CarParts.com, Inc. (PRTS) Q3 2012 Earnings Call Transcript

Welcome to U.S. Auto Parts Fourth (sic) [Third] Quarter 2012 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 (sic) [third] quarter 2012 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, 2013. Before we begin, we would like to remind everyone that the 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 hereof. 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 the 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. With that, I would like to now turn the call over to Shane Evangelist.

Thank you, George, and thanks everyone for joining the call. We executed well in many parts of our business including margin expansion, online marketplace growth and offline growth. Online search traffic, however, continues to be a struggle for us as we work through some fundamental changes in the landscape. We believe we're doing what needs to be done to make that part of the business work well for us again. Gross margins for the quarter came in at 31.4%, which is typically a seasonally low gross margin quarter for the business. We did this by reducing low margin transactions and focusing on product that earns a good return. Our online marketplace business grew 20% year-over-year. We anticipate this growth to continue for the foreseeable future, and we believe we will push $50 million in revenue in 2013. I think it's also noteworthy that our store on eBay Motors, Car Parts Wholesale, is anticipated to hit 1 million total user feedbacks in the coming months. This is noteworthy because it's the first time in eBay Motors history that a U.S. seller of auto parts has reached 1 million user feedbacks. To put that in some more perspective, the next closest U.S. seller on eBay Motors has 700,000 user feedbacks. So congratulations to our eBay team for closing on a great achievement. Our offline business grew 42% year-over-year, and we believe it's on track to push $30 million in sales in 2013 as the team has executed very well on gaining new customers and expanding our product offering. We have great leadership guiding that side of our business. Unfortunately the great execution in many areas of our business has been masked by impact to year-over-year declines in traffic. As such, our total revenue for the quarter ended down 7%. It has not been unusual for us from time to time to experience decreases in traffic from search engines. We have historically made adjustments to our strategies, which have resulted in outside visitor traffic reaching as high as 40 million visitors a month. As we discussed in our last call, the changes we have made over the last 18 months to address decreases in traffic have not had the desired impact, and thus we have changed our strategy. We believe long-term strengthening our core brand is the best approach to continued visitor growth, and as such, we have aggressively been consolidating websites. On our last call, we anticipated converting 3% of our revenue in the next 12 months and another 10% the following 12 months. Currently we have consolidated 2% of the revenue, and we are pleased with the initial results, showing better-than-expected sales based on websites' historical performance. Said differently, we are seeing a lift in sales post-consolidation over what we would have expected. Based on the early results we have decided to accelerate the consolidation and anticipate it being completed within a year. While we're encouraged by the early consolidation results, it's important to set the proper expectations about growth over the next 12 months. We anticipate we will continue to see double-digit declines in traffic year-over-year until the consolidation is complete. Once complete, we believe we'll return to double-digit growth as there are many indications that traffic continues to grow online. In addition to comments from eBay and Amazon about continued success selling auto parts, we have a great indicator of traffic growth within U.S. Auto Parts. Currently JC Whitney is up 20% in year-over-year visitor growth. The online market for auto parts is strong, and we look forward to participating in that growth again. In anticipation of the negative year-over-year traffic trend, we have taken measures we believe will produce positive free cash flow in 2013 by reducing $6 million of costs from the business, $4 million in OpEx, and another $2 million in CapEx. We should see the full impact of these cost reductions starting in the first quarter. Clearly, the next 12 months will be a difficult financial period for the company as we shift our strategy from operating multiple sites to strengthening our core brands. Fortunately we have built a great online business to be able to weather this period. We all look forward to turning the corner and returning to the growth we have previously enjoyed. Moving to AutoMD, we have made good progress during the quarter. We have very softly launched our new beta product into the market. When I say softly launched, I mean it is in the public domain but you have to know where to go to use it. We have done this so that shops that have not fully completed the sign-up process can do so. Additionally we still need to fix a few minor bugs prior to switching it over to the actual AutoMD homepage and marketing the service in local markets. The product is called AutoMD Insta-Quotes or AutoMD IQ for short. At a high-level, the product is the equivalent of Priceline or Travelocity for the auto repair and maintenance industry. Basically if you know what is wrong with your vehicle or simply need an honest mechanic in the area to diagnose your vehicle's needs, AutoMD Insta-Quotes has the technology, distribution partners and shops to provide realtime quotes for the jobs required. For example, if you need brake pads for your GMC, AutoMD IQ will provide quotes to you within seconds that the local shops will stand behind. This provides pricing transparency, coupled with user feedback on shops to ensure you go to a highly reputable installer. In addition, customers are offered 5% cash back on all services when they pay with a credit card they registered at AutoMD. And they are reassured with 100% satisfaction guarantee. AutoMD IQ can provide these quotes because we have built the technology and partnership with local distributors that provide AutoMD access to shop-specific pricing, and the shops themselves have told us exactly how to price their products and services. We anticipate market testing will happen either by the end of the quarter or the start of the first quarter next year. The markets are Bakersfield, California, Long Island and Queens. If you want access to the product, you can go to www.AutoMD.com/iq, with IQ in lowercase letters. That's AutoMD.com/iq, with IQ in lowercase letters. You'll need a local address in the markets, I would suggest using 100 A Street in Bakersfield, California, 93301. That's 100 A Street, Bakersfield, California, 93301. I would also reiterate the shops are finalizing their profiles with things like uploading pictures, and we continue to work through some minor bugs. While we don't provide full guidance, consistent with our previous calls, we will provide a view into the current quarter sales. We are currently trending down 14.7% quarter-to-date. Much of the decrease is a result of reduced traffic year-over-year which, as we discussed earlier, we have a plan to address through website consolidation. On a positive note, we anticipate gross margins to come in around 3Q levels, on which -- in which is typically a low gross margin quarter, which we believe sets us up for margins above 32% in 2013. In closing, with the exception of traffic decreases, we executed well during the quarter: our margins expanded, our online marketplace business grew and our offline business grew. Given the decreases in traffic forthcoming, we have taken the necessary steps, we believe, that will allow us to generate free cash flow in 2013. We are also taking steps to ensure the future growth of the business by consolidating websites and focusing in our core brands. Fortunately we have a business model that can absorb the short-term impact in order to set us up for long-term growth. Finally, we have very softly launched AutoMD, a product that we believe will change the way consumers repair their vehicles and subsequently, change the do-it-for-me industry. I want to thank you for your time, and I'll now turn the call over to David.

