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MNRO > SEC Filings for MNRO > Form 10-K on 29-May-2013All Recent SEC Filings

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Form 10-K for MONRO MUFFLER BRAKE INC


29-May-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following table sets forth income statement data of Monro expressed as a percentage of sales for the fiscal years indicated:

                                                              Year Ended Fiscal March
                                                        2013           2012           2011
Sales                                                    100.0 %        100.0 %        100.0 %
Cost of sales, including distribution and
occupancy costs                                           62.0           59.7           59.6

Gross profit                                              38.0           40.3           40.4
Operating, selling, general and administrative
expenses                                                  27.9           26.9           28.1

Operating income                                          10.1           13.3           12.3
Interest expense, net                                      1.0            0.8            0.8
Other income, net                                          -             (0.1 )         (0.1 )

Income before provision for income taxes                   9.1           12.6           11.6
Provision for income taxes                                 3.3            4.7            4.4

Net income                                                 5.8 %          8.0 %          7.2 %

FORWARD-LOOKING STATEMENTS

The statements contained in this Annual Report on Form 10-K that are not historical facts, including (without limitation) statements made in this Item and in "Item 1 - Business", may contain statements of future expectations and other forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this Annual Report on Form 10-K, the words "anticipates", "believes", "contemplates", "see", "could", "estimate", "intend", "plans" and variations thereof and similar expressions, are intended to identify forward-looking statements. Forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed. These factors include, but are not necessarily limited to, product demand, dependence on and competition within the primary markets in which Monro's stores are located, the need for and costs associated with store renovations and other capital expenditures, the effect of economic conditions, the impact of competitive services and pricing, parts supply restraints or difficulties, industry regulation, risks relating to leverage and debt service (including sensitivity to fluctuations in interest rates), continued availability of capital resources and financing, disruption or unauthorized access to our computer systems, risks relating to protection of customer and employee personal data, risks relating to litigation, risks relating to integration of acquired businesses, including goodwill impairment and the risks set forth in "Item 1A. Risk Factors". Except as required by law, we do not undertake to update any forward-looking statement that may be made from time to time by us or on our behalf.

CRITICAL ACCOUNTING POLICIES

We believe that the accounting policies listed below are those that are most critical to the portrayal of our financial condition and results of operations, and that required management's most difficult, subjective and


complex judgments in estimating the effect of inherent uncertainties. This section should be read in conjunction with Note 1 to the Consolidated Financial Statements which includes other significant accounting policies.

Inventory

We evaluate whether inventory is stated at the lower of cost or market based on historical experience with the carrying value and life of inventory. The assumptions used in this evaluation are based on current market conditions and we believe inventory is stated at the lower of cost or market in the consolidated financial statements. In addition, historically we have been able to return excess items to vendors for credit or sell such inventory to wholesalers. Future changes by vendors in their policies or willingness to accept returns of excess inventory could require a revision in the estimates.

Carrying Values of Goodwill and Long-Lived Assets

We have a history of growth through acquisitions. Assets and liabilities of acquired businesses are recorded at their estimated fair values as of the date of acquisition. Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. The carrying value of goodwill is subject to annual impairment reviews in accordance with accounting guidance on goodwill and other intangible assets, which we typically perform in the third quarter of the fiscal year. Impairment reviews may also be triggered by any significant events or changes in circumstances affecting our business.

Because we have only one reporting unit which encompasses all operations including new acquisitions, we believe there is little risk of impairment. The goodwill impairment test consists of a two-step process, if necessary. We perform a qualitative assessment to determine if it is more likely than not that the fair value is less than the carrying value of goodwill. If the qualitative factors are triggered, we perform the two-step process. The first step is to compare the fair value of our invested capital to the book value of our invested capital. If the fair value is less than its carrying value, the second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of goodwill with the carrying amount of that goodwill. If the carrying amount of goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill.

Intangible assets primarily represent allocations of purchase price to identifiable intangible assets of acquired businesses and are amortized over their estimated useful lives. All intangibles and other long-lived assets are reviewed when events or changes in circumstances indicate that the asset's carrying value may not be recoverable. If such indicators are present, it is determined whether the sum of the estimated undiscounted future cash flows attributable to such assets is less than their carrying amounts.

