Coast.

Okay. And then one final question. Regarding the working capital benefit, with your lighter inventory model, what do you think is still possible? As we examine the current balance sheet and model, what additional cash could we potentially realize from the inventory?

Great question. I think if you look at Q1 to Q2, you definitely heard the metrics start to flatten out a little bit. We're still at about 72 days of cash conversion cycle reduction still around 190, 195 of that inventory to accounts payable ratio, or accounts payable to inventory ratio. So I think you're definitely showing that we're in some of the later innings, but there's still more benefit to come as we get new vendors signed up for extended terms and also continue to drive volume through our existing vendors on the programs. But I think the slowdown in some of the growth in the year-over-year metrics is indicative of kind of later innings.

Okay. Great. Thank you.

Thank you.

Our next question today is from the line of Brian Nagel of Oppenheimer. Brian, your line is now open. Please go ahead.

Hey, this is William Dossett on for Brian. Thanks for taking my question.

Good morning, William.

Thank you. The first question is about the consumer. What can you do internally to drive comparable sales and gain more traction if the consumer remains under pressure? Additionally, regarding the industry, what pressures need to ease for us to see an improvement in the current trends of trade-down and deferral that you are observing?

Yeah. So William, this is Mike. I'll take it. Regarding your first question, we discussed this in Q4 as well. We chose not to shift our focus to lower-priced offerings for several reasons. Primarily, it wasn’t profitable. We were making minimal profit while investing in skilled technicians to install inexpensive tires, which is not our core business. Additionally, customers purchasing those tires often didn’t want to get necessary services done, particularly impacting our brake category and other important service areas for us. That’s our business model. Secondly, we opted to adjust our pricing and reorganize our stores. We observed that our product assortment attracts a profitable customer base that contributes positively to our organization’s profit. We’ve successfully managed our margins and controlled expenses through careful oversight of overtime and planned wage investments. As we move through Q3 of last year, we had much of this in the market. In Q4, we initiated changes to achieve a balanced mix, aiming for solid growth in tiers one through three while offering appropriate products for tier four. Currently, regarding the consumer, it's all about the weather influencing customer traffic. We notice customers are deferring purchases and opting for lower-priced options, and a significant weather event could potentially shift consumer behavior. When customers do come into our stores, we anticipate the winter selling season will be brief but intense, and we feel well-prepared for it. Many of the measures we implemented in Q3 are beginning to positively impact Q4, allowing us to see a return to normal comparables.

Okay. Yeah. That's very helpful. Thank you. And to follow up on that and to ask about the guidance for the full year, can you remind us what the compares are with the weather? And what gives you confidence that the weather can drive improved comps via just historical knowledge of the business? And also just with the full year comparable sales, can you talk about the breakdown of your expectations between ticket and traffic?

I'll start by discussing ticket and traffic. We typically maintain a balanced approach to these factors. As we move out of October, if we experience a weather event, we anticipate significant growth in customer numbers. Additionally, this leads to an increase in large ticket items like tires, which we also need to manage alongside our expenses. Looking ahead at comparable sales for the rest of the year, I expect November and December to be challenging. However, if a winter event occurs, it could help improve our comparable sales. For Q4, it appears we initiated this plan during that period, but we see softer comps in Q4, especially with the inclusion of a 53rd week in the quarter.

Okay. Thank you very much.

Thank you, William.

And our next question today is from Daniel Imbro of Stephens. Daniel, your line is now open.

Hey, good morning guys. Thanks for having our questions. I guess, I want to start again, Mike, maybe on the 300 small or underperforming stores. Obviously, they're seeing the same maybe deferrals and struggles as the rest of the industry, but I'm curious, just operationally, when you look across them, we've been improving those for about a year. They've generally done better than the stores. Like what's left to do from a self-help standpoint in those smaller stores? Can they grow without an industry turnaround, or from here are they kind of dependent on a similar macro improvement at those 300 underperforming stores?

Daniel, when I look at the overall store performance, I focus on those underperforming stores as a double-digit growth opportunity for us. There's a lot of variability in that performance. I actually see a large subset of those stores that are performing extremely well. That gives me a lot of confidence that we're on the right path. It's a people story, it's a retail execution story. I would say this is always going to be something that we're going to focus on from the day I started with the organization. We always identified underperforming stores, poor performing stores. It's just part of retail. These stores are located in good areas. It's all about people, process, and execution. That's why it's always going to be part of our storyline of why I feel confident that we can grow this company.

