Carparts.Com Inc (PRTS) 2007 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the US Auto Parts fourth quarter and fiscal year 2007 earnings conference call. At this time all participants are in a listen only mode. Following today's presentation instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Thursday, March 6, 2008. I would now like to turn the conference over to Anne Rakunas with ICR. Please go ahead, ma'am.

Welcome to U.S. Auto Parts' fourth quarter and fiscal year 2007 conference call. On the call today from the company are Shane Evangelist, Chief Executive Officer and Michael McClane, Chief Financial Officer. By now everyone should have access to the fourth quarter and fiscal year 2007 earnings release, which went out today at approximately 4 PM Eastern. If you have not received a release, it is available on the Investor Relations portion of the U.S. Auto Parts website at www.USAutoParts.net by clicking on the U.S. Auto Parts Investor Relations tab. This call is being webcast, and a replay will be available on the Company's website until March 20th.

Before we begin, we would like to remind everyone that prepared remarks contain certain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance and speak only as of the date thereof. We refer all of you to the risk factors contained in U.S. Auto Parts' annual report on form 10-K and quarterly reports on form 10-Q filed with the Securities and Exchange Commission for a more detailed discussion on the factors that can cause actual results to differ materially from those projected in any forward-looking statement. U.S. Auto Parts assumes no obligation to revise any forward-looking projections that may be made in today's release or call.

Please note that on today's call in addition to discussing the GAAP financial results and outlook for the Company, the following non-GAAP financial measures will be discussed. EBITDA and adjusted EBITDA. An explanation of U.S. Auto Parts use of these non-GAAP financial measures in this call and the reconciliation between GAAP and non-GAAP measures required by SEC regulation G is included in U.S. Auto Parts press release today, which again can be found on the Investor Relations section of the Company's website. The non-GAAP information is not a substitute for any performance measure derived in accordance with GAAP, and the use of such non-GAAP measures have limitations which are detailed in the Company's press release.

And with that I would now like to turn the call over to Michael McClane.

Thank you. Hello, everyone, and thank you for joining us today. We are going with a new format for today's call. First I will provide a summary overview of the full-year 2007 followed by a more detailed discussion of our fourth quarter and full-year financial results and operating metrics. I will then turn the call over to Shane who will discuss our strategy, operating plans and updated 2008 guidance and finally we will conclude the call with your questions.

2007 was a year of transition for U.S. Auto Parts marked with many accomplishments as well as learning opportunities. While we experienced both successes and challenges, we believe the work done in 2007 will set the foundation for future growth and will provide value to our stockholders for years to come. We are excited to have new leadership with Shane as our CEO. His experience growing a consumer focused e-commerce business at Blockbuster is already providing us tremendous value.

We are happy to announce that we have entered into a preliminary settlement in the securities litigation. In connection with this settlement the Company recorded a charge of $4.5 million in 2007, of which $3.9 million was recorded in the fourth quarter.

Net sales for the fourth quarter of 2007 increased 1.4% to $37.3 million versus $36.8 million in the prior year period. Our e-commerce sales channel declined by 1.4% to $28.2 million from $28.6 million in the prior year period. Our online marketplaces, sales channel declined 4.5% from $4.2 million versus $4.4 million in the prior year period. These decreases were fully offset by an increase of 16% in off-line sales, which is comprised of sales from our Kool-Vue productlines and other products sold through our wholesale channel.

Sequentially net sales for the current quarter decreased by 1% from the third quarter of 2007. Net sales for the year ended December 31, 2007 increased 34% to $161 million versus $120.1 million in the prior year. Our online marketplace sales channel increased 29.6% to $20.6 million versus $15.9 million for the prior year. Our e-commerce sales channel increased 37% to $122.6 million from $89.5 million in the prior year.

We would have liked to have achieved a higher level of sales in 2007 especially as the year came to an end. The main reason for the shortfall from our own internal plans was inadequate staffing in our call center. We were understaffed in key functions including sales and customer service, which resulted in higher-than-expected call abandonment rates and longer hold times than we generally experience. We estimate these negatively impacted revenue.

