Effie Veres - FTI Consulting John W. Van Heel - Monro Muffler Brake, Inc. Brian J. D'Ambrosia - Monro Muffler Brake, Inc. Robert G. Gross - Monro Muffler Brake, Inc..

David L. Kelley - Jefferies LLC Rick Nelson - Stephens, Inc. David Bellinger - Oppenheimer & Co., Inc. Matthew J. Fassler - Goldman Sachs & Co. James J. Albertine - Consumer Edge Research LLC Michael Montani - Evercore ISI Brett D. Hoselton - KeyBanc Capital Markets, Inc. A. Carolina Jolly - Gabelli & Co..

Good morning, ladies and gentlemen, and welcome to today's Monro Muffler Brake's Earnings Conference Call for the Third Quarter of Fiscal 2017. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time.

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. At this time, I'd like to introduce Ms. Effie Veres of FTI Consulting. Please go ahead, ma'am..

Thank you. Hello, everyone, and thank you for joining us on this morning's call. 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 more fully described in the press release and the company's filings with the Securities and Exchange Commission.

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 sensitivity to fluctuations in interest rates; dependence on and competition within the primary markets in which the company's stores are located, and the need for 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, or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

The inclusion of any statement in this call does not constitute an admission by Monro, or any other person that the events, or circumstances described in such statements are material.

Joining us for this morning's call from management are John Van Heel, President and Chief Executive Officer; Brian D'Ambrosia, Chief Financial Officer; and Rob Gross, Executive Chairman. With these formalities out of the way, I'd like to turn the call over to John Van Heel. John, you may begin..

Thanks, Effie. Good morning, and thank you for joining us on today's call. We are pleased that you are with us to discuss our third quarter 2017 performance. Today, we will start with a review of our third quarter results and update on our growth strategy, and then the outlook for the remainder of fiscal 2017.

Then I'll turn the call over to Brian D'Ambrosia, our Chief Financial Officer, who will provide additional details on our financial results.

Despite a difficult operating environment, the return of winter weather late in the third quarter, combined with our effective cost control and solid integration of recent acquisitions allowed us to achieve third quarter earnings at the midpoint of our guidance.

Fiscal year-to-date, we've been able to capitalize on this challenging market and accelerate our acquisition and greenfield activity with the opening of 67 net new stores and the pending acquisition of 16 additional Car-X locations. Combined, these acquisitions represent $150 million in expected annualized sales and 16% sales growth.

These acquisitions not only build a strong foundation for future profitability, but have also allowed us to add to our store footprint in new Southern markets.

It is our ability to accelerate acquisition growth, particularly in tough years for the industry in our geographies that allows Monro to guide to flat earnings per share for the year despite negative comparable store sales, underscoring the strength of our business model. Turning to our third quarter results. Sales increased 21% to $288 million.

Comparable store sales increased 2.3%, with sequential improvement month-to-month. Comps in October declined 4.1% and improved to negative 2% in November.

And as mild weather gave way to snow in December, comparable store sales for the month in December increased by 11% when adjusted for one additional selling day in the month, as Christmas shifted into our fiscal fourth quarter. Traffic for the quarter increased 2% driven by a strong December, but with flat traffic in October and November.

Winter weather in December also unlocked pent-up demand for tires, with comparable store tire sales in the third quarter increasing 6% led by unit growth, particularly in December when units increased approximately 25%.

Larger ticket and discretionary service category such as brakes, alignments and front-end shocks remained under pressure, but showed meaningful improvement from prior quarters. General maintenance was flat for the quarter. From a geographic perspective, our Southern markets continue to outperform in the months of October and November.

But with the late arrival of winter weather, our Northern markets significantly outperformed in the month of December. As we enter the fourth quarter, we've seen a return to the milder temperatures, which have once again impacted our top-line, particularly as we lap our most difficult comp of the previous year.

Quarter-to-date comparable store sales adjusted for one less selling day in the quarter are negative 7%, compared to an increase of 7% in the same period last year. That is driven primarily by a decrease in tire units, which more than offset positive comps in the brake category. Also, sales in the first week of fiscal February were up 1%.

We expect comps to improve as we move through the fourth quarter as comparison significantly ease. Last year's February and March combined comparable store sales were negative 3.4%.

Turning now to gross margin, as previously guided to, third quarter gross margin declined by 250 basis points versus the prior year due to the impact of fiscal 2017 acquisitions, including the newly acquired tire wholesale business. Gross margin was also impacted by higher tire sales, which carry a lower margin than our service category.

However, on a comparable store basis, gross margin was flat year-over-year due to lower material cost, primarily related to tires and leverage on fixed expenses. As expected, the decline in gross margin was more than offset by 280 basis points of leverage on SG&A.

On a comparable store basis, when excluding due diligence cost, third quarter total operating expenses increased less than 1% year-over-year, a result of our effective cost control. Now, I'd like to provide a brief update on our digital initiatives.