Thanks, Shane. Good afternoon to everybody on the call. Unless otherwise stated, this quarter refers to consolidated Q3 2012 and last year refers to Q3 2011, and comparisons are Q3 2012 compared with Q3 2011. Also, percentage and basis points discussed are calculated using net sales. However, for advertising, we'll discuss comparing to net Internet sales. Adjusted EBITDA for the quarter was $2.7 million compared to adjusted EBITDA of $3.1 million last year. Adjusted EBITDA excludes noncash share-based compensation expense of $450,000 this quarter and $623,000 last year. Adjusted EBITDA also includes restructuring costs of $640,000 this quarter related to the closure of our call center in LaSalle, Illinois and a related reduction in workforce of 71 employees. Last year we incurred $3.8 million in restructuring costs related to the WAG acquisition and $211,000 in legal cost to enforce intellectual property rights, which are also included in adjusted EBITDA. This quarter's net sales were $73 million compared to $78.6 million last year, a decrease of 7.1%. Total online sales decreased 10.2% this quarter, principally driven by a 9.5% decline in traffic, a 5% decline in average order value, a 4% decline in conversion, partially offset by a 3% improvement in revenue capture. As Shane mentioned, our offline business was exceptionally strong this quarter, with net sales increasing by over 40%. Turning to margins. This quarter's gross margin was 31.4%, up from last year's 31.0%. Gross margin improved due to a higher penetration of sales from our private label business as well as improved margins across our branded line. We have seen consistent expansion in our margin throughout the quarter, increasing 120 basis points from Q2 of 2012 and 90 basis points over Q1 of 2012. Online advertising expense, which includes catalog cost, was 7.5% of net online sales this quarter compared with 9.5% last year. The decline in online advertising expense was due to reduction in print catalogs of $900,000, as well as improved leverage of our marketing spend on lower sales volume. This quarter's marketing expense, excluding online advertising expense, was 10.9% of net sales compared to last year of 8.9%, up 200 basis points, primarily due to higher amortization of cost related to software deployment and restructuring costs related to our LaSalle call center. General and administrative expense was 6.7% of net sales this quarter and 11.6% last year. The decrease is primarily due to JC Whitney restructuring costs that occurred last year of $3.8 million and lower depreciation and amortization expense in Q3 2012. Fulfillment expense was 7.8% of net sales this quarter, up from 5.7% last year. The increase was primarily due to higher depreciation and amortization expense from software deployment. Technology expense was 2.2% of net sales, slightly up from 2.1% last year. Visitors on our site for the quarter were 38.1 million, down 9.5% over last year. Orders placed through our e-commerce channel this year were 573,000 with an average order value of $115, down from last year of $122 but consistent with Q2 2012 of $116. Our conversion rate was 1.5% this quarter, down from last year of 1.57%. Revenue capture was 83.9%, up from last year of 81.2%, primarily resulting from improvements in our fill rates. This quarter's customer acquisition cost was $7.74, down from $9.70 last year, primarily due to a reduction in online advertising spend. Now turning to the balance sheet, quarter-end cash and securities were $1.1 million and debt was $17.1 million. Debt, net of cash, increased by $4.5 million during the quarter, primarily due to a reduction in accounts payable of $4.2 million, capital expenditures of $2.5 million, offset by adjusted EBITDA of $2.7 million. It is our practice to sweep excess cash against our revolving credit facility to minimize interest expense, so we expect our quarter-end cash position to range around $1 million as it has been for the last 2 quarters. And with that, I'd like to turn the call over to questions.

