Neil Watanabe - CFO Aaron Coleman - CEO, President & Director.

Analysts:.

Welcome to U.S. Auto Parts First 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 first quarter 2018 earnings release, which went out today at approximately 4 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 May 22, 2018.

Before we begin, we would 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 and suppliers and competition.

The 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. 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 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 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 could 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 the outlook for the company, the following non-GAAP financial measures will be discussed, EBITDA and adjusted EBITDA. An explanation of the 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 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 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 like to turn the call over to Neil Watanabe..

Thank you, Operator. Good afternoon, everyone, and thank you for joining us to discuss our first quarter 2018 results. 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 recorded as discontinued operations following the dissolution of the AutoMD subsidiary in the first quarter of 2017.

Net sales for the first quarter were $78.4 million, a decrease of 3%, compared to $80.8 million in the year ago quarter, with the decrease largely driven by 13% lower e-commerce sales.

This was partially offset by an 11% increase in our marketplace sales channel, driven by our strong value proposition and continuous expansion of private label products. In fact, we added approximately 1,500 new private label SKUs during the quarter.

Private label sales grew 3% in Q1 and accounted for 75% of net sales, compared to 71% in the year ago period. As discussed on the prior call, during the beginning of the quarter, we experienced some softness in the private label sales. However, these sales began to pick up and were nearly double digit in growth in the last month of the quarter.

Also note that offline sales, which is comprised of our wholesale revenues, were up 15% in Q1 to $8.7 million. Gross margins in Q1 increased 50 basis points to 29.9%, compared to the year ago period. The increase in margin was driven by our higher-margin private label mix as well as optimized pricing strategies.

We continue to expect gross margins to range between 29% and 30% going forward. We reduced our total OpEx in the first quarter to $21.9 million compared to $22.6 million last year. As a percentage of revenues, OpEx remained at 27.9%, reflecting our commitment to maintaining our overall profit objectives, despite lower revenues for the quarter.

OpEx would have been favorable by 50 basis points if we excluded $0.3 million increase related to higher legal expense associated with the Customs issues and additional expense for our accelerated filer status.

Net income in the first quarter decreased to $0.7 million or $0.02 per share, compared to $0.8 million or $0.02 per share in the year ago quarter. Adjusted EBITDA increased to $4.1 million, compared to $4 million in the prior year.

As a percentage of revenues, adjusted EBITDA improved 30 basis points to 5.3%, with the improvement driven by price optimization and higher conversion rates, in addition to adjusting our cost structure in line with shift in sales channel mix.

It's worth noting that excluding the aforementioned $0.3 million in higher OpEx, adjusted EBITDA would have been up 11% to $4.4 million. Now let me provide some details on our key operating metrics for the quarter. Total orders in Q1 were 901,000 versus 949,000 in the prior year.

e-commerce orders placed in Q1 decreased 11% to 460,000, with an average order value of $98, compared to $104 in the year ago period. The decline in e-commerce orders was driven by lower traffic, partially offset by higher conversion.

Though total orders declined, we were more efficient during the quarter with a 50 basis point improvement in e-commerce conversions to 2.3%. Revenue capture, defined as the amount of actual dollars retained after taking returns, payment capture and product fulfillment into consideration, was 88% of gross sales, compared to 85% in the year ago period.

This is the highest revenue capture percentage in the company's history and reflects our efforts to improve the customer experience through better in-stock rates and reduced returns. In the first quarter, we also reduced our customer acquisition cost to $7.31, compared to $7.43 last year.

The decrease was driven by our decisions to reduce marketing spend as we continued to experience a shift in channel mix to online marketplace sales. However, we began to see strong improvements in March in our e-commerce channel, which Aaron will expand on later in the call. Turning to the balance sheet.

At March 31, 2018, we continued to have no revolver debt while having a cash balance of $9.2 million, compared to no revolver debt and $2.9 million of cash at fiscal year-end 2017. The increase in cash was driven by improvements in working capital, free cash generation, as well as a temporary favorable payment terms with one of our shipping vendors.

Our revolver debt continues to benefit from favorable payment terms we have negotiated with our import vendors, through the use of letters of credit. We ended the quarter with inventory of $58.1 million, compared to $54.2 million at the end of 2017 and $57.2 million in the year ago quarter.

The increase was primarily due to increased private label stock inventory, in part, to achieve our goal of a higher in-stock rate on key items. With that, I'll turn the call 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. As discussed on our last quarterly call, the first quarter got off to a slow start.

However, we launched several web initiatives throughout the quarter that quickly drove meaningful improvements in conversion and began to improve our e-commerce sales comp trend.

In the second half of the last year, we communicated our strategy to improve the customer experience, increase conversion and accelerate e-commerce growth by implementing improvements to our product landing pages, product discovery process, checkout, mobile, site speed and optimizing the post-purchase experience.

As reflected by our Q1 recovery in March, we believe our strategy to revitalize growth in our e-commerce business is beginning to bear fruit. We're in the process of deploying additional initiatives from our product road map to our flagship sites, and the early results continue to show promise.

We are also continuing to embrace the strong growth in our marketplace channel. It's worth noting that our Q1 was our ninth consecutive quarter of double-digit marketplace sales growth, reflecting our commitment to being present wherever consumers are purchasing auto parts online.

We remain in the process of expanding our current marketplace partner network, while also working to expand our relationships with current partners. Given our efficient supply chain, as well as our broad product assortment, we continue to believe there is tremendous opportunity to expand our reach through these and other marketplace channels.

We've received several inquiries from the investment community regarding the impact of tariffs on our business. Fortunately, the tariffs that went into effect do not impact any of the aftermarket products we sell. We'll continue to monitor the situation closely and provide any relevant updates as appropriate.

As we mentioned in our press release today, we recently filed a lawsuit against the United States Department of Homeland Security in the U.S. Court of International Trade.

The lawsuit asserts that 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 infringe trademarks held by the original automotive manufacturers. U.S.

Auto Parts intends to vigorously defend its right to sell out aftermarket automotive grilles under well-established trademark doctrines, as the grilles are neither counterfeit nor is there a likelihood of confusion between our aftermarket products and OEM parts.

While the number of seized automotive grilles currently represents less than 1% of our overall revenue and product assortment, we have taken this action to remove overly burdensome bonding requirements arising from the wrongful seizures and to ensure that Customs expeditiously processes the flow of our goods into the United States.

We have already won a temporary restraining order reducing the bonding requirement to 3% of the commercial invoice value of each shipment and have a preliminary hearing on the matter scheduled for May 9. We expect to issue a Form 8-K following the court's decision on the preliminary injunction hearing.

Looking ahead, we continue to expect net sales in 2018 to increase low single digits on a percentage basis, compared to 2017. However, in light of the anticipated costs associated with the Customs issues, we are revising our adjusted EBITDA outlook, and now it's expected to range between $13 million and $14.5 million.

This compares to our previous guidance of $14.5 million to $16 million compared to $14.2 million in 2017. With that, we'll now open up the call for questions..

Operator:.

Thank you all for joining the call today. We look forward to meeting with some of you at the Jefferies automotive conference in May or during our periodic non-deal roadshows over the next couple of months. If we don't chat then, we look forward to speaking with you next when we report our second quarter results in August..

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