Welcome to the CarParts.com Third Quarter 2021 Earnings Conference Call. On the call from the company is Lev Peker, the Chief Executive Officer; and David Meniane, Chief Operating Officer and Chief Financial Officer.

By now, everyone should have access to the third quarter 2021 earnings release, which went out today at approximately 4:01 PM Eastern Standard Time. If you have not reviewed the release, it is available in the Investor Relations section of the company's website at carparts.com/investor.

This call will be available for replay via the webcast archived at carparts.com/investor. Before we begin, we would like to remind everyone that the prepared remarks contain forward-looking statements within the meaning of the federal securities laws. The 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 statements.

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 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 of the company's non-GAAP financial measures, such as adjusted EBITDA, will be discussed.

In expectation of CarParts.com use of non-GAAP financial measures in this call and the reconciliation between GAAP and non-GAAP measures required by the 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 measures driven in accordance with GAAP and such non-GAAP measures have limitations, which are detailed in the company's press release. With that, I would like to turn the call over to CEO, Lev Peker. Please go ahead..

Thank you, operator, and good afternoon, everyone. As you saw in today's press release, CarParts.com achieved its seventh consecutive quarter of year-over-year growth with net sales up 21% from Q3 last year and 90% on a 2-year stack.

Online demand continues to exceed our outbound capacity, and I want to thank the team for working both smarter and harder to navigate this extremely difficult environment. We believe we're the best-positioned company long term to disrupt an industry with only single-digit online penetration and a total addressable market of over $300 billion.

We continue to expect 20% to 25% compounded top line growth and 8% to 10% EBITDA margins over the long term, derived from the successful implementation of our strategy of right parts, right time and right place. Let me give you a quick update on each of the 3 pillars of our strategy.

Right part means ensuring our customers can find the exact solution that fits their vehicle on our website. We're very excited that we have been able to continue to increase our inventory position and now have the highest level of inventory in company history and feel very confident going into the rest of the year as well as heading into next year.

And we're excited about mechanical parts being the fastest growing segment of our business as well as entering next year with a newly built category management function led by senior executives who come to us from automotive retailers like GPC, NAPA as well as large traditional retailers like Best Buy.

Our direct sourcing strategy and vertically integrated supply chain are a considerable competitive advantage. At a time when availability in the industry is tight, a reliance on a local distributor can leave a dropshipper at the back of the line, forcing them to pay a higher price, assuming the part is even available.

Distributors often choose to maximize profits from their limited inventory by shifting the resources to more profitable channels. When we look at out-of-stock rates across the industry, we noticed a significant disparity in the haves and have nots.

We believe that being a have through vertically integrated stock shipping delivers a superior value proposition. Our vertically integrated business model of going straight from manufacturer to consumer is a key reason why we have been able to demonstrate 21% year-over-year top line growth this quarter.

We were able to offer products when other competitors couldn't. I want to remind everyone that right now we're only limited by our capacity, and there is a cadence to opening and expanding our distribution centers. David will provide additional details in his supply chain update.

At the same time, we also remain focused on reducing the paradox of choice for our customers. We don't want to give consumers too many or too few choices, and so our model is flexible enough to add branded products where we have gaps in our private label assortment and to offer a full range of good, better, best products.

Over the last quarter, we have also built proprietary processes to help us identify gaps in our catalog, and we expect to start expanding the range of choice for our customers even further this quarter.

Right times means getting the customers back on the road as quickly as possible, and to accomplish that, we continue to work on getting closer to our customers and reducing delivery times.

With our new Florida facility opening in the first half of next year, we expect to be able to service 55% of our customers within a 1-day transit time and 98% of our customers within 2 days. Right place means empowering our customers to choose how they want to repair and maintain their vehicles.

We expect to have a more detailed update on the first quarter conference call, but I can tell you that we're working hard to build solutions that we believe will make booking and automotive repair as seamless and as simple as streaming a movie on Netflix. I will now turn it over to David to provide some financial and operational highlights..

Thanks, Lev. As Lev mentioned, in the third quarter, we generated revenue of $142 million, up 21% versus prior year of $117 million and 90% on a 2-year stack. Gross profit was up 10% to $47 million with gross profit margins at 33.4%. Gross profit margin had a slight impact due to mix shift to drop ship parts as we fill gaps in our inventory.

