Welcome to the U.S. Auto Parts fourth quarter 2018 conference call. On the call from the company are Lev Peker, Chief Executive Officer and Neil Watanabe, Chief Financial Officer. By now, everyone should have access to the fourth quarter 2018 earnings release, which went out today at approximately 4:00 PM 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 21, 2019.

Before we begin, we would like to remind everyone that the prepared remarks contain certain forward-looking statements within the meaning of the federal security 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 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 the 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.

In addition, please also note that the percentage and basis points discussed are calculated using net sales, with the exception of advertising, which we will 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 Lev Peker..

Thank you operator and good afternoon, It's an honor and privilege to rejoin U.S. Auto Parts team as CEO after spending several years with the company between 2008 and 2014. In just five short years since my departure, the company and industry at large has seen considerable changes. Consumers continue to shift their shopping habits online.

Since 2014, offline DIY aftermarket auto parts sales have only grown at about 1% CAGR while online auto parts sales have grown at an approximately 20% CAGR. Further, the online auto parts category is expected to more than double by 2023 to $29 billion, signifying its continued momentum. Over the years, U.S.

Auto Parts has established itself as one of the premier online providers of aftermarket auto parts with some of its brands like JC Whitney dating back more than 100 years, when aftermarket parts were being sold through catalogs. Today, U.S.

Auto Parts serves its customer through a variety of sales channels, including several owned and operated e-commerce websites, as well as multiple third-party online marketplaces. Over the last 18 months, the company has certainly not performed to its full potential and its financial results have been disappointing to everyone.

2018 was struck with various setbacks, some of which were largely out of the company's control such as the customs issue encountered at the Port of Norfolk. On the other hand, the company has struggled to revitalize its e-commerce business, as reflected by the continued e-com traffic declines since Q4 2017.

I believe the struggle from our e-commerce channel have largely been internally driven issues as opposed to also structural business challenges. In fact, in just over two months since rejoining the joining the company, we have already identified multiple opportunities designed to revitalize our e-commerce channel and return U.S.

Auto Parts to profitable revenue growth. This will require reallocation of resources and incremental investments in personnel, technology and new marketing strategies in 2019.

Although there is much work to be done and near-term results will continue to be impacted by some of the setbacks from last year, we are committed to making the changes necessary to return U.S. Auto Parts to revenue growth in 2019.

We have a solid foundation from which to build with talented and engaged associates, strong industry expertise specifically in private label products, a highly efficient supply chain and more than 1.5 million private label and branded products to serve a large and growing consumer base for auto parts.

But before commenting further on our plans, I would like to turn the call over to Neil to walk us through the details of our Q4 and full year results for 2018.

Neil?.

Thank you Lev and good afternoon everyone. I would like 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 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 fourth quarter results.

Net sales in the fourth quarter were $64.6 million compared to $68.5 million in the year ago quarter, representing a 5.7% decline.

This was primarily driven by a decrease in marketplace sales with one of our channel partners and a 5% 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 1% in Q4 and accounted for 76% of the net sales compared to 73% in the year ago period.

Gross margin in the fourth quarter was 25.6% compared to 30.3% in the year ago period. The decrease was primarily driven by costs associated with port and excess carrier fees from the customs issue discussed on previous calls as well as an increased freight cost.

Please note that we are now recognizing all port and carrier fees that were incurred in 2018 as period expense due to the one-time nature of these costs as opposed to amortizing them as part of cost of goods and have restated the prior quarters in fiscal 2018 to reflect that change.

The auto parts industry has gotten more competitive both from a branded and private label perspective. At the same time, freight costs have continued to rise and we don't anticipate a change to that in the near-term. We expect both freight and competitive pressures to continue to impact gross margins in 2019.

We are taking steps to offset some of these pressures such as developing exclusive private label products not readily available through our competitors, delivering a better customer experience and making changes to our supply chain by getting closer to the customer to realize freight savings. Moving on.

Total OpEx in the fourth quarter was $21.3 million, compared to $20.2 million last year. As a percentage of revenues, OpEx was 32.9% compared to 29.4%, with the increase primarily driven by cost associated with executive management changes.

Net losses in the fourth quarter were $4.5 million or a loss of $0.13 per share, compared to a net loss of $4.1 million or $0.12 loss per share in the year ago quarter. Adjusted EBITDA was $0.7 million, compared to $2.8 million in the prior year quarter.

Please note that this quarter's adjusted EBITDA adds back the $5.2 million of expenses, including stock-based compensation expense, costs associated with our customs issue and severance and other costs related to transition within our executive team. As a percentage of revenue, adjusted EBITDA was 1.1% compared to 4.1%.

The decrease was primarily driven by lower sales due to 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. We anticipate that these lower in-stock rates to further impact adjusted EBITDA in the first quarter of 2019.

