Good morning, ladies and gentlemen, and welcome to Monro Inc.'s Earnings Conference Call for the Second 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. [Operator Instructions] 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.

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 2, 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'll spend the first part of our call this morning reiterating our strategy which we are firmly committed to. After that, I'll provide an overview of the continued progress we've made as evidenced by our second quarter results, along with some perspective on inflationary pressures that are impacting the consumer and our business. I'll then provide an update on our cash creation and capital allocation. Before I start, I'd like to thank all of our teammates in our stores and our store support center for their continued dedication to serving the needs of our customers in our business. As a reminder, regarding our strategy, we are a leader in the highly resilient and largely non-discretionary auto services aftermarket. We have significant scale that gives us important competitive advantages over smaller players in our industry. We leverage our scale and the strength of our financial position to make critical investments in our business. Our people and technologies deliver an outstanding guest experience. For more than a year, we have been actively addressing the staffing needs of our stores. We have built the labor capacity in our stores to meet customer demand. We are now focused on continuously improving our in-store execution, properly training new and existing teammates, and reallocating resources between front of shop and back of shop investments to maximize store productivity. We still have important work to do to achieve the kind of operational excellence that will allow us to consistently deliver on our mid-single digit comp store sales expectations. We are committed to a balanced approach between service and tire categories to drive additional profitability at our locations. We are also continuing to execute on our strategy to improve our underperforming stores, which represent about a quarter of our overall store…

Thank you, Mike. And good morning, everyone. Turning to slide 7, sales decreased 5.1% year-over-year to $329.8 million in the second 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 $29 million in the prior-year second quarter. Comparable store sales increased 1.3%, while sales from new stores increased $8 million. Gross margin decreased 220 basis points from the prior year to 35.4%. A higher mix of tire sales and 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 costs 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 100 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 $93.3 million or 28.3% of sales as compared to $96.2 million or 27.7% of sales in the prior-year period. The increase as a percentage of sales was principally due to the divestiture of our wholesale tire and distribution assets. This was partially offset by prudent cost control in the quarter. Operating income for the second quarter declined to $23.5 million or 7.1% of sales. This compared to $34.5 million or 9.9% of sales in the prior-year period. Net interest expense decreased to $5.7 million as compared to $6.3 million in the same period last year. This was principally due to a decrease in weighted average debt. Income tax expense was $4.7 million or an effective tax rate of 26.6% compared to $7.3…

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. I'd now like to provide an update on recent board actions. First, our board has retained the services of an independent third-party search firm to assist the nominating and corporate responsibility committee in identifying a diverse pool of potential qualified board candidates with appropriate skill sets and experience. In addition, the independent and disinterested members of the board have initiated a process to engage a financial advisor to evaluate options for recapitalization that would provide for all of Monroe's outstanding stock to have one vote per share and for the elimination of veto power of one class of stock over another. We'll provide further updates on this work as appropriate. With that, I will now turn it over to the operator for questions on our quarter.

[Operator Instructions]. The first question comes from the line of Daniel Imbro of Stephens Inc.

I wanted to start on maybe [indiscernible] just the pricing. You talked about maybe choosing not to pass some of that through. Mike, if I heard you right, I think you said you're doing that to kind of limit deferral and try to retain some of those services. But when we look at the category, it looks like there was kind of a pickup in deferral across brakes and alignments. Can you maybe help to square away those comments and discuss a little more why you chose not to pass through the pricing and whether that's a temporary shift or kind of an ongoing change to your pricing on some of these categories for the next couple of years?

