Q2 2019 Earnings Call

Welcome to the U.S. auto parts second quarter 2019 conference call.

On the call from the company are left patterns.

Chief Executive officer and deeper than that.

Chief operating officer, and Chief Financial Officer.

By now everyone should have access to the second quarter 2019 earnings release, which went out today at approximately four or five P.M. eastern time.

If you have not viewed the release it is available in the Investor Relations section of the U.S. Auto Parts' website at U.S. Autoparts Dot com.

This call is being webcast a replay will be available on the company's website through August 22nd 2019.

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.

The 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 suppliers.

Hey, good competition. The forward looking statements are based on current information and expectations are subject to uncertainties and changes in circumstances I do not constitute guarantees of future performance.

The 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 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.

You with 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 release. The reasons actual results could differ materially from those anticipated in these forward looking statements, even if new information becomes available in the future.

Please note that on todays call. In addition to discussing GAAP financial results and the outlook for the company non-GAAP financial measures measures such as adjusted EBITDA will be discussed.

An explanation of U.S. auto parts' use of non-GAAP financial measures in this call and the reconciliation between GAAP and non-GAAP measures required by FCC regulation G is included in the U.S. Auto Parts' press release issued 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.

With that I'd like to trickle over to our CEO , Matt Tucker. Please go ahead Sir.

Thank you operator, and good afternoon, everyone. It has been a little over seven months since I took over as CEO and I'm very proud of the progress. Our team has made to begin the repositioning youre sort of parts for growth and profitability.

We have rebuilt and strengthened our team with key personnel most of which joined in the last few months and well executed on various initiatives laid out at the start of the year, including a significant consolidation of our E. Commerce websites. What started the year was 18 and are now down to four websites. What's the goal of ending the year with three core sites.

As we've discussed on previous calls we want to focus our resources on fewer properties through a better job at both growing and optimizing besides while ensuring each property has a unique and differentiated value proposition for the customer is three core websites in food Carpark dotcom, JC Whitney Dot com and auto parts warehouse Dot com.

I'll have more to discuss on these later in the call.

Since our last update where they're going to roll out our new three year strategy, that's worth calling right part right time and the right place.

Put simply we want to make sure that the customer orders right parts other vehicle well want to deliver it to them quickly and we want to be agnostic to how they want to install their parts.

I'll have more on our strategy later in the call as well.

As noted in our press release today, we have begun to emphasize our focus on our private label products.

We have sourcing capabilities, a great supply chain and the catalogs I have thousands of hours invested into it.

Our ability to effectively source and monetize its private label products is one of our strongest assets I don't know plan to take full advantage of that.

As a result of the shift in focus we have begun to allocate your resources to our brand that does not which will continue to impact revenue on topic over the near term.

However, we expect the benefit of a higher proportion of private label sales, but that I've considerably better margins and profitability.

Emphasizing our private label business will enable us to better manage our operating expenses and we're in the process of implementing various initiatives there on the leaner and more efficient cost structure.

But before commenting further on our plans I'd like to turn the call over to our COO and CFO , David the speak in more detail about our second quarter financial results David.

Thank you Latoya jumping right into results net sales in the second quarter were 73.7 million compared to 77 million in the year ago quarter. This was primarily driven by 13% decrease in E. Commerce sales due to our proactive reduction of negative and low margin transactions and de emphasis of branded product sales.

Private label sales increased 1% in Q2 and accounted for 79% of net sales compared to 75% in the year ago period.

As we accelerate our private label sales, we expect this trend to continue at a faster pace.

Gross profit in the second quarter increased 6% to 21.8 million compared to 20.5 million last year, given our proactive reduction of branded product sales, which accounted for 24% of total revenue in 2018. We believe gross profit is now a more effective barometer to gauge our growth going forward.

Gross margin in the second quarter increased 280 basis points.

The 29.5% compared to 26.7% in the year ago period.

Last year, our margins were impacted by demurrage and attention charges.

And we have the pension charges this quarter as well excluding these charges from both periods would have led to a gross margin of 30.1% in Q2 2019 compared to 28.1% in Q2 2018, a 200 basis point improvement. This was primarily driven by an increase in selling our on our higher margin private label products and improved pricing strategies.

Total opex in the second quarter was 23 million compared to 21 million last year as a percentage of revenues opex increased to 31.2% compared to 27.3% primarily driven by increased marketing spend investments in our marketing platforms and people as well as severance and other employee transition cost. Our team has been laser focused on improving gross margins. Since we joined the company. This year and we are now beginning to focus on our operating cost structure as I've mentioned this business can be operated more efficiently. So we plan to take aggressive action to realign our cost structure to better match, our new directive and strategy.