We attributed the poor initial performance of the call center to lack of senior level leadership and accountability in the Philippines, as well as the transition of these services to our new facility earlier this year. We have taken corrective action and have seen the signs of early improvements. While we still have room for improvement we believe that the call center will not negatively impact sales going forward and expect the call center to be fully executing by the end of the first quarter of 2008.

Gross profit for the fourth quarter increased 5.8% to $12.7 million or 34% of net sales versus $12 million or 32.6% of net sales for the same period last year. On a year over year basis the increase in gross margin was primarily due to higher prices on certain products, lower product costs from our suppliers and lower outbound freight costs. Sequentially gross margins declined approximately 200 basis points to 34% in the fourth quarter of 2007. The sequential decrease in gross margin was primarily due to promotional site discounts that ran in October and November of 2007 that we did not run in the prior year period, as well as an increase in wholesale product sales.

Marketing spend was $3.2 million or 9% of net sales for the fourth quarter of 2007 compared to $2.9 million or 8% of net sales in the prior year period and $2.4 million or 6% of net sales in the third quarter of 2007. The sequential increase in marketing spend primarily reflects increased spending on paid search. We expect our marketing spend on paid search to return to third quarter 2007 levels in 2008 as we more closely align our spend with the incremental returns generated on the variable contribution margin of our customers.

G&A expense was $8.9 million or 24% of net sales for the fourth quarter of 2007 compared to $2.6 million or 7% of net sales in the prior year period and $3.2 million or 8% of net sales in the third quarter of 2007. Included in our fourth quarter 2007 G&A expenses are a $3.9 million pretax security litigation settlement charge, $400,000 of severance expense, $700,000 in costs associated with the hiring of our new CEO and $400,000 of facility startup costs related to a new distribution center.

For the fourth quarter of 2007 adjusted EBITDA or earnings before interest, taxes, depreciation and amortization and share-based compensation expense which is a non-GAAP measure was a loss of $3.4 million, compared to adjusted EBITDA of $3.2 million in the corresponding prior year period. Adjusted EBITDA excludes non cash stock-based compensation expense of $600,000 and $300,000 in the quarters ended December 31, 2007 and 2006, respectively.

Adjusted EBITDA for the year was $7.8 million or 4.8% of sales, a decrease of 41% from $13.3 million or 11.1% of sales in 2006. Included in our 2007 adjusted EBITDA are approximately $4.5 million in security litigation settlement charges, $400,000 of severance expense, $700,000 in costs associated with our new CEO and $400,000 of facility startup costs related to a new distribution center.

Adjusted EBITDA excludes non cash stock-based compensation expense of $2.2 million and $900,000 for the years ended December 31, 2007 and 2006, respectively. It is important to note that our fiscal year 2007 financial results were adversely impacted by the $4.5 million securities litigation settlement charge. This charge results from the Company's preliminary agreement to resolve the pending stockholder litigation against the Company and certain of its officers, directors and underwriters in connection with our IPO in February 2007. This settlement is still subject to court approval and completion of confirmatory due diligence.

While the Company denies any wrongdoing, the Board of Directors and management believe the settlement is in the best interest of our stockholders as it will avoid any substantial burden, expense and uncertainties that would be involved in protracted litigation. We are pleased to put this issue behind us and focus the entire efforts of the Company toward executing against our strategic growth plan and capture the significant market opportunity we are addressing.

Turning to our operating metrics for the fourth quarter, to better manage the business we have reset key operating metrics to use placed orders as the basis instead of prior net order basis in order to eliminate the impact on the operating metrics of returns, unfilled orders and incomplete payments. In addition, the Company is adjusting the measurement of monthly unique visitors to improve consistency and usability. The number of our monthly unique visitors in the fourth quarter increased 20% year-over-year to approximately 24 million in 2007 from 20 million in 2006 and remained consistent with the third quarter of 2007 at 23 million. Unique visitors based on our new measurement criteria were 25 million for the fourth quarter of 2007 compared to 24 million for the third quarter of 2007.