A really important question. I would say what we saw in the second quarter is very different from what I was talking about in the first quarter. When I looked at our data, looked at the industry and looked at how tires were performing, we were talking about that as a significant headwind and the consumers were definitely telling us and talking to us about the fact that things were tightening up with our consumer in the marketplace. As an organization, we did a ton of work around really divesting our nine distribution centers and then selling our tire distribution center to ATD and really bringing that to life. One of the things we've recognized is the fact that we were going to broaden our assortment across all of our stores. And, yes, we were going to be very price competitive. Just to remind everybody that the investment in our labor and our technicians is still paramount. And I want to keep these techs working. And I really want to continue to drive to mid-single digits. But I want to do that in a very balanced approach. Tires – and I would say tires absolutely outpaced our service categories, but also talking about our service categories, that's our next focus, is really getting a balanced approach for us to deliver that mid-single digit growth and beyond. And, yes, we did a lot of work on tires. And we are getting rewarded with that, with sequential improvement. And now we're actually seeing units positive in October. And I like that position where we're starting to go positive in units. And I'm talking about positive customer count rather than just pricing as our way to driving sales improvement.

I saw a question on that and you talk about not using price. I guess, are your competitors doing the same thing? Are you seeing others continuing to pass through price? And if you are gaining shares and you're not passing through price, is there a risk that others just start getting sharper on price on the tire categories or some of your service categories? And then it becomes more price competitive than the industry has been historically?

Yeah, no, that's a really good point. I think the big change for us, especially using ATD, is we changed our mix. And we talked about good, better, best. The majority of our stores had only really better, best. So we introduced opening price point using our broader distribution relationship. And we got rewarded for that. So, we are priced for a similar SKU, just like our competitors. We are very consistent. We're not taking prices below market. We're really holding our price and staying competitive. But we're really now more attractive to a whole new customer, especially on the tire side, which is that opening price point tire customer.

The next question comes from the line of Brian Nagel with Oppenheimer.

The first question I have, just with regard to kind of the longer term, that target of mid-single digit comp growth. In the current quarter, we ran low-single digits. Mike, maybe just help bridge that? What has to happen? How much of that is internal in the efforts there versus some type of stabilization or improvement, if you will, in the macro environment?

I would say, the macro environment is what it is. I think October is a great indicator of what we're doing right now. It's approximately 4%. And just to remind everybody, we didn't get any help from Hurricane Ian at all. So I would say that the team performed well, really driving what I believe is going to be an expectation going forward with that mid-single digit number. I think, Brian, it's really clear to me. You've got to grow tires and oil, and that's your customer. And those are the customers that come into your stores over and over again. And at Monro, we weren't always looking at having increased customers. We were driving a lot of our sales improvements through price. And I would say that's still a part a the equation, but it's now very balanced. So how the organization situated right now is we're very focused on improved units, actual units, as well as increased sales through units and price on the tire side and having the appropriate service categories coming to life. And the big category, obviously, would be brakes. Although we see everything we're seeing, the industry is still behind last year. We do believe that's a deferral cycle and we're going to be able to take advantage of it when the customer comes back.

My follow-up question. You mentioned in your comments just, I think, you're seeing potentially the end of the deferral cycle. I know you just mentioned a second ago, too. So I guess, why would that be happening here? If we look just broadly speaking from an inflation perspective and other – there's still a lot of pressures on consumer. Why do you think you're starting to see potentially the end of that?

In this business, and I've been in this business for 30 years, brakes don't get better over time, tires don't get better over time. So I really look at vehicle miles traveled. That's stabilizing even versus pre COVID. So I see a lot of the behaviors really were with the customer, saying, okay, they're deferring at first. I saw four tires to two tires, two tires to one tire. And now I'm seeing the customer actually looking at service categories, especially on undercard, these are expensive services and they're waiting. And I think as an organization, our opportunity is to go back, reach to those customers, invite them back in, so that we can take care of their services. Those cars don't get better over time. So I feel like, in the past, I've always referred to as a two month to three month deferral cycle. And it seems like at least on the tire side, that's come back faster. I credit the team's execution, as well as our new distribution relationship. And then, on the service side, it's very consistent with that also, specifically calling out brakes and chassis.

I would add to that, Brian. When the consumer is coming back and we've seen it in our tire category, they are looking for value. And so, it's really important, as Mike said, that we repositioned our assortment and we're seeing that in opening price point. We're seeing that across all tiers where we're seeing customer shopping at price points that maybe they wouldn't have previously and repositioning that tire assortment has been important to make sure that we get the share of that customer as they come back and look to service their vehicle.