As we have stated in the past, we're always focused on maximizing margin dollars after marketing spend and fulfillment expenses. We're very proud of our supply chain, logistics and data science teams' ability to navigate the current environment and dynamically adjust pricing based on all these external factors to protect margin dollars.

Historically, our industry has enjoyed the ability to raise prices and maintain margins.

And even though the volatility of current circumstances has driven up cost faster than we'd like to raise prices, we're confident that we can restore our normal margins despite container costs going from $7,500 to $30,000, inbound parts increasing in cost by 10% to 15% and continuing pressure from freight surcharges, margin only compressed 100 basis points since the start of the year.

The financial impact to gross profit from increased container cost and retention was about $1.5 million. We strongly believe that these factors are temporary, and as the global supply chain improves, we expect to return to a more normalized gross margin. Net loss for the quarter was $4.7 million versus income of $1.4 million in Q3 2020.

The decline was mostly due to an increase in noncash expenses. Adjusted EBITDA in Q3 came in at $2.3 million versus prior year at $5.1 million, a change which was primarily driven by the temporary issues mentioned, higher labor cost and increased investments in the business.

Given the likelihood that the labor market will remain tight, we will continue to invest in talent, tools and technology to improve efficiencies in our fulfillment centers. As we've mentioned before, the timing of our investments into our business will vary from quarter-to-quarter, and we continue to invest ahead of today's revenue.

We are, however, very encouraged with the progress that we've made in marketing, branding as well as best-in-class personnel, both of which are helping to lay the foundation for significant levels of growth in the years ahead, and we continue to believe that in the long run, we will achieve 8% to 10% EBITDA margin. Turning to our balance sheet.

At the quarter end, our cash position was $21 million, primarily driven by an increase in inventory to $132 million, a company record, as we prepare for our peak season. Thank you to our inventory forecasting team and global supply chain teams for this great achievement, especially in this challenging supply chain environment.

Our ABL remains untapped with $30 million of availability with the option to flex up to $40 million of capacity. Now that we've covered some financial highlights, I'd like to spend more time talking about our supply chain road map. One of the critical components of our long-term plan is our vertically integrated supply chain.

We always say that our inventories are oxygen and this could not be more true than in the current environment. Our strategy revolves around parts availability and speed the customer. And because our parts are fit specific, there is no substitution. Having the right inventory and stock close to the customer is critical.

For the last 3 years, we've worked hard to expand our assortment, increase parts availability and get parts to our customers faster by being closer to them. With our Texas and Florida warehouse expansions, we're taking another step to increase our capacity and reduce transit time.

Long term, our goal remains to cover 80% to 90% of the country in 1-day transit time. One of our goals is also to rapidly connect the end consumer, whether a do it yourself or do it for me with premium quality parts at competitive prices.

Now today, we offer an assortment of replacement and mechanical parts, but over the long term, we intend on building a one-stop product and service destination to get all drivers back on the road by leveraging our technology, our data, our inventory and our fulfillment capabilities. Now moving on to the next topic.

Recently, there has been a lot of talk around inflationary pressures on retailers. Now despite cost increases on raw materials as well as freight increases, our supply chain makes CarParts.com uniquely positioned to offer competitive pricing by removing steps in the distribution chain.

Looking at current gross margins, investors can see how we were able to pass on most of the transient costs and yet remain competitive in the marketplace. Our data science team has developed a lot of proprietary models to dynamically adjust pricing in real time and maintain margin dollars even in an inflationary environment.

Over time, we feel very confident about hitting our margin targets by leveraging our channel mix and our own fulfillment network. Another item in the news has been the flow of containers from overseas. I'm sure most of you have seen the images on TV of ships sitting idle outside of the port of LA for weeks.

Despite this and numerous other supply chain challenges, we're very excited that our teams were able to successfully build up inventory. We believe that even if the global supply chain continues to get worse, we will be able to continue to operate with minimal impact relative to our competitors because of our vertically integrated business model.

We feel very comfortable not only with the current inventory position but also our ability to source additional inventory globally. By ending the quarter with the most inventory on our books in company history, we believe that we will be able to meet customer demand through the rest of the year and through 2022.

Also, while there are talks of container cost rising, we're starting to see the tight change, thanks to the incredible support of our ocean carrier partners. Now on to an update on our current expansion projects. We're excited to announce that our Texas expansion is going well.

Some of the racks are already up, and we have a lot of inventory on the way. We will spend the next few months building up inventory and expect the expansion to increase our capacity in Q1 2022.

