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Monro Muffler Brake, Inc. (NASDAQ:MNRO)

F1Q09 Earnings Call

July 24, 2008 11:00 am ET

Executives

Robert Gross- Chief Executive Officer

Catherine D’Amico- Chief Financial Officer

John Van Heel - President, Secretary

Analysts

Scott Stember- Sidoti & Company

Tony Cristello- BB&T Capital Markets

Cid Wilson - Kevin Dann & Partners

Jack Balos - Midwood Research

John Lawrence - Morgan, Keegan

Gerry Heffernan - Lord Abbett & Company

Graham Tanaka - Tanaka Capital

DeForest Hinman - Walthausen & Co

Operator

Welcome to the Monro Muffler Brake first quarter 2009 conference call. (Operator Instructions). I would now like to introduce Karen Barbara of FD.

Karen Barbara

I would just like to remind you that on this morning’s call management may reiterate forward-looking statements made in today’s release. In accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, I would like to call your attention to the risks and uncertainties related to these statements which are now more fully described in the press release and in the company’s filing with the Securities Exchange Commission.

These risks and uncertainties include but are not necessarily limited to uncertainties affecting retail generally, but the consumer confidence, and demand for auto repairs. Risks relating to endeavors service including sensitivities to fluctuation from interest rate dependence upon and competition within the primary markets in which the company’s stores are located and the need and costs associated with store renovations and other capital expenditures.

The company undertakes no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events and circumstances after the date hereof or to reflect the occurrence events, unanticipated events. The inclusion of any statement in this call does not constitute any admission by Monro or any other person that the events or circumstances described in this statement are material.

Joining us for this morning’s call from management are Rob Gross, Chairman and Chief Executive Officer; Cathy D’Amico, Chief Financial Officer. With these formalities out of the way, I turn the call over to Rob Gross.

Robert Gross

Thanks Karen. Good morning and thank you for joining us on today’s call. We are pleased that you are with us to discuss our first quarter 2009 performance. I will also provide you with an update on our business as well as our outlook for the second quarter and full year 2009. I will then turn the call over to Cathy D’Amico, our Chief Financial Officer who will provide additional details on our financial results.

We are please with our performance for the first quarter and are encourage by the positive momentum that our business has sustained over the past five months despite a very challenging environment. As you know consumer confidence is at historically low levels due to many factors including high fuel cost. As a result consumers continued diverse spending when possible and are driving 7 to 800 fewer miles per year an average. That said our business is been only minimally impacted if that all by the decrease in miles driven, because the decrease is not enough to significant reduce the need for repairs

or oil changes.

You may know that oil changes should occur every 3,500 miles to 4,000 miles. However, tighter spending by consumers puts pressure on our store traffic and higher ticket repairs and has also resulted in choppy sales trends in the prior year periods. At the same time, if sales of new cars decreased customers must maintain or make larger repairs on their existing vehicles. In addition our business has been subject to significantly higher material cost, with oil and tire cost increasing several times already this calendar year and showing no signs of stopping.

Given these dynamics, we adopted a strategy of driving store traffic to increase the advertise spending and improve in proven programs and are continuing to implement price increases more frequently and significantly. These strategies have proven effective in our first quarter to continued solid execution, our ability to leverage our low cost business model and of course our strong commitment to quality service and reputation as a trusted service provider.

Now I’d like to review the highlights from the first quarter. Quarterly comparable store sales grew 5.6% on top of the 6.2% increase for the first quarter of fiscal 2008 and exceeding our originally estimated range of 3% to 5%. We generated total sales increase of 11.8% achieving a $120.4 million in sale, compared to a $107.6 million in sales for the prior year first quarter. Total sales included an increase from new stores of $7.4 million, $6.6 million of which was generated from the 19th former Craven and Valley Forge stores and seven former Broad-Elm group stores, which we were acquired in July of ’07 and January of ’08 respectively.

Comparable store sales for our ProCare stores increased 8.2% for the first quarter. As you may recall the first quarter marks the first time that ProCare stores were included in the total comparable store sales base. Net income for the first quarter was $7.8 million and earnings per share were $0.39 compared to $0.36 for the first quarter of last year.

During the quarter store traffic increased 2.5%. Oil changes reminded a key driver for our business. At the same time we’ve experienced significant increases in oil costs over the past several quarters. While we are concerned about the potential impact of our higher oil change prices and our store traffic we have been aggressive in offsetting these higher cost by rising our price and collecting an additional $2 per oil change.

Fortunately we’ve been able to make these necessary price adjustments while maintaining strong relationships with our valued customers. In fact, we achieved comparable increases in the number of oil changes in both our tire and service stores, which were up 3.7% and 4.4% respectively compared to the first quarter of 2008.

Contributing to the success, was our oil change and more program, which includes a free tire rotation and pressure check, as well as a free break inspection with a purchase of an oil change. This program drives new and existing customer to our locations and encourages them to come back to us when they are in need of bigger-ticket repairs. In addition to raising our prices for oil changes, we are also successful in passing along commodity and manufactures price increases in our tire category.

Comparable store sales for tires increased approximately 9% for the quarter, which was driven partially by 7% price increase in June, on top of a 6% increase implemented earlier this calendar year. While these increases were quite significant, our customers generally understand that higher prices are largely results of the macro environment and trust us to service their vehicles as efficiently and economically as possible.

