CarParts.com, Inc. (PRTS) Q4 2011 Earnings Call Transcript

Welcome to U.S. Auto Parts Fourth Quarter 2011 Conference Call. On the call today from the company are Shane Evangelist, Chief Executive Officer; and David Robson, Chief Financial Officer. By now, everyone should have access to the fourth quarter 2011 earnings release, which went out today at approximately 4:00 p.m. Eastern Time. If you have not received your 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 March 15, 2012. Before we begin, we'd like to remind everyone that prepared remarks contain certain forward-looking statements, and management may make additional forward-looking statements in regard to your questions. These statements do not guarantee future performance and speak only as of the date hereof. We refer all of you to the risk factors contained in the 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 statements. 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 the outlook for the company, following the non-GAAP financial measures, will be discussed: EBITDA and adjusted EBITDA. An explanation of U.S. Auto Parts' use on the 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. 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. With that, I'd now like to turn the call over to Shane Evangelist. Please go ahead, sir.

Thank you Kelly, and thanks all for joining the call. Before we get into comments on the quarter, I want to introduce David Robson, our new CFO. David most recently was the CFO at Mervyn's department stores, and prior to that, held various positions at Guitar Center. We were attracted to the operational focus David has demonstrated in the past and that same operational focus he will bring to U.S. Auto Parts. We are very pleased and excited to have David on the team, and I will now turn the call over to David for his comments before I close with my own.

Thank you, and thanks to all for joining the call. Before I get into commenting on the quarter, I would like to introduce myself. I am David Robson, the new Chief Financial Officer for U.S. Auto Parts, and I am glad to be here. I bring to the company a long history in retail, working at both brick and mortar and e-commerce, and both larger and smaller companies. After being at U.S. Auto Parts for only a short period of time, what I have learned is the company has a fantastic management team. I can also say that I'm truly excited about the opportunities that lie ahead. As more and more customers continue to transact online for auto parts and accessories, U.S. Auto Parts as the market leader, is poised to capitalize on this growth, with its unique combination of advantages in the marketplace in terms of size, scale, product offerings and customer experience. With that, I'd like to turn to the results of the quarter. Unless otherwise stated, "this quarter" refers to consolidated Q4 2011, and "last year" refers to consolidated Q4 2010. And comparisons are Q4 2011 compared with Q4 2010. Also, percentage and basis points discussed are calculated using net sales, except for advertising, where we will discuss using net Internet sales. On our last call, we stated that we would no longer break out EBITDA contribution between our core business and WAG businesses. It all now runs on 1 platform and is 1 business. As we report the 2012 results on future calls, this will be the case, and we will report our financial results on a consolidated basis. However, for the fourth quarter of 2011, we will continue to break out some of the financial metrics between J.C. Whitney and the core businesses. Adjusted EBITDA for this quarter was $1.9 million compared to adjusted EBITDA of $4.3 million last year. Our core business had adjusted EBITDA of $3.3 million for the fourth quarter compared to $3.7 million last year, while J.C. Whitney lost $1.4 million in adjusted EBITDA this fourth quarter compared to positive adjusted EBITDA of $600,000 last year. Consolidated adjusted EBITDA this quarter excludes a noncash write-down of intangibles related to the J.C. Whitney tradename of $5.1 million and $800,000 in restructuring charges associated with the J.C. Whitney business. Adjusted EBITDA last year excludes $1.5 million of restructuring charges related to J.C. Whitney, and adjusted EBITDA for both years excludes noncash, share-based compensation of $660,000 and $630,000, respectively. Turning to sales. This quarter's net sales were $77.2 million compared to $80.4 million last year, a decline of 4%. Our core business had net sales of $61 million for the fourth quarter, an increase of 11% from last year. J.C. Whitney sales were $16.2 million for the quarter, a decrease of 36% from last year. The decline in fourth quarter sales was primarily due to a reduction of 4% in revenue capture over last year and a drop in average order value of 6% over last year. We continue to see growth in traffic, reaching 40.7 million visitors this quarter, up 9% from last year. Our conversion rate fell during this quarter by 2.8% compared to last year. Gross margins declined 330 basis points this quarter to 30.8% from 34.1% last year. Gross margins for our core business was 31% this quarter compared to 33.4% last year. Gross margin for the J.C. Whitney business was 30.1% this quarter compared to 35.5% last year. Overall, consolidated gross margins were primarily impacted by increased competition in the marketplace, as well as higher freight expense. Higher freight expense impacted gross margins by 110 basis points. We increased our penetration rates of the private label engine and accessory business during the quarter, which helped offset the margin decline. Marketing expense, excluding advertising, increased to 9% of sales this quarter compared with 7.8% of sales last year. The increase in marketing expense was primarily due to higher amortization of software deployments, as well as additional marketing services. This quarter's advertising expense, which includes online and catalog, was 9.6% of Internet net sales compared to 9.4% of Internet net sales last year, up 20 basis points. General and administrative expense, excluding integration expenses related to J.C. Whitney for both periods, was 7% of net sales this quarter, down from 8.5% of net sales last year. The decline was primarily due to lower rent and legal expenses. Integration expenses for J.C. Whitney was $800,000 this quarter and $1.5 million last year. Fulfillment expense was 6.6% of net sales this quarter, up from 5.8% of net sales last year. The increase was primarily due to additional depreciation and amortization expense. Technology expense was 2.3% of net sales this quarter, down 30 basis points from last year. The reduction was primarily due to lower computer support and payroll expense. As I mentioned earlier, in the fourth quarter this year, we took an impairment charge of $5.1 million related to the J.C. Whitney tradename. The impairment charge resulted from lower sales performance on the J.C. Whitney site compared to estimates made at the time of the acquisition. We also reported a tax benefit of $1.7 million associated with the impairment charge. Visitors for the quarter were 40.7 million, up 9% over last year. Orders through our e-commerce channel were 682,000 for the quarter, up 3% from last year. The average order value was $115 compared to $122 last year, down 6%. Revenue capture was 81.4% compared to 85.0% last year, down 4%. This quarter's customer acquisition cost was $9.87 compared to $10.73 last year, or a reduction of 9%. Turning to the balance sheet. Quarter-end cash and cash equivalents and investments were $13.6 million, and debt was $17.9 million. Cash and cash equivalents and investments decreased by $9.2 million over the last year, primarily from capital expenditures and the pay-down of long-term debt. With that, I'd like to turn the call over to Shane.

