Aaron Coleman – Chief Executive Officer Neil Watanabe – Chief Financial Officer.

Gary Prestopino – Barrington Research Eric Beder – Small Cap Consumer Research.

Welcome to the U.S. Auto Parts Third 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 third quarter 2018 earnings release, which went out today at approximately 4:00 PM Eastern Time.

If you have not received your release, it’s 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 November 12, 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 succession plan for a new Chief Executive Officer, 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 could 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 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 project net income without unreasonable efforts. In addition, please also note that the percentage in 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 Aaron Coleman. Thank you, you may begin..

Thank you, operator. Good afternoon, everyone, and thank you for joining us to discuss our third quarter 2018 results. Earlier this month, the Board and I mutually agreed upon a succession plan that will have me stepping down as CEO during the next several months.

It’s been an honor and a privilege to lead such a hard working group through this dynamic period in our Company’s life cycle. And I look forward to what’s the store for the next chapter of my career as well as the many opportunities ahead for U.S. Auto Parts.

Turning to the quarter, in Q3, we continued our work to enhance the customer experience on our e-commerce sites as reflected by consistent improvements in conversion and revenue capture. Although, we continued to experience lower traffic to our sites, we remain keenly focused on our improving our traffic acquisition to return to growth.

During the quarter, we also experienced lower marketplace sales with one of our channel partners due to a reduction in search presence on their platform.

We’ve gone through similar cycles in the past, where a marketplace partner makes an update to their platform that adversely affects our business over the short-term and we expect this situation to be no different. Ultimately, our marketplace partners reward companies that focus on quality, customer experience and broad product assortment.

And we remain very well-positioned in both regards. I’ll expand on this later on the call. But first, I’d like to turn it over to Neil to walk through our third quarter results.

Neil?.

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 third quarter results.

Net sales in the third quarter were $69.5 million compared to $73.8 million in the year-ago quarter, a 6% decline. This was primarily driven by a decrease in marketplace sales with one of our channel partners.

We also experienced a 4% decrease in e-commerce sales attributable to a reduction of traffic and lower in-stock rates resulting from our Customs issue. Private label sales were down 3% in Q3, and accounted for 74% of net sales compared to 72% in the year-ago period.

Also note that offline sales, which is comprised of our wholesale revenues were up 8% in Q3 to $7.5 million. Gross margin in Q3 was 27.4% compared to 29.6% in the year-ago period. The decrease was primarily driven by cost associated with port and carrier fees from the Customs issue as well as increased freight costs.

Excluding these fees, gross margin would have been 28.7%. As a result of the amortization treatment of port and carrier fees from the Custom issue, we continue to expect gross margins to remain between 27% to 28% over the next two quarters.

For fiscal 2018, we currently expect the amortization of these port and carrier fees to approximate $1.9 million. Total OpEx in the third quarter was $19.6 million compared to $20.5 million last year. On a dollar basis, we were $900,000 less than the prior year. As a percentage of revenues, OpEx was 28.3% compared to 27.9%.

Net income in the third quarter was $0.4 million or $0.01 per share compared to net income of $0.9 million or $0.02 per share in the year-ago quarter. Adjusted EBITDA was $2.5 million compared to $3.6 million in the prior year quarter.

Note that this quarter’s adjusted EBITDA adds back stock-based compensation expense and costs associated with our Customs issue and removes the $1.4 million received from the sale of the AutoMD asset, which closed in Q3. As a percentage of revenue, adjusted EBITDA was 3.6% compared to 4.8%.

The decrease was primarily driven by the aforementioned decline in marketplace sales and lower traffic to our e-commerce sites, along with lower in-stock rates due to the Customs issue. Now let me provide some details on our key operating metrics for the third quarter. Total orders in Q3 were 815,000 versus 915,000 in the prior year.

E-commerce orders in Q3 decreased 4% to 443,000 with an average order value of $96 compared to $99 in the year-ago period. Despite the lower orders, we improved efficiency during the quarter with a 70 basis point increase in e-commerce conversion to 2.7%.

This is our sixth 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 into consideration, also improved to 88% of gross sales compared to 86% in the year-ago period. This is the result of the improvements made to our return process, order fill rates and payment capture.

In the third quarter, our customer acquisition costs increased to $7.31 compared to $6.95 last year. The increase was driven by an increase mix of paid versus organic traffic. Turning to the balance sheet. At September 30, 2018, we had no revolver debt for the 10th consecutive quarter.

We also had a cash balance of $8.3 million compared to no revolver debt and $2.9 million of cash at fiscal year-end 2017. $5.5 million of the cash balance is attributable to the timing of payments with one of our shipping vendors, which we expect will normalize during the fourth quarter.

We ended the quarter with inventory of $53.4 million compared to $54.2 million at the end of 2017. And we continue to focus on optimization of our inventory productivity. As discussed on our last quarterly call, I would like to update listeners about our detailed review of the reselling announced tariffs for products imported from China.

There are three different groups of tariffs that have been initiated 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 was implemented on August 23, included approximately 30 of our SKUs, and will not have a material impact. The third group was implemented on September 24 and was reported as $200 billion in scope. The third group covers the majority of our industry and impacts 14% of our net sales.

As previously discussed, our goal in any tariffs will be to pass the cost along to consumers and maintain our gross profit. However, we will monitor the competitive landscape and adjust our pricing strategies accordingly. With that, I’ll turn the call back over to Aaron..

Thank you, Neil. In the third quarter, we continue to work towards our goal of revitalizing our e-commerce sites and expanding our marketplace channel partnerships. On our e-comm sites, we deployed several new initiatives from our product road map to further enhance the customer experience.

The execution of these initiatives continues to improve conversion and validate the work that we’ve accomplished. From a traffic perspective, we continue to see a decline in the third quarter, driven by lower organic traffic and a decline in paid traffic due to unfavorable customer acquisition economics.

We have recently enhanced our marketing capabilities through new hires as well as partnering with external expertise to help restructure our marketing acquisition strategies.

We believe our customer focus product roadmap will continue to translate into conversion improvements, while the new marketing acquisition strategies should translate into improved traffic trends.

In auto marketplace channel, as I mentioned earlier, we experienced lower sales with one of our channel partners due to a reduction in our search presence on their platform. Our marketplace partners are constantly evolving their platforms to ensure that they’re optimizing around their own customer experience.

In the past, we’ve responded positively to these changes to improve our presence with them over time. This is accomplished fundamentally with strong titles, images, applications, listing data and tremendous service levels.

While we took a step back this quarter, over time, we continued to believe that providing an exceptional customer experience and broad product assortment will enable more presence with all of our marketplace partners, this one being no different.

It’s also worth noting that we have experienced more than 40% marketplace growth in the third quarter of 2017, which made it an incrementally challenging quarter to comp this year. These comps get a bit easier going forward.

Despite lower sales with this channel partner, in Q3, we began to scale our product assortment with our newest marketplace partner, Walmart.com, as well as supported the implementation of the direct 1PL model with Amazon. While very early in the process, we believe these new partnerships presents strong, new revenue opportunities over the long-term.

On the wholesale side of the business, we continue to experience solid revenue trends, which as a result of our efficient supply chain, relevant merchandising assortment and high service levels.

Turning to our updated and will outlook, we now expect net sales in 2018 to decrease mid single-digits on a percentage basis compared to 2017, primarily as a result of the Customs issue we’ve discussed last quarter and the current limitations on our ability to import growth as well as lower than expected marketplace sales.

This compares to our previously issued outlook of a low single-digit percentage decline compared to 2017. We also expect adjusted EBITDA to come in at the low-end of our previously issued guidance range of $12 million to $14 million.

To provide a more accurate representation of our core business results, note that adjusted EBITDA excludes cost incurred from the Customs issue and costs related to the CEO transition given their extraordinary nature, as well as proceeds from the sale of our AutoMD assets, given its non-recurring nature.

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

Great, thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Gary Prestopino from Barrington Research. Please go ahead..

Hi, good afternoon. I realize you’re early in the relationships with these two new Walmart and the Amazon relationship.

But is there anything more you can shed on it, I mean how long have they actually been up and running? What’s been kind of the take rate? Anything like that?.

Yes, just to clarify, Gary, and thanks for the question. With Amazon, we’ve had a historical relationship with them as the traditional marketplace seller. The new relationship is really around the 1PL model. And we established that last quarter. But only began doing limited tests at the end of last quarter and the beginning of this quarter.

So that assortment has been relatively limited, it’s a little bit different model. So we wanted to make sure that we’re set up success to scale those in the future. So that’s very early on. In terms of Walmart, that is more of a traditional marketplace relationship. And we’ll be adding our assortment very quickly.

The first couple of thousands of SKUs are live today, and we’ll be increasing that probably to our first full private label assortment by the end of this quarter..

How many SKUs would you eventually have on there?.

We’ll have at least – or will probably focused on our private label SKUs that are close to 50,000, plus our branded SKUs that we can make sure that our assortment and data is world class. So over time, it will be well north of 50,000..

Okay.

And then, Neil, did I hear you say that the port fees this year in total is going to be $1.9 million, is that right?.

That’s correct. The amortization of the port fees are going to be amortized through the year and into the first quarter. But for this year, fiscal year of 2018, we project that to be $1.9 million. There will also be a component of legal fees as well, which we approximate for the year will be about $700,000..

Okay. So $1.9 million worth of legal, $700,000.

So those are backed that of adjusted EBITDA, right?.

That’s correct. As well as our projections for adjusted EBITDA for the year..

Okay. And then last question I have is historically or in the past when you’ve had some of these issues with the channel partner with the reductions in search presence.

How long does it take for you to get that restored to back where do you were prior to this happening?.

Yes, that will be a good question. Yes, sorry, Gary, good question. The platforms are making changes on a continual basis. So some platforms make hundreds of changes a year, some make a couple of dozen. So it really does vary. They’re always trying to change their user interface. They’re always trying to change their algorithms.

And we don’t necessarily know what’s in them. Nor do we really want to try to reverse engineer. What we try to focus on at the end of the day is having the best product assortment, having the best data to present and making sure that our service levels are world class.

And think that if we take care of those things over time, we’ll get rewarded with great presence. We adjust – we’ve seen this in the past, and we always make adjustments to making sure that we continue to focus on those three areas..

So if I could read between the lines, this could probably continue into 2019 as well?.

There’s a couple of different things there. One, we’re adding more assortment, we’re improving our data, we’re trying to always make sure we optimize. At the same point, this quarter as I said in the script, was a very difficult comp in terms of that 40% Q3 of last year. The marketplace comp gets a lot easier in Q4 and into Q1..

Okay, thank you..

[Operator Instructions] Our next question is from Eric Beder from Small Cap Consumer Research. Please go ahead..

Good afternoon..

Good afternoon, Eric..

Hi. Could you talk – you had a little bit of issues in traffic and conversion. When you look forward into next year, should we start to see a resumption of positive support there? So I know that you’re working with your other vendor.

But in terms of your own business, should we be seeing gains – come back in traffic and conversion?.

Yes, so – I think that the team, the entire company should be real proud about what they’ve accomplished over the last six quarters in terms of conversion and improving the overall customer experience. So we’ve seen those metrics certainly move in the right direction by being customer focused and deploying their initiatives.

Clearly, we need to make more improvements on traffic. And as we indicated in last quarterly call, we’re going to bring in both internal talent as well as third parties to help us refine our customer acquisition strategies. And so we think that there’s certainly opportunity there.

And you’ll see some of those strategies come to life over the next couple of quarters. And we’re even starting to see a little bit of a more favorable comp in our traffic trends in October compared to where we were in Q3. So we certainly think that the conversion story is working. And that there’s a lot more opportunity on the traffic side..

And when you look at the tariff issue. So you – we’re going to see more tariffs coming through, pretty much on every one of your products.

One has the many result on the ones that you’ve you raised prices on the smaller sample that you’ve already tariffs being put on?.

Well, Eric, on the first and second tariff, on the products imported from China, the assessment was 25% of the cost of the product. The third tariff, which went into effect on September 24, was issued at a 10% increase and scheduled to go to 25% on January 1.

As we stated on our call, our plans are to continue to pass the tariffs increase under our selling price to ensure that our profit margins are not negatively affected. On the first two tariffs, we haven’t seen any sales resistant on that. And on the third, it’s a little early to tell.

We clearly going to closely monitor the pricing of all items affected by tariffs, which could impact sales demand. And we’ll make any modifications to our pricing strategies accordingly. We still continue to believe that we want to low cost providers on our private label offerings products, which we have cost advantage over both branded and OEM..

And just to follow-up on that, Eric, as Neil said, we’ll put the increases into the marketplace, we’ll watch demand carefully, and we’ll see if the elasticity curve takes a certain shapes. We’re going to try to maximize gross profit dollars versus gross profit percentage.

And we’ll kind of look part name by part name and see, which one consumers are responding to and which one competitors are responding to in different ways..

Interesting, okay. In terms of Customs, so you’ve mentioned in the financial impact on the Customs business. I know it also had an operational impact.

Are we now completely behind the operational impact of the Customs business we had in the first half of the year?.

Yes, this is the follow-up to some of the comments that we made in the last quarter. To be clear, what we wanted to indicate was behind us, was the supply chain impact, was the product flow impact and we have not seen either of those resurface since we thought this was behind us and around the end of July beginning of August..

Okay, and the final question here. When you look potential share buyback, uses cash, I know the cash is a little bit inflated this year and this quarter.

Is there – the stock is where it is, would that be something you’d be looking at here?.

We’re confident that the board is going to have a robust conversations on the best deployment of capital. And we believe that this is certainly one of the areas that they’ll consider in this quarter and the quarters to come..

Okay, guys. Good luck for the holiday season and congrats..

Thank you, Eric..

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

I want to thank everyone for joining the call today. We look forward to meeting with some of you at the Noble’s Investor Conference in January. We’re doing our periodic non-deal road shows over the next months. If you don’t chat then, we look forward to speaking with you next when we report our fourth quarter results in March..

Thank you..

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