Monro Inc (MNRO) 2006 Q4 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Monro Muffler Brake fourth-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct the question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder ladies and gentlemen, this conference is being recorded and may not be reproduced in whole or in part without permission from the Company. I would now like to introduce Ms. Cara O'Brien of Financial Dynamics. Please go ahead.

Thank you, operator. Hello everyone and thank you for joining us on this morning's call with Monro Muffler. I would just like to remind you that on this morning's call, management may reiterate forward-looking statements made in today's press 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 more fully described in the press release and the Company's filings with the SEC. These risks and uncertainties include but are not necessarily limited to uncertainties affecting retail generally, such as consumer confidence and demand for auto repair; risks relating to leverage and debt service, including sensitivities, fluctuations and interest rates; dependence on and competition within the primary markets in which the Company's stores are located and the need for and cost 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 or circumstances after the date hereof or to reflect the occurrence of anticipated events. The inclusion of any statement in this call does not constitute an admission by Monro or any other persons that the events or circumstances described in such statements are material.

Joining us for this morning's call from management are Rob Gross, President and CEO and Cathy D'Amico, CFO. With these formalities out of the way, I would like to turn the call over to Rob Gross. Rob, please go ahead.

Thanks Cara. Good morning and thank you all for joining us on today's call. I will begin with a brief overview of the quarter and year, provide an update on our recent acquisition and other strategic initiatives and review our outlook for fiscal '07. I will then turn the call over to Cathy D'Amico, our Chief Financial Officer, who will provide additional details on the financial results.

During fiscal 2006, we continued to execute our strategic plan and make progress on our key initiatives. As a result, we increased same-store sales by 1.7%, the Company's fifth consecutive year of comp sales growth, improved our operating margin by 60 basis points and grew our bottom-line by 15%, our seventh consecutive year of 15% or greater bottom-line improvement. I'd like to take a moment to review a few of the key highlights for the year.

First, we achieved a record level of $39.8 million in operating income which represents an increase of 16% from 2005 and record diluted earnings per share of $1.51 per share after a $0.02 charge in fiscal 2006 related to the acceleration of stock option vesting versus $1.35 in fiscal 2005. Excluding the stock option charge, our diluted EPS would have increased 13% to $1.53 per share from fiscal 2005.

Second, we continue to drive comparable store sales increases with our maintenance services and tire categories leading the way. For the year, we generated an 8% comp store increase in the maintenance service category and a 7% comp gain in tires. The expansion of these categories is a result of our efforts to provide our customers more the maintenance services that they require even as they continue to defer larger ticket repairs whenever possible and the strength of our growing tire business. For the year, the tire category increased to 23% of total sales from 20% last year and maintenance services were 28% of total sales compared to 27% last year.

Third, we were able to raise our prices twice during the year. When consumers need repairs, they come to Monro because they trust us to do the job right the first time and not to sell them services they don't need. It is this customer loyalty we have built over the years, our market dominance and our convenience that has allowed us to implement a program of consistent price increases.

I also want to highlight our 60-basis-point improvement in operating margin from the prior year, which was achieved despite the shift in sales mix to the lower margin tire and service categories. We are very focused on constantly improving our business model, leveraging fixed costs and taking out expenses that are invisible to the consumer. This allowed us to translate a single-digit sales increase into a solid double-digit bottom-line gain.

We also continue to open new stores in existing markets. During the year, we added 10 new stores, including for B.J.'s locations which helped us further increase our market presence at attractive price.

In addition to driving organic growth, we also made significant progress on our stated acquisition strategy. During the third quarter, we acquired a 13% stake in Strauss Discount Automotive, which operates 100 stores in the New York City, New Jersey and Philadelphia markets. We are extremely excited about Strauss' solid presence in these highly desirable markets and are pleased that they have already begun to benefit from our relationships, industry expertise and buying power. Our amended agreement gives us the option to acquire the 87% of Strauss we do not currently own on or before September 30, 2006. We have made substantial progress in working with Strauss' management team to date and we look forward to adding the Strauss locations in the second quarter of fiscal 2007.

We took another significant step on the acquisition front during the fourth quarter with our bid for ProCare Automotive which subsequently closed in April. While we there is still a lot of work ahead, we are very optimistic that ProCare will prove to be an excellent addition to our business. ProCare is somewhat unique from our past acquisitions in that we have typically purchased well-run mature chains that are accretive to earnings within the first 12 months of ownership. However, since ProCare was in Chapter 11, it will have more in common with greenfield stores from a modeling perspective. In other words, it will take longer than prior acquisitions to ramp up to Monro's historical margin levels, but on the other hand offers above-average opportunity for comp sales growth going forward. For example, we expect the acquired ProCare stores to run significantly higher comps in years two through four as compared to our typical acquisition.

We are confident our operating team is up to the task of integrating these new stores. In fact, we have made substantial progress in our first three weeks of ownership and are encouraged by our accomplishments to date. Within our first weekend of ownership, we have already installed our point-of-sale system in all stores, provided initial training to store employees, delivered an initial inventory to each store and added all employees to our payroll system. We opened all stores for business on the morning of May 1 after having formally won the bankruptcy auction on April 28, 2006. Of the 75 locations we acquired, we plan to convert approximately 44 to the Monro Muffler Brake & Service brand and the remaining 31 locations into Mr. Tire stores, thereby leveraging our strong brand names. We are particularly pleased to add a substantial number of service stores to these important existing markets where we have every confidence in our field management team's ability to effectively integrate and develop these stores.

As always we were very disciplined and committed to buying right and I want to stress that we were able to purchase ProCare at a very attractive price -- approximately $130,000 per bay, which includes 8 times rent, CapEx and inventory investments, versus 160,000 per bay for a greenfield store. And in the ProCare acquisition, we start out with their dedicated employees, proven real estate at attractive rents and an existing customer base. We have already taken steps to demonstrate the benefit of Monro's acquisition of these locations to both ProCare's employees and customers. In fact, we recently launched a marketing program to welcome all of ProCare's customers to the Monro family and to provide advertising support to the markets in which these stores operate.

