Carparts.Com Inc (PRTS) 2018 Q2 法說會逐字稿

Welcome to the U.S. Auto Parts Second Quarter 2018 Conference Call. On the call from the company are Aaron Coleman, Chief Executive Officer; and Neil Watanabe, Chief Financial Officer.

By now, everyone should have access to the second quarter 2018 earnings release, which went out today at approximately 4 p.m. Eastern Time. If you have not received the release, it is available on the Investor Relations portion of the U.S. Auto Parts website at 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 through August 22, 2018.

Before we begin, we'd like to remind everyone that the prepared remarks contain certain forward-looking statements within the meaning of the federal securities laws, and management may make additional forward-looking statements in response to your questions. Forward-looking statements include, but are not limited to, statements regarding future events, our future operating and financial results, financial expectations, expected growth and strategies, key operating metrics and current business indicators, capital needs and deployment, liquidity, product offerings, customers and suppliers and competition. Forward-looking statements are based on current information, and expectations are subject to uncertainties and changes in circumstances and do not constitute guarantees of future performance. Forward-looking statements involve a number of factors that could cause actual results to differ materially from those statements. 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 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, nor does it intend to, update or revise any forward-looking projections that may be made in today's release or call, or to update or revise the reasons actual results to differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Please note that on today's call, in addition to discussing GAAP financial results and our 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, 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 those with such non-GAAP measures have limitations which are detailed in the company's press release.

Please note that we are not including a reconciliation of adjusted EBITDA guidance to projected net income due to the high variability and difficulty in making accurate long-term forecasts and projections of our net operating loss carryforwards, which have a significant impact on future net income. As a result, we are unable to quantify a projected net income without unreasonable efforts.

In addition, please also note that the percentage and basis points discussed are calculated using net sales, with the exception of advertising, which we'll be discussing and comparing to net online sales.

Unless otherwise stated, all financial data reported, including, but not limited to, revenue, gross margin, operating expense and net income loss, excludes our discontinued AutoMD reporting segment.

With that, I would now like to turn the call over to Aaron Coleman.

Thank you, operator. Good afternoon, everyone, and thank you for joining us to discuss our second quarter 2018 results.

Before we get into the second quarter, I wanted to provide an update on our pending litigation against the United States Department of Homeland Security and the U.S. Court of International Trade. As we mentioned on our last earnings call, our lawsuit asserts the United States Customs and Border Protection, an agency of the Department of Homeland Security, has been wrongfully seizing automotive grilles being imported by U.S. Auto Parts on the basis that the grilles are allegedly counterfeit and infringed trademarks held by the original automobile manufacturer. We commenced the lawsuit to remove the overly burdensome bonding requirements arising from the wrongful seizures and to ensure that Customs expeditiously process the flow of our goods into the United States. During the second quarter, the court granted our motion for a preliminary injunction and ordered that Customs would be restrained from enforcing any type of enhanced bonding requirement on U.S. Auto Parts in order to obtain entry of its shipments into the United States, and that Customs must use its best efforts to process all of U.S. Auto Parts' import products not implicated by Customs' underlying trademark infringement allegations in a timely manner. Despite the favorable court order, we continue to experience issues with our product flow arising from Customs' inability to process our shipping containers in an expeditious fashion. At the time the court order was granted, Customs was holding approximately 200 of our shipping containers that carried not only the grilles alleged to be counterfeit, but many of our other products as well. So although the seized automotive grilles initially accounted for less than 1% of our annual revenue, we began to experience out-of-stock rates across many other categories due to the backlog of containers, which Customs was holding. We also began to incur significant port and carrier fees resulting from the increased period of time our containers remained at the port. These fees associated with the unreleased product as well as the increased legal costs associated with the product seizures and the bonding litigation also negatively impacted our quarter. And together with the increased out-of-stock rates, we experienced lower sales, lower gross margins and higher operating expenses for the second quarter.

