Okay, we'll get started. Thank you very much, everyone. So my name is Peter Keith, Senior Research Analyst at Piper Sandler, covering Hard lines and Broad lines. Very happy to introduce Monro, who you probably know, but they are a leading auto service and tire dealer in the U.S. They have about thirteen hundred service centers across thirty-one states. So with me today from Monro, we have Brian D'Ambrosia, the CFO, and then in the audience, we have Felix Veksler, who's the Senior Director of Investor Relations. So Brian, thank you very much for coming.
Appreciate being here.
Okay, so let's just kick it off. One opening question we have to a lot of companies here is just around the core customer.
Sure.
You serve clearly more of a middle-income consumer. So what are you seeing in overall spending trends, trade down, visits? What's been your observation in this kind of confusing environment?
Yeah, it's a great question, and we do serve kind of that low to middle-income consumer. Our average age of vehicle is six years plus that we see, and certainly someone who's driving an older vehicle is doing so typically for financial reasons. They're also very value conscious to begin with, which is why they're a customer of the auto aftermarket. What we're seeing is really value-conscious behavior by that consumer, as you would expect in this environment, and that kind of manifests itself in a couple ways. One is through deferral. Our services are nearly all non-discretionary, but over shorter periods of time, the consumer can certainly make some discretionary decisions regarding extending service intervals or maybe driving in less than you know perfectly safe brakes or tires.
We've seen that behavior, even during recommendations that we've made, while they might have been in for other needed work, and we see safety concerns or other items of concern on their vehicle. We're seeing a lot of times that service gets declined at that point and moved out to a scheduled date later. We're also seeing trade down, besides the deferral, and that's primarily in the tire category. You have different options in tires from our, you know, Tier One, higher-end manufacturers, all the way down to Tier Four, which is traditionally more of a price point and less of a brand recognition at that point, and we're seeing that trade down happen, throughout the tire ecosystem.
Okay. All right. And when you started your fiscal year ends in March, so you started your new fiscal year that we're in now, in April. You said on that earnings call at that time you were the same-store sales were down double digit, low double digit, I believe. But then in the subsequent call, you talked about you're seeing this sort of steady sequential improvement month on month. And maybe you can just dig into what's. It sounds like there's some company initiatives that are driving that, so help us understand that improvement.
Yeah. I would say first and foremost, the environment really hasn't changed, particularly over that short period of a time. So, we believe that our actions and our initiatives that we launched against that real continued challenging backdrop drove some different results as the quarter went on. As you mentioned, we were down 13% in comps in our April month, 11% in May, and down 5% in June, and during that period of time, we became very aggressive at taking back our tire units, and we did that through the partnership with our manufacturers. That trade-down dynamic I talked about has led most of the industry to move from, let's say, a 20% kind of penetration rate at the opening price point to above 30% now.
We've been able to hold our traditional percentage of about 25%, and we've done that through really strong promotions funded and supported by our manufacturers in the Tier One through Three space. That's allowed us to preserve margins. It's allowed us to remain loyal and helped our manufacturers through a difficult environment, which we're clearly seeing, and they're clearly seeing. It also provides a lot of value to the consumer because now they're running on a tire that has a manufacturer's warranty, a mileage warranty, 40, 50, 60, 70 thousand miles. It's a brand name that's more likely them to recognize, and it's just an overall better value and better fit for their vehicle.
So it's a, it's a win, win, win, and we're seeing that overall allow us to take share in One through Three, even though we might be giving up some share in the Tier Four category.
Okay. All right. So, the other thing I just wanted to understand, the gross margin expansions. You mentioned you're preserving margin 'cause you're getting some of the Tier One to Three vendors, suppliers are supporting some of the promoted prices. But the gross margin expansion has been really impressive, so help us understand what's driving that, and is that a sustainable dynamic?
Yeah. The biggest driver of gross margin in our first quarter was related to the improvement in productivity of our technicians. We drove a significant 240 basis points of gross margin expansion related to technician pay as a % of sales coming down. And that's all related to our training and productivity initiatives around how we schedule our stores, how we manage hours in our locations to make sure that we're doing the most efficient job of marrying up demand and capacity in stores, and during the day and during the parts of the week. And what that has done is previously, we were taking about 90 days before we really expected a technician to come in and be fully productive.
That's down to about three weeks now, because of the training and the support that we're giving the technician in store, and that's allowing us to meet demand with fewer scheduled hours and drive costs down. The other piece of that expansion was we had a little bit of material margin expansion of a hundred basis points, and that was largely driven by our service categories. While we held in tire, like I described, our service categories, it was really what led by field execution, better discipline and the use of discounting to guests and all of that.
