U.S. Auto Parts Network, Inc. (PRTS)
Q2 2008 Earnings Call
August 5, 2008 5:00 pm ET
Shane Evangelist - Chief Executive Officer
Michael McClane - Chief Financial Officer
Steven Becker - Greenway Capital
Katie Benjamin - Thomas Weisel Partners
Jim Markins - Vastech
Welcome to the U.S. Auto Parts second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Laura Foster.
Welcome to U.S. Auto Parts second quarter 2008 conference call. On the call today from the company are Shane Evangelist, Chief Executive Officer; and Michael McClane, Chief Financial Officer. By now everyone should have access to the second quarter 2008 earnings release which when out today at approximately 4:00 pm Eastern Time. If you have not received the 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 until August 19.
Before we begin we would like to remind everyone that the prepared remarks contain certain forward-looking statement and management may make additional forward-looking statements in response to your question. These statements do not guarantee future performance and speak only as of the date hereof. We refer all of you to the 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 more 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 revise any forward looking projections that maybe made in today’s release or call. Please note that on today’s call in addition to discussing the GAAP financial results and the outlook for the company the following non-GAAP financial measures will be discussed, EBITDA and adjusted EBITDA. An explanation of U.S. Auto Parts use of these non-GAAP financial measures in this call and the reconciliation between GAAP and non-GAAP measures required by SEC Regulation G is included in U.S. Auto Parts press release today, which again can be found on the Investor Relations section of the company’s website.
The non-GAAP information is not a substitute for any performance measure derived in accordance with GAAP and the use of 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 Michel McClane.
On today’s call I will discuss our second quarter financial results and operating metrics. I will then turn the call over to Shane, who will provide an overview of our second quarter business highlights followed by a more detailed discussion of the key drivers of our business and an update on our 2008 guidance before turning the call over to the operator for your questions.
We are pleased to deliver second quarter results inline with our expectations. Net sales for the second quarter of 2008 were $43.1 million at the high-end of our previously stated guidance range of $40 million to $43 million. Adjusted EBITDA for the quarter was $1.9 million, within our previously stated guidance range of $1.8 million to $2.5 million. Our net sales of $43.1 million for the second quarter of 2008 represented an increase of 2.4% from $42.1 million in the second quarter of 2007.
The year-over-year increase in net sales is primarily the result of an 18.9% increase in our online marketplaces channel and 1.9% increase in our e-commerce channel. Partially offset by a 14.3% decline in our offline sales channels. Sequentially net sales for the current quarter increased by 7.7% from the first quarter of 2008, the sequential increase in net sales was comprised of a 34.7% increase in our online market place sales channel and a 7% increase in our e-commerce sales channel. Partially offset by a 14.9% decline in our offline sales.
As anticipated we continue to experience softness in the second quarter in our wholesale division as we transition the way from a significant customer. We are very encouraged that our core online business was driving our sales growth in the quarter, particularly exciting was the 34.7% increase in our online marketplaces channel. Without going into too much detail for competitive reasons we implemented a new strategy within this channel that had a positive impact on sales while maintaining strong gross margins and we expect to continue to refine the strategy in order to continue to capture additional benefits.
Gross profit for the second quarter increased to $14.6 million or 33.9% of net sales versus $13.8 million or 32.8% of net sales for the same period last year. On a year-over-year basis the increase in gross margin was primarily due to a higher percentage of products distributed via our stock and ship and more favorable vendor contracts.
Sequentially gross margins declined 50 basis points to 33.9% in the second quarter of 2008 compared to 34.4% in the first quarter of 2008. The sequential decline in gross margins is primarily due to higher outbound freight costs from our third-party carriers associated with rising fuel prices.
We estimate the increase in freight cost reduced our gross profit and impacted gross margins by 350,000. In order to mitigate this impact going forward, we increased prices in mid-June and will be testing price elasticity during the third quarter. Many of our costs have increase in the second quarter, when compared to prior year. We are investing in the business in order to support our longer-term strategic plan.
During the quarter we incurred $600,000 of team building costs to put the right team in place. This was a predictable expense that we believe will benefit our shareholder overtime. While we have invested in certain area to support the long-term grow of the business, we have also aggressively eliminated costs that were not delivering adequate value. For example, we transitioned all cost in our functions to the Philippines and also reduced our headcount in the Philippines by 150 people during the quarter. We have also eliminated or reduced other operating costs in order to improve profitability levels going forward. We expect to see the financial impact of these changes in the second half of the year.