The conversion rate during the fourth quarter was 1%, down from 1.1% in the third quarter and a decrease of 1.2% year-over-year. Conversions based on our new measurement criteria was a 1.2% for the fourth quarter of 2007 compared to 1.2% for the third quarter of 2007. Orders placed to our e-commerce channel decreased slightly to approximately 238,000 compared to 241,000 in the prior year period and approximately 243,000 in the third quarter of 2007. E-commerce orders based on our new measurement criteria were 293,000 for the fourth quarter of 2007 compared to 297,000 for the third quarter of 2007.

The average order value in our e-commerce channel was $118, a decrease from $119 in the prior year period and $120 in the third quarter of 2007. Average order value based on our new measurement criteria was $125 for the fourth quarter of 2007 compared to $127 for the third quarter of 2007. The customer acquisition cost in the fourth quarter of 2007 was $10 compared to $9 dollars in the prior year period and $6 in the third quarter of 2007. Customer acquisition cost based on our new measurement criteria was $8 per customer for the fourth quarter of 2007 compared to $5 for the third quarter of 2007.

Turning to the balance sheet, as of December 31, 2007 cash and short-term investments was $42.1 million. Inventory was $11.2 million. Accounts Payable was $8.1 million and total debt was $1.0 million. And with that I would like to hand the call over to Shane.

Thank you, Michael. I have now been here for a little over four months. During that time I have worked with the team to conduct a full internal assessment of our business in order to develop our strategic and operating plans. At the center of that assessment has been to ask our customers what they want when they are buying auto parts. We surveyed both existing customers and the general customer who has purchased an auto part in the last 12 months to identify the things we do well, the things we need to improve upon, and the specific market segments within the automotive space that present the greatest opportunities given our strengths.

In addition to talking with our customers and potential customers, we completed industry sizing and looked at online activity for auto parts websites. According to industry reports the overall auto parts market in the US when considering the retail value of auto parts bought through retailers and service centers is over $120 billion. Of that $120 billion we estimate that less than 2% is generated online. And over the last five years we estimate that online sales for auto parts has grown somewhere between 20% to 30% annually.

Another telling indication that customers are migrating online is recent comScore data that shows visitors to the top 25 online auto parts retailers has increased 15% year-over-year for January. In terms of demographics and buying patterns we analyzed both (inaudible) socioeconomic customer segmentation as well as our internal research and believe our current online customers over index, and income and education live more suburban and overall resemble typical e-commerce customers. Our average customer splits their behavior between both off-line and online retailers. And when shopping online our research indicates they typically search at least three sites prior to buying where they are driven by product selection and price sensitive.

50% of our customers perform work on their car every month and 90% do this every quarter. Finally, our internal research produced the most encouraging statistics I have seen since I joined U.S. Auto Parts. Of the approximately 69 million households in the US that bought an auto part in the last 12 months, either through a retailer or from the service center, 55% or 37 million households said they are open to buying auto parts online.

So looking at the data we believe the typical consumer behavior lines up very well for U.S. Auto Parts' competitive advantages, which are as follows. Our expansive product offering of over 700,000 SKUs, our competitive prices, our ability to minimize customer acquisition costs by managing organic search across multiple sites. And finally, due to our low-cost Philippine operations we believe we are able to scale quickly and cost-efficiently to keep up with future demand.

We have also identified areas that need improvement. First and foremost, we need to listen to customers better. We need to do this when they visit one of our websites, when they engage one of our call center representatives, when we deliver product to them. We must make it easier to find and buy parts, including doing a better job at managing categories, merchandising what customers need and optimizing our pricing.

We must be more knowledgeable when we take their call and above all, we need to do a better job of delivering on our promise when it comes to fulfilling product to our customers, a theme you will continue to hear from me. To sum this up we have a great marketing mechanism, a vast selection of products and huge traffic to our sites where we had previously fallen short as in converting site visitors into customers and capture repeat business due to hit and miss back end delivery. Simply put we must do a better job with the end-to-end customer experience.