The real opportunity we have to move from where we are and where we've been running to what we want, what our goal is, which is really high 30, 38, 39% pre-COVID gross margins, is to see that top line return to growth. Even on a 2, 3% comp, we will start to see significant leverage against a component of our cost of goods, which is fixed, which is our occupancy costs. So our occupancy costs, rent, building maintenance, the geography of that on the P&L is in gross profit, it's in cost of goods, and a growing top line will lead to margin expansion there. That actually cost us 120 basis points of margin in the quarter on the lower sales.
Okay, and to frame that up, because I think it's important, you had pre-pandemic, I think it was a 39% gross margin, and you're kind of mid-30s right now.
Correct.
300-400 basis points below, and closing that gap, you think can be done primarily through positive same-store sales growth?
That's correct. Positive same-store sales growth. There's a little bit more runway left on technician pay, and then, obviously, managing our labor costs or our material costs appropriately.
Okay. All right, great. And whether it impacts the gross margin or not, or sales trends, I did want to ask about competition. You know, it does seem from maybe the outside view that, I don't know if the tire industry is getting more competitive, but there's been more news about tire consolidation and more companies getting big quickly, some acquisitions. How has that competitive backdrop evolved in tires over the last five years?
Yeah, it's still, it's still highly fragmented and hyper local. We don't necessarily have, you know, that, that one competitor where it's, it's us and them duking it out in every market across the country. If you look at our competition in any given market, there's going to be two, three, four national chains, as well as a handful of local competitors, regional, and then you've got a handful of mom and pops. So the consumer has choice, and really, it comes down to who's able to deliver a trusted experience, which includes getting them in when they want to, when they want to come in, providing the, the services that they require, doing it right the first time, and then following up with them to make sure we can help them with other, other vehicle needs.
And we feel like we've positioned ourselves through the technology stack that we've added post-COVID, pre-COVID, and post-COVID, around how we operate our stores, including our most recent, technology advancement, which is our Digital Courtesy Inspection, to really create transparency with the guest, and our highly trained and knowledgeable teammates, as we talked about training, helping them get more productive, but also, to be able to do their jobs better and deliver quality for the consumer. So we're really focused on improving that experience. The fragmentation is such that the top 10 national chains only have about 15% of the share. There's about 120,000 locations nationwide. You can be a top 10 tire dealer, I'm sorry, top 100 tire dealer with only 10 locations.
So there's a long tail of fragmentation, and that's why the competition really is hyper local.
Okay. And even some of those bigger players, how do you view yourself as competitively differentiated? You talked about the inspection. What might you offer that some of those other larger, fast-growing chains don't have?
Well, first, we're full service, so we're 50% tires, 50% service. So where you've got some chains that are more focused on oil change, we provide oil change, a different value prop on oil change, maybe not a 15-minute oil change. But we'll do a complete oil change, which includes inspecting your vehicle for other needed work, giving you a safety report on that vehicle. The equivalent of going to the dentist and making sure that the actual dentist comes in and looks at your teeth after the cleaning, not just going in for the cleaning. There's others that are just focused on tires. They will not even really do alignments. So they'll put your tires on, you got to still get it aligned somewhere else. That's not us.
We offer full service on tires, alignments, and then also, if we find other needed work, the same thing, we'll be able to move you into how can we help with your brakes that are down to two or three thirty-seconds? And then we do really a good limited amount of service under hood and under car. So around the wheel, brakes, ball joints, suspension, and then under hood with air conditioning service and flushes. So that positions us in really a way that we can help you maintain your vehicle. We're not gonna do heavy repair.
If you need a replaced head gasket, we're happy to refer you back to the dealer, but we're gonna be able to deliver the brake job, the oil change, the tire service at a much more competitive price than the dealership, and we feel with higher quality than our competition and relative to the mom and pop, with more convenience. We're open on Sundays. We typically have 10+ locations in every geography, so whether you need to go to work and have your car fixed while you're at work or while you're at home, we'll likely have a location near you to be able to help you.
Okay. One thing that I have talked to Felix about is just, you talked about the fifty-fifty mix of tires and then the general repair services, and sort of everything has been seeing same-store sales pressure, and it sounds like tires are, in many ways, the traffic driver. Just help us understand that sort of customer experience and what ultimately you, what levers you pull to sort of draw them into this, to the service centers?
