All right. So last but certainly not least, happy to introduce Monro. So they're an auto repair and service provider. They serve the do-it-for-me segment, which is about 50% of their business. Exciting story as they go through their turnaround plan. Led by President CEO Peter Fitzsimmons and Executive VP and CFO Brian D'Ambrosia. Pleasure to have you guys here, and we'll get it started. Everybody hear me okay? So maybe to start off, if you can just give us a few-minute introduction of Monro for the people in the audience who might not be as familiar.
Sure. So Monro is a national chain of auto aftermarket service businesses. We sell tires, and we also provide a wide range of services that include oil changes, brake jobs, ride control work, what I would describe as preventive maintenance. The company's been around for probably 60 years, Brian. And I think we've been public since 1991. We, like others in the industry, have had some headwinds from what's going on with traffic. But about 8 or 9 months ago, the board was unsatisfied with the pace at which the company was improving its performance. And so I know some of the board members and learned about the opportunity to take the CEO job. I've been working in retail and the aftermarket for 25 years. Some of you would know that I've had an affiliation with the consulting firm AlixPartners for over 20 years.
By the way, I also have worked in private equity as an investor. So I have capital allocation experience. And after joining the company at the very end of March, literally, Brian, I think it was at the very start of the new fiscal year. Our fiscal year starts in April. We undertook a diagnostic and perhaps, Eddie, you're going to ask me some more questions about that. Brian, would you want to add anything to my comments?
No, I would echo Peter's comments about our work over the last eight months that we'll unpack as we go through the questions, I'm sure. But the meaningful progress we've made in changing the trajectory of the business against that challenged backdrop, particularly more recently in traffic trends.
Yeah, I mean, we could start there. So after joining the company, you went through a review, a strategic review of the company. Can you just share some of the findings you found and then kind of the strategic pillars you guys are continuing with?
Sure. So anytime that I would begin to work with the company, either in the CEO seat or in some other role, I would try to do a diagnostic that involves senior management as well as the next layer of management in the company. And so, in April and May, with Brian, Nick Harris, Chuck, and a number of other executives, together with AlixPartners, we looked at the things that we thought would move the needle most this year. And we set as our goal a desire to meaningfully increase operating income this year, regardless of what happens in the economy. I think I had three hypotheses and then one thing that became very obvious in the first week I was there. The three hypotheses were, first, you really should be looking at the store portfolio to see if all the stores in it deserve to stay in the portfolio.
The second would be, we know that traffic has been an issue in the aftermarket. What can we do to drive incremental traffic? And the hypothesis was, what through marketing can we do?
The third need or hypothesis was, in every retailer or aftermarket company I've ever worked in, and I've worked as a CFO in auto parts. I've worked as a CEO in collision repair. There's a need to raise the level of performance in all the stores. Usually, there's uneven performance. And I felt that was true at the company. Certainly, from talking to Brian and Nick, I felt that was true. And then the realization in the first week or two was prior management had been involved in merchandising, and a couple of the people who really were leading that effort were gone.
And it was very clear to me that we were under-resourced in the merchandising area. And so the fourth workstream that we set back in May, all of which were approved by the board, was to improve our merchandising team. And when Eddie asked me, I'd be happy to tell you what we did with each of those workstreams.
How about we start there on merchandising? Can you just provide more detail on that and then how you're aligning assortment with customer demand currently?
Sure. I think I felt that we were a bit over-inventoried and our assortment was too broad, particularly in the tire area. Half our sales are tires, half our sales are service with some kind of part involved. And so we felt that over time, what we wanted to do was to make sure we had the appropriate assortment in each of the tiers, one, two, three, and four tire tiers that met the customer need without having everything for everybody. And we felt that if we worked on that from the outset, we would be able to reduce our inventory levels and provide the guests with a more clear view of what we stand for. And so we also recognized we needed to strengthen the team itself. And we were fortunate in June to hire Katie Chang as the Senior Vice President of Merchandising.