We do finally believe the supply chain disruption to our non-grille-related parts is largely behind us, as all of our containers, which had been held up at Customs have been released as of the end of July. However, in an effort to avoid future supply chain disruptions, we have ceased importing all automotive grilles from outside the United States and began to procure alternative sources, despite the fact that we firmly believe these grilles do not infringe on any trademarks. This was a much less expensive alternative than continuing to incur port and carrier fees and the ongoing disruption to the rest of our supply chain. This will reduce revenues and gross margins over the near term as our entire grille category accounts for approximately 3% of our total annual revenue. The amortization treatment of the port and carrier fees associated with unreleased products will also continue to impact gross margins and operating expenses for the next 3 quarters. We will continue to evaluate our options to help expedite our ability to import grilles, as we do not believe the trademark infringement allegations have any merit nor do we believe the allegations should prevent us from importing grilles, which are not alleged to violate trademark law or which we would otherwise be authorized to sell.

With that, I'll turn the call over to Neil for our second quarter results.

Thank you, Aaron, and good afternoon, everyone. I'd like to provide a summary of the financials reported in our press release today as well as an overview of key business metrics. Unless specifically noted, I would also like to remind listeners that all metrics exclude the AutoMD operating segment, which is being reported as discontinued operations, following the dissolution of the AutoMD subsidiary in the second quarter of 2017.

Moving on to our second quarter results. Net sales in the second quarter were $77 million compared to $80.2 million in the year-ago quarter, with the decrease primarily driven by a 9% decrease in e-commerce sales, attributable to a decrease in e-commerce traffic and lower in-stock rates, resulting from our previously disclosed customs issue. We also experienced a slight reduction in marketplace sales, resulting partially from the same lower in-stock rates. Private label sales were flat in Q2 and accounted for 75% of net sales compared to 72% in the year-ago period.

Also note that off-line sales, which is comprised of our wholesale revenues, were up 13% in Q2 to $8.5 million. Gross margins in Q2 was 27.9% compared to 29% in the year-ago period. The decrease was driven by higher freight costs as well as factors associated with the customs issue, including lower in-stock rates on higher margin products and port and carrier fees associated with the unreleased product at the Port of Norfolk. As a result of the amortization treatment of these fees, the company expects gross margin to range between 27% to 28% over the next 3 quarters compared to our typical 29% to 30% range. For fiscal 2018, we currently expect the amortization of these port and carrier fees to be -- to approximate $1.8 million.

Total OpEx in the second quarter was $21 million compared to $21.7 million last year. As a percentage of revenue, OpEx was 27.3% compared to 27.1%, with the increase driven by higher legal costs resulting from the aforementioned customs issue.

Net loss in the second quarter was $0.5 million or negative $0.02 per share compared to net income of $26.9 million or $0.67 per share in the year-ago quarter. Note that the 2017 period included a $25.9 million tax credit resulting from the release of a valuation allowance on our cumulative net operating losses.

Adjusted EBITDA, which adds back stock-based compensation expense and costs associated with our customs issue, was $2.8 million compared to $3.8 million in the prior year quarter. As a percentage of revenue, adjusted EBITDA was 3.6% compared to 4.8%. The decrease was primarily driven by the aforementioned lower net sales and gross margins resulting from the customs issue and a decline in organic and paid traffic.

Now let me provide some details on our key operating metrics for the second quarter. Total orders in Q2 were 857,000 versus 954,000 in the prior year. E-commerce orders in Q2 decreased 10% to 443,000 with an average order value of $102 compared to $103 in the year ago period. Despite the lower orders, we improved efficiency during the quarter with a 70 basis point increase in the e-commerce conversion to 2.7%. This is our fifth quarter in a row of improved year-over-year conversion rates, which tells us that the investments we've made to enhance the customer experience on our core sites are working.

Revenue capture, defined as the amount of actual dollars retained after taking returns, payment capture and product fulfillment as consideration, also improved to 88% of gross sales compared to 85% in the year-ago period. This is a result of the improvements made to our return process, order fill rates and payment capture.

In the second quarter, our customer acquisition costs increased to $7.29 compared to $6.99 last year. The increase was driven by an increase mix of paid versus organic traffic.

Turning to the balance sheet. At June 30, 2018, we had no revolver debt for the 10th consecutive quarter. We also had a cash balance of $6.8 million compared to no revolver debt and $2.9 million of cash at fiscal year-end 2017. This increase was attributable to the timing of payments with one of our shipping vendors. We ended the quarter with inventory of $54.2 million, which is flat compared to the end of 2017.