Yeah, that's a great question, and I think that the first thing is there's two main traffic drivers. Certainly, if somebody knows they need brakes and their brakes are squealing, they're gonna find one of our locations and come in. But a lot of times, you look at the different traffic drivers. The first is gonna be oil change. It's the most frequent service that people have every six months. It used to be every three months, three thousand miles, but the technology has moved on. We will be, you know, seeing that vehicle more frequently, getting more frequent inspections on the vehicle and build a relationship there with that guest, get them into our CRM, be able to market back to them.
So that's a big part of taking oil and converting it into a lifetime guest, which supports car count. Tires is the other big piece. It's a less frequent service, every two and a half, three years, but it allows us to take the wheels off, inspect the vehicle, look at the brakes, measure the brakes. Brakes and tires tend to be at very similar service intervals, so a lot of times we're able to make recommendations around those other higher-ticket services. So both categories are really important for us to be able to witness the vehicle and then execute our comprehensive courtesy inspection.
Okay. So, I guess, so if you could talk a little bit more about the tire industry. I think oil change industry's been fairly steady with some other publicly traded players posting same store sales-
Yeah
- growth. But tires feel like they're in this recession, and so maybe help us unpack that a little bit. Are we a significant amount off of, like, pre-pandemic unit levels? What's driving the recession?
Yeah.
Help us understand tires, 'cause it feels like there should be a natural bounce back at some point.
Yeah, I think the tires have really been taking the brunt of the aftermarket downturn because of their high ticket, right? So if you're gonna come in for tires, you're gonna be spending between $500 and $1,000 on, depending on whether you're in Tier One or opening price point. And so with that high-ticket purchase, it's similar to the mattresses or the appliance or any other thing that a consumer has a hard time digesting into their already tight budget that has been made tighter by inflationary pressures in other parts of their budget. So, that's really where it becomes the trade-down you start to see really make itself into the aftermarket because they're needed, but they can't be bought at the $1,000. The $500 becomes more palatable.
Maybe you even have certain customers willing to move into the used tire market, which can be a whole other area of concern related to safety and quality. So it forces them into the Tier Four tires, and that's why we've done a really good job of partnering with our manufacturers, of figuring out how can we get that consumer back into a Tier One through three tire by delivering a lot of value to them, and allowing them to not have to make some of the trade-offs that they're forced to make.
But I think that what needs to happen and what exacerbated it last year was we really didn't have a weather event in the Northeast or in the Mid-Atlantic or the Midwest until you know three storms blew through within two weeks in January, and that really was winter. So our peak tire selling season, the industry in the geographies that we serve, October, November, December, January, it's important for those months to have some more normalized weather trends, and I think that will force the consumer to continue to make those investments in tires, and we'll be there with value when they do.
Okay. All right, and so I wanna move on to cash flow, so I wanna make sure I get it right, but you have your expectations are to generate at least $120 million of cash flow this year, and so I was just doing quick math, CapEx guidance about $25–$30 million, so based on your market cap, you've got a free cash flow yield of over 10% right now, so you're generating quite a bit of cash, so what, what are the strategies to, to drive that cash flow today? Can those be ongoing as we think about even moving into next year?
Yeah, absolutely. So we actually took that number up to 120. Originally, when we had talked in April, that number was about $100 million for the year. The reason why we have confidence in that is that, first of all, the business traditionally delivers a lot of cash, even on pressured profitability, which I would say we're in that realm of pressured profitability right now, at least through our most recent quarter. What I would say is we've got a lot of D&A add back, about $65-$70 million. And then we also have done a really good job through our partnerships with strategic vendors of optimizing inventory, and we've done that through inventory levels in the stores, really focusing on fast-moving inventory.
We divested our wholesale tire business a couple years ago, which has allowed us to move to a much more just-in-time basis with our key tire distributors, and that's allowed us to free up a lot of cash. In addition to that, those extended those strategic partners really allow us to take advantage of extended payment terms as well, which has made our AP to inventory ratio 170%–180% over the last couple of years. So with that, we freed up a lot of cash out of working capital, and that really. That, with just a little bit of profit improvement, gets you to the $120 million of operating cash flow.
Okay. And some of those working capital drivers, is that the fiscal year 2025 initiative, or is that kind of something multiyear that you'll continue to work on?
It's been multiyear. We generated about $130 million last year of cash from accounts payable.
Okay.
We're projecting to generate that cash as part of additional cash as part of that $120 million call that we made. And over time, ultimately, you know, the working capital improvements will need to be supplanted with improved operational cash flow from execution at the stores and day-to-day profitability. But in the meantime, it just shows the cash-generating power of the business, even when in a period of tougher P&L results.