Over the past several weeks the management team has been refining our operating plan and long-term vision. We believe this plan should allow U.S. Auto Parts to capitalize on the huge opportunities we see before us. I would like to layout the key elements of that plan with you now. Our plan is rooted in U.S. Auto Parts being synonymous with two things; price and selection. Any car, any part, anywhere for less is our goal.

To accomplish that we plan to focus on four key areas over the next 12 to 14 months that concentrate our core online do-it-yourself segments. We will increase sales of existing SKUs through improving website and call center conversion, expanding our customer acquisition channels and improving our product fulfillment process. We plan to increase sales through the addition of new brands and SKUs in both existing and new categories. We plan to improve our supply chain economics by seeking out the least expensive supplier for any given part.

We plan to improve our infrastructure and compliance needs to ensure we scale adequately and effectively. The nonnegotiables that must be accomplished in 2008 are fixing the back end customer experience from the speed at which we deliver product to the call center interaction to making it easier to return product. This must be fixed in order to grow a base of loyal customers. We must improve the front end website experience and call center action. We need to create an experience where the customer wants to shop again.

Longer-term over the next two to three years we plan to continue to serve our core do-it-yourself customers through ongoing infrastructure and customer service improvements to provide a friction-less buying experience. We also plan to increase our focus on the do-it-for-me market; these are customers who typically feel they do not have the knowledge or time to handle maintenance and repairs on their own. We believe that we can change this dynamic in this segment of the market by offering customers an alternative to the repair shop where many feel they are sold a bill of goods they really don't need. By developing content, community and services on our network of sites that appeal to the do-it-for-me customer we believe we can create a safe environment to empower them to become a do-it-yourself customer, or at the very least arming customers with better knowledge and lower-cost parts before they go to their repair shop.

As we are in the early stages of implementing our 2008 operational plan, we will not be providing full-year 2008 guidance. However, we will provide our first quarter expectations in addition to targets for key metrics. We believe this is important in order to give our owners a strong sense of where we are taking the business. For the first quarter 2008 we expect to achieve revenue in the range of approximately 38 to $40 million and adjusted EBITDA in the range of approximately 1.6 to $2.1 million. For the year ending December 31, 2008 the Company expects revenues on a year-over-year basis to decline in the first half of 2008 versus the prior period, and increase in the second half of 2008 versus the prior period.

We are also providing the following key metrics to help you better understand the operating improvement goals we have set for ourselves; we plan to update you on our progress throughout the year. The first is revenue collection. We currently capture approximately 76% of revenue from placed orders. Said differently, of customers that press the bill my credit card button in the checkout process, we only recognizes 76% of that e-commerce revenue. We don't capture the other 24% of revenue because either the inventory is not available and thus never ships to the customer. We don't capture valid credit card and thus can't bill the customer or the product gets returned. Obviously you will never capture 100% of revenues, but after analyzing ways to improve these areas we believe we can increase this to 86%, resulting in expected annualized run rate increase of $12 million.

The second area is website conversions. We think we can improve our conversion rates from the current 1.2% to 1.4%. One way being through better category management, listening closely to the customer to find out specifically what they need and help them find it. This is a different approach than our previous approach that focused on universal site implementations. It is also noteworthy to report that conversion rate has previously pushed 1.4% before. So we anticipate we should be able to get back to those levels. The 20 basis point improvement could be an additional $20 million annually.

Third is call center conversion. Our call center conversion is currently averaging approximately 15%. We believe we can increase this to 18% by improving training, better separating customer service calls from sales calls, and creating teams of agents that are category experts. Currently 25% of our dedicated sales agents convert above 18% so this is not uncharted waters. This improvement could result in an annualized incremental revenue addition of $7 million.

Finally, repeat purchases. We believe we can increase repeat purchases from the current 15% to at least 20% by delivering products faster, more accurate shipping and by simply taking care of customers better when they encounter a problem. And remember, approximately 9% of our customers service their car every quarter. So clearly there is additional demand for parts among our existing customers. We believe the incremental annual revenue opportunity here could be approximately $6 million.