I'd also like to mention that we have completed a detailed review of the recently announced tariffs for products imported from China. There are 3 different groups of tariffs that have been contemplated by the administration. The first group, which was implemented on July 6, included approximately 450 of our SKUs, which represents approximately 1.5% of our net sales. The second group, which has not been implemented yet, includes approximately 30 of our SKUs that will not have a material revenue impact. The third group has also not been implemented yet and is $500 billion in scope. We believe that the third group would cover the majority of our industry. It is important to note that our goal with any tariffs would be to pass the cost along to consumers and maintain gross profits.

With that, I'll turn the call back over to Aaron.

Thank you, Neil. Let me begin by thanking all of the U.S. Auto Parts' team members for their continued focus on improving the customer experience and building long-term value. Despite the challenges we encountered on the customs issue, we have continued to focus on executing our core initiatives of revitalizing our e-commerce sites and expanding our marketplace channel partnerships.

On our e-commerce sites, we believe the investments we've made to improve the customer experience are bearing fruit. We've improved our product landing pages, product discovery process, checkout, mobile and site speed, and post-purchase experience, all with the goal of accelerating growth in our e-commerce business and improving conversion. It's difficult to accurately assess how our e-comm sales would have performed during the quarter without the customs disruption and lower in-stock rates. However, the consistent improvements to conversion tell us that our customers are valuing the improved experience.

We're in the process of deploying additional initiatives from our product road map to our flagship sites, and early results continue to show promise. Despite the improvements to conversion, we have continued to experience a decline in our e-commerce traffic, which is attributed to lower organic traffic and a decline in paid traffic due to customer acquisition economics. We are in the process of enhancing our marketing capabilities through consulting and leadership changes with the goal of reversing these trends.

Our marketplace sales were down 0.1% compared to the year-ago quarter, which ends our more than 2-year consecutive streak of generating double-digit marketplace sales growth. Again, this was partially a result of the customs issue. Nevertheless, we continue to work on expanding our marketplace partner network during the quarter, as we remain committing to being present wherever customers are purchasing automotive parts online.

I'm pleased to report that in June, we signed an agreement with a major global retailer to begin selling our branded and private label products through their online marketplace. This expansive marketplace presents a tremendous opportunity for us to sell automotive products to a large, new customer base. We're very excited about this marketplace channel development as well as our ongoing improvements to our e-commerce sites, which we believe will significantly enhance our business for years to come.

I would also like to announce that we recently sold our AutoMD assets to [Power Stop] for $1.4 million. As you may recall, we shut down our AutoMD operations last year to focus solely on our core operations and we're utilizing AutoMD solely as a media business. We'll use the cash proceeds from this transaction to focus on our core operations.

Turning to guidance for the quarter. We now expect net sales in 2018 to decrease low single digits on a percentage basis compared to 2017, primarily as a result of the customs issue and the current limitations on our inability to import grilles and lower-than-expected marketplace sales, which compares to our previously issued target of low single-digit growth compared to 2017.

Given the materiality of the cost incurred from the customs issue and its extraordinary nature as well as the nonrecurring nature of the sale of our AutoMD assets, we are excluding these items for adjusted EBITDA to provide a more accurate representation of our core business results. However, as a result of the loss sales attributable to the customs issue and lower-than-expected marketplace sales, we are revising our adjusted EBITDA guidance and now expect it to range between $12 million and $14 million compared to our previously issued target of $13 million to $14.5 million.

With that, we will now open up the call for questions.

(Operator Instructions) Our first question is from Eric Beder from Small Cap Consumer Research.

I just have a quick accounting question. So Neil, on the customs costs, how are those going to be expensed or amortized going forward? How should we think about those for the modeling process?

Eric, there's really 2 buckets of cost that have been incurred based on the customs issue. The first one is direct costs, which are related to the port and carrier fees, which we've incurred through the end of the July, which we indicated was approximately $1.8 million. Those costs are going to be amortized over the next 3 quarters as part of the cost of goods calculation. The other direct cost is legal, and these costs will be expensed as incurred. The indirect costs are productivity loss in our distribution center processing based on the abnormal flow of product. And the other indirect costs are lost sales due to our out-of-stock due to the 200 containers, which were seized and delayed. We believe that these costs, these indirect costs, have been absorbed in Q2 and the negative impact of these items is behind us.

Okay. Aaron, so could you talk about some of the changes you're doing to the website, other pieces to drive more customer traffic and kind of how do you expect that to impact results now and what should we be thinking about going forward in the future?