Okay. And so, great capital. What is your priorities for use of cash? So your leverage ratio seems very reasonable right now at about point five times debt to EBITDA.
Yeah.
Doesn't seem like you need to pay down a lot of debt. So what are you doing with all the cash?
Yeah. Well, if you look at the $120 million, like you said, your $25–$30 million, $5 million of CapEx, that puts us at about $90 million of free cash flow. We have $40 million of finance lease obligations, that are considered debt and financing leases on our balance sheet. So principal payments on that is another $40 million. That puts us at about $50 million of remaining cash flow. Our dividend that we pay is about $35 million at these levels. And that leaves us about $15 million to be able to, you know, operate the business, pay down some debt, or use it for other investments back into the business.
The most important thing is that even at these sales levels and these profit levels, which we believe will be kind of cycle lows as we look back on this period of time, we're able to meet all of our capital allocation priorities.
Yeah. Okay. And I wanted to make sure we touched on acquisitions. So Monro does have a long history of being acquisitive. Where do you stand today in making acquisitions, looking at opportunities, and again, using some of that excess cash?
Yeah, absolutely. Monro's grown up to be 1,300 stores, probably only 100–150 stores were greenfields, and the rest, really through roll-up of attractive acquisition opportunities, both infills and moving us to new geographies, and that's gonna be very much part of the strategy over the midterm to long term. We'd love to see, you know, consistent 10% top line growth with a great mix of positive comps and additional unit growth through M&A or greenfield, and we've got white space in great states like Texas and Colorado and Arizona that we don't even have stores in yet, in addition to the infill opportunities we have in our existing footprint. So, the balance sheet, as you said, is strong and poised for that type of growth.
We've been very focused on some of the foundational elements of what we've talked about already, and it hasn't been a bad time to be more interfacing because their deal market has slowed down with cost of capital rising, some bid-ask spreads opening up between buyers and sellers because of it, but we think that M&A will be a big part of our strategy going forward.
Okay. And as we think about that go-forward strategy today, I think you have about 16 different brands based on the region or the geography. Do you contemplate any brand consolidation, then be able to leverage advertising and customer data?
Yeah, we're always looking at, you know, the trade-off between brand equity of the brands that we're acquiring in respective markets that we're entering, and the value of having that streamlined kind of behind-the-scenes ability to leverage the value of a single brand. With the digital marketing approach, the idea of advertising, you know, having to. When you're not on radio, not on TV, and you don't have to list five different brands that you are in that marketing, and you're really going after the digital customer, you can support multiple brands a lot easier. Websites are standard, but can be skinned differently for multiple brands. So the efficiency you get out of advertising is not as great as it used to be when you had traditional media.
But there are still advantages to having a single brand, and we're always looking for where we should be collapsing those. It's not a leading priority right now, but it is something that we plan on addressing, case by case.
Okay. All right. So last question for you, in the interest of time. The long-term, EBIT margin opportunity. So I believe your expectation is eventually to return to a low double-digit, EBIT margin versus, 4.5% today. We spoke earlier around 300– 400 basis points of gross margin, but that would be a very attractive margin expansion over the years.
Yeah.
So what are the building blocks to drive that type of margin expansion over time?
It starts with gross margin, right? We've 400 from where we are, moves us into those high single digits. The last bit is really using that incremental top line to leverage our fixed G&A costs. The team's done a really good job of holding G&A costs flat, flat, flat over the last three years. We've done that by taking about $10 million plus in costs out through back office optimization. We've offshored some transactional roles to lower-cost geographies and countries, and all that has really allowed us to hold our G&A flat in spite of the inflationary headwinds we've seen.
We get some more normalized comp trends, and we'll start to see real benefit from a leverage standpoint, and that should be the last bit on top of the gross margin improvement that would get us back into those double-digit operating margins.
Okay. And to just put a bow around that, the comp trend you addressed, to get back to even just a low single digit, and you can leverage both the fixed costs in your cost of goods and your G&A.
That's correct. That's correct. Both those fixed cost buckets will gain leverage. And then, as we mentioned earlier, we still have, within variable margins, in gross profit, opportunities, to continue to, to wring out some more points in, in technician productivity.
Okay. Great. Sounds like a really nice opportunity.
Yeah.
Thank you very much, Brian.
Thank you for having me.
... for participating today.
Appreciate it. Yeah. Thank you.