So in total from the categories just discussed we have identified approximately $45 million in incremental sales that once operationally objectives have been fully implemented should produce annual sales of approximately $200 million, with adjusted EBITDA margins of approximately 10% of net sales. As we highlighted in the past, EBITDA flowthrough increases significantly as we scale the business. We hope to have all of these operational objectives in place for 2009.

Additionally, we believe there is another $35 million incremental revenue that could be achieved through price optimization, increasing unique visitors through SEO, finding additional customer acquisition channels, increasing average order value and incorporating media into our sites. We have already begun work to capture this revenue, as well.

I cannot tell you exactly when we will complete the implementation of our operating plan. Part of our plan requires process improvements, much of it requires technology improvements and many are dependent on the other. If we get these rolled off earlier in the year, there will be more upside in 2008. However, what the team is focused on is implementing these properly, not cutting corners and building the proper infrastructure to support and capture the potential market opportunity that exists. I can commit to this; we are building a team that executes.

In closing I remain very excited about the opportunities ahead of us. We believe by executing the plan I just laid out, the growth of our business is in our control. We believe U.S. Auto Parts is poised to capture a significant share of the market by delivering against collection and prices and delivering world-class service. We are aware of the areas in need of improvement. We know how to improve upon them and we're working to achieve our goal of becoming a world-class e-commerce Company. We will continue to listen to our customers, deleverage our competitive advantages and providing more compelling reasons for customers to shop more often online with U.S. Auto Parts by improving our end to end consumer experience.

With that said, I would like to thank you again for participating on our call today and thank our shareholders for their support. It is much appreciated. Operator, we would now like to turn the call over to you for questions.

(OPERATOR INSTRUCTIONS) Aaron Kessler, Piper Jaffray.

A couple questions. First, can you just clarify the $45 million in incremental sales? Is that an annualized number or a quarterly number? I think you also cited a $200 million number. And also on the quarter you talked about some of the problems with the call center. Is there any other issues that led to maybe some slower conversion rates in growth? Are you starting to see maybe a slowing consumer? Does that have any impact on it? And I have one follow-up question.

On the first question that is an annualized run rate, and I think what you will see there is we were trying to take in our year end number here plus that number and saying that on an annualized basis that gets to $200 million. So that $45 million is over the course of a year. As it relates to the call center, yes, we missed some staffing opportunities there. And but I don't think fundamentally outside of that there is a structural problem. We saw increase in site traffic on our website. So we think demands there for product; we just have to do a better job selling it.

And any update on some of your other conversion initiatives? I know Howard has been working on the last few quarters; maybe you can give us an update there.

In previous calls (inaudible) most of the initiatives were around the implementation of Endeca and our unified catalog. Here's what I tell you. The unified catalog, while absolutely the right thing to do from getting the back end system in place, to manage the multiple sites with the same costing information, the implementation on the front end and the clarity with consumers are shopping it may have impacted that. We are now going back in to figure out a way to better present the product to the consumer, the information to the consumer. So I think you will see a lift as I anticipate in conversion over the course of the year as we go back in and clean some of the display that the consumer is currently seeing online.

Great. Thank you.

Matt Nemer, Thomas Weisel Partners.

Good afternoon, everyone. First question is I'm just curious on some of the markets that you gave, which were helpful, by the way, you mentioned that you think the online market has grown 20 to 30% over the last two years. And I'm just wondering why your organic growth seems to be lagging that and who, therefore, is growing at maybe a faster rate than that. And I guess sort of how and why?

I'm not clear on the organic growth. I think we've actually had pretty decent organic growth over the last two to three years; if I recall it was up 20% in '06, 20% in '07, somewhere in those ranges. So actually I think it is pretty consistent with that number. Matt, here is how I will tell you how we got there. We took a look at the data that AAI provided as it relates to both catalog and online penetration. We then also looked at other industry data as the mix shift between catalog and online has taken place, we then applied those to the numbers and that is kind of how the shift moved.