So to sum up fiscal 2006, we again produced very strong year-over-year operating results, outperforming our peers during what was a challenging operating environment for much of the year. We also made measurable progress on our acquisition strategy and further strengthened our foundation for future growth.

I would now like to discuss our outlook for fiscal 2007. For the full year, we are currently estimating bottom-line growth will range between 11 and 17%, which is in line with our stated bottom-line target of approximately 15% growth. However, I want to stress that the quarters are going to look noticeably different than the prior year. Specifically, we expect a Q1 diluted earnings per share will be below last year’s levels, Q2 earnings per share will be approximately flat with last year's Q2, third-quarter EPS will be up approximately 25% over last year and fourth-quarter EPS will be up approximately 100% over last year. I would like to take a moment to walk through the factors that are causing this shift.

First, as I mentioned, ProCare is going to take a longer time to ramp up than our typical acquisition. As such, we view fiscal 2007 primarily as a building year for this group of stores. We are currently expecting ProCare to add 33 to 35 million of sales during fiscal 2007 and to be breakeven to a loss of $0.05 on the bottom line for our 11 months of ownership. We expect the majority of ProCare's dilutive impact will be felt in the first half and particularly in Q1 as we invest in the business and work to fully integrate the new stores. That said, we believe ProCare is an excellent investment and it will positively contribute to comparable store sales and bottom line in fiscal 2008 and beyond.

Second, the industry environment was particularly challenging in Q4 as rising gas prices and interest rates caused consumers to continue to defer automotive repair purchases. Thus far in quarter 1, we have seen this trend continue in both traffic and comparable store sales. That said, we believe that many of these purchases cannot be deferred indefinitely and history tells us that our customers will return. Even as household finances become tight, consumers will need to spend to keep their cars in good shape and avoid the even greater expense of purchasing a new vehicle.

Thus far in Q1, April comps were down approximately 4%. While we have seen some improvement in May with comps down approximately 2.4%, our first quarter comps are expected to be down versus the prior year. For the full year, however, we are projecting an increase in comparable store sales of 1 to 3%, which assumes consumers returning to more normal purchasing patterns later in the year.

Third, we are working on a new oil supply agreement which we expect to result in a substantial increase in cooperative advertising funds for the full year. But due to the reporting of this contract under EITF 2-16, will be skewed towards the third and fourth quarters.

And finally, fiscal 2007 is a 53-week year which means we will have an additional week of operating activity reported in the fourth quarter of fiscal 2007 as compared to the same period in fiscal 2006.

To summarize our outlook, we currently expect earnings per diluted share in fiscal 2007 to be between $1.68 cents and $1.76 compared to $1.51 earned in fiscal 2006. This range assumes comparable store sales of 1 to 3% for the full year and total sales in the range of 410 to 420 million, including 33 million to 35 million for the ProCare stores. On a quarterly basis, we expect a Q1 to be in the range of $0.45 to $0.48 per share compared to $0.52 last year due to a 2 to 3% decrease in comparable store sales and the operations of and integration costs associated with the ProCare acquisition. That said, we expect to see the second half significantly higher than last year due to the expected timing of consumer purchasing patterns, the expected improvement and results of the ProCare stores as the year progresses, the new oil supply contract and the extra week in Q4.

Additionally, it should be noted that our fiscal 2007 estimate includes $0.02 of expense related to stock options, the same level as fiscal 2006, although the expense in 2006 was all recorded in the fourth quarter.

As demonstrated by our fiscal 2006 results and our estimated full year 2007 results, our operating model is working and we remain as confident as ever. We are proactively working on advertising and marketing initiatives to drive traffic and we continue to closely monitor expenses to mitigate the impact of slow consumer spending. As always, we remain committed to taking advantage of attractively priced acquisition opportunities created by the difficult market conditions to continue our growth and generate future earnings without risking the integration of either ProCare or Strauss.

More simply put, with our operating margins more than double most of our competition, any industry weakness creates the opportunity for accelerated growth for Monro as competitors will need to sell. Further, we have an excellent team in place to lead us forward. In that regard, I'm pleased to announce that Joe Tomarchio, Jr. has been promoted to President of the Tire Group. Since Joe joined our company with the acquisition of Mr. Tire, he has done an outstanding job leading this important growth area of our business and in that time, we have increased the number of tire stores that he is responsible from 26 to 115.

We also announced today that our Board of Directors approved a 40% increase in our quarterly dividend to $0.07 quarterly, or $0.28 annually. This decision not only reflects our commitment to enhance shareholder value and encourage long-term investment in Monro, but also underscores our confidence in the future prospects of the Company. Given our strong financial position and cash generation, we have the flexibility to both pay dividends and continue to invest in growing our business.

All of that said, as we look ahead, we are confident in the position we've established for Monro Muffler Brake in the marketplace and are optimistic about the long-term effectiveness of our operating model and our future growth prospects. We remain committed to growing our business and increasing profitability over the long run. We look forward to a solid fiscal 2007. Further, given our opportunities with Strauss and ProCare, we are even more optimistic about our prospects in 2008 and beyond.

This completes my overview and now I would like to turn the call over to Cathy for a more detailed review of our financial results. Cathy?

Thanks, Rob, good morning everyone. Sales for the quarter increased approximately 9%. New stores, which we define as stores opened after March 26, 2005, added $5 million. Also included in sales is a bulk sale of $3.5 million of slower-moving inventory. Comparable store sales decreased 4/10ths from the last year and that compares to a 4.5% increase in comparable store sales in the fourth quarter of fiscal 2005.

There were 78 selling days in the fourth quarter of fiscal 2006 as compared to 77 selling days in the fourth quarter of fiscal 2005. Year-to-date, sales increased 9.3%. New stores -- I'm sorry -- those are stores that opened after March 2004 -- added 26.6 million. Comparable store sales increased 1.7%. Bulk sales of slower-moving parts totaled $4.1 million. And in that regard, it is important for us to decrease inventory and improve turns as more of our vendor agreements are renewed is subject to the EITF 02-16 and that bulk sale helped us to do that. That compares to a store comparable store sales increase of 2% for the year ended March 26, 2005. There was one additional selling day in fiscal 2006. There were 308 selling days in fiscal year '06 and 307 in fiscal year '05.