First quarter comparable sales for breaks increased approximately 5%, which also help drive the increase in our average ticket. Sales for the break category benefited from our breaks forever sales program and which we guarantee break pads for the life of the car, and replace pad at only the cost of labor.

With regarding to other product categories, comparable store sales for alignments, which are closely associated with tire sales in our high margin, increased 12%. Comparable store sales for our mid margin, maintenance service category, increased approximately 6%, while exhaust was down 4% for the quarter.

With that I’ll now move to a discussion of our growth strategy. I’ll start with an update on our ProCare stores, which as I mentioned were added to our total comparable store sales base this quarter.

ProCare’s first quarter sales were $10.5 million and comparable store sales were up 8.2%. We are encouraged by ProCare’s performance for the quarter and the positive trends experienced in the business. ProCare is operating profitably, with operating income of $1 million and pre-tax income up $600,000.

Additionally, with three days left in July, comp sales in the ProCare stores are up approximately 11%. We are pleased with the contributions of Craven and Valley Forge tire stores that we acquired in July of 2007. These stores were slightly profitable in the first 12 months of ownership, versus a forecast of break-even. Further, we made progress and integrated our Broad Elm tire chain acquisition and how this grand reopening is part of the Mr. Tire chain in June.

We are pleased with our gain in market we are in. The Buffalo area as result of this acquisition and are satisfied with the progress of its integration. As we have stated before we are confidently assisting potential acquisitions and look forward to capitalizing on additional fairly-priced opportunities that may come above in this difficult environment.

We are fortunate to have the financial flexibility and liquidity to take advantage of these growth opportunities as they arise. Regard these opportunities all I can say is, we are getting closer. We not only seem to expand to reasonably priced acquisitions, but to grow organically as well. To that end, we continue to be pleased with the results of our Black Gold program and which we aim to expand our market share and increase the sales of tires and services in our service stores.

During the first quarter, our 145 Black Gold stores continued to out-performed non-Black Gold service stores entire unit sales, plus 20 versus plus five as well as in comparable store sales plus seven versus plus five. We are on track with our stated goals of adding 25 to 50 stores to our Black Gold program by the end of the fiscal year of 2009 and we’ll focus our expansion in the Cleveland and Columbus areas where we have existing tire stores.

Another important driver of our organic growth during the first quarter was the expansion of our highly effective, low-cost for advertising campaign designed to bolster awareness of our location and to drive new and repeat customer traffic. The addition store advertising program, which we tested in fall are geared largely towards Internet, direct mail advertising campaigns as well as select ratio advertising. We found that radio ads are especially effective as many people listing the radio while they are driving their cars, when our advertisements are most likely to resonate with them.

Our incremental ads spent for the quarter for these programs was $500,000 which we more than recouped as a result of increase traffic in sales. We are thrilled with the result of these programs and the continued momentum they are generating. We will continue to run these programs in Q2 while carefully measuring the effectiveness and returns.

I would now like to briefly discuss our outlook for the second quarter and fiscal year 2009. As I mentioned at the start of the call, we are encouraged by our continued sold performance and positive trends over the past five months, no longer an aberration in my view. Interestingly, I went back to the 1992 period and for those three years, Monro’s comp store increases were better than any three year period since.

We have a very good start to fiscal 2009 and have achieved comparable store sales growth for July of 8% as of this weekend. Well, we certainly are cognizant of the macro environment we are cautiously optimistic about our outlook for the second quarter and the reminder of the year as we expect to continue to produce strong results.

As detailed in our press release this morning, we expect second quarter comparable store sales growth in the range of 3% to 5%. We expect second quarter EPS to range between $0.36 and $0.38, which compares to $0.29 for the second quarter of 2008. Additionally every 1% comp, about 5% is worth another of $1.5 in EPS for the quarter.

From the full year, we now expect comparable store sales growth in the range of 3% to 4%. This compares with our originally anticipating range of 2% to 4%. We expect total fiscal 2009 sales in the range of $455 to $465 million and now expect fiscal year EPS in the range of $1.10 to $1.18 versus our previous estimate of $1.08 to $1.18.

As we mentioned during our fourth quarter call although we are already low-cost operators, our goal is to reduce expenses by approximately $1 million in fiscal year 2009 in order to further increase our operating efficiency. As anticipated we cut costs by approximately 250,000 in the first quarter, which we achieved largely through reductions in back-office expenses. We expect the reminder of the $1 million in cost reduction to be realized in roughly equal installments over the reminder of the year.

Before I turn the call over to Cathy, I want to reiterate that we are encouraged by our results for the quarter and for the past several months. While this time has been difficult for some of the players in our industry, we are satisfied that our dedication of quality service and our trusted reputation enable us to capture market share and growth despite the economic environment.

We will continue our focus on industry leading execution in this dynamic environment and we’ll continue to actively manage our business in order to take advantage of opportunities and react to increasing costs in order to keep up this positive momentum. This completes my overview and now I would like to turn the call over to Cathy for more detailed review of our financial results. Cathy?