Marketing expense excluding advertising was $4.1 million or 9.5% of net sales in the second quarter of 2008, compared to $2.7 million or 6.4% of net sales in the same period last year. On year-over-year basis the increase in marketing expense was primarily due to increase personal added in our Philippines call center, partially offset by the elimination of our U.S. based call center. We also invested in establishing category teams in Philippines, which Shane will elaborate on.
Marketing services costs were higher as we ramped up our affiliate channel and e-mail campaigns. Online advertising was $2.5 million or 5.8% of net sales in the second quarter of 2008 compared to $2.2 million or 5.2% of net sales for the prior year period and $2.6 million or 6.5% of net sales for the first quarter of 2008. The sequential decline in advertising expense reflected our decision to limit incremental spending on paid search to breakeven levels based on our estimated lifetime value of a customer.
Effective in the second quarter of 2008, we modified our billing arrangements with a significant supplier. We previously received a marketing co-op any volume discount, which will now be included as a direct reduction in product cost. This resulted in increased marketing costs of $350,000 offset by an equal amount in improved gross margins in our online business.
Fulfillment expense was $2.4 million or 5.6% of net sales in the second quarter of 2008 compared to $1.9 million or 4.5% in the prior year period. The increase in fulfillment is primarily due to higher personal costs related to our expansion of our warehouse and purchasing personnel and increased depreciation expense as well as the addition of our Tennessee distribution center.
Technology expands with 800,000 or 1.9% of net sales in the second quarter of 2008, compared to 500,000 or 1.2% of net sales in the prior year period. The increase was the result of cost incurred to build up a technology leadership team to support the company strategic plan.
G&A expense was $4.6 million or 10.7% of net sales for the second quarter of 2008 compared to $3.7 million or 8.8% of net sales in the prior year period. The increase in G&A reflects approximately $500,000 in higher payroll and related expensed due to increased headcount and increase of $200,000 in administrative operating expenses related to public company compliance costs. Increased amortization expense of 300,000 partially offset by a 250,000 legal settlement charge that the company incurred in the prior year period.
During the second quarter we recorded an $18.4 million or $0.62 per diluted share, non-cash write-down of intangibles associated with the Partsbin business, which we acquired in May of 2006. This charge is included in our amortization of intangibles and impairment loss.
We recorded an impairment of $16.7 million for our website assets, 100,000 for our software, 900,000 for our vendor agreements and 700,000 for our domain names. We performed an impairment analysis during the second quarter of 2008 as we had identified certain key indicators of impairment.
The company engaged an independent third-party to calculate the fair value utilizing a discounted cash flow approach for its intangible assets. We expect to continue to reduce our cash paid for taxes over the remaining 12 years of the asset life for tax purposes.
For the second quarter of 2008 adjusted EBITDA or earnings before interest taxes depreciation and amortization, impairment loss on intangibles and share based compensation expense which is a non-GAAP measure was $1.9 million compared to adjusted EBITDA of $3.8 million in the corresponding prior year period.
Adjusted EBITDA excludes non-cash stock-based compensation expense of 700,000 and 600,000 in the quarters ended June 30, 2008 and 2007 respectively. Total severance, recruiting and relocation cost during the second quarter of 2008 was $600,000. As a remainder before turning to our operating metrics for the second quarter, we previously reset our measurements of key operating metrics to use gross orders placed as a basis instead of our prior practice of net orders, which will eliminate the impact of returns, unfilled orders and incomplete payment on this operating metrics.
The number of our monthly unique visitors in the second quarter of 2008 was 24 million, an increase from $22 million in the prior year period and a decrease from $26 million in the first quarter of 2008. The year-over-year increase in unique visitors reflects our ongoing search engine optimization efforts. Sequentially, the decline in unique visitors reflects search algorithm changes in the second quarter of 2008.
Our conversion rate during the second quarter was 1.4%, an increase from 1.2% in the first quarter of 2008 and inline with 1.4% in the prior year period. The sequential increase in our conversion rate is due to improved ROI on our paid search during the quarter. As a remainder our conversion rate does not account for duplicate, unique visitors to each of our different site, which means that a visitor that shops on two of our sites in a given month will be counted as two monthly unique visitors.