A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models, but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with accounting guidance, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our actual cost of capital has changed. Therefore, we may recognize an impairment of an intangible asset or assets even though realized actual cash flows are approximately equal to or greater than our previously forecasted amounts.

Self-Insurance Reserves

We are largely self-insured with respect to workers' compensation, general liability and employee medical claims. In order to reduce our risk and better manage our overall loss exposure, we purchase stop-loss insurance


that covers individual claims in excess of the deductible amounts, and caps total losses in a fiscal year. We maintain an accrual for the estimated cost to settle open claims as well as an estimate of the cost of claims that have been incurred but not reported. These estimates take into consideration the historical average claim volume, the average cost for settled claims, current trends in claim costs, changes in our business and workforce, and general economic factors. These accruals are reviewed on a quarterly basis, or more frequently if factors dictate a more frequent review is warranted. For more complex reserve calculations, such as workers compensation, we use the services of an actuary on an annual basis to assist in determining the required reserve for open claims.

Stock-Based Compensation

The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model that uses the following assumptions. Expected volatilities are based on historical changes in the market price of the Company's Common Stock. The expected term of options granted is derived from the terms and conditions of the award, as well as historical exercise behavior, and represents the period of time that options granted are expected to be outstanding. The risk-free rate is calculated using the implied yield on zero-coupon U.S. Treasury bonds with a remaining maturity equal to the expected term of the awards. We use historical data to estimate forfeitures. The dividend yield is based on historical experience and expected future changes.

Income Taxes

Our provision for income taxes and effective tax rates are calculated by legal entity and jurisdiction and are based on a number of factors, including our income, tax planning strategies, differences between tax laws and accounting rules, statutory tax rates and credits, uncertain tax positions and valuation allowances. We use significant judgment and estimates in evaluating our tax positions.

Tax law and accounting rules often differ as to the timing and treatment of certain items of income and expense. As a result, the tax rate reflected in our tax return (the current or cash tax rate) is different from the tax rate reflected in our Consolidated Financial Statements. Some of the differences are permanent, while other differences are temporary as they reverse over time. We record deferred tax assets and liabilities for any temporary differences between the tax reflected in our Consolidated Financial Statements and tax bases. We establish valuation allowances when we believe it is more-likely-than-not that some portion of our deferred tax assets will not be realized.

At any one time, our tax returns for several tax years are subject to examination by U.S. federal and state taxing jurisdictions. We establish tax liabilities in accordance with the accounting guidance on income taxes. Under the accounting guidance, the impact of an uncertain tax position taken or expected to be taken on an income tax return must be recognized in the financial statements at the largest amount that is more-likely-than-not to be sustained. An uncertain income tax position will not be recognized in the financial statements unless it is more-likely-than-not to be sustained. We adjust these tax liabilities, as well as the related interest and penalties, based on the latest facts and circumstances, including recently published rulings, court cases and outcomes of tax audits. To the extent our actual tax liability differs from our established tax liabilities for unrecognized tax benefits, our effective tax rate may be materially impacted. While it is often difficult to predict the final outcome of, the timing of, or the tax treatment of any particular tax position or deduction, we believe that our tax balances reflect the more-likely-than-not outcome of known tax contingencies.

RESULTS OF OPERATIONS

Fiscal 2013 As Compared To Fiscal 2012

Sales for fiscal 2013 increased $45.4 million or 6.6% to $732.0 million as compared to $686.6 million in fiscal 2012. The increase was due to an increase of $99.6 million related to new stores, of which $95.3 million came from the fiscal 2012 and fiscal 2013 acquisitions. Offsetting this was a decrease in comparable store sales


of 7.3%. Additionally, there was a decrease in sales from closed stores amounting to $6.4 million. Fiscal 2013 was a 52-week year, and therefore, there were 361 selling days as compared to 368 selling days in fiscal 2012. Adjusting for days, comparable store sales were down 5.5%.

As occurred in previous years, we completed the bulk sale of approximately $2.4 million of slower moving inventory to Icon International, a barter company, in exchange for barter credits. The margin recognized in these transactions is typically less than our normal profit margin. The barter transaction that occurred in fiscal 2013 decreased gross profit and operating expenses by .1% of sales.