Catherine D’Amico

Thanks Bob. Good morning everyone. Sales for the quarter increased 11.8%, comparable store sales increased 5.6% and new stores which we define as stores that opened after March 31, 2007 added $7.4 million, including $6.6 million from the former Craven Valley Forge and Broad-Elm stores. As Rob started the ProCare stores are now included in the comparable stores sales numbers and that compares to the comparable stores sales increase of 6.2%, in the first quarter of last year. There was 77 selling days in the first quarter of fiscal 2008 and in fiscal 2009.

At June 28th, 2008, the company had 713 company operated stores as compared with 696 stores at June 30, 2007. During the quarter ended June 2008 the company closed 7 stores. Just a brief overview of the ProCare stores, as you know we acquired them on April 2006 out of bankruptcy. These stores suffered a significant decline in the recent year and have underperformed. However sales have improved and continue to improve since the acquisition and efforts continue, which focus on increasing sales volume reducing cost and improving margin.

Comparable store sales for the ProCare stores increased 8.2% in the first quarter of 2009. In the first quarter of 2009 also gross profit improved by a 100 basis point and operating income improved by $400,000 to a $1 million as compared to the same period in the prior year. Additionally pretax income increased by $600,000 to a pretax profit of $0.5 million that’s compared to a pretax loss last year of a $100,000.

We believe we are finally turning the corner on the ProCare stores. Gross profit for the quarter ended June 2008 was $50.9 million or 42.3% of sales as compared to $46.7 million or 43.4% of sales for the prior year quarter. The decrease in gross profit for the quarter ended June 2008 as the percentage of sales is due to several factors. The Valley Forge, Craven and Broad-Elm stores acquired in fiscal 2008, increased consolidated material cost and decreased gross profit by $0.03 or percent of sales due to their heavier tire mix.

In addition chain-wide there was a shift in mix to the lower margin tire and maintenance service categories away from higher margin categories. There were cost increases as well in oil and tires. For oil the company was able to effectively offset these increases with increases in selling prices thereby preserving margins.

Additionally selling price increases across the Board helped to partially offset the margin depression caused by mixed changes in cost increases. Overall about one third of the increase in material cost was due to mixed changes and two thirds were due to cost increase. Partially offsetting these increases was the decrease in labor cost as a percent of sale primarily due to the continued significant improvement and productivity of the technicians at the ProCare stores achieved through improve sales and rightsizing of crews. Occupancy costs decreased four tenth of a percent as a percent of sales from the prior year as the company gain leverage with positive comparable store sales.

SG&A expenses for the quarter ended June 2008 increased by $4.2 million to $36.9 million from the quarter ended June 2007 and were 30.6% of sales as compared to 30.4% in the prior year quarter. The increase in SG&A expense as the percentage of sales is largely due to an increase in manager pay related to several factors. There was a 21 stores increase in the weighted average number of stores and there were increase incentives in the first quarter of fiscal 2009 due to improved store performances compared to the prior year.

Additionally management expense increased as a percent of sales is compared to the prior year due to two factors. There is additional stock option and other compensation expense in the first quarter of fiscal 2009 primarily associated with the CEO’s October 2007 contract renewal. Additionally increased management bonus was provided in the first quarter of fiscal 2009 as compared to the prior year, due to the expectation that the company will attain required profit goals for fiscal 2009 which it did not attain in 2008.

With regard to the $4.2 million increase in SG&A expense between fiscal 2008 and 2009 $2.2 million is attributable to an increase in compensation for store managers and as well as addition - new store managers with the increase in stores and field managers as well as the executive management. Overall management incentives are higher than the previous year due to the current and expected improvements in performance at both, the store and the cooperate level. Of this amount $0.5 million relates specifically to field and corporate management incentives.

Additionally our advertising expense increased overall by $600,000 and benefits expense increased by $700,000. Operating income for the quarter ended June 2008 of approximately $13.9 million increased by nine tenth of a percent of sales as compared to operating income of $13.8 million for the quarter ended June 2007. Operating income decreased as a percentage of sales from 12.9% for the quarter ended June 2007 to 11.6% for the quarter ended June 2008.

Net interest expense for this quarter ended June 2008 increased by approximately $300,000 as compared to the same period in the prior year an increase from 1.1% to 1.3% as a percentage of sales for the same period. The weighted average debt outstanding for the quarter ended June 2008 increased by approximately $66 million over the prior year quarter, primarily related to the funding of the Valley Forge, Craven and Broad Elm acquisitions and the funding of the stock repurchase program.

However, the weighted average interest rate decreased by approximately 400 basis points in the prior year. This decrease is due to a shift in a larger percentage of debt, bank revolver debt versus capital leases debt outstanding at a lower rate. The decrease in other income of $300,000 was primarily related to the fact that we received a one time payment in the lawsuit settlements with Strauss last year of $325,000.

The effective tax rate for the quarter ended June 2008 and June 2007 was 37.6% and 37.3% respectively of pre-tax income. Net income for the quarter ended June 2008 was $7.8 million decreased 4.7% from net income for the quarter ended June, 2007. Earnings per share on a fully diluted basis of $0.39 for the quarter ended June 2008 increased 8.3% over the prior year EPS of $0.36.