Yes. So similar to the comments -- similar to the prepared comments, I should say, we've made significant promise -- progress on the customer experience across the entire journey the past couple of quarters. We've released enhancements across our flagship websites that include site speed, product discovery, making checkout easier. In addition, we've improved the mobile experience with accelerated mobile pages and progressive website -- or progressive web app releases. And these initiatives are translating into significant improvements in conversion. In addition, we've made improvements in the post-purchase experience that translates into the improved metrics that you see on the web capture. Where we need to deploy additional resources is trying to reverse the trends on traffic, and so we'll be investing in new internal marketing leadership as well as engaging third parties to review all of our customer acquisition strategies. And I look forward to updating you on the next couple quarters on those investments.

And I want to add just a question additionally on the tariffs. So obviously, there's uncertainty whether the final round is going to go through and affect you. But I guess, the flip side of this is that this is probably -- these tariffs, if they continue to go through, will lead to higher costs and higher, I'm assuming, costs on new cars. Historically, when you've seen increases in that level of pricing, does it bring more customers to your website? And what do you believe also in terms of the price flexibility, if you have to raise prices, and will customers continue to come there?

Sure. A couple of different things. I'll try to unpack that. There's -- the tariffs are certainly something that we're dealing with a lot as well as many others. And we were relatively pleased that the first 2 rounds had a much smaller impact than anticipated. Obviously, the third round seems to cover the majority of imports. When you look at layering on the cost to our product costs because of our supply chain, because of the 1 or 2 steps there, we'll certainly have higher inputs, but there's many things that go into it. Right now, we're seeing fluctuations in currency and everything else. So everybody that's participating in our value-oriented product, we think that will incur similar inputs and maybe even higher in people that are multi-step process. So we're going to do our best to pass that along to the consumer and translate that into inflation, and we'll have to be very focused to see what others are doing out there and see how it affects demand. But we think that even with the increase in input costs there, we still will have a value-oriented option compared to the alternatives there in the marketplace.

Okay. And finally, I know you usually talk about adding more SKUs. Obviously, this quarter had a lot of uncertainties to it. Is that still a big part of this business, adding more SKUs to this business, and that's something you're still focused on?

Yes. No. Absolutely. We've got a lot of different growth initiatives and one of those is focused around product assortment. We continue to invest, similar to where we were in the past, on identifying the SKUs. We will pace similarly to last year in terms of volume and candidates. So we're continuing to invest in that area.

Our next question is from Beth Lilly from Crocus Hill Partners.

So Aaron and Neil, I want to understand, I guess, the cut in guidance, right? I mean, it's the grille issue and then the traffic to the online is down. But as you look out to 2019, do you expect to get back to mid-single-digit top line growth? And then, my guess is, with this major retailer -- or this major online retailer, I should say, that, that should really be additive as we look out into 2019. I mean, the leverage in the model seems to be tremendous.

Yes. Thank you for the question. So obviously, we haven't provided guidance for 2019, but we believe that whether it's a product assortment or conversion initiatives, or investing in this area around traffic, or even new third-party partnerships, we're trying to position the company for growth next year. And obviously, we've had some headwinds in the first 6 months of the year with the Customs, and obviously, the grilles will be a headwind that we're going to try to mitigate as much as possible for the foreseeable future. But we believe in the underlying growth initiatives will translate into growth over time.

Yes. I mean, I'm looking at the valuation of your stock today, and if you look at the enterprise value of the business, it's -- if you take away the cash, it's $41 million and you should be -- if you take the midpoint of your guidance, it's $13 million in EBITDA. So the valuation is 3x enterprise value to EBITDA for your business today.

Yes.

So my next question is, why aren't you guys buying back stock?

Our -- Beth, our board reviews any type of repurchase program. The last repurchase program we had out there expired a few months ago. And there were a few items, capital projects and other things, that they had deemed to be a better use of cash versus stock repurchase not to say that we won't renew our stock repurchase program, but we currently have made decisions that the cash can be better utilized to build some of our business initiatives: private label, product inventory, et cetera, and some of our other areas that we're building the customer experience that we feel is longer term more value and benefit than the stock repurchase at this moment.

And I'll say similar comments, maybe just phrase it differently. The board is always looking to create shareholder value and they're looking at -- one of the ways that they do that is the allocation of capital. And so there'll be active discussions this quarter and next quarter and in future quarters of how that value can be most easily created. And there's been 2 stock purchase plans in the past and I'm sure it'll be considered on a regular basis. Just one other note, in terms of the cash at the end of the quarter, if you remember in Neil's prepared remarks, that is a bit higher than normal. There is a holdback from -- or there is a vendor payment terms that are still getting reviewed. So that's a component of that excess cash.