Katie really had an excellent background for what we were trying to do because she had worked at ATD, who is one of our suppliers, knows the tire world backwards and forwards. And she also, prior to that, had experience at Lowe's, the retailer. So she really knew what we were trying to accomplish from a retail perspective, a service business, as well as tires. Since then, I would add, we've added a couple of other important resources to merchandising, including a senior resource in tires and a senior resource in pricing. And both of those things are important to what we're trying to accomplish this year. We've met with all the vendors. I can tell you with great confidence that every single tire vendor would like to sell more tires to us.
And so we've had very constructive conversations with all of them about what we would like to have in our assortment and what we're looking for in terms of partnership. So I feel really good about where we are in terms of offering a narrower assortment that's appropriate for all our customers. And by the way, with ATD and a number of the other distributors, including US AutoForce, we have the ability to get any tire that the customer wants within half a day. So we're going to point the customer towards a certain type of assortment, but if the customer would like something else, we can get it for them.
Maybe staying on this tire for a little bit, can you just talk about the current tire environment? How you're kind of working with the manufacturers to meet consumer demand? And then any thoughts on when we might be able to see an end to this kind of deferral cycle towards the lower-tier tires?
Well, I think that from our perspective, the market continues to be interesting. Let me use that word. I think in the first quarter of the fiscal year, we felt we took market share, and I think we probably took a little bit of market share in the second quarter. I think one thing that the company has done even before my arriving was to manage the amount of people that trade all the way down to tier four pretty well. That's continued. So we've done, I think, pretty well in tiers one through three. At the moment, I feel very good about our ability to sell tires and more of them in this quarter and beyond than we have in the past.
But I think we both said just a couple just last week, actually, during our earnings call, that we felt a little bit of tension with a certain segment of our customer base around the pressure that they're feeling with rising costs. But I feel pretty good that what we're doing right now is going to drive incremental revenue regardless of what happens in the market.
So another focus area was finding the underperforming stores. I guess, and so earlier this year, you closed on 145 of the stores. Can you just talk about how you identified these and then if there's any opportunity to recapture the sales at some of your other locations?
Sure. So we knew from the outset that we were probably going to close some stores. The company's closed stores in the past, but more in the 20 to 30 range than a larger number. In the first two weeks we were there, we looked at the performance of every single store in the year that had just ended. Remember, I started at the start of this fiscal year, as well as in prior years. We looked at trends just as any one of you in this room would do. We concluded that there were about 100 stores that were no-brainers. We should close those 100 stores. Then we had another 100 that we thought could be a good market. Maybe things have just gone the wrong way in the last couple of years. Let's think about what, in addition, we would decide to do.
We conferred with Nick and the entire operations team and concluded we'd close another 45. I said back in April and May, I didn't want this year to be about closing stores. I wanted it to be about improving operating performance, and especially in the continuing stores. We were very aggressive in deciding that we wanted to get out of the stores by the end of the first quarter. We got board approval around May 20th. We had closed all 145 stores, I should say, by the end of May. We had moved all the inventory either back to vendors or within our system because we needed it somewhere else in the system by the end of June. We were completely done with exiting 145 stores in 45 days. Hard to do.
I can also tell you, and Brian may want to talk about this a little bit later in our conversation, that we immediately worked on monetizing the closed-store real estate. We've been successful with that in the second quarter. I think we continue to expect that. Exiting a combination of owned and leased stores will be cash flow positive, and most of that will be done within the next couple of quarters. It's been, I think, a very successful store closing initiative.
If you want to touch on the progress on the store exits?
Yeah, absolutely. Absolutely. We talked about it on our earnings call that we have, since the 145 stores, divested of the real estate of 24 of those locations, 21 leases, and three owned locations. In the quarter, that raised about $5.5 million of proceeds and a gain after the termination of the lease liabilities of almost $7 million. So, well on track to live into the cash flow positive comments that we've made about the monetization of the real estate and the exiting of the leases.
Do you need to effectively do that for the other 120 or so? Okay.
Yeah, and there's activity, some of which has closed, others that are in the process of closing in our current quarter. But we do expect that it will be completed over the next few quarters.