In Jacksonville, Florida, we're also happy to announce that construction of the building was completed this week, and racks and equipment are already on the way.

We expect the first inbound container to hit in early Q1, and like our previous distribution center openings, we will first focus on receiving an increasing inventory position; next, increasing outbound capacity; and finally, we expect it to contribute to sales in Q2 2022.

Investors who have been following our new management team since 2019 will understand that our growth opportunities are directly correlated to our inventory holding and outbound capacity and that our shareholders can expect a stair-step cadence in sales as we continually reach operating capacity and expand our supply chain with additional distribution centers.

As we open these fulfillment centers, the expanded capacity will drive increased revenues.

As we expand our assortment and get closer to our customers, increased capacity we feel very confident in our ability to, number one, get our customers to keep coming back; number two, increase revenue and improve margin; number three, grow at a 20% to 25% compounded rate and get the 8% to 10% adjusted EBITDA margin over the long term.

Finally, for our long-term shareholders listening today, know that we remain committed to our philosophy of financial discipline. We will only deploy capital where we see opportunities to accelerate our growth while earning a significant return on investment. I would also like to thank all the team members at CarParts.com.

I'm truly grateful to collaborate with such a talented and hard-working group of individuals each and every day. Your dedication to the mission of helping drivers get back on the road is inspirational. And with that, I'll turn it back to Lev..

Thanks, David. I just want to reiterate what David was just saying about the talent here. We're excited about building a world-class team from tech to data science to supply chain and category management.

As the supply chain challenges persist, it will become increasingly obvious that being vertically integrated while retaining the ability to drop ship on an as-needed basis will prove to be a more competitive model than a 100% virtual inventory or a 100% drop-ship model. This is because we control our own destiny on sourcing and fulfillment.

We will continue to aggressively invest in vertically integrating our business, going direct from manufacturer to consumer while at the same time ensuring that we're giving customers a solid selection of premium parts. Thank you for taking the time to join us for today's call.

And with that, I would like to hand it over to the operator to open it up for questions..

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

Curious on inventory. Nice to see the overall growth there and talking about your guys' sourcing. But breaking that down one step further.

How do you feel at the SKU level of in-stock inventory and where you guys sit going forward?.

Ryan, it's David. Listen, we feel really good about where we are. I think right now in this environment, more than ever, it's really a game of parts availability. It's having the right inventory in the right location. In a supply chain environment like this, safety stock becomes more important.

So by design, we're really focusing on having more inventory on our books. Ultimately, our inventory turns 3x to 4x faster than the industry average. Some part names could be better, but we're in very good shape right now..

And then on all the external pressures with freight being 1 of them, just cost inflation, you went through a bunch of them.

But how do you feel on gross margins in the quarter and then over the next several? Did things get better or worse throughout the quarter? And then how should we think about kind of run rate in the next several?.

Yes. I think every retailer is really facing some inflationary pressure. I think for us, it comes from multiple angles. So raw materials, inbound freight, outbound freight. I think what matters is what you do with it and how do you turn it into an opportunity. So we've been focused on building our team in-house to manage that supply chain.

We continue to build kind of that vertically integrated supply chain to connect the dots between factory and the customer. I think we've developed also a unique ability to dynamically adjust pricing at the SKU level and still be competitive. This year is really the perfect example. In an environment like this, we were able to continue importing.

The highlight is really building up that inventory and raise prices to protect margin dollars. So we feel good about where we are..

And I'll just add one more, Ryan. I think if you think about who our customer is, historically, we serve a DIY customer. And so a lot of the inflation you're seeing in the market is labor inflation. And so for us, that means that our customers have more money in their pockets, which gives them more buying power.

And so that's a big positive for us as well..

And on the dynamically adjusting the prices, any way you can detail in that a little bit more, if that's -- you guys are doing more of that, always doing that? Just kind of how your data science team is getting smarter and better..

So we're doing it more frequently now than we used to. Historically, we would change prices 2 to 3 times a week. Now we're changing prices almost daily. And again, it's done at the SKU level depending on how much the costs have gone up, of the inbound freight, outbound freight, which you see it's shipping out of, what package is going in.

So we're doing it on a daily basis now. The thing that you have to weigh is that how quickly you raise prices has an impact on your marketing spend efficiency.

So it's a fine balance between kind of just jacking up the prices all the way high and then your marketing spend becomes inefficient because in the market, there is somebody that might be undercutting you or even if not, the customer may delay the purchase. So we're kind of constantly trying to increase prices.