Gross profit at 36.8% for the fourth quarter ended March 25, 2006 declined as a percent of sales when compared to the same with last year which showed a gross profit of 38.5%. The declining gross profit as a percentage of sales is due to several factors. The primary reason for the decline was a shift in mix to lower-margin tires and maintenance services from the core higher-margin steering and exhaust business. We also experienced cost increases in both oil and tires between fiscal year '05 and fiscal year '06. Comparable store tire sales increased approximately 6% in the quarter and maintenance services increased 1%. The bulk sale of slower-moving inventory at a lower gross profit contributed to 2/10ths% of the decline in total cost of sales.

Partially offsetting this decline in gross profit was a slight improvement caused by an increase in the higher margin comparable store brake sales of approximately 3% due to increased emphasis and promotion by operations and marketing in the quarter.

The amount of vendor rebates recorded against material usage in the fourth quarter of fiscal year '06 declined as a percent of sales as compared to the prior year quarter simply related to timing as the Company implements EITF 02-16 for new vendor agreements signed after December 2002.

Outside purchases remain a challenge as the Company continues to expand its service offering with the continuing parts proliferation but remains flat as a percent of sales as compared to the prior year. Additionally, labor and occupancy costs, both components of cost of sales, declined as a percent of sales as compared to the prior year quarter. Labor declined in part due to a shift in mix, but also due to better labor control and increased productivity as compared to the prior year. Occupancy cost decreased slightly as a percent of sales due to the leveraging of fixed costs against increased sales.

Gross profit for the 12 months ended March 25, 2006 declined as a percent of sales from 40.5% to 40.1% of sales primarily due to the shift in mix as previously discussed.

Operating and selling costs expenses for the quarter ended March 2006 decreased from 32.2% of sales in the prior year quarter to 30.5% of sales. The decrease is primarily attributable to the leveraging of fixed costs against sales and better experience in health and other insurance expense than in the prior year. SG&A expense for the fourth quarter of fiscal year '06 also includes a pre-tax compensation charge of approximately 300,000 related to the acceleration of the vesting of all outstanding stock options.

SG&A expense for the year 2006 declined by 100 basis points to 29.3% of sales from 30.3% of sales due to similar reasons that caused the decline in the fourth quarter of fiscal year '06.

Net interest expense for the quarter ended March 2006 increased by 0.2% from the prior year to 1.1% as a percent of sales. The weighted average interest rate for the current year quarter was approximately 270 basis points higher than the rate for the same quarter last year. Offsetting this was a decrease in the weighted average debt outstanding in the quarter ended March 2006 of approximately 10.5 million from the prior-year quarter. This 30-day LIBOR rate increased -- including the Company's spread, increased 120 basis points between March 2005 and March 2006, and prime increased 175 basis points in that same time frame.

For the year, interest expense was essentially flat as a percent of sales. The weighted average interest rate for the year increased by approximately 250 basis points from the prior year and offsetting this was a decrease in the weighted average debt outstanding for the year of approximately $6.4 million.

The effective tax rate for the fourth quarters of fiscal 2006 and 2005 were 40.8% and 33.2% of pre-tax income, respectively. In the fourth quarter of fiscal 2006, the Company reduced stock option expense, most of which is not tax-deductible. In the fourth quarter of fiscal 2005, the Company reduced excessive tax cushion by $200,000.

Other expense for the fourth quarter decreased by approximately $1.1 million from the prior-year quarter primarily due to the relocation and related gain on the sale of a store in the fourth quarter of fiscal 2006 as compared to expense from disposals in the fourth quarter of fiscal 2005. Diluted earnings per share for the quarter ended March 2006 were $0.21 one as compared to $0.19 for the fourth quarter of fiscal year 2005. For the full year 2006, diluted earnings per share increased 12% and were $1.51 as compared to $1.35 for the year ended March 2005. The weighted average shares outstanding for the quarter and year-to-date both increased by approximately 3% as compared to the prior year.

Moving onto the balance sheet, we still have a very strong balance sheet. Our current ratio at 1.6 to 1 is comparable to last year. Inventory is up approximately $1.7 million from March 2005 due primarily to new store openings and our continued efforts to improve stocking levels and mix of inventory to reduce outside purchases. However, turns were slightly improved from last year March. For the year, we generated approximately $32 million of cash from operations and received 4.4 million from the exercise of stock options and warrants. Total CapEx this year is approximately $19 million with 3 million coming from capital leases and 16 million through cash expenditures. We also realized approximately $3 million from the sale of fixed assets.

We've paid down $14 million of debt and paid $2.2 million dollars in dividend. We made a $2 million investment in Strauss and lent them $5 million. Depreciation and amortization totaled approximately $18 million. As a reminder, our debt to capital ratio is 20% and we have $93 million of availability under our credit line and plenty of room under our debt covenants. So as Rob said, it makes it very easy for us to do acquisitions as the right ones present themselves.

Rob gave some guidance for fiscal year 2007, stating an earnings range of $1.68 to $1.76 per share after an expected $0.02 charge for stock options under the new accounting rules. CapEx is expected to be approximately $32 million, which includes $6 million for ProCare, $3 million for an expansion of our headquarters and warehouse space to accommodate our growth and $6 million for new stores. Approximately 17 million will be for maintenance CapEx as compared to $12 million in FY '06. We expect depreciation and amortization to be approximately $20 million and free cash flow to be between 45 and $46 million. EBITDA should be in the range 65 to 67 million as compared to 58 million in fiscal year '06. We expect operating income as a percent of sales to be relatively flat as compared to fiscal year '06, which was 10.8%. However due to the change in accounting rules for vendor rebates which records these credits as a reduction of cost of sales, we expect to see if flip of about 100 basis points between cost of sales and SG&A with cost of sales declining and SG&A increasing. Interest expense at approximately 1% of sales should also be relatively comparable to fiscal year '06 and should range between 4 and $4.4 million.