Okay, and then you spent some time talking about initiatives to fix the back end experience and improve the front end experience. And I guess I am wondering what the cost of some of these initiatives that you've laid out could be, both from both in terms of expense and in capitalized costs.

Here's what I would say as it relates to investing in the business. I don't think about any one of those individual projects having a certain cost to it although I am sure they do and we're looking at those, for sure. But what we really need to do is ensure we've got the proper team in place to make sure we can deliver on some of these projects. So for instance, we sell product that we can't fill right now in some cases and we simply need to get processes in place and the systems built to alert us when that is happening so we can react faster. And so those are the sort of things we are working on to ensure that we are picking up those initiatives. So I wouldn't say that there is any one initiative outside of the building a new distribution center on the East Coast to get product shipped faster to customers, but outside of that one initiative this is sort of your basic blocking and tackling. Make sure you have the proper infrastructure in place and the team on board to ensure we can get that revenue that we are missing.

I realize you haven't given full-year guidance, but can you give us just some directional comments about CapEx spending for the year?

The CapEx spending I think your first question on internal costs, I think you will see that slightly increase from previous amounts as we focus IT efforts on building out applications and the technology platform overall. And I would expect the normalized run rate on CapEx to continue going forward. We did have some costs in the fourth quarter associated with building out the -- in the third quarter -- building out the Philippine call center so there were some CapEx there. But go forward you should see a normalized run rate short of a new DC that we would expect to start incurring costs in the fourth quarter of 2008.

And you hired someone to run that call center or is that still something a position that you are looking to fill?

We've actually hired a leader in the Philippines, and we are in the process here now.

Got it. And then lastly this is sort of a housekeeping question, but in terms of your cash balance, can you tell us what that is invested in, and is there any exposure to auction rate securities?

We have -- our cash balance as of now is invested primarily in money market that has no ARS exposure. We have about $7.75 million today that is invested in closed end funds. And those are associated with some of the auction failures. So that would be the exposure that I think you are referencing. Our policies are that we are not -- we have no mortgage exposure and it is really just in a closed-end funds and it is all the securities underlying those funds of AAA for us. So it is a liquidity question versus a collectibility issue.

Got it. And are you required to sort of potentially write that down at some point or call that out, or is it just too early to tell?

It is early to tell. Certainly hopeful that the auction process starts to have some success again, and even if it doesn't, we are sitting on what we think is collectible securities. Because of the AAA rating of the underlying securities not just the insurance wraps or the CEF directly. So we feel good about it. It is certainly a long-term security as we sit here today and as things unfold we will keep you posted. We were in a fortunate position to be able to liquidate a lot of our CEFs before the auction started failing. So we feel fairly fortunate in the shoes we are in today.

Okay, thanks very much.

(OPERATOR INSTRUCTIONS) Stephen Ju, RBC Capital Markets.

Good afternoon, guys. Among the initiatives that you mentioned, which do you view as being the priority or better yet the lowest hanging fruit? And the targets that you mentioned in terms of revenue collection, conversion, etc., should we view that as a twelve-month timeframe deliverable, or over a longer timeframe? Thank you.

First and foremost, the thing we are absolutely focused on is fixing the back end experience for delivering product to our consumers. The reason I say that is as we start to grow revenue, if we can't deliver and get repeat customers, then we don't have a long life ahead of us; but we think we do. We like where the analysis has taken us. We have a good feel for where the holes are, and we are absolutely working on addressing that. So that is the a number one priority for me. Number two I would tell you is once that conversion because that has the single biggest impact on revenues.

As far as timing on the initiatives go, those are not fixed date deliverables for us. We are focused around putting the team in place to deliver on those initiatives during '08 and certainly hope to exit '08 with those all in place and therefore see the lift in '09. But we are not at this point ready to commit to that.

Got it. What was your cash flow from operations in the fourth quarter?

I don't have that in front of me, but I will get that to you.

That's it. Thank you.

There are no further questions in the queue, so this does conclude the U.S. Auto Parts fourth quarter and fiscal year 2007 earnings conference call. You may now disconnect, and have a pleasant day.