If I could slip one more in. I hear exactly the point you're making. You're really now much more focused on pricing. So, generally speaking – and obviously, we're playing against a dynamic pricing environment given inflation and such. But is pricing now where it should be, are there still going to be tweaks going forward?

I feel good about pricing. But there's four things. When you look at our gross margins, it's price – it's our tire specifically with price. Most importantly, it's mix. So I want a balanced approach to the business. Brakes have a significant different margin portfolio than our tire category. And then last, but not least, is leveraging our investments in our technician pay. So when I look at our margin, price is one of four components of how I do this equation going forward.

The next question comes from the line of Bret Jordan with Jefferies.

Could you talk about the tire units versus price in the comp? I think you said they turned positive in October on units. But could you talk about the full quarter?

Bret, for the quarter, units were down, and it was led by price. But as Mike said, the units – we saw unit momentum as the quarter progressed leading to positive units in October.

I guess on the part side of the business because you've gotten out of distribution, were you 100% externally purchased parts in the quarter or are you still working through inventory you had when you were self-distributing?

We're still working through, but for the most part, since we don't have any distribution centers, whatever exists in the store, we're working through that right now. So a lot of activity, not only on the parts side, but the tire side really getting ourselves positioned to be really nimble. I would call us right now very nimble using our third-party providers as our new distribution arm.

Brian, could you give us the monthly comp cadence?

We're down 0.7% in July, up 1.9% in August, up 2.5% in September and then, as we said, up 3.7% in October, which obviously is our third quarter.

The next question comes from the line of John Healy with Northcoast research.

I wanted to dive a little bit more into the tiering on the tire side. Talking about adding a good line to the kind of portfolio makes a ton of sense right now. Is there a way to think about just how those tiers are priced? Like, what's the spread between good and best as well as what size of the of the portfolio you'd like that good or opening price point tighter to represent [indiscernible]?

Really important question. So, when I look at opening price point and specifically good, better, best, I'm looking at about – 33% is going to be opening price point, 33% or more, maybe as much as 40% is going to be mid-grade, and then the rest, about 25%, is going to be premium. And then you have specialty. So when I look at what we've done and using our third party partner – remember, we have stores that already had good, better, best, and they were performing well. It's the stores that didn't have opening price point that we then met and we put this new product in there. Didn't do any marketing. We basically just put it in the stores for our teammates to sell to our customers. And I believe that when we see our units starting to improve, that's the math equation that we really want to bring that to life. But I would use just easy math, one-third, one-third, one-third. And I would say, going forward, we're going to be looking not only at our tires, but also all of our categories where there's choice required. We're always going to give our customers choice because I do believe that's what they're expecting right now, especially now with regards to what I believe is a very difficult time for our consumer to make sure that we give our customers choice. From a pricing perspective, I'm looking anywhere between $20 to $30 as the gap per tire on price. So, good to better would be about a $20 difference. Now, truck tires and small diameter passenger light tires, obviously, have a small differential or larger differential, depending on the size of the vehicle.

Just comps and sales trends aside, I was really impressed with what you guys continue to be able to do on the working capital side of things. And kind of given this kind of adjustment you're making in terms of mix and adjustment that you're making in terms of kind of sourcing a bit, how much of this movement of working capital could still be ahead of you? Is there more to grab there? And how structural are the gains there, do you think?

I appreciate the call out on the working capital improvements. There's still more to come on the working capital side. We haven't really framed or quantified that element of guidance, obviously. But we do believe – and we talked about it in Q1 that the working capital reductions will be supportive of a likely record year in our operating cash flow this year. And that will continue to support our capital allocation strategy, which we made great progress in in the quarter related to our share repurchase, our continued dividend program, and then, obviously, we remain opportunistic as we evaluate acquisition. So, it's a big part of our cash deployment strategy, our growth strategy, our shareholder return strategy. And there's still a lot of opportunity ahead for us to take some cash out of working capital.

That concludes the question-and-answer session. I will now pass the line back to the Monro team for closing or additional 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.

That concludes the conference call. Thank you for your participation. You may now disconnect.