Would this be, I would suspect, diminishing returns, though, as far as, I mean, you sell what you can early, and then you got to have to work harder for it?
Not necessarily. Every buyer has a different diligence approach. On the owned stores, they can take a little bit longer because of the environmental phase two work that a buyer will do. So not necessarily. But there will be certain probably ones and twos as you get to the end where we'll make some decisions about time versus dollars.
Is the balance more? Does the balance have a higher mix of owned as opposed to leased stores?
Well, 145 were the original. And of that, 40 were owned. And so it was 21 leased, 3 owned in this last quarter.
To what extent do you need improving car counts to get the margin improvement? Do you have cost of goods or pricing or overhead wiggle room that you can, with a static base of car counts, get the margin? And what do you think the operating margin potential is? And I think your past peak EBIT was during a period where you owned your distribution. You've since outsourced it. Does that change the opportunity at the margin in two or three years?
Quick comment, and then you can pick up. One would be, I think we're a very different business than we were five years ago. We don't have a wholesale business anymore. We're a service business. I think that the things that we're doing, we're going to get to this in a little bit, I think, in marketing and improving performance in the stores is going to drive positive comp store sales. And that together with, I think, a pretty solid gross margin. If you looked at the first two quarters, you'd see that we were settling in in the mid-30s%. I think that's a good gross margin for us to significantly improve our operating performance. So I think revenue lift and mid-30s% margin is a key to significantly increasing our profit.
I would agree with that. I would say within gross margins, we have two components, kind of the more fixed nature of the costs, which I would put our occupancy costs as well as our technician labor. Certainly, at certain points, technician labor becomes variable, but we'll put it in fixed for now, and then variable material margins, so if we kind of rewind over the margin pressure we saw as we exited FY25 and it came into FY26, that was largely driven by variable margin pressure within tires and the material side. So as Peter said, with our pricing tool, as well as some flattening out of the year-over-year pressure related to tires, as we've done a good job of holding mix within those tier one through three categories while getting very good brand support from our branded manufacturers.
We saw 50 basis points of actually material margin expansion in this last quarter. So a good guy on the variable side, and we are hopeful that that continues as we continue to roll out and ramp up our pricing tool, which really doesn't increase prices, but obviously allows us to optimize pricing and balance volume and price. On the fixed cost side, that's going to just benefit from a larger top line and get leverage across those fixed costs, as well as obviously our G&A fixed costs. I would say that as it relates to the question of where should operating margins be, the high watermark, to your point, was 13, I think a little over 13%. We were a lighter mix of tires back then, so that certainly impacts the business. We did have an owned distribution, which has some puts and takes of its own.
But I would say that what we believe is that a stronger top line underpinned by improving traffic trends. Our year-over-year average repair order is up mid-single digits, as we talked about on the last call, really driven by a little bit of price, but a lot of attachment related to better execution across our ConfiDrive digital courtesy inspection, attaching other needed services to our traffic base, and so with that to continue and some improving traffic trends on the back of the marketing initiatives, that should set us up for over the coming quarters, not giving guidance here, but over the coming quarters for us to live into that fixed cost leverage on a better top line.
I hate to say this, when I think of Monro, I think of Triple M. Mavis, Midas, and Monro. Under one umbrella. So when you look at the data, no, no, don't. I'm not asking you to blink. I just think when I look at their comp store sales and the revenues and the geographic locations, can you kind of comment on what you think their margins are and how you would look if they followed you or you followed them?
I'm not sure that I could comment on their margins. What I can tell you is that our pricing tool, which uses machine learning or artificial intelligence, enables us to look at what our competition is doing in every market across the country. And we know what we're doing, and we know what kind of marketing support we're going to get from our tire vendors. And I think that's going up because they like what they hear from us. And we are 1,116 locations. That's a lot of scale for any tire seller. So I think that we're very competitive. And I think our pricing tool allows us to adjust either up or down by tier and by market what we want to do to make sure that we can attract more customers to our store.