Orders placed on our e-commerce channel increased to approximately 334,000 compared to 306,000 in the prior period and approximately 320,000 in the first quarter of 2008. The average order value in our e-commerce channel was $128, a decrease from $132 in the prior year period and an increase from $126 in the first quarter of 2008.
The customer acquisition cost in the second quarter of 2008 was $5.23 compared to $4.83 in the prior year period and $5.11 in the first quarter of 2008. Excluding the marketing co-op from all periods, customer acquisition costs would have been $5.77 in the second quarter of 2008 compared to $6.67 in the prior year period and $6.26 in the first quarter of 2008. Going forward we will report customer acquisition cost excluding marketing co-op reimbursements.
Turning to the balance sheet as of June 30, 2008 cash and short term investments was $34.1 million, inventory was $13.8 million, accounts payable and accrued expenses combined was $17.2 million. Our cash balance is entirely invested in money market accounts. In June and July we had partial redemptions of our auction rate preferred securities totaling $1.1 million. We continue to classify the remaining $6.7 million as a long-term investment.
Our free cash flow for the quarter which we defined as operating cash flow less capital expenditures was $1.1 million. This compared to negative $2.0 million in free cash flow in the prior year period. We are continually evaluating alternative for the use of our cash balance including implementing a share repurchase program.
Our primary goal in capital deployment decisions is maximization of share holder value. We have determined that investing in the growth of the business remains the company’s number priority and we believe that we can derive significant value through the execution of our long-term business strategy. In addition, we believe that current macroeconomic conditions may create opportunities to make accretive acquisitions at compelling price points.
Available cash on hand can have a significant impact on our ability to close an acquisition of a target company. Given these considerations we have decided not to conduct a share repurchase program at this point. We’re also pleased to see that our founder Mehran Nia and our CEO Shane Evangelist purchased a combined $1.7 million shares in a private transaction from the founders of Partsbin. We believed increased equity ownership aligned our management with our shareholders interest and with that I would like to hand the call over to Shane.
Michael just discussed the quarter in detail and I’ll now provide my take on it. We continue to be encouraged about the position of U.S. Auto Parts in the over $120 billion market in which we compete and we think there is no other Auto Parts online retailer better positioned to take advantage of the inevitable movement from all time buying to the current low penetrated online market.
We believe the combination of our low cost operating structure and efficient customer acquisitions will allow us to scale and capture share going forward supporting my assessment of recently released numbers by internet retailer. In those U.S. Auto Parts is the highest ranked company that sells Auto Parts online and the only one in the top one hundred for the second straight year.
To put this in perspective we are more than double the size of auto zone estimated online sales. As related to specific sites autopartswarehouse.com is ranked number one in both paid and organic search. We believe this clearly demonstrates our leadership position and provides us with a great opportunity to capture share going forward.
Specific to the quarter we had positive revenue comps quarter-over-quarter and year-over-year. The last time the company did that was the first quarter of 2007. We believe this demonstrates the progress we have made and affirms our plans are working. We were actually on track to better the $43 million we posted, but sales began to soften in June and we speculate that this was driven by a combination of macro factors as well as some pricing actions particularly in June to compensate for increased freight expense, which resulted in flat year-over-year comps for June.
We’ve learned a lot from the pricing increases and we are excited about the opportunity that lies ahead with that of freight optimization. As it relates to EBITDA for the quarter, we were pleased with the results and we’ve taken consideration incremental onetime expenses we incurred. While every quarter is going to have some one-time expenses, the second quarter was higher than the normal run rate due to the additional recruiting and severance expense.
The quarter results give me confidence that we will grow EBITDA in the coming quarters. As we turn the discussion of our operating improvement goals and the four key metrics we identified to track our progress. I think it’s important to revisit why we are focused on these metrics. These goals are important because as we get closer to achieving our targets we get closer to reaching the estimated annual revenue run rate of $200 million with an anticipated 8% to 10% EBITDA margin. We will be deploying technology and process improvements in the coming quarters to help achieve these goals.
In terms of revenue collection, the average for the second quarter saw an increase for just over 77% compared to an average of 76% for the first quarter, our stated goals 86%. Turning to call center conversion this metric stayed flat over last quarter 17%; our stated goal for the quarter for the call center remained 18%.