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

A couple of questions, Shane. You ran through it fairly quickly, but -- you changed your strategy last quarter to consolidate the sites. Maybe a little bit more color around that? I mean, it sounds like you're -- if you're thinking that -- it looks like sales are down 14% so far in the quarter. Is that something that again has changed in the industry or is that driven by your acceleration in your strategy? And maybe if you can add a little bit more color around what you saw from the consolidation so far that makes you feel like it's the right move?

Yes, Shawn, I think the big change from last quarter to this quarter is APW had been trending positive since any sort of changes were made in search. And we actually had APW flip negative year-over-year. That's the first time we've seen that happened with APW. We think that's a result of the number of sites we have and the content out there. And so before where we were saying, "Hey, we're going to consolidate 13% of our sales and we're going to do that over a couple of years," we think that content is probably having a bigger impact on APW, and as such, we have accelerated the consolidation efforts. Second, on the sites that we did consolidate, they were trending down at a high-level number. They were trending down about 25% and post-consolidation they were only trending down 6%. And so where we thought we'd probably lose some revenue, we actually saw an increase in what we would've expected that revenue to look like. So the combination of those results and the fact that the first time since I've been here APW went negative, we decided to accelerate that.

Okay. The -- but you made a comment about JC Whitney being -- was it up in traffic or what's now happening with revenue there?

Yes, Whitney currently is up in traffic and up in net revenue. So Whitney is on a trend back north, which is good. I think Whitney's traffic showing good, strong growth is a good indicator that online continues to be a strong place for consumers to go. Unfortunately we aren't getting our fair share right now, and we need to adjust our website strategy in order to do that.

Okay. And then -- and lastly, where are the costs going to come out of? It seems like you guys are probably getting fairly lean already in '13. And remind me if you can, what your line of credit is?

I can answer the line of credit. It's a revolving line of credit, and it really depends on our inventory levels and our accounts receivable. So it moves up and down, but we have a $40 million line of credit, which we can expand beyond that.

And the cost for next year? What -- how...