Right now, what we're trying to do is to increase unit sales with this pricing tool and all the marketing things that we're doing. And so I don't know exactly what other people's margins are, but I feel pretty good about our having a solid margin for the rest of this year.
Since we're on these kind of conceptual approaches. Solomon. His. Ownership of the blocking stock ends when? What's the status of his holdings?
So I believe the preferred C sunsets sometime next year in the spring.
Yeah, it'll be the announcement date of the annual meeting when we typically do that, end of June, beginning of July. And so, maybe also just to rewind one question back, I would say that one of the things that has come out of the assessment, as well as the work that was done by both AlixPartners and with Peter coming on, was we set a plan that we think we can deliver. Obviously, we haven't shared the full details of that plan. But we are holding each other accountable to that plan. And that will help us to deliver what we have talked about, which is meaningfully increased operating income and increase in adjusted diluted EPS and year-over-year increase in comps. And we believe this is building the foundation for improved operating performance in FY27 as well. So, if there is any difference in margin, difference in performance relative to the competition, we're focused on just being better than we were.
When you are thinking about capitalization, obviously, capital lease is a fairly significant portion of that. As you're going through this process on the owned versus lease going forward, any thought to that on the type of structure you want there?
Yeah, not really. The way we've got that capital lease, finance lease, and debt obligation balance on our balance sheet is from past acquisitions. So when we've done deals, we've kind of been agnostic in terms of whether we were going to give more purchase price, more term, and more consideration within the leases versus upfront purchase price for the seller. And because of that, if they want more term and more lease consideration, then the way the accounting and the purchase accounting works is you end up with more lease obligations. So no concerns there. We have been, as those leases, and you can see that our finance leases are decreasing at a higher rate than our finance lease payments. And that's because many of those leases, as they roll off and get renewed, are being put back on as operating leases. So we can go ahead and tackle the other two initiatives that you guys are going through.
Really dovetails with some of the questions that you've asked recently. Did you have a question?
Yeah, just one more question. And Peter, I guess when you think about your role with Alex and the turnaround of Monro, are you thinking that you stay with Monro when this turnaround is complete, or is this turnaround sort of a transition and then somebody else takes the baton from there?
I have a history of working with companies for as long as it takes to improve performance. I don't think I've been as fortunate as I have been in this particular case to have a company that has no liquidity problems. We have a $500 million line and $60 million borrowed. That has a reason to exist and prosper. So I'm not going anywhere. I can't tell you exactly what the terms of all that are, but I think I'm really excited to continue to work at the company. And the company has engaged third parties over time. AlixPartners has been very helpful in providing analytical support. The pricing tool is something AlixPartners helped the company develop. I'm going to get to this in one second, but our marketing strategy is something that the firm developed.
And to the extent that any third party might be helpful to the company on a go-forward basis, I certainly would be supportive of that. But I would also say that one of our objectives in stores, in marketing, and in merchandising has been to make sure that we got the people into the company because they were either there or because we recruited them that can own everything we're putting into place right now. And I think we're in a pretty good place on that. Marketing, two other work streams that are really important, marketing and store improvement. And questions around how are you going to improve performance and what's different this time? I think, again, in the first two months, the diagnostic revealed that we hadn't invested very much in marketing in the last few years. We'd underinvested in marketing.
The second thing that was obvious was one of the things that we did last year was use a promotional tool to drive oil traffic. And it drove oil traffic, but we weren't making any money on it. And so what we decided in May was we were going to introduce a series of digital tools to drive incremental traffic. We were going to do a customer segmentation that would identify what the preferred type of customer for us is. And that is a repeat customer who spends three times as much as the average customer and whose profitability and margins are much higher. And that we would begin to deploy a series of digital tools that includes Google Search, streaming, and some YouTube to drive incremental traffic. We tested that in the first quarter, meaning we tried 50 stores, let's see what happened.