Net loss in the second quarter was 1.5 million or four cents a share compared to a net loss of 0.8 million or two cents per share in the year ago quarter.

Adjusted EBITDA was 1.4 million in Q2 compared to 2.8 million in the prior year quarter.

The decrease was driven by lower sales due to the aforementioned decline in our ecommerce channel and proactive reduction of lower margin sales.

Although we anticipate these factors to continue impacting adjusted EBITDA through the end of the year, we remain committed to positive adjusted EBITDA in 2019 now let me provide some details on our key operating metrics for the second quarter traffic in Q2 was 14.2 million compared to 16.3 million in the year ago quarter with the decrease primarily driven by our focus on private label sales, which let us to proactively reduced marketing spend for branded product sales and as I've mentioned the lower traffic is also a result of the consolidation of our sites as we had 18 last year and now we're down to four sites.

Conversion in the second quarter was up 30 basis points to 3% compared to 2.7% for the same period last year, which mostly benefited from channel mix and a decline in traffic revenue capture defined as total sales after returns credit card declines and product fulfillment.

Was 87.8% compared to 87.7% last year.

Online average order value, which includes orders from both e-commerce sites and marketplaces was $80 compared to $88. In Q2 2018, the Cline and ASV was primarily driven by our shift in product mix from branded to private label, which comes with a lower price point, but significantly higher margin.

Turning to the balance sheet at June 29, 2019, we have no revolver debt.

And a cash balance of 0.9 million compared to 2 million of cash at fiscal year end 2018.

The decrease in cash as a result of employee transition cost technology, Capex marketing expenses as well as set up cost for a new distribution center in Las Vegas, which will begin shipping next week about a month ahead of schedule.

This new 125000 square foot DC will enable us to provide two day delivery or less than 94% of the country, while realizing savings in freight cost the expansion of our footprint will also position us to compete more effectively as a two day shipping or less has evolved into a requirement for many consumers.

We ended the quarter with inventory of 52.6 million compared to 49.6 million at the end of 2018, we still have work to do to improve our inventory productivity and this will remain a key focus for us in 2019 as our current position is not optimized our objective is threefold.

We do stock out improve inventory turns and minimise carrying costs in order to accomplish this we have completely overhauled our demand planning and forecasting team and have also started to use more advanced forecasting formula and software solutions out of stock items that had significant negative impact on our revenues in the past. So we expect to continue improving our inventory position moving forward.

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

Thank you David.

Across the organization our management than associate teams have embraced our new strategy have right part right time at the right place.

In order to execute on these three pillars, we needed to focus our attention on fewer assets.

At this time, we have consolidated our sides down to four and well continue down this path until each of our sites offer the consumer a unique value proposition.

Without going into too much detail our goal is to make car part of dot com our flagship site.

We have focused our efforts over the last few months on that side I don't have the platform the site that entirely.

We're in the process of rolling out the new site to select users right now and it should be available to 100% of our topic by the end of August .

Besides a significantly faster with speed below three seconds and we have also redesigned the user experience to make it easier to find the right parts free vehicle at the checkout.

We have other improvements that will get rolling out over the next few months and I plan to share those on our next call.

Overall, the technology and user experience teams have done a great job getting this new and improve the experience to our users ahead of schedule.

We also expect three platform, both the JC Whitney and auto parts warehouse sites over the next six to nine months.

It's also worth noting that we still have the U.S. autoparts dotcom domain that now serves as our general corporate Investor Relations website.

Moving on as part of our right time initiative, which is to be able to deliver the part the quicker we opened the third distribution center in Las Vegas.

And have received several containers and the facility.

We expect that to be fully operational by the end of this month.

I'll have more details to share with you on our next call.

Another key initiative for us over the last few months has been to continue building out our team was highly talented personnel.

Since our last update call. We have brought on the new senior VP of engineering VP of operations and then you're planning on replenishment Tim.

There is still work to be done to round out these organizations, but we have made great progress and the early results from these new individuals and teams have been very promising.

I'm also happy to announce that what do some period settlement terms, what the U.S. customs and border protection agency regarding last year, they should with our automotive girls.

And while the terms of the agreements are confidential, we can say that neither party has met at any wrong doing all of our outstanding enforcement issues are resolved and we now have no outstanding damage or duty claims.

Accordingly, we have greatly reduced our charges related to temporary storage fees and overtime as we have managed to care. The majority of our containers on the lot and well they completely out by next month.