With respect to repeat purchases this metric stayed flat for the quarter at 15%. Our stated goal for repeat purchases is at least 20%. We expect to see this number increase as we continue to make improvements in customer service and let me assure you we are very focused on improving the customer experience from the front end shopping experience to the backend delivery and returns. Probably the biggest anticipated improvement in customer experience would be product delivery time. Over the next 12 months we believe through the expansion of two additional distribution centers, we can cut delivery time of our flagship product in half.
Lastly, overall conversion averaged 1.4% for the second quarter and as we’ve previously discussed search engine algorithm changes impacted conversion positively but also reduced unique visitors. We continue to believe that the changes have largely offset each other from an overall revenue perspective. Our stated shorter-term goal for conversion is now 1.6% which takes into consideration the recent changes. I would also like to point out that we believe conversion over the next three years will grow beyond our stated short-term goal and let me elaborate.
We currently ask customers for the year making models of their cars for many parts also require additional information like cylinder, leader in sub model. Once we are able to incorporate these additional pieces of information, we anticipate the number of parts displayed to be cut in half providing a more relevant merchandising mix that reduces confusion during the browsing experience.
We’ll also be adding content over the next year to help people who are not quite sure what is wrong with their vehicle or how to fix it to become more confident in diagnosing and fixing their vehicle. We believe once we have built this content more customer’s shopping our site will be willing to try to fix their cars themselves thus creating more DI wires and we believe the macro economic conditions will also ultimately create more DI wires.
Finally we’ll update again through more website AD testing, will guide us to better online user experience. On this note we will be launching a beta version of the new Auto Parts Warehouse website this year and testing the performance of the new site. Once the new site outperforms the existing site we will deploy it and replicate the learning’s across our networks.
Another area for significant growth is adding skews to our product set. As I mentioned previously we compete in an industry that is over $120 billion with a relatively low online penetration. While our current product offering is extensive and probably the most comprehensive of online retailers, it simply does not meet the needs of our automotive parts buyers. We need to do a better job of identifying the customer segments we’re under serving and expand our product offering. We would do this through a combination of distribution partners as well as stocking product directly from a specific rim.
Over the next three years through a combination of increased conversion and additional skews we believe we can double this business. The management team is committed to long term and ensuring we capture the opportunity ahead. Speaking of the management team we’re making the necessary investment in human capital and structuring the organization to make sure we’re geared up to grow the business.
We have strengthened the number of key areas that should pay dividends in the future; the first is category management. We now have teams of people that are focused on the business of retailing, becoming experts and maximizing returns in these categories. Analytics and pricing; we’re now able to measure variable profit at a skew level and rectify price elasticity quickly and efficiently.
Product procurement; we have upgraded the teams showing products with more expertise in the overall automotive category focusing on adding new skews that will result in meaningful sales growth. Product marketing; we’ve added resources to ensure the proper development of our website with a focus on increasing conversion and finally technology; we have added very talented technologist with a strong background in building e-commerce platforms.
I’m very pleased with the speed of which we have been able to assemble a very talented team. We have struck at balance between resources of automotive expertise as well as resource who are experts in online retailing. We’re creating a culture that is metrics driven and data intensive and we believe the investment in our team will provide dividends going forward.
Turning from the long term to the short term, I will now discuss our guidance for 2008. For the third quarter we expect to achieve revenue in the range of approximately $38 million to $41 million and adjusted EBITDA in the range of $1.8 million to $2.8 million. We continue to believe that the second half of 2008 will comp ahead of the second half of 2007.
In conclusion we believe no one is in a better position to take advantage of the growth that we believe will come in the online auto parts market. We are pleased that we have become positive both year-over-year and quarter-over-quarter as well as June softened. We held it relatively well considering consumer spending and fuel prices. We also believe we identified and are working towards the right strategic initiatives, treating meaningful business that has the opportunity to double over the next three years.
We have talented and balanced management team who is committed to the long-term and is poised to grab a greater share of the 120 billion auto parts market in which we compete. We now simply need to execute. As always I would like to thank you again for participating in our call and thank our shareholders for their support.
We will now open up the call for questions.
Question and Answer Session
(Operator Instructions) Our first question comes from the line of Matt Nemer from Thomas Weisel Partners.
Katie Benjamin - Thomas Weisel Partners
This is actually [Katie Benjamin] for Matt Nemer. I just have a few questions. The first is, there has actually been a lot of discussion about sort of the deceleration in miles driven. I think it’s down about 2.5% year-to-date. Maybe you could talk about how you guys think about that in terms of maybe any kind of leading indicator for demand?