Now let me provide you some details on our key operating metrics for the fourth quarter.

Traffic in Q4 was down 18% to 16.5 million, compared to 20.1 million in the year ago quarter, with the decrease driven, in part, by reduced traffic from our platform conversion of JC Whitney and reduced marketing spend in December to account for a product mix shift resulting from the customs issue.

Conversion came in 40 basis points higher at 2.5% compared to 2.1% for the same period last year, reflecting the positive impact of better quality traffic through paid sources as well as improvements to our website such as faster site speed.

Revenue capture, defined as total sales dollars retained after taking into consideration returns, credit card declines and product fulfillment, was up 60 basis points to 86.7% compared to 86.1% last year, reflecting a reduction in product returns and credit card fraud due to improvements in our approval process.

Online average order value, which includes orders from both our e-commerce sites and marketplace, increased to $85 compared to $82 in Q4 2017. Quickly running through our full year results. Net sales in 2018 were $289.5 million, compared to $303.4 million in 2017. Gross margin for the year was 27.2% compared to 29.6% in 2017.

Excluding the port and carrier fees, gross margin in 2018 would have been 28.7%. Total OpEx in 2018 reduced to $83.7 million, compared to $85 million in 2017 despite the current year incurring $1.5 million in executive team transition cost and legal fees associated with our customs issue.

Net loss in 2018 was $4.9 million or a loss of $0.14 per share, compared to net income of $24.6 million or $0.62 per share in 2017. As a reminder, net income in 2017 included a $21.5 million income tax benefit due to the changes in valuation allowance in addition to the impacts of the Tax Cuts and Jobs Act.

Adjusted EBIT for the year was $10.4 million, compared to $14.2 million in 2017. Turning to the balance sheet. At December 29, 2018, we had no revolver debt and a cash balance of $2 million, compared to $2.9 million of cash at fiscal year-end 2017.

We ended the quarter with inventory of $49.6 million, compared to $54.2 million at the end of 2017 and we continue to focus on optimization of our inventory productivity. While inventory levels were not at the level we anticipated resulting in some out of stocks, we felt the composition and quality of our inventory improved.

In fact, as of December 29, 2018, approximately 90% of our assortment was less than one-year-old which is a direct result of our effective sourcing strategy and inventory productivity. I would like provide an update on tariffs and the impact to the U.S. Auto Parts.

As reminder, there were three different groups of tariffs initiated by the administration last year. The first two groups currently represent less than 1% of our annual net sales. The third group is what covers the majority of our industry and impacts 13% of our annual net sales.

As most of you may have heard, the administration has agreed to postpone these plans to increase third group of tariffs to 25% until a later undisclosed date. Overall, we have not seen a material impact to our business as we pass through cost to consumers, given that the tariffs similarly affect all of our competitors as well as the OEMs.

If a consumer needs a part to get their car working again, they are likely going to purchase the part, regardless of a price increase. Our goal in any additional tariffs would be continue to pass the cost through to consumers and maintain our gross profits, which seems to be the approach our competitors are taking as well.

We will continue to monitor the tariff developments and update our shareholders of any changes accordingly. With that, I will turn the call back over to Lev..

Thank you Neil. As I mentioned earlier, since joining the company we have identified several opportunities designed to return U.S. Auto Parts to growth. Our company mission is simple, to deliver the right part at the right time through any device or any channel.

To deliver the right parts, we need to enhance our backend architecture, restructure our data and catalog and deliver a best-in-class user experience on any channel we sell through.

One of the first actions I have taken to deliver on our company mission has been to start to rebuild and strengthen our team to help us navigate the evolving the e-commerce landscape. In the last month, we have hired a new Chief Marketing Officer who has begun to build a world-class marketing team.

We have also started building a user experience and analytics team to support both marketing and UX. Both of these teams are supported by our technology team, which is undergoing tremendous growth, both in the U.S. and Manila. These expanded marketing, UX and technology teams are critical additions that will look to execute on our new growth strategy.

Following my review of our operations, it was clear that part of our internal missteps were driven by a lack of focus, which resulted from spreading our resources too thin. In order to focus the team and to deploy our assets most efficiently, we are in the process of reducing the number of websites we operate.

This will allow for a more simplified development approach, more focused marketing and real attention to user experience. We plan to take a similar approach with our marketplace channel.

The reality is that our marketplace business has grown at a strong trajectory these last two years and now takes up a greater share of total revenue than it did in years past.

We still believe that we need to be present where the consumers shop but we need to provide users of our sites with the same or better experience than they receive on the marketplaces.

This is why we will be placing a significant effort on restructuring our data and catalog methodologies to enhance the discovery of products and make our catalogue a stronger competitive advantage. On the marketplaces, we will continue to adhere to best practices and we will continue targeting customers who prefer to shop in that channel.

To summarize, we want to focus our resources on fewer sites and stores and do a better job at both growing and optimizing them as opposed to spreading our resources thin across many sites and marketplace channels.

In addition to new personnel and the shift in focus, our return to growth this year would require additional investment by way of technology and new marketing strategies. From a technology perspective, we are in the process of enhancing our team to help us modernize our backend and frontend systems.

Reducing the number of sites and related platforms will help speed up some of these initiatives. Our technology organization is focused on ensuring that our customers receive the same experience they have come to expect from the best e-commerce players, regardless of vertical.

Customers' expectations today are shaped not just by our direct competitors, but by all of their experiences on the web and we have to ensure that we deliver the same or better. This includes site speed, discovery of product, ease of check out and post purchase experience, including setting the proper expectations for shipping times.

Transparency and accuracy will always lead to a better customer experience and increase the likelihood of a repeat customer. In terms of new marketing initiatives, we will be making investments in both organic and paid channels while also tapping into social media influencers and better brand marketing to drive traffic and awareness.

These efforts will also require implementation of a new CRM and various investments in retention marketing. While I am very excited for the journey ahead, there is much work to be done. The implementation of our growth initiatives will take time as we will have to take a step back before moving forward.

However, we expect to begin realizing some of the benefits from our investments towards the end of this year. Given my short timeframe back with the company, we will not be issuing guidance for 2019, but note that we have every expectation of delivering revenue growth for the year as well as positive adjusted EBITDA. The opportunities ahead for U.S.

Auto Parts are many and I look forward to leading the team and all stakeholders into this next chapter. With that, we will now open the call for questions..

[Operator Instructions]. Our first question comes from the line of Eric Beder from SCC Research. Please proceed with your question..

Good afternoon..

Good afternoon Eric.

Hi.

Could you talk a little bit about when we look at some of these, what should be correct mix here in terms of private label? Actually, where did private-label end up for the year? And where do you think it can go? And where do you think it can take margins here?.

Well, I think on the mix for the year, private label ended up around 73%. I think it still have quite a bit of room to grow. We re focusing our strategy on fewer sites and that will allow to also focus our strategy around merchandising higher gross margin products.

So the thinking that we have now is that one of our sites will be tailored to private label products where we will fill all the gaps that we have. There are some part names where we don't have any private label at all today. Breaks, starters and alternators are just some examples. So we are going to fill out all the parts names.

We also want to bring in private label products that are hard to find. Some of the examples that we recently brought in are dash covers for trucks. Those are higher AOV items. They are a little bit harder to find. And they allow us to enjoy a competitive advantage.

And then we want to focus our branded strategy around performance and accessories, which are also MAP items that sell at higher margins. But our private-label mix will continue to stay at around 75%. Now what it will do to our margins, we don't really know as we mix shift into higher margin branded products, as well as more private label products.

So we are not really sure what it will do to margins because there is also some freight headwinds that we are experiencing. So as we bring in larger parts, whether they are plastic or metal, it's more expensive to ship them. So we are not quite sure of the margin profile yet, but there a lot of opportunity in private label still..

Great. And when you look at the third parties you have right now, is the goal to shrink the amount of products they are offering or just to have less third parties, period..

So I think from a dropship perspective, what you may see is you may actually see us carry fewer SKUs. We still want to make sure that for every specific vehicles, very specific year, make, model, we are carrying a full assortment of parts that. But we may reduce the choices that the customer has to make.

So instead of carrying 20 brands, we may carry five or seven. So we are going through that evaluation right now at a part name level and at a vehicle level. So you may see us reduce the number of SKUs, which will in turn reduce the number of dropshippers we have.

But we are focusing on the customer and making sure that the customer can make the right choice when they are picking the parts..

Last question.

I assume, given the accounting changes you did for the cost for the customs issue, that that will be, so what should we expect the impact to be in Q1 of the remaining customs issues that you have here?.

Well, in Q1, Eric, we will be expensing anything that we incurred relative to the customs issue and really, there is just a trailing piece of some transload cost that will be expensed in the first quarter, approximately $300,000 range.

Everything else that we incurred in 2018, as we stated, has been moved back as period expense into the appropriate quarter. So to your question for Q1, that's the remaining expense relative to the customs matter for the freight and the carrier costs that we incurred which is what we anticipate for Q1..

And just to add to that, Eric, I think as far as the costs in U.S. correct, however the customs issue caused a disruption in our supply chain and so what happened as the SKUs were being held up at the customs, we have to make different decisions about sourcing product domestically. And so it extended our lead times.

So even though the customs issue, for the most part, is sort of dealt with, the supply chain still kind of bled into Q1. And so some of our out of stock issues that we are seeing in some part names is caused by that disruption to the supply chain.

