Welcome to the U.S. Auto Parts Third Quarter 2019 Conference Call. On the call from the company are Lev Peker, Chief Executive Officer; and David Meniane, Chief Operating Officer and Chief Financial Officer. By now everyone should have access to the third quarter 2019 earnings release, which went out today at approximately 4:05 p.m. Eastern Time.

If you have not viewed the release, it is available on the Investor Relations section of the U.S. Auto Parts website at usautoparts.com. This call is being webcast, and a replay will be available on the company's website through November 15, 2019.

Before we begin, we'd like to remind everyone that the prepared remarks contain 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 in strategies; key operating metrics and current business indicators; capital needs and deployment, liquidity, product offerings, customers, 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 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 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 for 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, non-GAAP financial 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 reconciliation between GAAP and non-GAAP measures required by SEC Regulation G is included in the U.S. Auto Parts press release issued today, which, again, can be found in the Investor Relations section of the 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 turn the call over to CEO, Lev Peker..

Thank you, operator, and good afternoon, everyone. It was a great quarter for U.S. Auto Parts as we began to realize the early benefits of executing our new operating plan that was introduced last quarter. For several key metrics including gross margin private label growth, this was our strongest quarter in several years.

This was also our second consecutive quarter of gross margin expansion and second consecutive quarter of positive adjusted EBITDA, which speaks to our strict focus on driving growth within our highest margin product categories and sales channels. Although we're proud of the early improvements, there is still plenty of work.

But before commenting further on the quarter and upcoming plans, I'm going to turn it over to David to provide some financial and operational highlights.

David?.

Thank you, Lev. Jumping right into results. The headlines are our team is incredibly focused on being more efficient and targeted with our initiatives, and year-over-year, online sales are up 1.7%. Private label revenues were up 15%, and gross profit dollars were up 15%.

We also hit our strongest quarter of gross margin since 2016, which was up 400 basis points to 30.5% compared to last year. Excluding detention and demurrage-related costs from both quarters, gross margin for the quarter would be 31.3% compared to 28.9% last year.

And even with us proactively cutting a significant portion of lower-margin branded product sales as well as exiting unprofitable offline businesses, we're happy to see third quarter sales remain roughly steady at $69.3 million.

As we mentioned last quarter, our ability to effectively source and monetize private label product is one of our strongest assets, so we're going to capitalize on this competitive advantage. As a result, we increased private label sales by 15% in Q3, our strongest quarter of growth since Q3 2012.

Further validating our execution here, private label accounted for approximately 86% of net sales compared to 74% in the year ago period. From an OpEx perspective, we're still working to become a leaner company. Given recent investments, notably the rollout of our Las Vegas DC and some key hires, we've been focusing on growth rather than training.

That said, we're making good progress to improve our cost structure and better manage our expenses to align with our new directives and strategy. As of yesterday, we shipped over 80,000 packages to our new distribution center in Vegas, and we expect volumes to continue increasing from here.

Lastly, on the financials, adjusted EBITDA in Q3 was $1.3 million compared to $2.6 million with the decrease partially driven by $633,000 of detention-related costs that were not added back to adjusted EBITDA and the remaining decline due to an increase an OpEx related to our Vegas distribution center. Now turning to the balance sheet.

At September 28, 2019, we had no revolver debt, and a cash balance of $1.1 million compared to $2 million of cash at fiscal year-end 2018. Our cash flow cycle remains healthy as we improved from last quarter, and we reduced our accounts payable and letter of credit balances while continuing to have no revolver debt. Moving on to key operating metrics.

Traffic in Q3 was 13.8 million compared to 16.4 million in the year ago quarter with the decrease primarily driven by consolidating our websites down to 4 from 18 last year and also reducing marketing spend on branded products that drove traffic to our sites with a negative ROI.

Conversion in the third quarter was up 50 basis points to 3.2%, which mostly benefited from the improvements we made to our site, along with the enhancements to our traffic acquisition methodologies. Although we've made good progress here, we still have work to do as we implement additional improvements to pre- and post-purchase user experience.

Online average order value, which includes order from both our e-com sites and marketplaces, was $78 compared to $85 in Q3 2018. Now similar to last quarter, the decline in AOV is the result of the shift in product mix from branded to private label, which comes with a lower price point but significantly higher margin.