Yes. I understand that. But even if you put another couple of million dollars on the balance sheet, you've got -- you've had a perfect storm for a year in terms of these automotive grilles and the costs associated with that. But now you've signed an agreement with this major global retailer, which, arguably, I mean, your top line should start to grow again, you're going to get the leverage. So I'm just -- I'm a little bit scratching my head saying your company -- the valuation of your company in the marketplace is 3x than the value -- enterprise value to EBITDA. I'm just -- I'm confused why you wouldn't initiate some kind of small share repurchase program.

Yes. I understand your feedback and we'll certainly communicate that with the board. And as I said, they're continually evaluating the best uses of capital.

Okay. So along those lines, what will your expenditures be for the rest of the year and then what do you think they're going to be for 2019?

Well, we haven't provided guidance on 2019. And specific for the CapEx side, we've provided a range of -- was it $5 million to $5.5 million?

Correct.

For the year. And we invested -- we expect to hit that guidance that we've provided before. And we're about halfway committed as we're halfway through the year now.

Great. And do you think next year it will be along those same levels?

Well, we haven't provided exact guidance for next year in terms of the CapEx spend. What I can tell you is that, for the past 3 years, we've been at -- just around -- between $5 million and $6 million. And I don't see anything that would significantly change that in the next couple of years.

(Operator Instructions) And our next question is from [Stephen Branstetter] from [ABL Investments].

You stated that you signed an agreement with a major global retailer. We do assume that's not Amazon that was from the last call.

That was from the last call. So it is a new one.

So it is a new one. Do you have a date when this retailer starts?

The contract is in June. And we will ramp up with new product assortment over this next quarter. So we always start with new marketplace partnerships with a subset of our assortment and we make sure that all the operations are executing as expected, and then we'll ramp up more and more of our catalog.

Is there a reason not to disclose who the retailer is?

Really just making sure that we've got permission to use names on both sides. So we'll be working on that, in short.

So if permission is granted, then we possibly could see a press release when -- if permission is granted upon completion of the agreement?

Yes. That's the hope.

Okay. The press release mentions leadership changes. What part of the leadership? Are we talking about a sale of the company?

No. If I know what we're referencing here, I believe that, that was in my mention on the marketing side. So clearly, I think that we've made great progress on the supply chain, and even improving the customer experience through conversion improvements, where we're going to make changes as to try to draft -- to try to reverse some of the traffic changes we've seen. So we are going to bring in more marketing talent internally, and we'll also be working and engaging other third parties to evaluate all of our marketing strategies. So it's specifically on the marketing side.

Okay. So is the issue the -- basically, like Google AdWords, has gone up in price? Is that what you're facing?

Well, the marketing is across multiple channels. So we've certainly seen some headwinds on organic presence. We've seen some headwinds in terms of making the unit economics work on some of the paid, which includes SEM or shopping. And as we've -- over the last couple of years, as we've been disciplined around making sure that we get incremental margin from each transaction, we've pulled away from some of the campaigns that were low to negative margin. So we've got to figure out how we change the unit economics on that acquisition strategy. Part of it was trying to make sure that the website experience is good, so we're converting more people as they arrive. But we've also got to focus in terms of all the things that we're doing, from customer messaging, segmentation, things of that nature, to improve that traffic.

Okay. And on the container issue, was there a reason it took 2 months for them to all be released? Were they going through piece by piece?

We didn't have a whole lot of visibility into why it was delayed as much as it did. Some were weeks, some were actually closer to 4 months. Their processing throughput was very low and we were -- so we didn't have a lot of visibility on what's going on in -- on their side.

Is there an opportunity for your lawyers to seek payment from the government for the delays?

Yes. We don't really comment on any sort of pending litigation.

This concludes the question-and-answer session. I would like to turn the floor back over to management for any closing comments.

Thank you, all, for joining the call today. We look forward to meeting with some of you at the Canaccord Conference in August or the Liolios Gateway Conference in September that we'll be attending or during our periodic non-deal road shows over the next couple of months. If we don't chat then, we look forward to speaking with you next when we report our third quarter results in November.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you, again, for your participation.