We continue to see strong increases in our online appointments, as well as improved collection and use of customer email, feedback and reviews. We are pleased to report that customer reviews collected in the third quarter continue to post a 94% approval rating with a total customer satisfaction score of 4.5 out of 5, results we are very proud of.

We continue to develop and implement improvements to our customer experience, both online and in-store through enhanced tools and training for our store employees. Turning now to our growth strategy. The integration of our fiscal 2017 acquisition is progressing in line with our plan.

As previously announced, the third quarter included results from the Clark Tire acquisition, a 26-store chain of retail and commercial tire and service location, and a retread plant in Western North Carolina.

As a reminder, the transaction was completed in mid-September and also includes four wholesale tire centers that continue to operate under the Tires Now brand name.

We've been very pleased with the results from Clark Tire thus far and continue to expect the transaction will add approximately $85 million in annualized sales, representing a sales mix of 50% retail and commercial, and 50% wholesale.

We also continue to see solid results from the acquisition of McGee Auto Service & Tires, a chain of 29 retail and commercial locations and a retread facility in Florida, which we completed in the first quarter. McGee remains on plan to deliver $50 million in annualized sales, representing a sales mix of 40% service and 60% tires.

As a reminder, these acquisitions are strategically significant because they expand our retail and commercial business by 55 stores and $90 million in sales in the key markets of Florida and North Carolina, as well as add $45 million in tire wholesale business, which combined increases both our scale and market share.

They increase our tire unit purchases by approximately 25%, expanding our tire assortment and strengthening our purchasing power. As we previously stated, a $1 decrease in cost-per-tire is nearly $4 million in annual cost savings.

They also allow us to directly distribute tires to approximately 100 of our stores, or roughly 10% of our chain, strengthening our position as an independent dealer and reducing our reliance on distributors, thereby allowing us to maximize profitability, while creating new organic growth opportunities in the wholesale business.

And they expand our acquisition opportunities to include competitors with integrated retail, commercial and wholesale operations. Our strategy with respect to our commercial and wholesale operations, in the near term, is to integrate, strengthen and grow them in their respective markets.

Longer term, we will evaluate how we can further leverage them across the other 24 states and distribution centers we operate in. We believe these acquisitions will continue to strengthen our competitiveness in the market, while providing another valuable avenue of growth over the next several years.

I'm also pleased to announce today that we've signed a definitive agreement to acquire 16 stores from a Car-X franchisee, which includes 13 location in Illinois and three locations in Iowa. These stores are expected to generate $15 million in annualized sales, representing a sales mix of 75% service and 25% tires.

The stores will continue to operate under the Car-X banner and the transaction is expected to close this coming March. Fiscal year-to-date acquisitions completed and announced are expected to add approximately $150 million in annualized sales and represent 16% sales growth.

As we've recently discussed, we believe the consumer remains under pressure with stagnant wage growth, increasing rents and resets on healthcare deductible and increasing premiums impacting their spending. This is adding to the choppiness of the market, which is reflected in our recent top-line results.

However, it is this challenging market which has helped us accelerate our acquisition activities. At present, we continue to have more than 10 NDAs signed, each of them representing between 5 stores and 40 stores within existing markets.

Looking ahead, we expect the current operating environment will continue to create favorable, accretive acquisition opportunities. We've also continued to make progress on our goal of opening 20 to 40 greenfield locations in fiscal 2017. In the third quarter, we opened nine stores, bringing our total to 25 new greenfield locations fiscal year to-date.

We expect to open five additional stores in the fourth quarter. We have slowed the pace of greenfield activity in the fourth quarter, given the integration work we currently have underway with our 2017 acquisition. As a reminder, greenfield stores for us include acquisitions of one to four stores.

These store additions help drive scale on a local level by allowing us to increase store density in existing markets at very attractive costs. We will continue to capitalize on these opportunities into fiscal 2018. Now, let's turn to our outlook.

In light of weak comparable store sales in January over a strong comp last year, we have taken a cautious approach to our fourth quarter guidance. We expect fourth quarter comparable store sales to be in the range of a decline of 2.5% to 1% versus an increase of 50 basis points last year.

We expect comparable store sales to improve as we lap easier comparison for the remainder of the quarter. As a reminder, comparable store sales combined for February and March of last year were negative 3.4%. The low end of our comp guidance assumes that we recover one-half of this decline, while the high end assumes we recover the full 3.4% decline.

As is always the case this time of year, winter weather and snow will be a major driver. Based on this comp guidance and contributions from our recent and announced acquisitions, we anticipate total sales in the fourth quarter to be in the range of $262 million to $268 million.

Further, we expect fourth quarter diluted earnings per share to be in the range of $0.39 to $0.44, reflecting slight dilution from our fiscal 2017 acquisition. This compares to earnings per share of $0.42 in the fourth quarter of last year.