While pre-tax and net income decreased as compared to the prior-year, it is important to note a few things. First, interest expense is up $0.5 million directly related to the stock buy back and increased debt of $60 million. Second as I mentioned earlier there are a $0.5 million of management incentives included in this year that were not in the last year’s numbers primarily related to the improved operating performance of the company and the retention of our CEO, Rob Gross.

Third, last year’s numbers include the one time gain of 325,000 from Strauss settlement. Normalizing for these items pre-tax income is up about 6.5% over the prior-year in spite of tough gross margin pressures specifically in the form of rapidly spiking oil and tire cost.

Moving on to the balance sheet, our balance sheet remains very strong. Our current ratio 1.4 to 1 is comparable to last year’s first quarter and only slightly lower than year end. The decrease from year end is due in large part to our very deliberate and closed working capital management were above we were able to increase vendor payables and reduce bank debt this quarter.

We generated $19 million of cash flow from operating activities this quarter as compared to $15 million last year and we were able to pay down $15 million of debt during this quarter as compared to about $7 million last year in the same quarter. Last year’s first quarter did include $4 million of the stock buy back of which none occurred in this year’s quarter, as a result of the debt pay down our debt-to-capital ratio dropped to 37% from 42% at year end.

Last quarter we mentioned that we were finalizing an increase in our committed sum under our revolving credit facility. We were able to secure an additional $38 million with no change in terms or cost the borrowing. Bringing our total committed sum to a 163 million. $37 million borrow remains in the accordion feature. At the end of June, we had approximately $77 million available under the facility for borrowings for acquisitions or other needs.

During the quarter, we are also conservative with CapEx spending at $3.7 million, depreciation was approximately $5 million and we received $700,000 from the exercise of stock option. We paid about $1.2 million in dividend.

Inventories are up $3.1 million for March 2008, due primarily to the continued expansion of tire inventory in the Black Gold and other stores. Additionally, we added inventory and then offered to improve stocking levels and mix of inventory to reduce outside purchases and also the buyer had a price of cost increases from our vendors.

That concludes my formal remarks in the financial statements. With that I’ll turn the call over to the operator for questions. Operator.

Question and Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Scott Stember, from Sidoti & Company. Please go ahead.

Scott Stember- Sidoti & Company

You talked about the price increases; can you just give us a little bit of a timeline? I think you guys are scheduled for another price increase with oil changes in December if I’m not mistaken.

Robert Gross

We are constantly evaluating everything. The September fliers went out with moving. I believe it was about a 100 stores up in oil to 2499 from 1999, everything else stayed the same with a number of stores staying at 1999. Now again a 100 more stores at the 2499 level and additional stores at a 2499 level with $5 mainland rebates which we continue to test and make sure again, very cognizant of not wanting to do anything to negatively impact the store traffic that we think the advertising programs are generating. So, that would be what is coming down the pipe and what's occurring this year.

Scott Stember- Sidoti & Company

Alright, and just moving over to book there it’s nice to see that you guys are making a good traction there on the operating line. Could you maybe talk about some of the areas where you’re noticing success and maybe talk about future opportunities to expand markets there?

Robert Gross

ProCare you’re talking about?

Scott Stember- Sidoti & Company

Yes.

Robert Gross

Yes, I think the starting point is the guys have done a real good job finally, getting the right people working in the stores and while we’ve been dissatisfied and feel it’s underperforming, remember it was other bankruptcy running minus 30 constantly, we’ve only owned it for two years so, the people are in place now.

If you remember we advertised in November for the first time when we thought we had the right people in place and we did. Those advertising programs went over the new name on the outside of the location and it takes some advertising to get the name recognition out there and to get customers back into those locations and we’ve really started that processes and earned it in April through June continuing now until the second quarter where we are comfortable driving the traffic into the store.

The labor productivity is better, the sales volumes are now starting to go up, so it reduces our occupancy cost and I think as Cathy said that’s where we picked up the 100 basis points in margin improvement.

Scott Stember- Sidoti & Company

Right and Black Gold you gave some statistics, I missed a few of them. You were talking about I guess the tire sales?

Robert Gross

Tire units in the Black Gold stores are up 20% and they are up 5% in the non Black Gold service stores. For the quarter the company’s overall tire unit improvement was 7%, which is very favorable compared to, most of what we’re hearing out there, you might know better than I do and on the comp basis the Black Gold comps were up approximately 7% where the non Black Gold comps were up approximately 5% for the quarter.

Scott Stember- Sidoti & Company

That was for the whole store.

Robert Gross

Correct.

Scott Stember- Sidoti & Company

And last question on the acquisition environment, I know you mentioned that you’re closed. Are we looking at flier stores or is anything fair gain right now?

Robert Gross

I think, what I said specifically all I can say is we are closer.

Scott Stember- Sidoti & Company

And just what was the CapEx figure for quarter again Cathy and then I’ll leave it for someone else.

Catherine D’Amico

They’re $2.7 million Scott.

Operator

Thank you. Our next question comes from the line of Tony Cristello form BB&T Capital Markets. Please go ahead.

Tony Cristello- BB&T Capital Markets

I guess all things being equal Rob would you prefer to have traffic counts up for better comps?

Robert Gross

Right away I have to choose.

Tony Cristello- BB&T Capital Markets

To me in this environment having traffic up is a bigger signal than just being driven by pricing and its pretty impressive that your traffic up 2.5%, traffic on tires, which is a big deferral category, units being up 4.4% I think is what you said and so what I’m wondering here is, how much is coming from direct marketing or ad versus how much is pent-up demand that you’ve just simply reached the point where you cycle through and now you’re seeing that sales come through?

Robert Gross

Well I think certainly a piece of that is pent-up demand. I think certainly though the increase in advertising well not a tone money if $500,000 for the quarter being very targeted, only brining programs that have worked in the past, has been beneficial to drive new traffic because whether it’s the internet marketing and the buying of key words we’re doing a numerous market or increasing some of the direct mail being sent out to, also that we don’t normally cover or the radio, those are new customers. I think that shows up in the store traffic and it specifically shows up at a higher level with the numbers you quoted.

The 3.7% increase in tire store traffic and oil changes and 4.4% on the service store and that increases on oil changes, while the prices are higher in new customer. So, we already seen specially oil changes go up because to us that means we’re maintaining our current strong hold on our customer base and with the value equation we’re driving new customers into the door, which should feed into profitable in bigger jobs later on if we do a good job in servicing them, but I certainly don’t want to have to choose.

Tony Cristello- BB&T Capital Markets

Again I’m not in the Monroe market, so when you look at these advertise and sort of these direct market mailers one goes out for oil, will the same customer receive the second for tires or are you looking at when the last time they were in, what they came in for and basing that on sort of that data point?

Robert Gross

Sure, obviously with current customers one of the value added things we provide to the customer is again we’ve got a dominant lead in the month of their state inspection and we track when it’s time for their next oil change. So, we will certainly hone in and target them for specific services that we think they need and again customers that we see three or four times a year know when it’s time for the break, so when it’s time for the tires. We certainly have seeing customers trade down on tires getting less expense of tires, but that advertising program would be geared towards our current customer base.

The key words that we are purchasing i.e., say like used tires and things like that and fine tuning some of the internet advertising most likely is hitting an all new customer base as would any radio advertising we are doing because those are not vehicles we have historically done, they’re fairly new. It broadens our P&L and then once those drive the new customers in the door, again the process will start over again with us and those new customers that are being barreled down and are reading the month of their state inspection and start tracking their mileage so we can add value and let them know when it’s time for their service.

Tony Cristello- BB&T Capital Markets

I don’t know maybe the Cathy if you have this number or not, what is your add spend as a percent of revenue or is that something you can share with us?

Robert Gross

Sure, I think when we said in total for the year that the incremental advertising we are planning on doing if it continues to work is about $500,000 a quarter, that’s $2 million for the year, that would bring our overall company ad spend from what historically has been or about above 3.3%, 3.4% of sales up to 3.7% of sales.

Tony Cristello- BB&T Capital Markets

And one of the other pieces of this that I think when you look at that cost of goods I guess fuel costs are going up and from a distribution standpoint that has to be impacting this sum as well, that number is included in your cost of sales I’m assuming and how has that changed on a year-over-year basis?

Robert Gross

I can’t give you a specific number. I think that John Van Heel and his team have done a good job of as we said in picking up the $250,000 a quarter in cost savings cutting back roots, consolidating things, making our selves more efficient in the warehouse; again things have won’t negatively impact our customer, but certainly our cost of gas, our cost of diesel, our cost of utilities, our cost of oil all are up.

I think also those guys are doing a good job in hedging a lot of utility costs, so any year-to-year we only have 50% of those costs for utilities and natural fuel gas, negatively impacting us and a lot of that will come during the winter and we’ll see what kind of winter we have up in the Northeast, but we are focused on every piece and as we said at the end of the fourth quarter we really are running our business and it made adjustments on our business model not necessarily in anticipation of what the last five months have delivered and I don’t know if we can continue this momentum all the better with some of the adjustments we’ve made in the cost structure going forward to try and combat what is a high commodity cost and volume mix across the board.

Tony Cristello- BB&T Capital Markets

And one last question, you did a five, six comp and now July’s 8% comp and it seems like your guidance is three to five on compared to two, are we being conservative Rob.

Robert Gross

How about I tell you in September?

Tony Cristello- BB&T Capital Markets

Okay, fair enough. I will let’s someone else to ask some question, I appreciate of that.

Operator

Thank you. The next question comes from the line of Cid Wilson from Kevin Dann & Partners. Please go ahead.

Cid Wilson - Kevin Dann & Partners

Cathy what was the depreciation, amortization for the quarter, could you give that?

Catherine D'Amico

Yes, $5 million.

Cid Wilson - Kevin Dann & Partners

Okay, and also can you give some sense of what’s you’re long-term that the cap may look like by the end of this year, what your guidance is in terms of your target?

Catherine D'Amico

I wouldn’t expect we would play out $50 million in the quarter going forward Cid. Some of that was training, but I think we could probably be in the mid 30% that’s the Cap mid to low 30’s by the end of this fiscal year.

Cid Wilson - Kevin Dann & Partners

Okay and then my last question is that where there any geographical variances in your sales?