So while the real cost is mostly in 2018 and only a little bit in 2019, there is an opportunity cost that we are not really capturing and that we are seeing in the numbers today because we are seeing higher out of stock..

So you expect that to end by Q2 2019?.

Correct..

Okay. Well, good luck guys for 2019..

Our next question comes from the line of Gary Prestopino from Barrington Research. Please proceed with your question..

Hi. Good afternoon. A couple of questions here. Neil, just some number questions.

Can you give me what the average order value was for e-commerce and marketplace orders in the quarter?.

Yes. We had combined the number we gave for consolidated. We will get the income number for you in one second. Do you have another question, Gary? We are getting that number..

Yes.

And then what are your CapEx assumptions for this year? And with all of that what you are doing, which I want to get into a little bit more in terms of trying to lift your growth and the fact that the EBITDA is probably going to be down based on what you are saying, will you be having to tap your revolving line of credit this year?.

Let me the answer the CapEx question for you. We are planning and forecasting our CapEx for 2019 to be around approximately $7 million. That's up from $5.5 million in 2018.

As mentioned, we have various investments that we will be making that will run both through the P&L as well as through capital, but that will be something that will definitely get increased over prior years as we are investing in a lot of our IT infrastructure and systems and sites to reconfigure the platforms.

Relative to the revolver, we have historically, at each quarter-end been at zero on the revolvers. But we have always utilized the credit facility throughout the year based on seasonality and based on our purchases.

We are anticipating that there will be some quarters in 2019 that we may have a balance at quarter-end on the credit facility where in the past it's been zero. So I think that hopefully gives you some flavor that we have always used the revolver.

It's just at quarter-end we have been able to clean that down to zero, but based on timing of some of these investments and inventory purchases, et cetera, there could be some quarters in 2019 that we will have some level of balance..

Okay. And then Lev, in terms of what you talked about, you went through a lot of things there in terms of what you saw, what you are going to try and do, et cetera to rightsize this company.

If you could maybe just summarize it very simply, give us what you see are the key issues that you have got to turn around at the company to get to growth back? And how long is it going to take you to do it? Is this going to be all of 2019? Is this going to be a two-year ramp? You are talking about adding technology or architecturing the technology, adding people, et cetera, et cetera.

So I would appreciate that, just so we know where you are coming from..

Yes. So I think, to put it simply, the way we are thinking about it is, our mission is to get you the right parts at the right time at the right place. And what we mean by that is, we want to make sure that you buy the right parts for your vehicle. We want to make sure that it fits. So we have got to show them our catalog and data.

We have got to show you fewer choices so that it becomes easier for you to pick. The right time is we have got to be able to ship it to you quickly. So we have to make sure that our inventory is in the right position. We have to make sure we are close to the customer.

And the right place is, it's regardless of device which you are shopping on and we also want to start tapping into the do-it-for-me market.

Meaning, that it doesn't matter how you want to install the part, whether you are going to do it yourself or whether you are going to have somebody else install it for you, we want to be able to deliver the part for you. So that's the strategy simplified.

Now, in order to execute on that, we are going to need to shore up three areas that I have identified. One is marketing. The other one is technology. And the third one is user experience. So all the investment that you will see this year and throughout this year will be into those three areas and towards the three things I just identified.

Right part, right time, right place. So that's kind of how we are thinking about it.

As far as the timing, you know, you can't really rush it to much and we are trying to spread out the investment so that it's kind of timed well with our quarters but we expect to see some benefits towards the end of this year, but it will definitely spill over into next year..

Okay. Thank you..

So Gary, the average order value for e-com for the fourth quarter was $95 versus the prior year was $100. The marketplace was $73 versus $67 prior year.

So we had a little bit of a decline on the e-com side as we got more aggressive in pricing and marketplace was higher than the prior year based on the mix changes that we have had on product in that category. The total, as we stated, was $85 for both versus $82. So in total Internet, our average order value went $3..

Can I just ask one more question in terms of what you are doing, Lev? Are you going to be putting more of an emphasis on driving the e-commerce site growth, revenues through the e-commerce sites versus the marketplaces? Is that the end result here of what you want to try and establish?.

Yes. So the goal is to adhere to best practices in the marketplaces and to allow the marketplaces to grow at the same rate that the marketplaces themselves will be growing and to really grow our e-commerce business to focus on discovery, to focus on pre and post purchase customer experience and to really grow the e-commerce business..

Okay. Thank you..

We have reached the end of the question-and-answer session. And now I will return the call over to management for closing remarks..

Thank you all for joining the call today. We look forward to meeting with some of you at the Morgan Stanley Aftermarket Symposium later this month as well as the Cowen Future Of The Consumer Conference. in April. I couldn't chat then. We look forward to speaking with you next when we report our first quarter results in May..

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