Yes Katie this is Shane. Obviously, when people drive less, they have less maintenance, they have less accidents and I think that is not good for us overall as it relates to that macro trend. I think what’s helping us though is of course people are more price conscious, people are buying less new cars which would indicate that they are going to have to maintain their vehicle overtime. I’m not sure, if we can speculate one way or the other, but we do suspect that there is some delayed maintenance taking place for both engine and body parts. So how it all plays out overtime, I’m not exactly sure; I do though think that in reduced consumer spending our price point will be having taking just a long-term when people decide that they really needed to maintain their vehicles.
Katie Benjamin - Thomas Weisel Partners
Great that’s helpful. Also if you could touch on maybe the impact of product cost and inflation particularly direct import parts from Asia?
We saw some increase in sheet metal; probably not as much as you’ve heard from other folks, but some increase, but the real direct cost that’s probably impacted us more than that is freight expense as it relates to oil prices and of course for an online retailer dealing with shipping expenses is a big deal. So, we are actively working through that and managing it closely.
Katie Benjamin - Thomas Weisel Partners
Great and then next, you guys continue to see some pretty nice increases in your website conversion rate, maybe any updates on some of the initiatives that are going on there and then I know you mentioned about 1.6 short-term, I don’t know if you can give a little bit longer-terms guidance that will be great?
Right, so from the conversion perspective we’re doing the right things as it relates to multi-vary testing, testing on the site. We are as I indicated coming forward; we’re going to be putting on some additional information like soon or later our sub models should help narrow the research set and the result set and then longer-term, here’s what I know; I don’t know if it doubles, but I do know that there’s plenty of improvement. We talked to consumers who are indicating to us that they would buy if they could find better; they would buy if they could find the part they want. So, I clearly think there’s upside for us. I don’t know exactly what the number is but I do know that from our consumer research and where we are at today where people are telling us they are going to spend, we have opportunity for growth.
Katie Benjamin - Thomas Weisel Partners
Okay, and then lastly I know you guy haven’t provided full year guidance before, but if you could provide any directional comments on CapEx guidance for the remainder of the year?
For full year it’s somewhere between $5 million to $6 million from a CapEx perspectives; as we build out distribution centers in the back half of the year, whether we get it up or not, it may have an incremental working capital change in it while we ramp that distribution center from a cash flow need.
(Operator Instructions) Our next question comes from the line of Steven Becker from Greenway Capital; please go ahead.
Steven Becker - Greenway Capital
A quick question for you; I just wanted to make sure I’m reading this correctly. Just the adjusted EBITDA of 19 include the 600,000 of severance recruiting and relocation or do I add that back to get a true cash flow number?
The 19 includes those costs.
Steven Becker - Greenway Capital
Okay, so the 19 is net of those costs?
Correct, so if you were to in fact add those costs back then the number would be higher, the EBITDA number would be higher.
Our next question comes from the line of [Jim Markins from Vastech]; please go ahead.
Jim Markins - Vastech
A couple of question; can you talk about your call center; you said you have laid off some people in the Philippines; how was that affected your customer service levels there?
Yes, Jim we did make some reductions there; service levels have not been significantly impacted. As we’ve readjusted staffing we had some increase in average wait time, but we think we’ll be able to manage that going forward. Just to put a little color around it we actually stepped up that call center while we trained folks and so the reduction was planned, right. We stepped it up with new people over from the U.S. and when we felt stable we moved people back out and in fact actually year-over-year we are actually up in headcount over last year in the call center.
Yes, I mean the major transition Jim was when we shut the U.S. call center down. We staffed up in the Philippines, we migrated functions over there, we remained more than adequately staffed and took appropriate action once we were comfortable that the service levels were there for our customers.
Jim Markins - Vastech
Okay great and well I may quickly get over my head here on this question, but can you talk about the changes in the search algorithms that happened this past quarter that hurt your visitors sequentially?
Yes Jim, without going into too much detail we had some search engine -- don’t know the exact change, that ended up impacting where some of the sites were positioned on. The search results which ended up was less quick-to-resource sites, at the same time we actually saw conversion increase on the sites that continued to stay present.
And this is the same issue that we described in the last quarter; just we’re kind of updating you on the actual impact on the monthly unique visitor account.
Thank you, and at this time I see no further questions in the queue. I’d like to turn the call back to you.
We appreciate you attending the call and look forward to catching up with you next quarter and taking to you in between.