The remaining charges that should flow through our financials are they didn't spend related charges that are being amortized to cost of goods sold for the remainder of 2019.

As for automotive growth, we're now importing all girls not beautifully season.

One auto manufacturer in particular has taken an aggressive stance against aftermarket parts manufacturers and it's now litigating. This issue was one of our competitors were taking a wait and see approach with respect to these girls.

But otherwise we expect to be substantially back to normal in terms of our ability to sell growth.

And although we are finally, moving positions us customs and the boards well still have worked hard to improve our in stock rates and inventory levels.

As David mentioned, our inventory productivity is not meeting the standards of the new management team have said.

So we'll be keenly focused on inventory optimization in the back half of the year.

Overall, we have made progress on multiple fronts to reposition the company for growth and profitability. There are still many initiatives that we need to execute on but the company is moving in the right direction.

Well now have a better handle on our marketing and technology personnel and infrastructure and most importantly margins.

Our next steps are to realign our cost structure, what's your expected, resulting in meaningful cost reductions by year end.

He platform and optimize our sites improve inventory productivity and begin to leverage our new DC in Las Vegas, the reduced freight costs and speed up shipping times for our customers.

The journey for the new U.S. Autoparts is just beginning but were taking the necessary steps to deliver positive adjusted EBITDA in 2019, and look forward to maximizing value for all shareholders as we execute our operating plan.

With that we'll now open up the call for questions.

Operator.

Thank you, we'll now be conducting a question and answer session if you'd like to be placed in the question queue. Please press star one on your telephone keypad, a confirmation told will indicate your line is in the question queue.

You May press star two if you'd like to move a question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing star one.

One moment, please while we poll for questions.

Our first question today is coming from Gary Prestopino.

Barrington Research your line is now live.

Good afternoon gentlemen.

Hi, Gary.

Hey, how are you David when you kind of flow through some of those numbers you went through could we just possibly.

Just revisit some of your narrative first of all on the private label you said they were up how much 1.2% private label sales.

That's correct, yes that is the main focus of the company moving forward.

This is what were built for it's a much higher margin product line and this is what we're focusing on.

Okay, and then and then they comprise 79% of your sales in the quarter.

Yeah, this quarter, 79.2% compared to 74.9% last the last year.

Okay, and then in terms of the of the.

Branded could you give me those stats to in terms of the growth and then the.

As a percentage of sales.

Yeah branded was down about 20% year over year.

Yes, I think you said it was a percentage of sales about the.

So yeah last year for the second quarter was 24.1% this year, 20.4%.

Okay.

Can you.

Also just to help us.

Yes, great gross margin expansion, what what is the growth the gross margin differential to your company from a.

Oh on a private label versus branded basis.

How many bips of gross margin betterment do you get from selling a private label product.

Private label is significantly higher.

That's what I can say and and moving forward that's going to be the main focus again, even if you see branded sales down about 20% quarter over quarter or year over year. The gross profit is higher companywide.

Right.

So at least for the next couple of quarters as you go through this exercise or does the fact that the private label is going to take take more of the sales.

That would kind of.

Mute your sales growth overall, but really improve your gross margin am I correct in that assumption.

Yeah, that's correct and I think no as was stated on the call I think in David's remarks, I think a better barometer as maybe gross profit dollars and well also well also report on growth in our private label. So our goal is to accelerate that growth. Obviously, we're still had a lot of issues in Q2 as far as just touch on those and inventory sitting in a in the parking lot and not not being able to sell it. So all the growth what's kind of muted, but our goal is to accelerate the growth of our private label doesn't us.

Okay, I'll, let somebody else congrats thank you.

Thanks.

Thank you. Our next question today is coming from Jacqueline Kimble from small cap consumer research. Your line is now live.

Hi, Good afternoon, just a couple of a couple of questions.

I Love you and the team have now been at U.S. auto parts for a little over two quarters.

Uh huh.

What is then the biggest or what have been the biggest surprises and what do you think is the greatest potential longer term upside driver.

Yeah, I think the biggest surprise was the detention issue. So I've been here for six months, David has been here for call. It one quarter. One you know maybe three months.

So I think right when he started.

That's on the caught the attention issue. So that was about a call. It a 10 million dollar hats off to our gross margin onto our operating expenses. So that has definitely been a the biggest surprise I think as far as the upside I think in our strategy to kind of address is that you know our focus is on private label, which will sell at a higher margin and the company was actually built to sell private label will have very good sourcing capabilities quality control our warehouses. The product. So there are some barriers to entry into this business as far as private label goes and so I think for US that's the biggest upside and that's why we're taking the company.

Okay HM.