Okay. That's helpful. And then maybe moving over on the market share side, I think your commentary said you retained share in the higher margin, higher tiers, but obviously I didn't hear a commentary in the lower-end tiers. So is it just that we're seeing some competitors be price irrational out there on that opening price point, so you just don't maybe want to retain share there? And then based on history, could you share some context during periods of past macro pressure? I would guess opening price point maybe gains a larger percentage of industry sales. Is that true? So maybe where you guys are losing share, is that going to become a bigger part of the industry for the next few quarters if the macro keeps getting tougher?

We have chosen not to overcrowd our stores with opening price point tires. This decision was based not only on pricing but also on product assortment. Our experience in Q4 demonstrated that during Q3, when we sold a significant number of opening price point tires, our profits were minimal. From my observations of market trends, I believe that tiers one through three still hold a strong position in consumers' minds and continue to have demand. We were not anticipating a weak performance in these tiers when we conducted our forecasting and performance modeling. We expect this business to recover, and we are prepared for that. We do offer an opening price point in tier four, which is appropriately priced in our stores. However, we are cautious about increasing our focus on it because, in the past, doing so did not yield profitable results. We observed customers unnecessarily downgrading from tiers one, two, and three to tier four, and we aimed to prevent that since it was not beneficial for the consumers.

That's helpful color. And then last one, maybe Brian, just to follow up on Bret's question. Cash conversion has stabilized; cash flow maybe improves when sales do, but can you talk about how you're just thinking about uses of cash? Another quarter, I don't think you guys were active on the buyback, just where does that fit into your capital priorities? And maybe what are you guys looking forward to get more active on that use of cash? Thanks.

No, thanks Daniel. We look at it as a balanced approach. We are looking to continue to reduce our invested capital. We talked about that being $70 million so far through the first six months approximately. It's been more debt led right now. If you look at the balance since we announced the buyback, it's been pretty much 50-50 in terms of debt reduction and share repurchase for the amount of total capital that we've retired. So I would think that going forward over a period of time that's going to continue to be balanced, particularly as we start to get lower in the debt balance and the opportunity kind of diminishes to continue to pay down debt and reduce interest expense. There's going to be more opportunity to fulfill the remaining authorization that we have a $53 million on our $150 million authorization. So it's going to be balanced and we look to continue to generate that excess cash flow in order to continue to return the invested capital.

All right. Thanks so much, and best of luck going forward.

Thank you.

Thank you.

Our next question today is from the line of John Healy of Northcoast Research. John, your line is now open. Please go ahead.

Thank you for taking my question. I wanted to inquire about the comments regarding the reduction of less productive labor. It seems like a challenging task, whether due to location, tenure, or talent, especially considering the current shortages of mechanics. I would appreciate your overall perspective on how you are assessing this and what actions you are taking. Are we correctly understanding that the focus is on labor at the store level?

You're interpreting it correctly. We are placing a strong emphasis on store-level payroll. Over the past two and a half years, we have been focused on staffing our stores in anticipation of what we believe are positive trends in the industry. We are dedicated to training our technicians and ensuring we retain qualified individuals for the work that comes into our shops. My primary concern is managing wage increases, which is why we discuss overtime each quarter, as it is the main strategy for controlling unwanted payroll expenditures while ensuring our stores are adequately staffed. We remain committed to having quality technicians in our stores, and this focus on managing unproductive payroll, especially regarding overtime, will not change.

Got it. That makes perfect sense. And then just kind of industry type question. One of the things that surprised me recently was some of the Michelin commentary that US replacement shipments into the US were up like low double-digits in September. Just kind of your reaction to that, is that a sign that the industry is restocking or maybe a sign that you're starting to get some relief on pricing, so maybe folks are taking in product or you just thought it was an odd number. Just kind of curious on your thoughts on that.

I don't have anything specific to add. My focus is on ensuring our vendors deliver when needed. We maintain a strong relationship with ATD, and much of our inventory operates on a just-in-time basis, supported by a solid vendor community. When we see a 6% decline in tiers one through three, it impacts our larger manufacturers, who are investing in us to boost traffic. The positive aspect is our strong ties with vendor partners, which we will continue to depend on. We anticipate that customers will return, benefiting both them and us.

Great. Thanks guys.

Thank you.

Thanks.

Now we have no further questions in the queue today. So I'd like to hand back to Monro CEO, Michael Broderick, for any closing remarks.

Thank you for joining us today. This continues to be an exciting time to be part of Monro. 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.

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