That concludes my formal remarks on the financial statement. With that, I will now turn the call over to the operator for questions.

(Operator Instructions). Tony Cristello.

I guess the one question I want to ask on ProCare is, as you're now dug into the ProCare and their processes, is there anything you will be doing differently now in terms of integration that causes more near-term expenses than you originally anticipated?

And the second part would be -- what are some of the changes in terms of how you are approaching ProCare than maybe you were a month or six weeks or eight weeks ago?

Sure. I think the biggest immediate change that is going to cost us capital is, initially, we thought we would keep the ProCare brand name for anywhere from one to three years. It was a fairly strong brand name and obviously you eliminate the cost of changing the signs. We will be changing the brands immediately, as we said, to Monro Muffler Brake & Service on the 44 service stores and initiating the [Mr. Tire] brand in the three markets -- Columbus, Pittsburgh and Cleveland -- in 31 locations.

The reason for that switch in plan was the ProCare folks in their infinite wisdom decided to send a letter out to all customers telling them that they were in bankruptcy. So as opposed to running minus 9, minus 10 comps, which we were looking at and certainly knew that they were weak; after sending that letter out, again, in a high-service, low-trust business where consumers do have a choice of where they shop, consumers decided why do I want to shop from somebody in bankruptcy, and the sales deteriorated further. The good news is that all of this information was available early enough for other bidders in the bankruptcy process to see and probably scared them away or lowered the level of what they were willing to bid. So we probably got the property for less than we expected and also gained the additional capital requirement of changing the signs immediately, figuring it was easier to overlay the Monro and Mr. Tire brands and build those brands up as opposed to repairing the damage caused by that letter and some of the lack of marketing initiatives that typically you would expect with a company in bankruptcy not being highly motivated to drive sales for the winning bidder.

As far as the integration process -- that, as we said, has gone unbelievably smooth. While we say that it's easy to say that, but obviously it required a ton of work from everybody at Monro headquarters and our field team led by Chris [Hornbeck], Joe Tomarchio and [Craig Hoyle], they have done a fabulous job, were out in the markets constantly. We have all of our operating people in place. Certain locations we need to staff up and again work on rebuilding the brand.

That being said, we are comfortable now with the operations of the store, the POS systems are in place. We will began our marketing as we said this week to all of the old customers as well as maybe overlaying a little bit more marketing expense than we would normally have at this period to start the process of rebuilding the brand.

That being said, numbers for the first quarter and our estimate right now include approximately a $0.03 loss for Q1 for the ProCare stores, and that is attributable both to these integration costs, the marketing efforts we are putting forward and the fact that we have a job to rebuild the sales base there. Which is why overall we qualified these stores as the way we were looking at them as brand new greenfield stores that we need to -- it would be difficult to get 75 locations, open them in one day with good real estate at attractive rents and make money initially. And while we would rather not lose $0.05 in the first year of ownership, the upside for years out to run double-digit comps for numerous years consistent with the maturity curve that you would expect on a new store, certainly [instead to build] -- to open 75 new stores in the year and expect them to be profitable with the work that goes into them. So we are thrilled with the location of these stores. It gives us market dominance in Cleveland, Columbus and Pittsburgh, while giving us new markets in Cincinnati and Toledo. It's right within our geographic footprint and I guess that is a snapshot of where we stand.

That's very helpful. In looking [at] them, categorizing them as greenfield stores, how much different are they in terms of an annual run rate of that store versus where you are on your more mature service stores now?

Sure. When we took the locations over, they were averaging about 625,000 a location. The average Monro service store does about 525,000 a location. The average Monro Tire store does about 1.1, 1.2 million in sales per location. So the 31 tire stores in the three markets were identified because they are seven and eight-bay locations and would fit very well within our tire format. Obviously, they have huge upside potential on the sales side by converting them to tire locations. The ProCare service stores themselves ran a lower margin but did more sales than the average Monro location. That being prior to the last couple of months them running down anywhere from 25 to 35% comp. So currently, they're running below the average Monro store. Six months ago, they were averaging above. And certainly with our marketing and improved POS system and our operations folks getting in there, we would certainly expect them to get back on the service side to every bit that they were running prior to when they started having problems, put the company up for sale, had a two-month bankruptcy process. And on the tire store front, while it won't be one or two years before those locations are running our normal tire sales, we certainly would expect down the road they would get to that level with Joe and his team making improvements there.

Okay. And if I could just ask another question turn it over to someone else, but you now have the one sort of sizable acquisition in ProCare complete, and it certainly sounds like there is a lot, maybe still some work to do in turning this around. And as you get closer to September with Strauss looming, is there a situation where you will have the majority of the tough work at ProCare done and be able to transition your team over? Or, do you sense that resources in terms of manpower get stretched a little bit, or are you comfortable with the timing of everything?

No, certainly the reason for delaying Strauss was tied to the fact that we did not want to shortchange ProCare and we knew the numbers and we knew there was going to be work involved. And that being said, if we did not do ProCare when we did it, that deal for sure went away. And instead of adding to our market dominance and improving our business model, we would have had another competitor on the market which is not attractive either. So we viewed that as a huge growth opportunity, significantly contributing to our profitability and comp store sales improvement in '08, while also being defensive in nature.

As far as Strauss is concerned, the Strauss stores on the service side will all be converted to tire stores, and that will involve Joe and his team on a different area of the country that should not be any problem whatsoever. We will get through May, June, maybe July. But we certainly have shown our ability to multi-task and the August/September time frame will not create any risk for us in doing both of these acquisitions. As I said initially when we delayed the Strauss deal, we were not willing to take the risk of trying to undertake two big acquisitions in the same time frame.

Okay, great. Thank you.

Scott Stember.

Good morning. Cathy, on this took part of your comments, could you give -- I think you gave out some segment's comps in the quarter -- brakes, exhaust and those guys?