Now for inventory at September 28, we had $47.7 million compared to $49.6 million at the end of 2018. Now as we mentioned before, inventory optimization is top of mind for this management team. And while we're encouraged by the improvements today, we still have some work to do.

Our in-stock rates also continue to improve as a result of the forecasting formulas and new software solutions we began implementing last quarter, so we expect to continue the positive trend.

Lastly, we continue to see limited financial impact from tariffs as customers continue to bear most of the cost of those tariffs, and this is similar to what we're seeing from our competitors. With that, I'll turn the call back over to Lev.

Lev?.

Thank you, David. As you can tell, we're really excited about the progress we've made so far. Our core business is private label, and it's up 15%. Our conversion is north of 3% for the first time in the company's history and is largely a result of our strict focus on main properties and initiatives.

While we have stressed that our core e-com sites are where we're spending most of our time and dollars, the reality is that we're of course going to capitalize on any near-term tailwinds we may see in our marketplace business. Given our focus on private label, marketplaces represent an opportunity for us to distribute our products.

We are deploying significant resources or capital into this channel, but we will take what the market gives us as long as the margin is right. And as it stands, we're seeing some pretty strong momentum across our marketplace channel.

Overall, online marketplace orders were up 20% for the quarter, so we're pretty happy with our results there considering we're putting minimal resources towards this channel. Now it isn't all flowers and butterflies.

We are incurring higher transaction fees from our marketplace partners, which is increasing our marketing spend and taking some of the margin that we would obviously like to have. Marketplaces can make changes with our platform and our cost structure at any time, and we want to control our own destiny.

It is actions like this that further validates our need to own the customer data and control the sales process by driving more of the revenue mix through our e-com sites and not relying on the marketplaces. Our marketing spend was also up this quarter as a result of our events traffic acquisition initiatives.

We're optimizing our marketing spend to not just drive more traffic to our sites but to drive higher quality traffic to our sites. This is reflected in our conversion, which I said was the highest in the company's history. The improvements we've made to our websites also contributed to our better conversion rates.

As mentioned last quarter, we replatformed carparts.com, and dramatically improved site speed and redesigned the user experience to enhance the search and checkout process. Our goal is to get all orders out of our distribution center same day and to the customer within 2 days.

Lastly, I want to briefly touch on our new recently appointed Board member, Jim Barnes. Jim is a highly acclaimed supply chain and logistics veteran having spent the last 25 years deploying supply chain and enterprise solution for Fortune 500 brands and retail companies. We are pleased that he agreed to join us and help us continue our momentum.

So the main takeaway for listeners today is that we're really encouraged by the early improvements in our business as our strategies are beginning to take hold. However, it's important to keep in mind that there is still plenty of work ahead. Everywhere we look, we see opportunities to grow and improve. I feel like a kid in a candy store.

There is no stone going unturned when it comes to maximizing value for our shareholders. We're on top to deliver on our goal of adjusted EBITDA profitability for 2019, and we'll plan to keep this momentum going with an even stronger 2020. The best is yet to come. With that, David and I will open up the call for questions.

Operator?.

[Operator Instructions]. Your first question comes from the line of Gary Prestopino with Barrington Research..

A whole series of questions and I'll jump in and out and let others get some questions in. But first of all, great news on the private label side, the 86% mix.

Could you just give us what your branded and offline percentage of sales were this quarter and the comparison versus last year's third quarter?.

Gary, so on the private label side, this quarter was 86% and branded was 14%. Last year, private label was 74% and branded was 26%..

Okay. All right. So that's how you break it out. All right. So that's good growth there.

I mean what -- optimally, where do you think the private label percentage could get to? What would be a realistic level?.

Yes. So we think closer to 90%, 90-10 split is about right. We can't get rid of all branded because it does fill a gap in the catalog, and as you know, this is extremely long tail. And so there's definitely a place for branded for us. However, we think about it a little bit differently. We think through branded more in terms of strategic partnerships.

And so there's definitely a place for it, but 90-10 is probably the right number for us..

Good. And was happy to see the inventory optimization reflected in the inventory numbers themselves. Can you give us an idea of what kind of positive changes on a percentage basis that you got in your in-stock rates? And then in terms of, you said you skinnied down your SKUs.

Could you give us an idea of what percentage of your -- I would assume these were all branded SKUs that got pushed out..

So on the SKU diet, if you will, so we did remove a bunch of branded SKUs, especially where we saw that there was no gross profit after freights that could be made. And then as far as the in-stock rates, David will take that one..