Robert Gross

No, I mean business was fairly solid, the advertising programs were there, certainly ProCare’s in Ohio and Pennsylvania did a little bit better, but they’re starting off with the worst space. I mean the tire stores, the service stores, in general any weakness in our business is probably personnel related as opposed to geographically related.

Operator

Thank you. The next question comes from the line of Jack Balos from Midwood Research. Please go ahead.

Jack Balos - Midwood Research

Hi, I was just wondering given your recent increases in the prices of tires, how do the gross margins and tires now look versus a year ago? Are they still declining or are they stabilized?

Robert Gross

Well, I think they’re stabilizing. It’s hurting our overall gross margin because it’s becoming a bigger percent of the business. As Cathy mentioned the mix issue, but we’ve increased the price of tires relatively significantly with a 6% increase and a 7% already this calendar year. It’s being reflected in the comp store sales, the margin is holding up and what we see happening is we raised those prices across the board on all tires but people in the tier category are trading down.

Jack Balos - Midwood Research

Well how does that all end up in terms of the -- you’re saying the gross margin itself in tires versus a year ago is therefore lower?

Catherine D’Amico

Gross margins are little bit lower than it was the year ago on tiers.

Jack Balos - Midwood Research

Okay

Robert Gross

But in general Jack don’t forget, our alignments are up 12% and that’s probably about 90% margin business and that’s not included in what you’re asking which is this discreet gross margin on the rubber sale.

Jack Balos - Midwood Research

Okay, okay. Regarding the management incentive pay you made and the stock option as all that that occurred in this quarter; is this all just upfront first quarter spending that will not be repeatable going forward?

Robert Gross

No I think at least as far as my $22.80 options that I’ve got in ’07 obviously the company creates that charge, every year until they fully invest. I think there is another year beyond this year that that charge exits, but it’s a non-cash charge. As far as bonuses for the management team and Vice Presidents, that is an incremental dollar amount that won’t be paid until year end and we’ve hit the target, so from the cash flow prospective it’s not in there; from an expense prospective we’re hoping to continue a performance and get paid a bonus this year versus not getting paid in the last couple of years.

Jack Balos - Midwood Research

Okay, at so this point it should continue on a quarterly basis.

Robert Gross

That’s correct.

Operator

Thank you. The next question comes from the line of John Lawrence from Morgan, Keegan. Please go ahead.

John Lawrence - Morgan, Keegan

Rob would you talk a little bit about the distribution center and then clearly the last couple of years a lot of the retail guys have expanded inventory etc. how much of your sales is coming from the third party versus your distribution network?

Robert Gross

About 85% of everything we deliver is in-house, 15% would be net our Advanced AutoZone.

John Lawrence - Morgan, Keegan

And as you continue to move that, obviously that’s been one of the success factors; as you continue to grow and look at that network and now with the tire business so much strength how should we look at that going forward, I mean I guess two fold: number one, is what's the next cost element to the increase the distribution capacity?

Robert Gross

Again if you remember over the last couple of years in our CapEx we’d budgeted approximately $4.5 million for expansion of our warehouse in Rochester, New York and right now we’re delivering to all of the stores throughout. In the last couple of years, we decided based on the environment and the fact that we haven’t successfully grown to the same level we had hoped to, that that facility will be in a nice city; it hasn’t gone to the point where we have to do it.

When we grow the business further, you will see that capital expenditure will come out. It won’t significantly increase our cost. Some of the things you’re asking about relating to the distribution is why our inventory was up $3 million going into the busy season for parts proliferation for more tire buys, before price increases from the manufacturers who went into place to position ourselves to take advantage of bringing in stock, so we buy less outside.

John Lawrence - Morgan, Keegan

And as far as those commodity cost pressures, what's the next level of -- I understand your fighting through this everyday, but I mean what's the next level of discounts based on your size in some of these categories? Or is there another level of discount?

Robert Gross

Well, the more you spend there is always a level of discounts. Unfortunately as a percentage of sales, we don’t get it based on the absorbent cost we’re now paying, it’s based on units and tires or galloons in oil, but certainly as our traffic increases and as our oil change numbers increased and as we saw more tires and last year we were over a million units in tire sold and our units, first quarter we said we’re up seven, that will trigger additional co-op, which would then be plugged into a reduction in cost of goods, and show up in our gross margin, that’s the same thing that occurred last year.

Operator

(Operator Instructions) The next question comes from the line of Gerry Heffernan from Lord Abbett & Company. Please go ahead.

Gerry Heffernan - Lord Abbett & Company

Hey Rob, I’m not sure if it is the fact that you just speak so softly and slowly or I’m getting a little bit older. Did you say ProCare on a fully loaded expense basis was profitable?

Robert Gross

Yes.

Gerry Heffernan - Lord Abbett & Company

Okay and you made a mention that in April thorough June began a what is it a direct mail advertising program in the I guess what is referred to as the ProCare market?

Robert Gross

It was direct mail and some internet advertising.

Gerry Heffernan - Lord Abbett & Company

Okay. Was it direct mail that was pretty much evenly distributed over where that entire store base would be or did you target like a micro geography of the full ProCare area?

