Welcome to the CarParts.com Third Quarter 2020 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 2020 earnings release, which went out today at approximately 9:00 a.m. Eastern Time.

If you have not viewed the release, it is available in the Investor Relations section of the CarParts.com website at carparts.com/investor. This call will be available for replay via the webcast archived at carparts.com/investor, and also will be available through November 23, 2020, via telephone balance provided in the earnings release.

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, suppliers, competitors, the impact of tariffs and our tariff mitigation efforts and the potential impact of coronavirus on our supply chain and operating results.

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 several factors that could cause actual results to differ materially from those statements.

We refer all of you to the risk factors contained in CarParts.com 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.

CarParts.com 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, non-GAAP financial measures such as adjusted EBITDA, will be discussed and explanation of CarParts.com use of non-GAAP financial measures from this call and the reconciliation between GAAP and non-GAAP measures required by SEC Regulation G is included in the CarParts.com 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 to rise in accordance with GAAP and such non-GAAP measures have limitations, which are detailed in the company's press release. With that, I would now like to turn the call over to the CEO, Lev Peker..

a shift from Do-It-For-Me to DIY, a secular shift from off-line to online, and more recently, a shift away from public transportation, combined with the oldest car fleet the country has ever seen. First, we're seeing strong momentum in the DIY auto parts segment, with record numbers of consumers choosing to shop for their auto parts online.

This shift is driven by macroeconomic factors that we usually observed during uncertain economic conditions. Consumers react by maintaining their existing vehicles rather than purchased new vehicles.

Additionally, with availability of tools like YouTube, that help demystify consumer repair, it is easier than ever to save money by doing the repair yourself instead of taking the car to the shop. The second change in consumer behavior is a shift from off-line to online. Customers across many industries have been adopting online shopping.

The auto parts industry lags other verticals and online penetration by a wide margin. We're still in low single digits compared to other categories that are closer to 30% online penetration. We believe the shift to e-commerce will continue its acceleration as customers experience expanded selection, fast shipping and lower prices.

We believe we're the best-positioned company in our category to take advantage of the shift with our focus on getting the right parts to the customers quickly through our unique distribution model that goes from the factory to the consumer. We also believe that we're gaining sticky customer relationships that will prove to be resilient over time.

Nobody is going to a Blockbuster store after discovering Netflix. Lastly, miles driven continue to be below pre-COVID levels. However, they are trending in the right direction. According to the latest data available from the U.S.

Department of Transportation, they're down 12% from this time last year, but have rebounded by 50% from where they stood during the lows of the pandemic in April. As the country continues reopening and as consumers shift away from public and shared transportation, we believe that these metrics will improve.

We saw similar trends play out in China, and we expect the U.S. mobility will follow. We use these statistics and other macroeconomic factors as indicators for our business, but they do not dictate our ability to execute.

We delivered strong results in Q1, pre-COVID, with house brands up 42% and immediately following the first stimulus package when discretionary income improved. As stimulus and the additional benefits expired at the end of July, we continue to see strong trends in our business. Our weekly sales demand was consistent throughout the third quarter.

We also saw no significant difference in sales geographically based on location and children placed orders. Our brick-and-mortar competitors were always open and reported record sales, while at the same time, we drove another quarter of triple-digit revenue growth in our primary sales channel, CarParts.com.

Our strategy has proven resilient to large-scale changes in both buying and driving behavior, which tells us that we have established a strong operational foundation from which to navigate these dynamic times.

At the product level, we have maintained our focus on higher-margin private label parts or what we now call our house brands, which continue to make up the majority of our sales. And as we mentioned last quarter, we're excited to begin ramping our hard parts business.

We recently kicked off our TrueDrive brand and look forward to introducing expanded SKU offerings over the next several months under the Drive, SureStop and JC Whitney brand umbrellas. Overall, our performance this quarter demonstrates that we're continuing to operate from a position of strength.

With all the improvements we have implemented across our business over the past 18 months, we're well positioned to continue capitalizing on the significant expansion of the e-commerce industry for auto parts. With that, I'll turn it over to David to walk through our financial and operational highlights..

outstanding customer service, operational excellence and financial discipline. As Lev mentioned, the strong momentum in net sales continued in Q3, increasing 69% year-over-year to $117.4 million.

The increase was primarily driven by revenue growth from our flagship website, carparts.com, which continues to be our fastest-growing channel and grew 105% year-over-year. Gross profit in Q3 more than doubled year-over-year, reaching a company record of $43.1 million.

Gross margins expanded 620 basis points to 36.7%, making this our seventh consecutive quarter of gross margin expansion. The increase was primarily due to product mix, channel mix and logistics optimization. Total net income from the quarter improved to $1.4 million compared to a net loss of $1.4 million in Q3 2019.