Thank you, David. In 2011, we built our company through a number of challenges that we've communicated to you in depth before. Changes to our search channel, different approaches in competitive dynamics in our online marketplace business and our own efforts to integrate our purchase of J.C. Whitney into our core e-commerce platform, all combined to make 2011 a challenging year. That said, we believe we laid the foundation in 2011 to produce growth in 2012 and beyond. We believe there will be many things different in 2012 than in 2011 in our business. First, J.C. Whitney is fully integrated into the U.S. Auto Parts platform, and we now have the foundation and the analytics to improve that business going forward. Second, we believe we will see visitor growth return to many of our higher-converting sites. Third, our online marketplace business is on level footing and as competitive as ever, as we address changes in that channel in 2011. And finally, while we believe the 3 previous points will be a net positive for us in 2012, we have seen increased competition in the category over the last year, and we anticipate some gross margin compression in 2012 as we set a new floor for margins going forward. On our last call, we announced we had fully integrated J.C. Whitney into the U.S. Auto Parts platform. We are now able to manage the entire business under 1 set of operating systems. And while the integration of J.C. Whitney has proven to be challenging, traffic for J.C. Whitney is up 14% or 400,000 unique visitors, since we acquired J.C. Whitney. We believe this demonstrates the brand remains relevant, strong and top-of-mind for customers. We also remain the market leader for standalone online auto parts companies and have positioned ourselves to take advantage of an online industry poised for growth. We have made our sites some of the easiest to use, along with a huge selection of products. We believe our core strategy creates significant competitive advantage over the long term. We will continue to focus on: one, improving our end-to-end customer experience through improved website experiences, greater customer service and faster delivery of products; two, creating the most efficient supply chain in the online market. To that point, we now have 8,000 private label engine and accessory parts and look to add another 2,000 to 4,000 private label parts annually. Additionally, we have over 35,000 private label collision parts, which is, by far, the largest of any online seller; three, increasing our already millions of SKUs by adding SKU selections faster than competitors, with the goal of adding at least 150,000 new SKUs annually; and finally, producing double-digit visitor growth by taking advantage of more customers shopping online for auto parts. Our online marketplace business is healthier than it's ever been, which is a testament to our team's ability to adapt to external changes and build the winning strategies by channel. I believe this same team will be able to adapt to the changes made in the search channel in 2011 and drive more traffic to our higher-converting websites in 2012. On the final point of difference compared to last year, we have seen an increase in competition over last year, which is impacting consumer price points. Basically, many of the traditional do-it-for-me auto parts distributors servicing the offline service shops began selling products online in 2011. While most of them don't have their own website presence, they have inserted themselves into the supply chain of traditional online marketplaces. We anticipate this increased competition will compress gross margins anywhere from 100 to 300 basis points off our historic gross margins 33% as we determine proper margin percent levels to produce the highest gross profit dollar return. I believe it's also important to point out that even if gross margins were to compress to the low end of the range at 30%, our variable expenses operate the business are around 14% to 15% of sales, which would still have incremental sales generating incremental EBITDA contribution of 15% to 16% flow through. Moving to AutoMD. We continue to see positive unique visitor trends. We comped up over 17% quarter-over-quarter and over 100% year-over-year. We are now trending above 800,000 monthly unique visitors and remain the leading automotive repair consumer advocate website. About a year ago, we began calling shops on behalf of customers to get local quotes for their immediate repair needs. The results of these calls demonstrated a need for transparency. On over 1,500 job requests across the country, our average price variance from the lowest quote to the highest quote is over $250 and around 40% variance. We believe AutoMD has proven there is a legitimate need for transparency and consumer control, and we are now looking to automate this service going forward. And while we don't provide full guidance consistent with our previous calls, we will provide a view into our current quarter sales. As David indicated earlier, we will not be breaking out J.C. Whitney any longer. In total, we are trading up about 1% quarter-to-date over last year. I would add that we believe the first 2 months of 2012 are by far our most difficult comps. We continue to recognize that we have a number of moving parts in our business, and it's difficult to model. The best insight I can provide is a few data points to help you model the business. We said on our last call, if you were to assume 10% growth over 2011 on historic gross margins of 33%, the business should produce around $30 million in EBITDA. But we are trending below both of those marks. However, we do believe, as we exit the first quarter, we should begin to see double-digit growth for the overall business. In closing, I'm excited about 2012. I believe the challenges we addressed in 2011 have set us up for profitable growth in 2012 and beyond. And I look forward to and I'm honored to lead this team during that period. Operator, we will now open up the call for questions.