Based upon our updated fourth quarter guidance, we are lowering our expectations for fiscal 2017 comparable store sales to a decline of 3% to a decline of 2.5%, compared to our previous guidance, which called for a decline of 2.5% to 1.5%. We expect fiscal 2017 total sales to be in the range of $1.032 billion to $1.038 billion.

We have also updated our fiscal 2017 earnings guidance to $1.95 to $2 per share compared to our previous range of $2 to $2.10 per share to reflect the lower comparable store sales and slight dilution from our recent acquisitions in the fourth quarter. This guidance is based on 33.4 million diluted weighted average shares outstanding.

The midpoint of the full-year earnings guidance represents an operating margin of 12% and EBITDA of approximately $172 million. As I discussed with you on our last call and as you saw this quarter, the commercial and wholesale businesses we acquired in fiscal 2017 operate at a lower gross margin than our retail business.

However, they also require a lower level of SG&A expenses. Therefore, we continue to expect that this change in our sales mix will reduce gross margins by approximately 250 basis points and be offset by a similar reduction in SG&A expenses as a percentage of sales.

This was the case during the quarter, and we expect to continue to see this trend until we begin to anniversary these acquisitions next year. Said another way, our base business operates at about 40% to 41% gross margin. And in the fiscal 2017 acquisitions, we've added commercial and wholesale business, which operate around a 15% gross margin.

With commercial and wholesale at about 10% of overall sales, that 25% difference in gross margin will result in a 250-basis-point decrease in our overall gross margin. However, that will be offset by lower SG&A to generate those sales, minimizing the impact on operating margin.

In terms of earnings going forward, we expect the $105 million of retail and commercial annualized sales from our fiscal 2017 acquisition to contribute similarly to prior acquisitions. We expect the acquired wholesale business to contribute EBITDA between $4 million and $5 million, including improvements in tire costs and distribution efficiencies.

Importantly, our outlook for the industry remains positive and we expect to continue to strengthen going forward. Vehicles 13 years old and older continue to account for 29% of our traffic, in line with the previous quarter and up from 27% last year.

These vehicles produce average ticket similar to our overall average, demonstrating that customers continue to invest in and maintain their vehicles, even as they advance in age.

The other significant driver is that total vehicles in operation are expected to grow 9% by 2020, with vehicles in our sweet spot of six years old and older representing the majority of the growth. At the same time, the number of service base is expected to continue with slow, steady decline.

These trends should represent meaningful tailwind to our comparable store sales over the next several years. Before I hand the call over to Brian, I would like to provide commentary on some of the trends we expect to see in fiscal 2018.

First, we expect strong contributions from our fiscal 2017 acquisition, which represent approximately 16% annualized sales growth. We believe comparable store sales will benefit from easier comparisons, particularly in the first half of fiscal 2018.

We also expect to sign a new oil supply agreement in the first half of fiscal 2018, resulting in annualized sales of $2 million to $3 million – annualized savings of $2 million to $3 million.

We believe our purchasing power and cost competitiveness will continue to strengthen, particularly with respect to tires based on the 25% increase in annual tire unit purchases we realized from our recent acquisitions. However, this benefit may be offset by upcoming price increases from tire manufacturers.

To give you some detail, recent increases in raw materials have led many tire manufacturers to announce price increases in the mid-single digits beginning with February 2017 orders.

However, it's worth noting that not every manufacturer has announced the price increase, and some manufacturers are offsetting these price increases with additional volume rebate. We expect the overall supply of tires will continue to increase, making the market more competitive.

Given our increasing scale, we believe we are in a strong position to manage these higher costs, but it's still too early to provide specific guidance. And lastly, fiscal 2018 is a 53-week year. We estimate that this will benefit comparable store sales by approximately 2% and earnings per share by approximately $0.09.

Before I conclude, I want to briefly address questions I received regarding potential new government policy changes. Quite simply, we don't know what the impact of these changes will have on Monro until we see the exact details in government's plans.

I can tell you that a reduction in the corporate tax rate would be a significant benefit, given that our effective tax rate is around 38% on $100 million of pre-tax income. As far as possible, border adjustments or taxes, we import about two-thirds of our parts and a little more than one-third of our tire units.

These import tires are primarily at the entry level and are lower cost relative to branded tires. As you've seen, we continue to drive significant scale across our business, which gives us more flexibility in our supply chain, putting us in an enviable position – an enviable competitive position to manage through any potential cost pressures.

Having said that, we do hope that there are adults in the room hearing these policy discussions as they may be far reaching, impacting the majority of U.S. companies across multiple industries, not to mention significant price increases to U.S. consumers.

Our investors should also take comfort in the fact that any additional pressure on our industry whether from tire cost increases, changes in import policy, or a continued consumer pressure, will create additional acquisition opportunities over time, which will only strengthen our competitive advantages.

To conclude, I would like to thank our entire team for their solid execution this quarter. We greatly appreciate all of their work. Now, I'd like to hand the call over to Brian D'Ambrosia, for a review of our financial results.

Brian?.

Thanks, John. Sales for the quarter increased 20.6% and $49.3 million. New stores defined as stores opened or acquired after March 28, 2015, added $46.2 million, including sales of $43.8 million from fiscal 2016 and 2017 acquisitions.

Comparable store sales increased 2.3%, partially offsetting this was a decrease in sales from closed stores of approximately $1.9 million. There were 90 selling days in the current quarter and 89 in the prior year third quarter. Adjusted for days, comparable store sales increased 1.1%. Year-to-date sales increased $54.9 million and 7.7%.

New stores contributed $83.4 million of the increase including $77.1 million from fiscal 2016 and 2017 acquisitions. Largely offsetting this was a decrease in comparable store sales of 3.1%. Additionally, there was a decrease in sales from closed doors of approximately $6.5 million.

In a limited number of transactions for the delivery of tires to national account customers, we received a delivery commission. Historically, we recorded these as a gross transaction in sales and cost of sales, netting to the amount of delivery commission in gross profit. We believe that net accounting is more appropriate for these transactions.

Therefore, beginning in fiscal 2017, these transactions will be recorded on the sales line at the amount of the delivery commission. The impact of the adjustments, which lowered sales and cost of sales by equal amounts was $3.1 million and $7.4 million for the quarter and 9 months ended December 2016 respectively.

These adjustments were not material to the comparable periods of the prior year or to previously disclosed comparable store sales percentages. There were 271 selling days for the first 9 months of this fiscal year and 270 last fiscal year. Adjusted for days, comparable store sales decreased 3.5%.

At December 24, 2016, the company had 1,098 company-operated stores and 132 franchise locations, as compared with 1,031 company-operated stores and 138 franchise locations at December 26, 2015.

During the quarter ended December 2016, we added 9 company-operated stores and closed 8, including 2 damaged locations expected to reopen in the fourth quarter. Year-to-date, we added 81 company-operated stores including one purchase from an existing franchisee and closed 12 stores.

Additionally, two franchise locations have closed, and we purchased one location from an existing franchisee as a company-operated store. Gross profit for the quarter ended December 2016 was $105.6 million, or $36.6% of sales as compared with $93.4 million, or 39.1% of sales for the quarter ended December 2015.

The decrease in gross margin for the quarter was primarily due to the fiscal 2017 acquisitions, which have a higher material cost of sales than the retail business. On a consolidated basis, labor cost decreased slightly as a percentage of sales due to the impact of positive comparable store sales.

Distribution and occupancy cost decreased moderately as a percentage of sales as we gain leverage on these largely fixed cost over higher overall sales.

On a comparable store basis, gross margin for the quarter ended December 2016 remain flat with the prior quarter as lower product cost, particularly tires, offset a shift in mix from higher margin service categories to the lower margin tire category.

Gross profit for the nine months ended December 2016 was $303.7 million, or 39.5% of sales as compared with $293.8 million, or 41.1% of sales for the nine months ended December 2015. The year-to-date decrease in gross margin was largely due to the fiscal 2017 acquisitions as described for the quarter.

Additionally, labor costs increased slightly and distribution and occupancy costs decreased slightly as a percentage of sales as compared to the prior year. On a comparable store basis, gross margin for the nine months ended December 2016 remain flat with the same period in the prior year at 41.2% of sales.

Operating expenses for the quarter ended December 2016 increased $5.6 million and over $72.5 million, or 25.2% of sales as compared with $66.9 million, or 28% of sales for the quarter ended December 2015, primarily due to increased expenses for new stores, partially offset by reduced due diligence costs.

On a comparable store basis and excluding due diligence costs, total operating expense dollars in the quarter ended December 2016 increased less than 1% from the prior-year period. We believe that this demonstrates the effectiveness of our strong cost control in a period of soft sales.

For the nine months ended December 2016, operating expenses increased by $7.7 million to $207.4 million, or 26.9% of sales as compared with $199.7 million and 27.9% of sales for the prior period. The dollar increase primarily relates to increased expenses for new stores, partially offset by reduced due diligence costs.

Operating income for the quarter ending December 2016 of $33.1 million increased by 25.1% as compared to operating income of approximately $26.4 million for the quarter ended December 2015, an increase as a percentage of sales from 11.1% to 11.5%.

Operating income for the nine months ended December 2016 of approximately $96.3 million increased by 2.3% as compared to operating income of approximately $94.1 million for the nine months ended December 2015 and decreased as a percentage of sales from 13.2% to 12.5%.

Net interest expense for the quarter ended December 2016 increased $1.4 million as compared to the same period last year, which increased from 1.6% to 1.8% as a percentage of sales. The weighted-average debt outstanding for the third quarter of fiscal 2017 increased by approximately $99 million as compared to the third quarter of last year.