Sure. What I had said, Scott, was that tire sales for the quarter increased about 6% and maintenance services increased about 1%. Brakes increased about 3%, which was encouraging because that is our highest margin category. And the other categories declined in the quarter.

What was exhaust?

Exhaust was down about 15% in the quarter.

Okay. And, again, I missed a few of your comments. Free cash flow -- did you say 44 to 45 million in free cash flow, or was that operating cash flow for '07?

I define it as the same. That would be operating cash flow of 45 to 46 million. How do you define it, Scott?

Operating cash flow netted with capital expenditures.

Okay, so CapEx is 32 million, so it would be somewhere around 13, 14 million.

Okay. And what was the operating cash flow number again for '06?

'06 was approximately 32 million.

Could you, maybe just talking about Rob's comments regarding the shift in some of the earnings towards the back half of the year. You mentioned four points. Could you maybe talk about maybe the order of and importance to either one of them, whether it's the oil deal that you have? And maybe you could also just touch a little bit Rob on this new oil supply agreement and just talk about how we should expect things to shake out maybe a little bit more defined.

Sure. I think in '08, the new oil supply agreement will incrementally add about $3.2 million incremental co-op to the '08 year. It will obviously -- we are now in the start of '07. So a similar number would have been into '07. However, we haven't signed the agreement yet that will bring the additional co-op, and when we do sign the agreement, under EITF 02-16, you have to wait until the inventory turns before the cooperative advertising flows through cost of sales and hits your bottom line. So at the time we sign it, our inventory on oil turns about every eight weeks, we will have an eight-week lag where we will take a hit on cooperative advertising versus prior year related to the oil until the inventory turns. So obviously now that it's flowing through inventory turns and cost of goods, Q4 in particular will get a huge benefit of increased cooperative advertising or lower cost of goods which will significantly improve the bottom line. That, coupled with the extra selling week in Q4 is what makes it such a skewed number. '08, we will then go back to our normal seasonality. This will be a onetime blip in the numbers in '08. We might have -- '07 -- we might have something occur in '08 with another new vendor contract. But as these major contracts roll over into new deals that are accounted for differently while everything before December 31, 2002 was grandfathered in, we will see this shift occasionally where, while the new deals and our buying power and our growth has made us a very attractive customer for our vendors, we can extract the additional funds, but the timing of which will not be as smooth as our normal run rate.

So '07 is not portraying a seasonality shift between what you saw last year, which last year's number '06 on a quarter-by-quarter basis will be our typical seasonality that you can expect us to get back to in '08. '07 though, due to the timing and the size of this oil supply contract as well as the additional selling days and, frankly, minus 2 or minus 3 comps in Q1, moves and shifts the quarterly numbers significantly.

Now your guidance for the first quarter, did that include any of the shift or once again not yet because you haven't signed these agreements yet?

We have not signed the agreement yet. It includes what we think will be at this point our best estimate of the quarter. And if you are taking it from $0.52, which we did last year to our current estimate of 45 to 48, as we have always said, and usually we talk about the upside of comp store sales, we are a high-margin business that comp store sales incrementally add to our business model and the leverage of the business. If we are running a down 2, down 3 comp, you can assume that every 1 point is approximately $0.015. So if we're running a minus 3, you should expect it to be somewhere around $0.04 to $0.05 negative impact in the quarter; we're doing that.

Additionally, if you then layer in the ProCare number of let's say minus $0.03, you pretty much have our range for the quarter.

Right. Just going back to the oil supply agreement, sorry to beat this dead here, but could you just talk about how under the old agreement once again how things are getting done, just so we could just draw a clear differential here?

It would be recorded -- the vendor rebates, is that what you're ,asking Scott?

Yes, the vendor rebates, exactly.

That was under the old accounting rules, to record vendor rebates as you buy product and receive the vendor rebate. Now we record it as we sell product and turn the inventory.

And under the new agreement, you are expecting to turn I guess given the timing of when you sign this agreement and the timing of I guess seasonality-wise, you're expecting to see more of a benefit in the back half of the year?

Yes, because there will be a onetime deferral for about six to eight weeks as that first inventory that we buy under the new agreement has the turn. So you have a onetime lag. Going forward, you will not have it anymore, but in '07 you will have that onetime lag that you eventually get; it's just timing. But it's because we're now under the new rules. All of our agreements are transitioning slowly under the new rules. Last year, we signed a new brake agreement; that is under the new rules now. But there's still -- we had some long-term agreements that still are operating under the old rules, so it's a onetime blip to get under the new accounting rules.

Thanks for the explanation. The last question -- the guidance that you guys gave, at this point, that is void of any potential benefit from Strauss at this point, right?

Any potential benefit or any potential dilution, yes.

Gotcha, thank you.

Mark Cooper.

Good morning. Thanks for the clarification on free cash flow, I think that's important.

Sorry about that.

That's alright. The option programs have been accelerated. I'm kind of curious to know what your philosophy is on that portion of compensation that has [been] these options going forward.

As far as what we would plan on doing going forward?

Right, and how that may change or not.

Sure. First, as we stated, we took a $0.02 charge in Q4 to accelerate all of the stock options. Any vice president or higher level though also signed an agreement that while their options vested and were accelerated, they would not exercise them at least until the normal exercise date. So we're fortunate enough to eight years ago to have started a program where we give stock options to our store employees, store managers and lower level folks to let them have a piece of the rock and feel ownership in the Company. That group was really the group that got an influx of vested options immediately and have a tendency to take advantage of them a little bit quicker. Going forward, our philosophy is, if you're asking as opposed to restricted stock or some of the other compensation measures that others are doing, we like the fact that as a small company that historically gives out anywhere from 0.6 to 0.8 of 1% option dilution a year, so less than 1% a year, that that keeps everybody focused. It adds leverage to someone's earnings potential, and that that is a much more to incentivize a high-performing, highly-motivated both sales force and executive team to give them the opportunity to make real money if and only if the shareholders are benefiting also. So you will not see option grants above the 1% dilution level. We think that something below that is the right level to give people upside potential while certainly under the new accounting rules for options expense to be sensitive to the fact that $0.02 a year we feel is an okay expense to be absorbing to present the upside if and only if the Company and the shareholders benefit.