Going back to the detention charges for the first half of the year, So and I think that Dave.

Touched on this certainly how are how are they going to affect the company for the second half of the year.

Right. So just.

Good question, a quick reminder, on on the detention charges you know just to make sure that we're on the same page. These are the late fees for for not returning the containers to the carriers, which is different from the customs cost that we were incurring prior years. This has left just mentioned that this is the issue that we discovered as soon as I joined the company. So we set up and temporary storage the kind of increase that capacity and reduce those attention charges, but from a financial standpoint. These charges are being amortized into cost of goods sold but they also hit opex. So for the second quarter. The impact to gross profit was about 400000 and the impact to Opex was about 300000. So overall for Q2, the financial impact was 700 K.

Now for the back half of the year you know the total impact on the company is about 2 million. So we're left with about a million dollars combination of gross margin impact in Opex impact now from a cash standpoint, we've already spent most of that money, but from a financial reporting standpoint, it's going to trickle down until the end of the year.

Okay. So you have a couple of you have some things in place now and I think you're looking towards the back half of the year, but when do you think the inventory flows are going to be normalized.

Yeah, I mean inventory is is it something thats going to take a little bit longer due to our long lead times now obviously, we have a very good plan in place, but it. It takes time, but you know really the goal for US is to address the underlying issues that we've been facing which is you know out of stock issues and and stuff sitting in the warehouse for a little bit too long. So we want to optimize for turns and minimizing carrying cost, but it does it's going to take six to 12 months and just to add to that David was saying I think a lot of this you know what we didn't really have teams in place a we didn't give the people that were here at the right tools to kind of execute proper planning I'm on inventory. So I think as we have now started building a team for planning and replenishment as Wallace started getting the right tools for them to use and utilize the right formula as I think you will see it improving but because the lead times are three to six.

Man I was going to take a little bit of time for us to to get up correctly hopefully by the by the you know by Q1 Q2 of next year well have it right.

Okay. Thank you.

That's it.

Thank you.

Thank you.

Your next question is a follow up from Gary Prestopino from Barrington Research. Your line is now live.

Thank you.

Just a couple of more questions guys.

In terms of e-commerce , and online marketplaces or with your focus on private label are you fairly agnostic as to which market place any of those sales go through.

Correct and I think the way to think about it as you know well our ecommerce channel was doing the majority of the brands are transactions that were pulling out of that's why you may be seeing you know a little bit of a decline in our in our revenue on the E. Commerce channel. However, how we're gonna be reporting the growth and the private label and we're pretty agnostic to where it was solid.

Now some marketplace has cost us more but we you know we will have pricing mechanisms in place to two to compensate for that.

Right.

And then at one time, you had about 50000 sq use on branded I believe.

Where where does that eventually shakeout too.

And what else.

I'm, sorry, I'd love it and what categories would you want to stock for Brandon.

When all is said and done.

Yes, I think we've had a one point what we're reporting the private label skills.

And that number was 50000 I think we're up to 60000 now on the branded side you know, we'll have roughly call. It a 500000 to 600000 skews not including the variance like color on a material I think the way that were approaching it as.

No, we're not going to be able to private label every skews that's out there that does business as extremely long tail and so anywhere where we don't have a private label skill will be complementing that with the brands that skew.

And then we May also choose to pursue a good better best strategy, where when they show they use our one or two other brands, where we don't have inventory for example, because it's almost impossible to stay in stock on everything. So there is still going to be branded business. We're not exiting it's completely it just hasn't it plays a different role now.

Okay, and then as you as you work through more of what you're doing to right size the company.

What.

What is your target for a stock out rates what is your target for getting it down yes, I know I don't really want to know exactly what it is right now unless you want to make it public but in your mind, where where do you think you know.

Obviously zero stock outs would be optimal but what is an optimal.

No change from where you are now.

Yeah I think.

I think there's really no optimal number for us what we're trying to optimize for as you know that we're trying to optimize for the most sales was the least amount of carrying costs and so.

You know, it's hard to say what that stuck out number is because you know if if it's hoods it may be a little bit higher because they just take up so much space, but if its smaller parts like door handles our lights when they have a different tolerance. So I think it really varies by part time.

Which is why it's kind of hard to communicate on total.

Okay. Thanks, guys.

Thank you. Thank you we've reached end of our question and answer session I like to turn the floor back to management for any further or closing comments.

Thank you all for getting on the call today with Us and we will update you on our third quarter in November . Thank you so much.

Thank you that does conclude today's teleconference. You may disconnect. Your lines. This time and have a wonderful day, we thank you for your participation today.