Adjusted EBITDA in Q3 increased nearly 4x to $5.1 million compared to last year. The strong increase stems from higher sales as well as the consistent improvements in operations, technology, marketing, supply chain, customer service and other key areas of our business. Now turning to the balance sheet.

At fiscal quarter end September 26, 2020, we had a cash balance of $59 million compared to $2.3 million at the end of 2019, as we successfully completed a $60 million public offering that was 3x oversubscribed.

The offering closed on August 18, and we want to welcome our new long-term focused shareholders, but also want to thank many of our existing shareholders for participating. On the liability side, we paid down $12 million of liabilities tied to our credit facility, which represents virtually all of our debt outside of leases.

As a reminder, our ABL facility with JPMorgan Chase allows us to flex up to $40 million depending on inventory levels. Our company now has a clean capital structure and ample liquidity to support our long-term growth initiatives.

Our supply chain and inventory investments will be key drivers to our long-term strategy of right part, right time, right place. From an operational perspective, Q3 was very strong from a demand standpoint, and our network continued to operate at full capacity, both from an inbound and outbound perspective.

From an inventory standpoint, with the buys we placed in Q2, our replacement parts were in a stronger position, but our hard parts inventory continued to lag due to the longer lead times. We expect our inventory position to continue improving over the next 2 quarters. Now briefly touching on our footprint.

Our new Texas distribution center build out and ramp-up has been right on schedule. We're happy to announce that we're now receiving seven days a week and have already shipped over 10,000 packages quarter to date. We expect Texas outbound volume to grow as more inventory is received.

We're thankful to the city of Grand Paris for welcoming us and look forward to being part of this amazing community and creating jobs in warehouse operations, technology and customer service. Our results this quarter validate the strength and resilience of our strategy and our teams even in this uncertain macroenvironment.

We're proud of the strong foundation we have built, and we'll remain focused on building a long-lasting, exceptional company. With that, I'll turn the call back over to Lev..

As parting thoughts for today's call, I want to highlight a few points that make our business unique. In terms of our unit economics, we're profitable in nearly every transaction we make, even when factoring in customer acquisition and fulfillment costs.

We have continued to increase sales and improve our margins even without a new stimulus package or extended unemployment benefits. We believe we have built a robust business that can thrive in any market condition, especially in the recessionary environment.

Our business was already growing pre-COVID as a result of the operational improvements we have made across our technology, marketing and supply chain.

The heightened demand environment that emerged from the pandemic was the result of three broader trends I outlined above as shifts to DIY, shifts from off-line to online and more personal mobility, trends that we were in a prime position to capitalize on. This provides us with plenty of growth to capture for years to come.

While the overall e-commerce industry has, of course, benefited from pandemic-related tailwinds, we believe that the subsequent changes in consumer shopping habits for auto parts are here to stay.

We'll already retain roughly a third of our customers and expect this to grow as more consumers experience the convenience and benefits of fast shipping, low prices and a wider selection than almost any other auto retailer.

Across our organization, we have made exceptional progress in establishing CarParts.com as a modern and scalable e-commerce company. As we look to the fourth quarter and our trajectory into 2021, we'll work to further optimize both our back end and our customer facing operations.

We will continue to focus on expanding our inventory and fulfillment capabilities, while remaining financially disciplined when deploying capital to areas of our business in order to generate the strongest returns. With that, we'll open up the call for questions.

Operator?.

[Operator Instructions] Our first question comes from Ryan Sigdahl with Craig-Hallum Capital..

Congrats on the results and continued business improvements. Curious on business trends in October or post quarter end and how revenue margins have performed. And then secondly, if you could comment if revenue growth on a year-over-year basis has remained similar, declined, accelerated? You're at 69% growth in Q3.

Just, directionally, any comments would be helpful..

Ryan, it's David. So I know last quarter, we provided some minor indications of intra-quarter sales because there was a lot of uncertainty in the market. Now as a general rule, it's not really a practice we believe in. So we're really trying to focus on executing our plan, and we're following our internal rules of success.

And every quarter, we'll report our results. So ultimately, what we're doing is taking a long-term view and trying to build a business that we'll be proud to own decades from now. But I wouldn't really feel comfortable giving out kind of intra-quarter data right now..

And then just thinking about kind of the margins, both near-term.

As you spend on, you mentioned a lot of personnel; tech; distribution; fulfillment; et cetera, et cetera, can you walk through how you think about kind of the main levers on the cost side and margins in the near-term over the next several quarters, generally? And then also as you look out a few years, kind of where the main levers are in the model as the business scales?.