Has the Board considered at all, forgetting about the dividend which is de minimus at this point, using that to buy in the option expense, buy in the shares that wound up diluting?

We certainly at every Board meeting talk about every option. I think we started the dividend because to your point, it was de minimus, but certain investor groups are looking for it and we saw it at a level below 1%. That accomplished that goal. As far as buying back stock, the difficulty of that, even if it is just to offset the options piece, and again, I think our share count last year was up in total 500 or 600,000 shares as calculated in fully diluted earnings per share and we still came in at $1.51 versus $1.35. So while the number would've been stronger, it's still a nice solid 15% bottom-line improvement. But the feeling is with all the growth opportunities out there, both ProCare, Strauss and what we are seeing and what we expect to see, if the marketplace remains weak, the much stronger use of any capital we have, including potentially going from probably a too-low 20 to 25% debt to capital up to probably the normal rate for this business of 40 to 45% debt to capital, we would much rather use our cash to grow the business when we think we have an operating model that is better and we think that it is easily transferable to some of these acquisition candidates that are only getting cheaper as we speak to buy.

Okay. My last question then is, on the ProCare, you mentioned approximately $130,000 per bay is kind of a valuation metric I suppose. What are the total bays that you have prior to ProCare?

With ProCare, we bought approximately 450 bays. The overall chain is probably about 3750, so right about 15% size.

Thank you.

John Walthausen.

Good morning. A little bit on ProCare. Could you talk a little bit about what they were doing wrong? Because the volume numbers that you were giving before their recent decline sounds like that should be enough to sustain a pretty good business model.

Certainly, it was enough to sustain a very good business small. Some of the things that we saw that we fixed or are in the process of fixing is, as an example, Jon, they bought all of their inventory outside from NAPA. As you know, we are supremely focused on eliminating outside purchases, not that we don't think NAPA is a great supplier and we love them, but every time we buy something from them as we've said in the past, it's typically twice our cost of putting our own product in there. So, number one, that is a huge and easy way for us to improve their gross margins and their operating margins, but more importantly or just as importantly is, when you're only carrying $10,000 of inventory in a location and on average, Monro carries $70,000, your customer service is not going to be up to the standard that our operating model offers throughout. We invested in shop trucks for all of these stores. As you know, our POS system allows every location to have the seven closest locations on its own POS system. So basically, we have eight chances to have the inventory in stock before we have to buy it out. I think their labor modeling and scheduling was all out of whack. And if you remember eight years ago when we embarked on our focus on labor productivity, which we have since improved 40 to 45% over the time frame you and I have been talking, they have similar opportunities to become more productive, reduce their labor as a percent of sales as we start putting our operating model in there and start becoming more efficient.

The stores we're converting to tire stores offer huge opportunities because they don't do a very good job as none of us really do on the service side of the business with tires. And the growth in that category should be quick, should be large and should be very profitable in these markets. And then overall, we will get a lot of leverage in advertising being we will now be the number one player in store count and sales in three major markets -- Columbus, Pittsburgh and Cleveland -- and that will allow us to layer in some different kind of advertising programs just based on the sheer market coverage, the market dominance and other opportunities we have.

And then finally, there will be pricing opportunities. Not only will our costs go down significantly, but what we will be able to charge to consumers, we will bring their pricing structure more in line with the higher levels at Monro has gotten to over the years by as we said consistently taking advantage of our market dominance, our pricing power, and they'll be raising their prices to Monro's level which should continue to improve margins and obviously generate higher revenue.

A couple follow-ons on that. With inventorying these stores rather than buying from NAPA, do we have to physically expand them or change them? Is that a -- permitting -- is that an issue that we need to go through?

Sure. We won't have to expand the physical structure, but we will be adding racking, we will be adding tires and we will be adding our parts. So it's an investment that is included in that $6 million of ProCare. We have sign exchange, we have racking. We will be adding about 4.5 million of inventory to these locations. Certainly no requirement to get them quite up to the 70,000 of inventory that a typical Monro location has because there will be seven Monro locations surrounding that they will be able to feed off of. But $10,000 of inventory is woefully inadequate both from creating a good business model and your gross margins, but also customer service related which we will work to improve.

Okay. When I look at their web site, they seem to offer transmission and engine and electrical work, stuff that you don't offer and seem to be outside your bailiwick. Were they actually offering that? And if that is so, do we have to sort of re-staff to people who are more appropriate to the levels of service that we're doing?

Yes and no. They did offer those services which we have a tendency to shy away from. Part of the reason for that is the caliber of technician you need to perform those services is not efficient in a 700 store chain to get the velocity and labor productivity and labor margins that we normally look for. That being said, being a lot of these talented folks are still on staff, our objective would be to try and with now significant store count in these areas, potentially use them as we talk about sharing inventory. That might be a resource, but if we can instead of having 10% of their time being spent on transmissions and engine work and some of those things, being they already have a reputation for doing that work, potentially some of our Monro stores will be able to farm some of that work out to the more talented technicians and we can make the utilization of them performing these more expensive, more complicated services, utilize them a little bit better by feeding five stores transmission and engine work to the guy in the current ProCare store that has the capability of doing that work.

Do we have to shift compensation rates for the mechanics at ProCare to coordinate with Monro, or are they pretty much in line?

They were in line on the little higher and we have a normal process that every 90 days, we evaluate their guarantee rate versus their productivity rate. So as part of the built-in costs in doing this deal, certainly you don't want a bunch of employees walking out day one or prior to an acquisition when something like this is going on and we guaranteed peoples' pay at the run rate in January and February which is a slower time of the year for the first 90 days upon taking them over. So our expense structure will be a little bit higher than we like initially. That being said, hopefully over the first 90 days with the staffing in place, the additional marketing efforts, bringing in the inventory, the profitability and the sales will come back and no adjustments will be needed. That being said, however, if that does not materialize over this period, certainly the pay structure will be brought back in line with Monro's pay structure after our initial 90-day guarantee goes away.