Robert Gross

No, we have the customer list, the old customer list from ProCare when we purchased it and obviously that’s a starting point and then our normal direct mail would – we’ll get zip codes around stores and other opportunities and internet usage and markets like Columbus or Boston or Washington D.C. where there is a high-level of usage to identify opportunities to advertise which we did not significantly do as I said in the past just based on not being comfortable in driving traffic and underperforming.

Gerry Heffernan - Lord Abbett & Company

And that’s kind of the key I wanted to know to latch on there. In this April to June period, did you go all out on what you would consider a 100% marketing effort using that direct mail and internet list or are you in “you know what, let’s start doing it but we’ll turn the dial up” when and if we see success with handling the increase traffic.

Robert Gross

Sure, the overall for all stores, was $500,000 and we felt that we wanted to increase our advertising for new customers to get across effectively what is higher retail price to them. We didn’t want to raise our prices without trying to promote it and a lot of retailers in this environment cut back advertising and cut their prices.

We felt that with some of the programs we’ve implemented both in ProCare and companywide like the Brakes Forever, which we feel is a value added program to guaranteeing their brake pads, like the oil change and more where we will give you a free tire rotation and a pressure check and its adds value to what the customer is getting, makes our price point not totally be tied to price and generates a traffic increase and more names going in our data base.

So specifically, we didn’t do anything significantly more than ProCare and it was burdened with these costs that we did in the quarter companywide. I think the performance in ProCare just had further to go and I think that’s why you see it leading on a comp basis and you would expect that based on what it was before we got the stores and the two years it took us to fix them

Gerry Heffernan - Lord Abbett & Company

Right, that’s great I appreciate all that information. I guess kind of where I was going at this from was having worked with you guys for several years here I know that you were one, you have stated in the past with ProCare “hey look I’m not going to drive people in there only for them to have a lousy experience and then not show up again.” Two, when you go to do things you, “hey let’s start out, see if it works and then we can keep on adding on.” So I am just wondering now in ProCare was this a first step as far as driving traffic and you’re saying “you know what, there’s now a couple of more levers that I can pull now, but I’m happy with the way we are able to handle this first step in traffic increase” or did you just say “you know what, were ready now, all levers on.”

Robert Gross

I think certainly the $500,000 number per quarter we’re repeating that in Q2 and that would be the expectation for the additional spends both in ProCare and companywide in Q2. The question for us more is “can you afford to continue that level into Q3 and Q4 were the volumes are slightly lower; I’m certainly happy with the success in Q1.” If the answer is “do we have more bullets?” and if things continue the way they are, might you see us spend $750,000 at quarter or additional in ProCare to continue to drive traffic. I think the short answer is in Q3, for the ProCare stores, for sure we will continue at the level we currently are that has been working, that might be some reduction in Q3 and some advertising. If it looses still now obviously….

Gerry Heffernan - Lord Abbett & Company

Okay. I was trying to concentrate my efforts just on the ProCare market but my hard thoughts being and Cathy you can certainly jump in here too is that to the extent that you can start rationing up the traffic count in that area, we had a set of stores that was a drag on profitably for a while and they have the most, the greatest marginal benefit from a step-up in each percentage of traffic count give to the point we’ve just gotten back to a full absorption level and everything from here would be gravy as compared to the other stores where we’re trying to three yards and a cloud of dust, lets just get that a little extra more out of, because they’re already in a nicely profitable position.

Robert Gross

I don’t disagree with the promise that there is more upside on ProCare than there should be, that being said, I would like to see -- we’re talking about everything we’re doing has been working in the last five months and it’s going to continue and certainly I don’t think we’re going to go into Q3 or Q4 on ProCare and trying to ration it down. That being said 8% companywide, with ProCare 11% we are not talking about monumental incremental spend and I think, I’m saying that which probably supports your point and what your trying to say is “it’s 10% your business, yes it’s running up well, how much better would it do is another -- whatever it is $50,000.” I don’t disagree I’m trying to get through August.

Gerry Heffernan - Lord Abbett & Company

Okay, okay and please don’t report in September because that would be a prerelease. How about we wait for the news front in October.

Robert Gross

Well, maybe it’s going to be a good prerelease.

Operator

Thank you. The next question comes from Graham Tanaka from Tanaka Capital. Please go ahead.

Graham Tanaka - Tanaka Capital

Related to the ProCare maybe you can sort of get at terms of the sales per foot and the margins there now versus where you would like to get them to be?

Robert Gross

The sales per square foot I don’t have of that the top of my head. As our metrics of utilization kind of look at sales per day and if you saw my run rate of $40 million out of 72 square averaging six days, you probably have that number and what was the second one?

Catherine D'Amico

I think on margins Graham we’re doing probably a little better than we thought we would be on leverage at this point because it’s such a significant improvement from last year and getting some good leverage on the occupancy. On material costs we’d like to see chainwide, its better there. Some of that is a little bit outside of our control as we said with the material cost, but we can certainly emphasize mixed changes, more brake in the ProCare stores as we’re doing throughout chain as well. So that would be a area where we and maybe a little bit less in outside purchases there as where there might be a little bit more opportunity.

Robert Gross

The biggest opportunity, which I think Gerry on the previous question, was getting to is we need to grow the sales of ProCare. The runs are stable and as those sales go the biggest improvement we’ve made there, the labor and that’s stuff is great, but as sales go up 10% or 15%, our occupancy cost start dropping and net net our goal with ProCare would be -- the whole chain would run 150 basis points, 200 basis points behind the Monro Service stores in general and the reason for that difference is not the occupancy cost then, but the fact that they have smaller storage spaces and we will always have slightly more outside purchases in those locations than we will in the rest of the distribution network and the chain.

The biggest opportunity for us is they were down 30% top, when we took them over. If we can get back to only down 10, these things are very profitable and at least for the last five months, we’ve made some progress there and potentially maybe we can ramp it up and make more.

Graham Tanaka - Tanaka Capital

Well if the set map is relatively correct, you have the potential then of having maybe a 20% improvement in sales and therefore what kind of an improvement in margins as you go from what it was, to what you get to say in a year or two?

Robert Gross

Well, I think as a company as a whole, we say it’s approximately 40%; ProCare should be able to run at 38%.

Graham Tanaka - Tanaka Capital

And that’s right now roughly at what level?

Robert Gross

33%, 34% something like that.

Graham Tanaka - Tanaka Capital

Okay, so another 5% improvement? You have progress already in other words. You have…

Robert Gross

Yes, sure but again as we’re doing the map on this in a while, it certainly will be profitable and certainly will be meaningful and remember we’re talking about 8% of our sales.

Graham Tanaka - Tanaka Capital

Okay. The other is I just was wondering about the total time lag as cost increases and pass through’s in terms of price. I remember back, believe it or not, I go back as far to the late 70’s early 80’s when we had all these huge price increases, the first the line of oil price increases and a hyper inflation, and the companies that did well were those that were able to get their price increases through and not have a big lag relative to their cost increases. What kind of a time lag are you facing? Are you pretty much, doing a contemporary in this?

Robert Gross

Again the best and closest example is we had a 7% price increase from the tire manufacturers that went into effect July 1 and across the board, we raised all the prices on tires on June 1. So, that helped margins in June, which we should continue to see some benefit in July and by September we’re probably going to be in the same boat I guess.

We certainly have given notice and pretty much across the board whether it’s oil or tires, which are the big items that are going up, we will try and bring any manufacturers pass through dollars by 30 days and you get ahead of the curve. It’s a little bit more difficult sometimes with suppliers and the advertising to catch up, because those are two months out.

Graham Tanaka - Tanaka Capital

That’s fabulous. Now, the other thing is on the downside, were we to have a continued drop in oil prices and then show on the later products, tires, etc, would you be sticking on the downside or would you be lowering prices at the same time as cost go down?

Robert Gross

Lowering prices to retail?

Graham Tanaka - Tanaka Capital

Yes.

Robert Gross

No, I think we’ve found our new level and if the prices go down on the cost, ideally we would return that to you guys. Nothing is special dividend Graham. We make more of money.

Operator

Thank you. We have time for one further question. It comes from DeForest Hinman, Walthausen & Co. Please go ahead.

DeForest Hinman - Walthausen & Co

Hi, I kind of have two more on just one of these questions; do we have the material snow player business at all?

Robert Gross

Not really, I mean our markets are obviously the Northeast and lower. I mean radial tires and some of the products, whether it’s Goodyear or Bridgestone, Blizzards things like that that, we certainly sell those. We do have a material November tire business where in our markets, people upgrade and get new tires before the winter and that’s why our third quarter is stronger where margin gets a little bit weaker because the percentage of our business that is tire related specifically related to November as people buying tires, changing tires whatever it is, but upgrading their vehicles before the winter and the lions share of those expenditures ends up being on tires.

DeForest Hinman - Walthausen & Co

Alright, and then on the utility side, what do we heat location with. Do we have any ability to us waste oil burning systems, so it’s like we do the oil change, but we yet oil back and we can use it to heat the building?

Robert Gross

I have John Van Heel here, President of the company and John?

John Van Heel

Yes, we do have waste oil systems and in the number of our stores. It’s less than 200 of the stores and there we look for stores that have a high natural gas usage and enough put through or throughput on the oil changes to where we are putting the waste oil herein. Most of our stores are heating with natural gas though and as Rob said we normally hedged about 40% to 50% and fixed those costs year-to-year to try to maintain some consistency there in volatile markets.

DeForest Hinman - Walthausen & Co

And has the waste oil program in terms of the burning units, is that’s something we’ve been expanding or is that kind of just steady state?

John Van Heel

It’s more than at steady state. After Katrina certainly there was some benefit as we knew where the natural fuel gas was going to go. There is absolutely a payback and some kind of final print maintenance costs as you go forward. So, at very high levels of natural gas it makes more sense than where we were for at least part of the last 24 months. So, we’re little bit at steady state. The main thing is we do try to keep those natural gas contracts fixed there, so that we’re not really exposed significantly in a high cost market.

Operator

Thank you and at this time there are no further questions in the queue. I would like to turn it back to Mr. Gross for any closing remarks.

Robert Gross

Certainly we’re happy with the quarter, but we’re hoping to continue the momentum and one quarter does not the year, but it’s encouraging. Certainly the traffic improvements and that price increases are sticking and customers are coming back and they see value in our offering and we look to hopefully have some good news for you when we report on our next quarter and thank you very much for your participation and interest.

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