[Operator Instructions] Our first question comes from the line of Shawn Milne with Janney Capital Markets.

Shane and David, I've got a few. Let's start at the top. Can you talk a little bit more about the competitive pricing pressure? I'm not sure I fully followed you. It didn't sound like it was coming from the traditional bricks and mortar players online business, but more within some of the big marketplaces, perhaps you're talking about Amazon, eBay. And if you can flush that out a bit more. And is there anything that you can do going forward? Or is this the new normal? And then secondly, I know you're not going to break out the business going forward, but if you think about the growth dynamic in 2012 and just disaggregating, will Whitney start to begin to grow off this kind of low base and sort of ramp throughout the year? If you could just kind of add a little bit more color around that.

Yes, Shawn. On the first question around where we're seeing the competitive pressure, it is through the marketplaces, eBay, Amazon, although it's not necessarily eBay and Amazon specifically. Some of the traditional distributors who would distribute product to a service shop for that car to get fixed by a service center has, over the last year, started to sell that product online through Amazon and eBay. And that is where we're seeing some of the price point pressures come through. The good news for us is, we kind of foresaw this coming, and we started to aggressively build a private label business. And so the good news for U.S. Auto Parts is, we're not beholden to brands who are going to be sold cheaper by others online, but in fact, we're actually sourcing a lot of this product and still one of the lowest price points in the marketplace for maybe a Camry water pump because we direct source it. And so then so the question is, what's the new normal on margins? And so I think it's probably lower than it is today. I -- we'll have to see where it ultimately finishes, but because our private label business, specifically related to -- outside of the Whitney business right now, but just USAP's business, from a revenue perspective is close to 50-50 private label and branded. And so you can see how -- even if you ran down that path and you ran margins on the branded business between 15% and 25% and private label between 45% and 55% and even at one of the low-end on those and, say, branded was 15% and private label was 45%, which isn't the case, though, let's just say that -- those are the math you're using, then you're going to run margins around 30%. So do I think it will be above that? Yes. To what degree, I'm not exactly sure. And on the Whitney side of the business, there's one good news in the Whitney side of business is that there's a lot of MAP pricing in the accessory lines. So, in fact, you don't have the same sort of margin compression in the accessory business because of MAP pricing. That said, we're taking the same exact path we've done, which is to private label more accessory business to ensure that there's a differentiated product set in the offering for us. So that's how we're going to address it, and that's where the new price point pressures coming from there. Specific to Whitney in 2012, yes, I think we'll start to see growth again in 2012. We ran through what I would believe to be our toughest period in Q4. Q1 didn't start out great, sort of a continuation of Q4. But in the last few weeks, we've seen some noticeable improvement. We discussed on the last call that we had some issues specifically around, orders were down and revenue capture was down inside Whitney, and we've corrected those issues. In fact, the last few weeks, we've seen orders get back to normal, flat. We've seen rev capture get back to those normal levels they were previously. And what we're dealing with right now is an AOV issue on some of our higher-performing dollar ticket items. And so we need to go address those specific areas where we have lost sales in high ticket dollar items that also frankly had some high margins. And so that's our focus, and we think we'll get that rectified as we go forward as well.