Yes, great question. So if you look at our income statement today, ballpark, about 2/3 of our OpEx is variable expenses. So fulfillment and customer acquisition costs and credit card fees. Now on the fixed OpEx side, we still have some technology debt that we have to address before getting into the level that we feel comfortable at.

I think over time, we are going to get leverage in our OpEx. Short term, we do have a new DC, and we have some technology and catalog investments that we have to make to catch up. But I think as far as long term, we do see an opportunity to grow sales at a much faster pace than fixed expenses. But short term, again, we have some investments to make..

And then maybe just a follow-up.

Those investments, do you think those need to accelerate from where we are today? Or do you think you can generally hold -- now there's some seasonality, but generally hold kind of this level and then see more of that operating leverage? Or is there a need to accelerate that spend?.

No, I think we're going to try to stay disciplined. And obviously, we want to keep growing the company, and we want to keep the momentum going, but we want to do that at a profitable rate. So it's a balance of being profitable in growing the business and managing the investments on a quarterly or semiannual basis.

So we're just trying to stay disciplined and roll out the investments on a cadence that we think we can handle from a cash flow standpoint and profitability standpoint..

Then just one on getting a little more detail about on the underlying metrics, but what percent of e-commerce traffic mix is paid versus free? And then how does that compare versus either prior quarter or prior year, some historical comps?.

So last year, we were about 80% paid, 20% free. We're much more diversified. So for this year, we were targeting 50-50 split as we exit the year, and we're on pace for that. And then next year, we expect it to slip and be about 60-40, maybe 70-30 free versus paid..

Last one for me, and then I'll turn it over to the others.

Any commentary you can give on the pace of sales growth in states, regions where you had one -- well, two day shipping and then now one day shipping on kind of the initial out of Texas? Did that make a difference?.

So it definitely makes a difference. And again, we think we're uniquely positioned in that. We are selling a need-based product. And so speed to customer is very important. We're not selling kind of discretionary accessories and things like that, where customers can wait. We are selling something that a customer needs pretty quickly.

So we had a theory that getting closer to the customer would prove out to increase sales, and that theory is proving out right now. Texas shipped over 10,000 packages already. And we're getting the majority of those packages to customers within Texas in one day. And so we're seeing pretty good results.

It is going to take time to ramp up because it only has a few million dollars' worth of inventory in there. But as it ramps, we expect to continue to see this trend..

Our next question comes from Darren Aftahi with ROTH Capital Partners..

Just following up on the DC and Texas.

So the 10,000 units, can you just give us some more color on when it officially kind of was lit? And then kind of where you are from a capacity perspective? And perhaps how quickly that facility can ramp over the coming two quarters? And kind of what your expectation is for full capacity utilization?.

Darren, it's David. So yes, the rollout is basically on schedule. The way we do it is we start really small. So we start receiving a couple of containers and then turn on the sales. Right now, it's still at, call it, 10% to 15% capacity. Most of the labor right now is scheduled to receive the inventory more than ship it out.

So we're receiving 24/7, but we're not really turning on all the sales because the inventory just isn't there yet. For us, the schedule is really to keep receiving until the end of the year and have it, call it, between 65% and 80% capacity from a footprint standpoint by the end of the year..

A couple more, if I may. You called out investment in tech. Could you just be a little bit more specific what exactly in technology kind of you need to invest in? And what's kind of the time frame for that investment? And then if you would mind sharing the indirect channel sales in the quarter, that would be helpful..

So I'll tell you a little bit about the investments in tech. So a lot of our back-end systems are homegrown and really old. So a big one is our ERP. So we use Great Plains, which nobody really uses anymore. So that's the first thing that we need to kind of upgrade and get with the times. So that's a big investment for next year.

And then there are a few other systems that we're upgrading for us. We have a purchasing system, we have a forecasting system. So just a few systems that, on the back end, we need to upgrade. And then I'll let David answer the second question..

So I think your question, Darren, was on the wholesale as a percentage of revenue.

Is that correct?.

Correct..

So for Q3, we were at 5.8% of the sales were wholesale..

And then if I could just squeeze one more in. So given you've launched Texas -- and I know you don't probably want to talk about 2021.

Like how do we think about the layering or stacking of new DCs as we go out 12 months from now? Is that part of the conversation? Or is it kind of take your time with Texas and see how that rolls out?.

So we just completed the network study to determine what are the optimal locations to open DCs in order to hit 90% of our customers in one day. I think as we kind of let Texas roll out, and as we see sales come in, in Q1, we're going to start thinking about where do we go next..

Our next question comes from Elliot Alper with D.A. Davidson..

So impressive gross margins in the quarter. You spoke about the channel mix and product mix as a part of this.