Good. And then finally, what's the timing that we should expect to see ProCare's same-store sales comparisons get back to a positive? I mean, you talk about next year, but next year double-digit, it seems like we have to be positive well before the end of the year if we're going to actually do a double-digit next year.

Yes, it's difficult. Again, as we said, we viewed that we were buying something unbelievably attractive right on point of strategy within our markets and we bought it right and it's a little uglier than the normal 75 stores that we would look to buy. We figured our operating models better. We could earn some sweat equity, but you need to start the efforts. And I would expect June sales from a negative comp perspective to be improved over May, July being improved over June and progressively every month getting better. It is just difficult to predict exactly when you cross the threshold of getting back to flat and then start moving forward.

If I owned these things more than two weeks, I might be able to give you a little bit more information than that. But right now, we are certainly not looking to report negative comps in our Q4 of this year for the ProCare chain, not that they would be included in comps anyway. But as in everything we do, we are building a brand, we're building a business. And that being said, we are very focused on profitability. And as quickly as these things will improve with some of the efforts we're making, we will certainly be reporting on their progress in a lot of detail in mid-July when we come out with our first quarter numbers and I will have much more of a track record to relay to you.

That's helpful, but I'm correct in taking away from that then that in the fourth quarter, we should be getting to positive, or else we have to really reconsider the double-digit for next year?

Yes.

Okay, thanks, Rob.

I'm worried about tomorrow, John.

I know, me too. Thanks.

Jack Battles.

Just to clarify things, right now on a run rate basis for the ProCare stores, including whatever changes you're going to make in the heavy maintenance sales, are you going over -- are they over 400,000 a store? What is their number?

Well, we have 75 locations. Again, remember, we initially had 82, we ended up with 75 with the rejection of leases. So we have 75 locations and we said we'd do between 33 and 35 million in the first 11 months of ownership. That is a run rate of about $460,000 a year.

And you said that the average Monro store does 525?

And is very profitable at that level.

So at 450, that's almost 88% of the average Monro store?

And the average Monro store at 70 to 80,000 of inventory in it did not send a letter out to all its customers saying we're in bankruptcy but trust us. So I think the level of sales and the level of sales that we will run this year is not going to be the problem once we get to the Monro business model. But even when we buy well-run, mature companies, we say comps will typically be 2 to 3% and that it will take one to two years for us to get 600 basis points of operating margin improvement on something well-run that we buy. It certainly is understandable that potentially the 600 basis points gets significantly better versus what ProCare's business model was, but that it is not going to be an 11-month process to go from their failing business model to Monro's superior business model.

Let me ask you do this. When will your addition lower-cost inventory start to come into the ProCare stores?

We will be selling out of what they currently have. The low-cost inventory is already in their locations, not to the level it will end up being once we complete all of the racking. But, again, as Jon asked about the revenue on the comp side, we will see month by month marginal improvement and the operating margins of the ProCare stores month 15 being better than month three, month six being better than month three, month 24 hopefully if we do this right, mirroring the Monro margins going forward.

Okay. Did you say you only get around $70,000 of inventory into a typical ProCare store?

No, we said 70,000 is the typical amount of inventory that we would have in a Monro store. We would probably be looking in the ProCare stores more like 35 or 40,000 of inventory because we don't need more than that because of the dominance and convenience of our store count in these markets. Every one of these ProCare stores will both have access to approximately 80 to $100,000 although of tire inventory that our tire stores will have on hand and be on their POS system as available to them. And, they will have 70 or $80,000 of inventory showing in the Monro stores, closer to $125,000 of inventory in the Monro key stores. There will also be a short drive away for them to grab those parts at the Monro cost versus waiting for some outside vendor to deliver it to them.

Okay. Just to clarify something, and you may have given me the answer, I'm just not good at remembering these things, and that is, at what point in time will the inventory in the ProCare stores be at the same cost as the Monro stores?

We have minor inventory that we bought as part of the acquisition. That will be blowing through. It's insignificant. You will see the margins start to improve when we talk to you on July 15, and we will be happy to show you how that is going at that juncture. Again, Jack, we are kind of like two weeks into this thing.

Okay, I just thought you might know on a timing basis (MULTIPLE SPEAKERS).

Jack, under purchase accounting, you revalue all of the inventory you buy at the Company's acquisition cost, at Monro's acquisition cost. So it all gets revalued anyway.

Good, okay. One thing not relating to ProCare, but this bulk sale of $3.5 million of inventory -- who did you sell that to, and what was the gross margin on that?

We sold it to a barter company, and its gross margin was probably about half of what we normally get.

Has this happened before?

We've had transactions with this company before, but not for inventory. But we've disposed of inventory with vendors and others in the past, not this particular company.

One last thing, Rob. Did you have a 3% increase in pricing in March?

Yes.

And given circumstances now, I guess the next time frame might be in July -- is that what you normally do?

I would say that we would have a tendency to take a look at traffic and take a look at a minus 2 or 3% comp, which we are looking at at the first quarter. And if business continues to be weak, we might hold that off a little bit. There might be pockets of opportunities for us to raise prices. All of our data has shown that the price increases -- and again, we have done this eight years straight -- has not had a negative impact on our sales. But as with anything, we're going to keep an eye on it and work to drive sales and drive traffic and not do anything on a pricing standpoint that could potentially weaken our recovery, what we think is going to be a short-lived problem that a lot of retailers are going through, especially in the Northeast. But if I am running a minus 2 or a minus 3, I am probably not looking to be increasing prices 3%.

I don't if you noticed, but Dick's Sporting Goods had an extra 2% comp gain in their Pittsburgh stores because the Steelers won.

They did? Well, I guess we should have bought these things last year. Of course, we probably would have paid more, but maybe we would have been happier with the sales levels.

Maybe you could do some target marketing to the guys that won bets?

And some of our marketing programs that we're now rolling out in [Tustin] going forward are with the Cleveland Indians, are with the Cincinnati Reds now that we have more store count. And we are, as we will always continue to try new things to try and drive traffic.

I just have one last request for Cathy for this year. And that is, given the acquisitions you are making and the jump we're going to see in inventory, could you going forward show us what the inventory was for the same seasonal period this year versus last year? So when you report June, you show us June of '05 inventory so we can see what the jump is on a comparable seasonal basis, which is something that practically every other retailer does as a normal part of the financial disclosure?

I will be happy to share that with you and whoever is interested.

You're not going to print it?

We put what was required in the 10-Q, but I'm happy to share that information when we have the call.

Alright.

Cid Wilson.

I have a non-ProCare question since I think that we have asked enough questions on ProCare. Can you comment on how your sales trended between your B.J stores and your non-B.J. stores?

Sure. Again, B.J.'s are starting off a lower base. But as we said, typical maturity curve for new stores is plus 15 year 1 comp plus 10 plus 5. The B.J. stores are following that pattern. So our B.J.'s stores that are now in the comp base collectively, we're running up 10, up 11% comp.

Okay. And with regards to your guidance for same-store sales for the first quarter, is it reasonable to say that -- you mentioned how April -- I think you said April was down 4, May down 2.4. Is that still -- are tire comps still positive for the first quarter? And then is everything else -- is it the other categories that are down? If you can give us a breakdown in terms of what you're seeing so far in the first quarter?

Pretty similar. I think the biggest thing that negatively impacted the first quarter is for the first time, our traffic was down to a larger degree than the rest of the year. So we had the deferral and it looked like people just didn't come into the same degree. While we were always driving our traffic with oil changes and people were deferring on the higher ticket items, I think as we said, brakes started to improve and some of that came in. But we just had a traffic decrease of 2 to 3% for the first time in a long time. And that was the primary driver in Q1. Certainly minus [2.4] in May is nothing to write home about, but it is better than minus 4. And I mean the only thing I can draw upon is if you remember September last year, we were minus 4. People deferred, traffic was down and then November comps were up 7. I have no idea what $3 gas and the extent that it increased and what the consumer is thinking and is the deferral going to be three months this time or four months this time. Typically it has never been six months and typically again with all of the state inspections requiring work to be done to pass inspection, it needs to be done at some point within a one-year time frame. But until I see June numbers, which again, we'll report in mid/late July as well as we will give you an update of where we are in July. Certainly May is better than April. May is still at an unacceptable level. We're getting ready to start on the driving season with Memorial Day and after. And second quarter we're up against soft numbers. But until I see some meaningful turnaround in comps beyond four out of our last five days being positive, I'm not going to start extrapolating that. All is well on the home base.

Okay. And I'm not sure if I heard this in your previous comments, but what are your plans in terms of actual organic store openings this year, this coming fiscal year?

We said that the capital would be about $6 million, and based on leases and the number of B.J. locations, that will probably fall between 10 and 15 locations.

Okay.

We just gave you 75, Cid.

Absolutely, (indiscernible) I understand all of the catalysts ahead. And I think that (indiscernible) actually, that's it. If I have any other questions, I can call you off-line.

Absolutely, thank you Cid.

[Jamie Weiland].

Just a couple of quickies. The oil supply agreement you signed, did you say it adds $3 million incremental to co-op expenses -- co-op payments in 2008?

Yes.

So that will add an extra dime to profitability?

Yes.

And quickies with ProCare. Will you be profitable in ProCare by the fourth quarter?

We would be disappointed if we are not.

Okay. So the incremental swing in ProCare between losing 0 to $0.05 this year should be -- one would think at least a dime in 2008 incremental profit from that.

I would probably use a dime as a number for 2008 and hope that it's more.

A dime incremental or a dime profit?

A dime profit, so incrementally $0.15 potentially.

I think you said operating margins within 24 months to Monro levels. Is that what you're targeting for ProCare?

That is always our objective, and again, we would be disappointed because these stores are in our markets. We will be leveraging advertising, we will be leveraging distribution -- yes, that would be the expectation.

Last question. Of the 75, I forget what the number is that's going to be Monro, what's going to be Mr. Tire. But how did you determine that? Are the operating margins of those stores or the operating profit of those stores vastly different and why did you determine one thing over the other?

Again, as you know living in Baltimore, the success of our two-brand strategy in a market where Baltimore's market dominance, market share pricing power with both the Mr. Tire and the Monro brand has worked out very well for us. This was an opportunity for us to take three major markets, get a foothold in the tire locations, choose locations within these three markets -- Pittsburgh, Cleveland and Columbus -- that the ProCare stores were larger in footprint seven or eight bays as opposed to Monro's normal five or six bays. So there was room to put in a complete complement of tire inventory as well has not create redundancies between the Monro/ProCare brand combining and turning these other locations into ProCare Tire Stores. So it has to do with eliminating any redundancies, it had to do with the size of the ProCare locations and we will continue to fill in these three new tire markets potentially with an opportunity down the road for some of the Monro locations we currently have, converting into tire locations in these markets also to increase the critical mass of tire stores moving forward.

Outstanding. Last question with regard to Strauss. By the time we hit September, will you have some of the nuts and bolts done of the acquisition of real estate, of what you're going to do with the retail component? Will some of that be accomplished by the time you hit September and get it under your full ownership?

That would certainly be our objective and at that time where they are no longer a private company, we will lay it out in its entirety.

Okay, thanks Rob.

There are no further questions at this time.

Great. I just wanted thank everybody for their time. I know the call ran a little bit longer than normal, but you know, obviously, an important discussion and a lot of stuff going on which we are very excited about. Certainly '06 we're proud about our performance there. We certainly intend to deliver record results in '07, setting up '08 for what we plan on being a real significant move forward for Monro. We continue to focus on shareholder value. And as always, Cathy and I will be available after the call all day and whenever you need us to answer any other questions you might have. So with that, have a great day and I will talk to you soon.

Thank you. This does conclude today's conference call. You may now disconnect and have a wonderful day.