During the year, 144 stores were added and 10 were closed. At March 30, 2013, we had 937 Company-operated stores in operation.

We believe that the decline in comparable store sales for fiscal 2013 resulted mainly from the continued weak U.S. economy. With the continuation of high gasoline prices, lack of consumer confidence and high unemployment, we believe that customers are continuing to defer tire purchases and service repairs, especially on higher ticket items. Additionally, we believe that the milder winter weather this and last year also led to consumers deferring tire purchases. While it appears that repairs and tire purchases are being deferred more and for longer than in prior years, most can only be deferred for a period of time due to safety issues or state inspection requirements.

Gross profit for fiscal 2013 was $278.1 million or 38.0% of sales as compared with $276.4 million or 40.3% of sales for fiscal 2012. The decrease in gross profit for fiscal 2013, as a percentage of sales, is due to several factors. Total material costs increased as a percentage of sales as compared to the prior year. This was due to a shift in mix to the lower margin service and tire categories, the latter due in part to the acquisition of more tire stores.

Distribution and occupancy costs increased as a percentage of sales from the prior year as we lost leverage on these largely fixed costs with lower comparable store sales.

Labor costs were relatively flat as a percentage of sales as compared to the prior year.

Operating expenses for fiscal 2013 were $204.4 million or 27.9% of sales compared with $185.0 million or 26.9% of sales for fiscal 2012. Excluding the operating expenses related to the stores acquired in fiscal 2013, operating expenses actually decreased by approximately $1.5 million, after adjusting for the extra week in fiscal 2012. This demonstrates that the Company experienced leverage in this line on a comparable store basis through focused cost control and pay plans which appropriately adjust for performance.

Operating income in fiscal 2013 of $73.7 million decreased 19.4% compared to operating income of $91.4 million in fiscal 2012, and decreased as a percentage of sales from 13.3% to 10.1%.

Net interest expense for fiscal 2013 increased by approximately $2.0 million as compared to the prior year, and increased as a percentage of sales from .8% to 1.0%. The weighted average debt outstanding for the year ended March 30, 2013 increased by approximately $75 million from fiscal 2012, primarily related to an increase in debt outstanding under our Revolving Credit Facility to fund the purchase of our fiscal 2013 acquisitions. Largely offsetting this increase was a decrease in the weighted average interest rate of approximately 340 basis points from the prior year due to a shift in the percentage of debt (revolver vs. capital leases) outstanding at a lower rate. Additionally, amortization of financing fees over the higher outstanding revolving credit balance is causing a decrease in the weighted average interest rate.

Our effective tax rate was 36.3% and 37.0%, respectively, of pre-tax income in fiscal 2013 and 2012. The difference primarily relates to the accounting for uncertain tax positions which may vary from year to year.


Net income for fiscal 2013 decreased by $12.0 million, or 22.1%, from $54.6 million in fiscal 2012, to $42.6 million in fiscal 2013, and earnings per diluted share decreased by 21.9% from $1.69 to $1.32 due to the factors discussed above.

Fiscal 2012 As Compared To Fiscal 2011

Sales for fiscal 2012 increased $49.9 million or 7.8% to $686.6 million as compared to $636.7 million in fiscal 2011. The increase was partially due to a comparable store sales increase of 2.0%. Additionally, there was an increase of $38.4 million related to new stores, of which $3.1 million and $31.3 million came from the fiscal 2011 and fiscal 2012 acquisitions, respectively. Partially offsetting this was a decrease in sales from closed stores amounting to $4.5 million. Fiscal 2012 was a 53-week year, and therefore, there were 368 selling days as compared to 361 selling days in fiscal year 2011. Adjusting for days, comparable store sales were flat.

As occurred in previous years, during fiscal 2012, we completed the bulk sale of approximately $3.2 million of slower moving inventory to Icon International, a barter company, in exchange for barter credits. The margin recognized in these transactions is typically less than our normal profit margin. However, the barter transactions for fiscal 2012 had no impact on gross profit, but decreased operating expenses by .2% of sales as compared to fiscal 2011. There were no barter transactions in fiscal 2011.

During the year, 36 stores were added and 14 were closed. At March 31, 2012, we had 803 Company-operated stores in operation.

We believe that the flat comparable store sales for fiscal 2012 resulted mainly from the continued weak U.S. economy. With the continuation of higher gasoline prices and lack of consumer confidence, we believe that customers are continuing to defer tire purchases and service repairs, especially on higher ticket items. As evidence, tire sales, which have increased every year on a comparable store basis during the past three years, decreased slightly for fiscal 2012 when adjusted for days as compared to the prior year. During the year, Monro, like most all other tire retailers, experienced a decline in the sale of tire units, which is believed to be attributable to consumer resistance to steeply rising prices. Additionally, we believe that the milder winter weather this year led to consumers deferring tire purchases. Related tire categories such as alignment sales declined for fiscal 2012 as well. We did have comparable store exhaust and brake sales increases for fiscal 2012, supporting our belief that consumers are keeping their cars longer and repairing them instead of trading them in for new cars. While it appears that some repairs and tire purchases are being deferred, most can only be deferred for a period of time due to safety issues or state inspection requirements. When customers do come in to have their vehicles repaired, our belief that they spend more on average because the problem with their vehicle has worsened due to additional wear, as evidenced by an increase in the average sales per invoice for fiscal 2012 as compared to the prior year.

Gross profit for fiscal 2012 was $276.4 million or 40.3% of sales as compared with $257.5 million or 40.4% of sales for fiscal 2011. The decrease in gross profit for fiscal 2012, as a percentage of sales, is due to several factors. Total material costs increased as a percentage of sales as compared to the prior year. We experienced significant increases in oil and tire costs as compared to the prior year and, for competitive reasons, did not increase selling prices to the degree that would have preserved gross margin percentages at prior year levels. Higher margin categories, such as brakes and exhaust, which had comparable store increases in the fiscal year, helped to slightly offset the effect of tire and oil cost increases, as did cost reductions obtained through the use of direct import products.

Distribution and occupancy costs decreased as a percentage of sales from the prior year as Monro, with higher overall sales, was able to better leverage these largely fixed costs.

Labor costs decreased as a percentage of sales as compared to the prior year, mainly due to better control of payroll and improved labor efficiency as measured by sales per man hour.


Operating expenses for fiscal 2012 were $185.0 million or 26.9% of sales compared with $179.1 million or 28.1% of sales for fiscal 2011. When removing the extra week in fiscal 2012, operating expenses were 27.2% of sales for fiscal 2012. The improvement in operating expenses as a percent of sales is largely due to focused cost control on higher sales.

Within operating expenses, over $8.3 million in selling, general and administrative ("SG&A") expenses are directly attributed to increased direct store expenses such as manager pay, advertising and supplies related to the fiscal 2012 acquisition stores and a full year of expenses for the fiscal 2011 acquisition stores. On a comparable store basis, direct store expenses decreased $4.2 million (net of an increase of $2.2 million in expense related to the 53rd week) as compared to the prior year, demonstrating that we experienced leverage in this line through focused cost control. We incurred $1.9 million in costs related to acquisitions including $1.3 million in due diligence expenses related to the unsuccessful acquisition of Midas, Inc. Other drivers of the dollar increases in SG&A expenses were store support costs that increased by approximately $1.9 million including increased workers compensation and health care costs, partially offset by decreased management bonus expense of $1.6 million due to the Company not attaining certain profit goals for fiscal 2012. Additionally during the year, we sold seven stores for which a gain of $1.7 million was recognized.

Operating income in fiscal 2012 of $91.4 million increased 16.6% compared to operating income in fiscal 2011, and increased as a percentage of sales from 12.3% to 13.3%.

Net interest expense for fiscal 2012 increased by approximately $.1 million as compared to the same period in the prior year, and remained flat at .8% of sales for the same periods. The weighted average debt outstanding for the year ended March 31, 2012 decreased by approximately $12 million from fiscal 2011, primarily related to a decrease in debt outstanding under our Revolving Credit Facility. The weighted average interest rate increased by approximately 180 basis points in fiscal 2012 due to a shift to a larger percentage of debt (capital lease vs. revolver) outstanding at a higher rate.

Our effective tax rate was 37.0% and 38.0%, respectively, of pre-tax income in fiscal 2012 and 2011. The difference primarily relates to the accounting for uncertain tax positions which may vary from year to year.

Net income for fiscal 2012 increased by $8.8 million, or 19.1%, from $45.8 million in fiscal 2011, to $54.6 million in fiscal 2012, and earnings per diluted share increased by 17.4% from $1.44 to $1.69 due to the factors discussed above.

CAPITAL RESOURCES, CONTRACTUAL OBLIGATIONS AND LIQUIDITY

Capital Resources

Our primary capital requirements for fiscal 2013 were divided among the funding of acquisitions for $163.3 million, as well as the upgrading of facilities and systems, including the completion of the approximate $4.6 million expansion of our Rochester, New York office and warehouse facility which began in fiscal 2012, and funding of our store expansion program, all totaling $34.2 million. In fiscal 2012, our primary capital requirements involved the funding of acquisitions for $39.2 million, as well as the upgrading of facilities and systems, including $3.3 million of construction in progress for the expansion of the Rochester, New York office and warehouse facility, and systems and the funding of our store expansion program totaling $28.6 million. In both fiscal years 2013 and 2012, capital requirements were primarily met by cash flow from operations and from our revolving credit facility.

In fiscal 2014 we intend to open approximately four new stores. Total capital required to open a new greenfield service store ranges, on average (excluding the acquired stores and BJ's locations), from $350,000 to $950,000 depending on whether the store is leased, owned or land leased. Total capital required to open a new greenfield tire (leased) location costs, on average, approximately $600,000, including $220,000 for equipment and $150,000 for inventory.


Monro paid dividends of $12.7 million in fiscal 2013. In May 2013, Monro's Board of Directors declared its intention to pay a regular quarterly cash dividend of $.11 per common share or common share equivalent beginning with the first quarter of fiscal 2014.

We also plan to continue to seek suitable acquisition candidates. Management believes that we have sufficient resources available (including cash flow from operations and bank financing) to expand our business as currently planned for the next several years.

Contractual Obligations

Payments due by period under long-term debt, other financing instruments and
commitments are as follows:



                                                      Within       Within 2 to       Within 4 to      After 5
                                         Total        1 Year         3 Years           5 Years         Years
                                                               (Dollars in thousands)
Principal payments on long-term debt   $ 127,847                  $         660     $     127,187
Capital lease commitments/financing
obligations                               63,813     $  4,914             9,332             8,949     $ 40,618
Operating lease commitments              167,468       35,237            56,320            34,465       41,446

Total                                  $ 359,128     $ 40,151     $      66,312     $     170,601     $ 82,064

We believe that we can fulfill our contractual commitments utilizing our cash flow from operations and, if necessary, bank financing.

Liquidity

In June 2011, we entered into a five-year, $175 million Revolving Credit Facility agreement with seven banks (the "Credit Facility"). The Credit Facility amended and restated, in its entirety, the Credit Facility agreement previously entered into by Monro as of July 2005 and amended from time to time. The Credit Facility also provided an accordion feature permitting us to request an increase in availability of up to an additional $75 million.

In December 2012, the Credit Facility was amended to include the following: the committed sum was increased by $75 million to $250 million; the term was extended for another one and a half years, such that the Credit Facility now expires in December 2017; and the $75 million accordion feature was maintained. There were no other changes in terms including those related to covenants or interest rates. There are now six banks participating in the syndication. There was $127 million outstanding under the Credit Facility at March 30, 2013. We were in compliance with all debt covenants as of March 30, 2013.

During fiscal 2013, the interest rate on the Credit Facility was 100 basis points over LIBOR.

Within the Credit Facility, we have a sub-facility of $40 million for the purpose of issuing standby letters of credit. The line requires fees aggregating 1.125% annually of the face amount of each standby letter of credit, payable quarterly in arrears. There was $20 million in an outstanding letter of credit at March 30, 2013.

The net availability under the Credit Facility at March 30, 2013 was $103 million.

Specific terms of the Credit Facility permit the payment of cash dividends not to exceed 50% of the prior year's net income, and permit mortgages and specific . . .

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