I guess, any more color you could share specifically on the gross margins? And then kind of how we should think about gross margin going forward into the December quarter?.

Elliot, it's David. So I'm actually glad you asked. I think when looking at margin, it's really best to look over the course of several quarters and at least really the full year because that's how we manage it internally. That's how we look at the business.

We've always said that we like margin in the mid-30s, but to your point, it's going to fluctuate up or down based on channel mix and product mix.

I do want to call out that for Q3, which is the quarter that we're talking about, we did make some -- a couple of opportunistic buys of branded inventory, and we sold through that inventory, which gave us extra margin. So I wouldn't really consider that a recurring thing. And then, in addition, I think we saw a slight decline in our return rate.

But obviously, that will fluctuate quarter-over-quarter. I think, in general, again, we try to have more of a long-term view, and we're looking at creating a business that we'll be proud to own a decade from now. So it will fluctuate a little bit up or down based on channel mix and product mix..

[Operator Instructions] Our next question comes from Eric Beder with SCC Research..

Eric, could you talk a little bit -- I want to follow up on the last question.

What are you seeing now that you are getting bigger in terms of better deals from your branded products partners?.

I'm not so sure it's about us getting bigger. I think the fact that we have our own fulfillment, and we can buy inventory, put it in our DCs and distribute it to the consumer, and then also give brands sort of the awareness that they're looking for, that our competitors can't really give them. I think that's what allows us to get deals.

I'm not so sure it's about us getting bigger, but we have been successful in going direct with a lot of the brands -- a lot of the big brands and something that we haven't done before. And so we'll continue down that path to extract better margin and also to allow us to get better utilization of our warehouses..

We've spent last few years looking at the product that comes from your private label versus branded.

Is it becoming less a difference in terms of margin going forward that we should be thinking about as you incorporate this branded product in your own warehouses and capture some of that gross margin and overall operating margin?.

Yes. There's still a difference between private label and branded. So we still can't get it quiet to the same level as private label, but we are getting closer. So before, if you looked at our P&L last year and you compare the private label and branded, the gap in margin was, call it, 2,000 bps.

Now it's probably closer to 500 to 700 bps difference in margin..

And what has been the response -- I see you've been ramping up the amount of SKUs for JC Whitney and you rolled that out.

What has been the response in the customer base to the JC Whitney and I guess, to the other two branded private label products that you've been rolling out?.

So we've been doing it kind of slow for now. But so far, the response has been good. I mean, we saw a good response when we switched our fuel tanks to a different brand. So replacement isn't really a brand, right? It's just what we decided to call the product years ago.

And so when we switch it to a brand, we do see an uptick, but we have a long way to go to build awareness for all of these brands and to translate to the consumer what it actually means when they buy these branded products. So we have things like warranty, and we'll be offering other things to stand behind the product.

But we do have to build awareness for all of our brands..

And to build on that last question, could you tell us a little bit about what you've been doing, increasing in terms of marketing? I know you've been doing some more stuff with NASCAR, and you've been doing some more mailings.

Could you kind of give us a little bit run through what you're seeing and what is working in the last two quarters and what you see going forward with that?.

Yes. So NASCAR, we're very happy with our partnership with Michael McDowell and Front Row Motorsports. The customer affinity is very good, and their customers, the NASCAR customer is very closely tied to what our customer looks like. So we like that partnership, and it's been working. The season is over, so we did our last race a couple of weeks ago.

And so we're looking forward to the next season. We've also been doing a lot of TV. As you know, TV, we're very opportunistic in terms of our buys for TV. And as a lot of companies in the travel industry pulled out, we were able to get some really low CPMs. And we have a way to measure TV now. And so we've seen really good results from TV.

We pulled out during the election cycle because the CPMs were getting kind of high. But we're coming back in at the end of this week, now that the election is over. So seeing really good results there in terms of driving direct-to-site traffic, and we'll continue down that path..

And if I can add to that, Eric. I think on the upper funnel stuff and the TV, it's a great opportunity for us to build a brand for CarParts.com long term. So if you think about the business last year, our house brands in Q3, Q4 were up 15% year-over-year. And then pre-pandemic, they were up 41% year-over-year.

So in Q3, we had 69% growth despite no stimulus or extended unemployment benefits in August or September. So we are seeing, long term, a dramatic shift of consumers going from off-line to online, very similar to other industries.

And with the number of cars on the road going up and number of miles driven going up, we're really empowering drivers to shop in a new way and buy premium quality brands in a fast, convenient way at a very attractive price.

And part of the upper funnel marketing efforts is really to give that message to consumers so that people can understand that there is a different way to shop for auto parts..

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