And just 1 follow-up. The -- I think part of what you said on the last call was, given all the integration issues, there have been -- maybe right way to say, taking the eye off the ball a little bit on the core business and revenue capture and whatnot. I mean, do you -- are we now in a position where the blocking -- do you think blocking and tackling on revenue capture in the core business should begin to improve? Because, clearly, the competitive issue, that's a different dynamic, but some of this other stuff seems to be things that the company could rectify.

Yes. So revenue capture, clearly, was impacted as we did the big systems integration, as we set up vendors in our system and managed those vendors. And we are acutely aware of the issues we created, and we've solved those issues. There may be a little bit of an impact in Q1 as we've eaten through them. But as of late, we're back at historic levels on the USAP side. And as I indicated earlier, Whitney is back to close to historic levels on their revenue capture side. So I think operationally, Shawn, we're back where we need to be from a revenue capture perspective. It will come in lower than it had traditionally for just the USAP business, as Whitney had a lower revenue capture number. However, as it relates to executing the way we should be executing as a business against those numbers, we're back to where we should be on those.

[Operator Instructions] And our next question comes from the line of Mitch Bartlett with Craig-Hallum.

Just AutoMD, you've scaled to, I think, you said 800,000 monthly, which is a fairly robust number. But I guess the question is, what are you spending on that business? How strategic long-term, how wedded are you to the business of AutoMD?

Yes, Mitch, we're very committed to AutoMD. We think it's got significant upside for the business. I believe that consumers need an advocate in the marketplace, and I think we can be that advocate. What we're going to spend this year, we'll spend a couple of million dollars in CapEx on it, and I would -- roughly between $0.5 million to $1 million in EBITDA from an operating cost perspective. I think if you look at the numbers, we launched it about 2 years ago. We're now at 800,000 unique visitors, and we're ahead of anybody in the marketplace that was there previously. We've talked about this product called the AutoMD Negotiator, where we think we found a very interesting niche in the marketplace. And without going into too much around that for competitive reasons, we're going to work on that product this year and get it more automated.

Good enough. And then on the growth rate, Whitney, you started the previous quarter comping down 40%, and then it gradually improved as you went through the quarter. And now into the first quarter, it's sounding like it's significantly better than where it was before. You talked about up 1% so far for the quarter in total revenue. So I'm just wondering how far back AutoMD has come. I didn't mean AutoMD, I meant J.C. Whitney, I apologize.

J.C. Whitney? Yes. So I'm going to be consistent with what we talked about earlier because if I start to throw a number out now where we're at, we're going to try to get back to that at the end of the quarter. So with that said, here's what I would tell you, similar to what Shawn asked. From an orders perspective and from a revenue capture perspective, we're close to flat on a year-over-year basis. And by the way, that's with a 56% reduction in marketing spend year-over-year. So we pulled marketing spend back. We've been able to keep quarter count relatively flat year-over-year, and a lot of that has to do with the fact that we've added a lot of our product to Whitney and we've seen sales through those products. So the promise of what we anticipated happening, which was the synergies of taking U.S. Auto Parts products and putting it up on Whitney, we're starting to see some success on that. Where we're still getting hurt on a comp basis year-over-year is AOV decreasing pretty significantly. Certainly, we're nowhere near we were in the fourth quarter, but we're not back to single-digits down either yet. So we think we've got a plan to address the AOV issue, specifically on categories that are traditional high-ticket items for us that we've got to go make sure we can convert on. These items are also a little bit more complicated to navigate for a consumer. And so we've got plans in place to make that navigation work better than it is today, and we think we'll see that happen over the next quarter or so. And we look forward to -- and look forward to growing Whitney, and we think we'll grow Whitney kind of, as we've said, second half of the year on, for sure.

Great. One last question, if I could. Just the last call, you talked about the inventory management, the reorder rate issues in the system. Has that been cleared up?

Yes, a lot more focus around it. We're in a much better position now that we're on 1 system, and we've got clean looks at inventory management. I mean -- I think we've had inventory [ph] over 50 million now, Mitch, so we certainly got a lot of focus around it. And we'll make mistakes, certainly, but I think we've got a better handle on where we were than where we were in the first part of the fourth quarter right after cutover.

[Operator Instructions] There are no questions in the queue. I'd like to now turn the conference back over to management for any closing remarks.

Well, we appreciate you joining the call today, and we look forward to updating you on the next call. Thank you.

Thank you. Ladies and gentlemen, this concludes the U.S. Auto Parts Fourth Quarter 2011 Conference Call. We thank you for your participation. You may now disconnect.