We had a control group, we compared what happened, et cetera. We started implementing that in July. And in each month since there, July, August, September, October, we've added about 125-150 stores to this. In every single tranche that has received the digital tool support, we've seen positive comp store sales, every single one of them. And it lasts. Through the end of October, we only had about half of our stores covered. I would say that in the second quarter, we'd had maybe a third covered. There's a lot of upside based on what we've seen in terms of incremental comp store sales coming from applying the digital tool, maybe not to all the stores, but to a significant majority. We also have had a CRM capability that we've used quite a bit over the years, and we have a certain amount in our budget for that.
But again, with the tools that we've developed, we are much more conscious of how to reach with the right content the different segments. I'm going to name two segments that are important to us. One would be what we think of as a value-oriented buyer. And that's someone who's interested in not just one service, but tires, oil, brakes, more than one service. And obviously, those are attractive customers and they're good margins. And so that customer is going to get a certain type of content in the digital marketing that we use to attract that customer in the store. There's another important customer, a reasonably affluent customer who has got a newer vehicle, who really wants to trust the service people that they go and get their service from. That's a different type of content that they get.
And so the segmentation, plus our ability to use digital marketing, I think, together, and digital marketing is acquisition, whereas CRM is pulling existing customers back into your stores, that also will contribute to driving incremental revenue. The last thing I would mention to you is you all have heard us talk about the call center, which has been in place for probably a year and a half. There's 350 stores that aren't on the call center. They'll be on it in two weeks. All of these things collectively are going to contribute to pretty good comp store sales in the next couple of quarters, above where we were before. And of course, we're all concerned about the challenges that we have in the current market, but I think that the marketing things that we put into place are really going to pay off soon.
Then marketing and improving performance in the stores go together. You've heard us talk about our inspection tool, which is called ConfiDrive. We introduced it about a year and a half ago. Last year, Nick and the team were very effective at getting everybody to do it. This year, they know how to do it. And not only can we provide every single guest that comes into the store with a free inspection that tells them what sorts of things they ought to be thinking about doing to improve the safety in their vehicle, but we can give them photos. We can say, "Here's a brake pad that needs to be replaced." Here are some other things that you should be thinking about. And where that's paid off in the last two quarters is with significantly higher unit growth in brakes and in ride control.
Two very high margin coming to the question about where your margin is going to end up, service categories. So the inspection tool is also going to help us drive incremental profitable revenue across the stores. There's a couple of other things that we're doing in the store performance area. For example, more and more guests engage using online scheduling or calling and making an appointment through the call center, and they don't necessarily speak to somebody at the store. We have an ability now to reach out to that guest before they actually get into the store because we know they're coming on Saturday at 10:30 and say, "Can you just expand a little bit on what you want? You said you wanted two tires.
Just tell us a little bit what you're looking for so we can be ready for you." Everyone knows that good service companies provide a good guest experience when you come in. And if we're contacting the customer before they actually arrive, they're going to get a better experience. There's some other things that we've put into place. We have excellent measurements of what we're doing in every store every day, and we look at it early in the morning. But we've added something that we're calling a district manager toolkit, which tells every store manager what they should be thinking about. Why am I not getting enough attachments to my tire sales? What other things should I be thinking about? Where is my labor productivity? We can provide much more information to the district manager and the store manager so that they can manage their business better.
And I know from a lot of experience in the aftermarket that you can't be too complicated. You got to keep it pretty simple. I think we'll continue to stay focused on the five to 10 things that matter for stores to improve their performance. So really, over the next few quarters, it's the marketing and the marriage of the marketing and the store performance that I think will improve our business.
Peter, Brian, we are unfortunately out of time, but I want to thank you very much for a really comprehensive look at what's ahead. It's very clear that the plan, at least to me, in place is one that is measurable, is actionable, and something that you all can execute on. So I wish you luck and thank you very much for being here.
And Mario, thank you for including us. Time flies.
It does. Thank you very much. Good luck.
No problem. Thank you.
On behalf of my teammates, I just want to thank you. Thank you all for being here. Also, a special thanks to the AV team for helping with the seamless Zoom. For those who enjoyed this content, please join us November 14th at the Convene in New York for our healthcare symposium, and thank you all, and we'll see you at number 50. Thanks.