This increase is due to an increase in debt outstanding under our revolving credit facility, as well as an increase in capital lease debt recorded in connection with the fiscal 2016 and fiscal 2017 acquisitions. The weighted-average interest rate increased by approximately 20 basis points as compared to the third quarter of the prior year.

For the nine months ended December 2016, net interest expense increased by $3.2 million as compared to the same period in the prior year and increased from 1.5% to 1.8% as a percentage of sales for the same period.

Weighted-average debt increased by approximately $72 million and the weighted-average interest rate increased by approximately 20 basis points as compared to the same period in the prior year. The effective tax rate was 37.2% of pre-tax income for the quarter ended December 2016, and 33.1% for the quarter ended December 2015.

The effective tax rate for the nine months ended December 2016 and December 2015 was 37.1% and 36.7% respectively of pre-tax income. Net income for the current quarter of $17.6 million increased 15.3% from net income for the quarter ended December 2015.

Earnings per share on a diluted basis for the quarter ended December 2016 of $0.53 increased 15.2%, as compared to last year's $0.46. For the nine months ended December 2016, net income of $51.9 million decreased 2% and diluted earnings per share decreased 1.9% from $1.59 to $1.56. Our balance sheet continues to be strong.

Our current ratio at 1.1:1 is comparable to last year's third quarter and to year-end fiscal 2016. Inventory turns at December 2016 improved modestly as compared to year-end and third quarter of last year.

In the first nine months of this year, we generated approximately $102 million of cash flow from operating activities and increased our debt under our revolver by approximately $81 million. Capital lease and financing obligations increased $33 million due primarily to the accounting for our fiscal 2016 and 2017 acquisitions.

At the end of the third quarter, debt consisted of $185 million of outstanding revolver debt and $210 million of capital leases and financing obligations. As a result of the fiscal 2017 borrowings, our debt-to-capital ratio, including capital leases, increased to 41% at December 2016 from 34% at March 2016.

Without capital and financing leases, our debt-to-capital ratio was 24% at the end of December 2016 and 16% at March 2016. Under our revolving credit facility, we have $600 million that is committed through January 2021. Additionally, we have $100 million accordion feature included in the revolving credit agreement.

We are currently borrowing at LIBOR plus 100 basis points and have approximately $388 million of availability, not counting the accordion. We are fully compliant with all of our debt covenants and have plenty of room under our financial covenants to add additional debt for acquisitions without any issues.

All of this, as well as the flexibility built into our debt agreement, allows us to take advantage of more and larger acquisitions and makes it easy for us to get acquisitions done quickly.

During the first nine months of this year, we spent approximately $28 million on CapEx, approximately $8 million in the first quarter and $10 million in each of the second and third quarters, and $134 million on acquisitions, which also includes the small one to four store deals.

Depreciation and amortization totaled approximately $33 million, and we received $2 million from the exercise of stock options. We paid about $17 million in dividends. This concludes my formal remarks on the financial statements. With that, I will now turn the call over to the operator for questions.

Operator?.

Thank you. We'll go first to Bret Jordan of Jefferies..

Hey. Good afternoon, guys. It's David Kelley in for Bret this morning.

Just wondering if you could provide some quick commentary on regional performance delta in January and February, maybe what you're seeing in Northern versus Southern markets, and if you've seen any change from December to January in some of your Southern stores that'll be great?.

Sure. In January and February, the Southern markets continue to outperform. Obviously, when you look at our January and February of last year, we sold a lot of tires because we finally – last year we got a little bit of winter weather in January. So, that's really skewing the result I think.

Overall, like we said, the South was flat for the quarter, in the third quarter, and that is with some impact early in that quarter in October from Hurricane Matthew, which impacted those stores primarily. So, for January and February I think those trends are continuing. The South is continuing to outperform..

Okay. Great. Thanks. And just a quick follow-up on that.

You mentioned tires, any significant performance shifts in other specific categories? Just looking again kind of end of year or two, what we're seeing in January year-to-date?.

Yeah. Sure. Well, and I called out during my prepared remarks that the brake category quarter-to-date in these first five weeks is positive. I think it's plus 2% on a positive last year, and that certainly is a much better run rate than what we saw earlier this fiscal year..

Okay Great. Perfect. And then one more and I'll pass it along. Any color on, I guess, some of the multiples you're seeing in the acquisition market, any significant changes there either up or down? That would be great as well..

No. In the 5 to 40 stores that we've talked about here where we have more than 10 NDAs still, we're not seeing any changes in the multiples. What I will say is that we do buy-off of trailing EBITDA. And in a year like this, trailing EBITDA is pressured. So, prices overall are reflecting that and getting better..

All right. Thank you. Appreciate the commentary..

Sure. Thank you..

We'll move next to Rick Nelson of Stephens..

Thanks. Good morning..

Good morning..