Oh, yes. The cost. Yes. A couple of places, Shawn. One is we pulled a bunch of capital out, a couple of million dollars in CapEx. We pulled another $4 million of OpEx. Some of it coming from run rate costs in the business, some of it coming from folks, from people. But I would say I don't think we've cut ourselves too thin here, Shawn. We think the online auto parts business is going to grow. We think we're going to be a good participant in that. I think we got to get through this period. And as such, we're still going to continue to have enough folks in the business to capitalize that going forward.

Yes. I mean, there are not too many businesses that we know that you can cut them to prosperity. So we'll have to see what happens.

[Operator Instructions] Our next question comes from the line of George Kelly with Craig-Hallum Capital Group.

A couple of questions. First, what -- can you talk a little bit about the competitive landscape, and just if there's something about your products or your pricing that's making it harder to continue growing here?

Yes. So George, we commented on in the past how the competitive landscape has gotten more competitive, with more products showing up online. But I think for our business, we've got a lot of private-label products. And we are very strong in selling that product. And it's got good margins associated with it. Clearly what we need to do as a business is to accelerate the private label part of our business. We need to weather this reduction in traffic as we get healthy. And then I think we'll see continued growth.

Do you look at the traffic -- the changes here in traffic, is that an issue of the -- I mean, what do you think is the main issue behind -- is it just that you can't put enough marketing dollars in each brand? Or is it that the product, the pricing, the competitive situation is just so much more intense that it's hard to win on price now?

Yes, I think, George, that the search engines are much more focused on stronger brands with more product offerings. And I think we need to focus ourselves around stronger brands with more product offerings. And I think it's just that simple. And in order to do that, we need to focus on a smaller number of brands to do it going forward.

Okay. And when you said that you're consolidating websites, can you give an example of 2 website -- like, how does that work?

So there's 2 functions that have to take place in consolidating a website. One is you have to move the content that's on the website over to the destination website. So you go into a page and you say, "I'm going to take the content from this page and move it over to the other page." And then there is also links that may have been built to that page that you would also move over to the destination page, and then you turn it off, and you tell the search engines that you no longer want it to look at this site, you want it to look at that site for that content. So it's a very arduous process. One that we have to go sort of page by page, site by site to do.

Okay. And then if you had -- how many websites did you have before you shifted, and how many do you expect when it's all said and done?

George, we never disclose the number prior, but what I can tell you is it will be a handful of sites, 4 to 5 sites at the end, that are what you would consider set up for the search engines to look at.

Okay. So 4 to 5 sort of main, branded sites?

That's right.

And then just a couple more. Has any of the change recently here been for mobile, do you think? I mean, do you see -- have your competitors invested a lot in mobile, or is that still too early, do you think?

No, I -- certainly we see a user shift to mobile in our numbers. APW is close to 1 million mobile visitors a month as well. So we're seeing very similar traffic trends mobile-ly, and we've put a lot of investment behind mobile to ensure that we're up to speed with everybody. We've got mobile apps, we've got applications both for iOS and Android, and we plan to continue to do that.

Okay. And then debt balance, where do you expect that to be at the end of the fourth quarter?

It's probably going to be about $1 million lower, but it's all predicated on the timing of our inventory flow. But I would say that's a good gauge. So pretty close with where we ended this quarter.

Okay. And then I guess just thinking about IQ. Can you talk anymore about sort of what you expect if 2013 played out as you hope? Do you think you can be in 5 markets or more by the end of the year?

By the end of 2013?

By the end of 2013, yes.

Yes, certainly we hope that to be the case. We're going to go into a few markets here now. We're going to run some media behind it. We'll test it. We'll -- if it plays out the way we anticipate it to play out, then we'll expand rapidly into more markets.

[Operator Instructions] And I'm showing no further questions. I'll turn the call back to management for closing remarks.

Thank you, all, for joining the call. We look forward to talking to you on the next call.

Ladies and gentlemen, this concludes our conference for today. We thank you for your participation. You may now disconnect.