1% to 2% seems to be the magic number of what we can go up every week or so, so that's kind of what we're trying to stick to..

One more for me, and then I'll turn it over to the others. But David, you mentioned cargo containers, the cost of them skyrocketing.

Can you quantify that down to how impactful that was to gross margin?.

Yes. I mean this quarter, part of it was the cost of container and part of it was kind of labor shortages impacting our ability to receive. About $1.5 million is a good number for Q3..

And our next question comes from the line of Darren Aftahi with ROTH Capital Partners..

This is [Dylan] on for Darren. To start, I know you mentioned that demand's still sort of outstripped your capacity on the outbound side.

But could you help us understand sort of some of the puts and takes with the sequential sales decline? Like how much of that could have been just some typical seasonality versus potential renormalization in e-commerce trends? Or is that just surely just a fact of potential inventory limits from just the buildup in supply chain constraints?.

Hey, [Dylan], it's David. Yes, good question. So you are correct. Historically, if you compare Q3 to the first half of the year, there is some minor seasonality. The other thing, too, to remember is that Q2 is really our peak season, and we run really beyond 100% capacity. And you can't really run a network overcapacity over long periods of time.

I think one factor that impacted us slightly is labor shortages in one of our markets. One of our distribution centers is in LaSalle, Illinois. And we have a fantastic team over there in that DC, but we do feel the impact of outbound capacity. And I think that's where the extension in Texas and the new DC in Jacksonville becomes so valuable.

It kind of derisks the entire network. And overall, we feel pretty good about going into our peak season..

Got it. And then on the inventory sourcing, you talked about having a good amount for both 4Q and then into fiscal year '22. I mean like how much visibility do you have into what -- I know you've done a lot of work on data science since the new management team has taken over.

Like how much visibility do you have into the SKUs that -- to make sure you're stocking the right SKUs is what I'm trying to say..

Yes. It's David again. We have quite a bit of visibility. I mean over the last 2 years, we've built a dedicated team just for inventory forecasting and data science, and we manage the business at SKU level for every region. So that means every fulfillment center.

Now obviously, the supply chain can be a little unpredictable, but we're able to react in real time. we've basically spent the last 3 years building out that capability. We're also augmenting that capability now with artificial intelligence and machine learning algorithm to be even more accurate. So it's definitely becoming a core competency of ours..

Last one for me.

In terms of the original Grand Prairie square footage, was that 100% full in terms of capacity for inventory during 3Q?.

Yes. The original Grand Prairie, Texas is operating at full capacity and it's full..

[Operator Instructions]. And our next question comes from the line of Thomas Forte with D.A. Davidson. ..

One question and one follow-up. So you talked in previous quarters about your ability to manage the supply chain by sourcing products outside of Asia.

Can you talk about -- or can you give an update on those efforts as far as what you're doing from a sourcing standpoint to maximize your inventory?.

Yes. So -- hey, Tom, this is Lev. So we're sourcing some of our products out of Europe now. We've got some products coming out of Spain, some product coming from Turkey. But for the most part, on the collision side, a lot of products is coming out of Taiwan. The majority of our product is out of Taiwan.

On the mechanical side, we are sourcing from China, but we're also starting to diversify that a little bit as well. But the majority of our product comes from Taiwan, some from Europe and then a small percentage out of China..

And then for my follow-up question, I appreciate all the commentary on the supply chain challenges. Good reason for all that.

But I want to talk about some of your growth initiatives you've talked about the past few quarters, in particular, mobile mechanic and your efforts that you're doing for a customer who's the do-it-for-me customer rather than the do-it-yourself customer..

Yes. So we have a team dedicated now -- and this is Lev again. We have a team dedicated now to do-it-for-me initiatives. Right now, it's kind of manual. It's in one market. It's in Texas. And we're doing a few different things there. Mobile mechanic is one.

The other one is we're helping customers arrange appointments and getting quotes for them from their local shops. So there's a lot of work going on behind the scenes. I think we'll have a more substantive update for you on the next call as we kind of ramp up the efforts and ramp up the team.

We'll have a little bit more information to share with you guys on the next call. But the work is ongoing, and there is now a team dedicated to kind of getting it done, and you'll see some changes on the website to reflect some of this as well in the coming months..

And this concludes today's question-and-answer session. This also does conclude today's conference call. Thank you for participating, and you may now disconnect. Everyone, have a great day..