I'd like to follow-up on guidance for the fourth quarter, which implies EBITDA margin down about 100 basis points we're calculating.

If you could tell us what the drivers are to that?.

Yeah. It's simply deleveraged from the sales adjustment. The impact in the change in our guidance reflects the fact that we had anticipated a positive comp in the fourth quarter here, and given the start in January, we needed to revise that. So, it's just basically that impact.

If you take that, that's basically a 3.5% comp store change, comp store sales change on the low-end and the high-end. And if you look at that versus the sort of $0.075 for every 1% comp for the year, you'll basically get $0.06 or $0.07 in that (38:18)..

Got it. Thanks for that color, John. Also, I'd like to ask you about these tire price increases, so you said some of the manufacturers are trying to put through mid-single digit growth.

Do you think those types of increases, do they stick? And if you could talk about your ability to pass those on to the consumer?.

Sure. They certainly stick a lot less with the company that's growing their tire unit purchases by 25% like us. And the other thing is, we'll see what happens to commodities going forward. The increases in commodities kind of accelerated late in the calendar year. So, we'll see if that continues.

In terms of passing them along, I think there's two things I would say is first, we will certainly try to pass any increases that we're seeing along, and I would expect competitors, particularly smaller competitors, to need to do that, given the choppy and more difficult operating environment.

So, what we're looking for is if our costs go up less than theirs, and you try to pass it along, maybe we get some help from the margin side. But we'll have to see. In the past, if we were putting through price increases, we might be able to pass half of that along historically or half of the announced increases along.

And if we do better on our increases, we'll look to protect first our gross profit in terms of dollars per tire, and then we'll look to see if we can manage cost to get some benefit there. But it will be a pressure that certainly wasn't there when we had this call in October..

I think back in October, you had talked about a $1 per unit cost advantage per tire..

Right. I mean, in this case, I'm not issuing guidance or maybe that might be more or like the best result as opposed to the base result going forward. I don't know, We'll certainly update at the end when we issue guidance for fiscal 2018.

And we're working hard to make sure that our increase in unit purchases is going to pay-off for us and our stockholders..

All right, great. Hey, thanks a lot and good luck..

Thank you..

Up next from Oppenheimer, we'll hear from Brian Nagel..

Hi. This is David Bellinger on for Brian. I have a few quick questions. So, first on the January accounts being down about 7%.

How should we interpret that, that bascially sales slowdown? Did a strong December shift sales at a January? And basically, how meaningful is January in terms of Q4? Are tires or other categories more pronounced versus other quarters?.

Yeah. So, sure. I think the short story on January is that we were up against a big comp in the prior year, driven by some recovery of sales last year from a weak third quarter. And this year, we, certainly, had a big spike in December, and came in and saw some warmer weather throughout our markets in January. We haven't had much snow.

And so I think running up against the high conflict we had last year, it's just – we gave most of that back. So, I think what's important as we pointed out is the February and March comparisons get much more favorable. February has started out in the first week at plus 1%, and so I expect that our trends should improve as the quarter goes forward.

I talked about the brake category being positive, on positive sales last year. And I would expect we have some tire unit opportunity, particularly with some snow as the quarter moves on here..

Okay. And then just following-up on that. So, clearly a normalized winter ahead of – no real help to December comps. Just when you stacked it up to past winters, with the colder temperatures. I know it's tough to quantify.

But in your opinion, could that December and winter period been harsh enough to propel and sort of a longer tail for auto services demand into the coming spring and summer months ahead?.

Well, I think our comps were weak at the beginning of this fiscal year. So, we've at least gotten some winter weather during this winter. Not enough of it. Certainly, it would have been great had it come in November as well because that is the biggest tire selling month of the year.

So, before I make predictions about next year, I would hope that we continue to see some cold weather and some snow, which gets plows out on the road and creates potholes. That really helps lay the groundwork for a strong first half of the year.

I think regardless, I'm optimistic about the first half of the year next year, given the very favorable comparisons that we'll be up against..

Got it. I appreciate you taking my questions. Thanks, John..

Sure..

We'll go next to Matt Fassler of Goldman Sachs..

Hello, and good morning too. I want to first revisit the question that Rick asked about EBIT margin, implied EBIT margin in the fourth quarter. We're just trying to process some of the guidance that you gave in interest and taxes and such.

But it looks like you've got EBIT margin implied down about as much as you had it down in the first and second quarters during which period the comps were down substantially more than you're guiding down in Q4 in the March quarter.

So, is there – and I know when you spoke about the acquisitions that have kind of different P&L geography, you suggested that they kind of have a similar operating margin end game.

So, is there anything else that could be pressuring the operating margin relative to sales compared to the trends that we saw earlier in the year?.

Yeah. I think there are a couple of things. First of all, the fourth quarter is the lowest sales quarter, and that's a piece of it. We – and the acquisitions are dilutive. It will be much more dilutive than the first two quarters.

We purchased McGee and – during the first quarter, and then we purchased the much larger Clark business in this – where the results came in to our results for the first time in the third quarter. So, I think if you look at those, those really bridge the gap..

And as you think about the seasonality of the tire business relative to (46:30) is obviously where the acquisitions are tilted relative to the rest of the business, is it more weighted away from Q4?.

I'm sorry. The....

Is the seasonality of the tire business even more extreme than the rest of the business, whether that works against Q4 profitability?.

No. I mean, in terms of the tire business, we said that the biggest driver of the tire business within our markets is winter weather, particularly as you hit Q3 and Q4..

Yeah..

Q3, I view that as the sort of peak of seasonality related to that business with Q4 sort of close behind there. So, yes, if we get more snow, I expect that to be a positive for the remainder of the quarter here..

Got it. Second question, just want to make sure I understand the impact of the day shift, I guess where the Christmas holiday fell. So, it sounds like it was included in that reported comp, though you did disclose the comp X, the extra day, which I guess is about a percentage point lower.

It sounds like the month that you gave us, though, were adjusted. So, in other words, the day is out, and then, I guess one of the reasons there might have been a bigger difference between the total on the comp sales number.

Would that have driven a bigger difference between the total on the comp sales number, or is that more the acquisitions that would have done so? Because it sounds like....

No. It's really – yeah. It's really the acquisitions..

Got it. And....

Go ahead..

And then my final question kind of moving past the extra day stuff, which I know can be banal, and I think you touched on this, John, just if you look at some of the government data on tire PPI and CPI, that had been favorable for you, at least theoretically so where you had a bit of a spread that should have been hopeful on margin.

What's your expectation for tire margin as commodity costs are to move higher again?.

Well, I guess it depends on – you're saying if commodity costs move higher, I guess, I would tell you what we said about the cost increases. If that – to the extent that that drives cost increases, it will drive lower cost increases for us, I would expect, because of our large volume and growing volumes.

And we certainly run the business to maintain our margins, so we will certainly look to pass along those increases and maintain our pricing discipline as we have in the past. So I guess, I don't have any specific guidance around that but like everything that impacts the entire market, we ought to see some competitive advantage arise from it..

Understood. Okay. Thank you so much. I appreciate it..

Sure..

From Consumer Edge, we'll go to Jamie Albertine. Please go ahead. Your line is open..

Great. Thanks and good morning, everyone. Just a quick housekeeping item. I noticed that your interest expense ticked up a little bit. I just want to make sure to ask you how we should think about that going forward, (50:22) of an elevated interest expense estimate flowing through the model, number one.

Number two, more strategically, however you want to define it but, what percentage of your portfolio would you say today is Northeast relative to Mid-Atlantic and Southeast? And how quickly will that change over time with respect to acquisitions? Because it does seem like you always are active in the acquisition market but there are clearly aren't any sort of big one or two transaction items that can really shift that percentage quickly? So, if we were to sit here today and sort of model out the next two or three years, what's the percentage today? And how will that look like, in your opinion, in the coming year or two? Thanks..

Sure. Let me take the second question first. Right now, our comp base is a little over 80% what we call north, and a little under 20% in the South. So, obviously adding the majority of the acquisitions that we made are in the South, so that should probably – that will increase the Southern exposure there.

From our perspective, looking out the next couple of years, I like the growth in the South, that's great, but we get so much operating leverage in all of the acquisitions that we complete that I don't want anyone to have the impression that we're not interested in doing acquisitions in any of our markets. That is a key piece of our strategy.

But going forward, you should expect us to be active all throughout our markets and with a particular interest in the South, but not some kind of fundamental preference from this point forward.

The other point that I would make along with that is when you look at dilution and dilution on the operating margin, in the year with big acquisitions, the basic approach that we have and part of our strategy or one of the results of our strategy is that we continue to add acquisitions and dilute the operating margin and then bring it back up as we integrate those acquisitions.

So, this year, you're seeing that more markedly because we're in a year early in these acquisitions in the integration process where they're dilutive, but we have all the sales coming on. So, that is a dynamic that is something that we will continue to see. And I think it's not necessarily a good thing.

But it's just a result of what I view as a great strategy that we've been able to execute. So, I want to make sure that – and that is a particular interest as we look at the fourth quarter here. We're going to have acquisitions that are dilutive because we're adding sales early in the integration process. On the interest expense, Brian will take that..

Yeah. So, the interest expense is up. The big driver of that is just the weighted-average debt outstanding that's $99 million higher than it was in the prior-year quarter.

Debt, obviously, affected by the acquisitions, the debt that we incurred for borrowings for payment of the acquisitions, and also capital leases that we assumed as part of those acquisitions. So, that is not too difficult to model in terms of our typical pay-downs against future deals will affect the amount that we have outstanding related to that.

So, the interest rate was less of an impact on it, only 20 basis points. But we are currently 100 basis points over LIBOR. So, any variability in LIBOR will affect our rate going forward..

Got it. Thank you, gentlemen, for both those answers. And just if I may, a quick follow-up on the strategic question, John. Can you provide an update, I know in prior calls we talked about how you're fulfilling your stores in the Southern part of the country, this was the Georgia and Florida markets from quite a distance.

Can you just give us a little bit of an update as to how you're looking at investments into may be Southeastern distribution, or how we should think about the impact related to that in the coming quarters from whether it's a COGS or SG&A perspective, or a combination thereof that the impact to operating margin ahead of your potential investment in a closer distribution facility? Thanks..

Sure. You're right. We are distributing from a distance to those stores. As I've said previously, we are taking a look at opportunities for distribution centers somewhere potentially in the Florida market. And we said we were looking at that in the back half of this fiscal year. We're doing that.

And I would – what I don't want to do is get out in front of that if we're going to be making an acquisition that might have some redundant warehouse space or availability there. So, we want to give some time for that. And I think what I've said previously is still the case.

We're certainly not maximizing the cost of goods benefits, but I still believe that we need to be over 100 stores for a distribution center down there to pay-off. And so, we will be looking that over the next several months and updating as we issue our guidance for fiscal 2018..

Okay. Great. Thanks, again, and best of luck for the next quarter..

Thank you..

Moving on to Michael Montani of Evercore..

Hey, guys. Thanks for taking the question. Just wanted to ask if I could on the third quarter.

Can you split out what's in the tire comp of plus 6%? What did you see in terms of price versus units in the quarter?.

Sure. Units were up 8% and average ticket was down 2%. And that was....

Got it..

...mostly – it was mostly trade down some price..

Okay. Thank you. And then one quick one on Fair Labor Standards Act, which looks like we're able to avert, I guess, in December.

Is that going to have any ongoing negative headwind because you all would have communicated that or are you able to avoid that potential expense step-up?.

No. We did not roll out any changes there..

Okay..

We were – we want to see what any final rules are before we go changing pay plans. We don't like to change pay plans on people..

Got it.

And then, I guess, the last one was a bit of housekeeping, but just can you give us a mix of percentage of revenue by category for the quarter?.

Sure. For the combined – for the company, brakes was 12%, steering was 9%, tires was 52%, and maintenance was 26%. The difference is exhaust, but it should be about 2%..

Got it. Thank you..

Yes..

From KeyBanc, we'll go next to Brett Hoselton. Please go ahead..

Good morning, gentlemen..

Good morning..

Could you please comment on your tire mix shift to lower margin tires? Is that a management strategy, or is that simply a result of consumer preference?.

It's really consumer preference. As we've said in the past, what we've done over the last couple years is broaden our assortment. And we've done that in part with increased lines of import tires. But, we broaden that assortment to provide consumers choice, good value for them where we are able to make good gross profit dollars per tire.

And really, more than anything, it's consumer choice..

And then on the tire pricing front, to-date, you haven't seen any impact of tire pricing in the most recent quarter and through January.

Is that a fair statement?.

You mean retail?.

Yes. Yeah. Well, in terms of – tire pricing in terms of the sell-in..

Yeah. At retail to consumer, we haven't seen any significant changes really from recent trend.

In terms of sell-in to dealers or to tire dealers in the industry, I would expect January sell-in there, so many manufacturer sells to maybe reflect the fact that that some companies, including ours, are trying to make sure that they buy ahead of any cost increases that are coming to them..

Okay. Fair enough. Thank you, John. I appreciate it..

Sure. Thank you..

Moving on to Carolina Jolly of Gabelli..

Good morning. Thanks for taking my call..

Sure..

I know we had spoken about in the past that some of your acquisitions cannibalized some of your revenues.

Is that built into your current comps?.

I think that is the dynamic that we see in specific markets where we're buying businesses that – and we really saturate the market. Certainly, it wasn't a huge impact in the past quarter. In the past quarter, I think what we said is that our business in the winter reacts to snow, and that was sort of proven in spades in the quarter..

And then also -.

Yeah. This is Rob. Carolina, we're not going to blame weak comps, on facility and grabbing market share, making more money in a market.

It's just an edge on but if you add 10% of the acquisition growth, one year, and additional 10%, a year before, and knows they're working their way into the system and operating margins, it's going to have some slight negative drag..

Okay. Thanks..

But we own our weak comps..

And that does conclude today's question-and-answer session. At this time, I'd like to turn the call back over to Mr. John Van Heel for closing remarks..

Thank you all for your time this morning. In this choppy market, we're focused on driving profitable sales. At the same time, we're aggressively expanding our business through acquisition, laying the groundwork for sales and earnings growth next year and beyond.

As always, we appreciate your support and our team who works to provide outstanding service to our customers every day. Thanks again, and have a great day..

And again, that does conclude today's conference. We thank you all for joining..