Yes. So Gary, on the in-stock rate, we don't really give out the percentage because we break it up between our collision business and our engine parts internally, but it is higher than it was at the beginning of the year. The way we think about it is we want to support a higher growing private label business with a lower inventory footprint.

So what you can see is that inventory came down, but again, in-stock rates went up and the inventory is going to turn faster..

Your next question comes from the line of Eric Beder with SCC Research..

Congratulations. So you've cut the websites from 17 to 4. I know it's going to probably end up at three.

How have you been able to maintain the customer base there? And how have you been able now to try and start to segment those different websites for different customers? And how is that working out?.

Yes. So the way that we think through that is carparts.com is our flagship site, and so everything we do is going to be reflected on that site. The other sites are being utilized in different channels for different purposes. But the way to think through it is we're really focused on carparts.com and making that site our flagship site..

And you did a bunch of updates at site.

How has that helped the customer experience? And has the customers seen any difference with that site going forward?.

So we've done -- we just cut over a couple of weeks back to 90% of traffic carparts.com to a new interface. And so we've seen improvements in conversion rates because the site is faster and the experience is a little bit better. We've made some changes to checkout flow and then made a lot of changes to the mobile experience.

But the majority of the conversion increase that you are seeing is more likely due to the channel mix that we're seeing. So as we kind of lose a little bit of organic traffic on carparts.com and we continue spending to acquire customers, that channel converts at a higher rate.

On top of that, as we pulled out of branded in terms of spending money on it, private label converts at a higher rate than branded as well, so I think it's more of a channel mix. And then within the channel, it's a product mix. So the big portion of the conversion increase you are seeing is more due to those changes in the market.

But there is -- the site is faster and experience is better. We still have a lot of room to grow conversion rates on that site specifically due to user experience changes and site speed. But we'll talk about that probably in Q1..

Sure. And last question here. So a lot of this push has been to get people to go into your site and buy your parts, and that's kind of the goal. You are now able to collect the data from that and use it.

How have you been -- or how are you starting to kind of be better at focusing on what the customers' wants and needs are beyond the initial part and to maximize kind of the use of the data that you're collecting..

Yes. So we've implemented -- at the end of August, we've implemented a CRM tool, and so we've now started creating user profiles and starting to understand what's really in the data for us.

We also built a team around retention marketing, and so over time, you'll see us utilizing that data to personalize e-mails not just to the customer but also to the vehicles that they have and then also get more into the life cycle of that vehicle, right? We know when maintenance periods are. We know when the end of life for that vehicle comes.

So we'll be able to insert ourselves into the conversation much better by knowing the customer's vehicle by collecting that data and then by analyzing it and then producing much better marketing out of our retention marketing team..

Your next question is a follow-up from Gary Prestopino with Barrington Research..

Sure. Lev, David, I just wanted to ask you about the marketing expenses were up year-over-year, which I understand you're spending that on traffic growth, right? And then fulfillment was up.

Is that basically due to the Vegas DC?.

Yes. The fulfillment part, yes, it's up due to Vegas DC. On the marketing spend side -- so there are two components to marketing spend. One is the final value fees that were paid to the marketplaces for doing business there, it gets booked into marketing spend.

And those fees have been coming up because they've been also spending money on Google trying to acquire traffic, so they've been increasing fees on us. And the other part of it is us acquiring customers out in the marketplace, which has also increased.

But just be aware that there are two components to marketing spend, which is why we're really focused on kind of working on our three channels, if you will, retention, marketing and such, in order to drive the marketing spend on our own e-commerce channel down so that we can reduce reliance on the marketplaces..

And then I just wanted to make sure. You will be down to 3 websites by year-end with a focus on carparts.com..

Either year-end or early Q1, yes..

Okay. Okay. And then could we expect -- given what you're seeing out there, there's a seasonal decline in sales in Q4.

Is that -- should that be the case this year as well?.

Yes, I think if you look historically, Q1 and Q2 are kind of the same. And then Q3, it falls off a little bit, and then Q4, it falls a little bit off from Q3. I think the other thing that may have an impact is private label is up 15% for us in last quarter.

And as you know, this is a long lead time business, and so as we try to build up inventory, we may see a little bit of a softness, but we don't anticipate a huge decline..

At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Peker for closing remarks..

Thank you, everyone, for joining the call, and we'll talk to you in March..

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation..