CarParts.com, Inc.

Good afternoon. At this time, all participants will be in a listen-only mode. After the presentation, there will be a question and answer session. Please note, this call is being recorded. I would now like to pass the conference over to our host, Tina Mirfarsi, Senior Vice President of Global Communications and Brand. Please go ahead.

Hello, everyone, and thank you for joining us for the CarParts.com third quarter conference call. Joining me today are David Mignon, Chief Executive Officer, Ryan Lockwood, Chief Financial Officer, and Michael Huffaker, Chief Operating Officer. Before I turn it over to David to start the meeting, I have some important disclosures. The prepared remarks and responses to your questions could contain certain forward-looking statements related to the business under the federal securities laws. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with the business. For a discussion of the material risks and other important factors that could affect results, please refer to the carparts.com annual report on Form 10-K and 10-Qs as filed with the SEC, both of which can be found on our Investor Relations website. On the call, both GAAP and non-GAAP financial measures will be discussed. A reconciliation of GAAP to non-GAAP financial measures is provided in the carparts.com press release issued today. And with that, I would now like to turn the call over to David.

Thank you, Tina, and thanks, everyone, for joining us today. Over the third quarter, we made progress against our plan to position car parts for a strong fiscal 2025 and beyond. We began the year by refocusing our strategy on three key elements. Number one, driving growth and net margin. Number two, accelerating efficiency and effectiveness to quickly deliver improved profitability. And number three, achieving sustainable growth with strong long-term free cash flow. In line with this strategy, we focused on driving margin improvement and saw pre-freight margins increase to 54.6% in the third quarter from 50.8% in the prior year quarter. The improvement was driven by lower input product costs and updates to our pricing and customer acquisition strategies to target a higher value consumer base, as well as less reliance on promotions and discounts. This higher value customer is seeking quality parts with value pricing and provides a higher margin profile with better unit economics long term. We continue to have high confidence in our roadmap with several evidence points that we will share today. Some are early in the journey, but showing positive momentum. We expect to emerge from this transition period positioned to capture the growing opportunity in front of us within a fragmented and underserved $400 billion auto parts market. Customers value our offering, and our business model is highly differentiated, scalable, and difficult to replicate. As a reminder, we generate e-commerce traffic on CarParts.com in excess of 100 million visits per year. Our nationwide fulfillment network is now at 1.2 million square feet with two-day shipping capabilities in the majority of the country, and our infrastructure is backed by a proprietary catalog that includes both collision and mechanical parts with a complete assortment of private label and premium branded parts, creating a competitive moat. I'd like to call out now that we saw three weeks of impact from Hurricane Celine and Milton on our business across Florida, Georgia, Tennessee, North and South Carolina, and Virginia. Our facility in Jacksonville, Florida was briefly closed, is undamaged, and now back to shipping at full volume. We will continue to watch for residual impacts on our business in the region, and our thoughts go out to anyone impacted by these devastating storms. Now I'll provide some details around the progress we've made in each of our strategic pillars before turning the call over to Ryan for a financial update. First, we continue to optimize our product and service assortment to maximize the profitability of our e-commerce channel. Over the last 12 months, we've been working on re-platforming CarParts.com to increase performance and shorten our development cycles. This initiative requires the full commitment of our technical resources to deliver new website experience and infrastructure. And I'm proud to announce that CarParts.com is now in a best-in-class cloud-based infrastructure that allows us to roll out new features faster than ever. Historically, our legacy monolith infrastructure prevented us from making meaningful changes to our shopping experience. We can now deliver new features quickly and in parallel at a lower cost which we expect will result in increasing order patterns, conversion, and basket size. We have recently rolled out several strategic initiatives that took about two weeks each that historically would have taken us six to nine months to roll out, such as our partnership with Simple Tire, offering a full assortment of tires with installation, our new shipping and product protections, our VIN lookup that has over 30,000 uses in just two weeks, Although early in the journey, all these initiatives are seeing take rates and usage higher than anticipated. Over the next two quarters, we're committed to delivering additional revenue generating features such as AI powered product recommendations, a loyalty program, as well as other marketing technology enhancements to make our marketing dollars work smarter. Our mobile app continues to perform with over 550,000 organic downloads to date. Today, 80% of our customers shop on mobile, and we expect direct in-app purchases to drive customer acquisition savings over time by reducing our reliance on search engine and performance marketing while incentivizing repeat purchases. On the product assortment side, we continue to invest in new categories with an attractive margin profile that targets a more affluent customer base. In the third quarter, we focused our efforts on three specific areas, all of which showed positive early results. Our OE premium brands are up 24% year over year. Our European brands are up 23% year over year. And finally, our wholesale commercial sales channel, excluding the impact of our Vegas move, is up mid-single digits. These three categories accounted for approximately 5% of our overall business in the quarter, and are expected to grow rapidly as we continue to expand our assortment, helping change our customer profile and increase EBITDA margin. We will provide a more detailed update on our next call. Next, we continue to invest in additional growth opportunities that will increase brand awareness and recognition while expanding our marketplace presence and customer base. We're happy to announce the launch of our eBay store in Canada with a full assortment of mechanical parts. We're leveraging our best-in-class catalog and marketplaces capabilities to capture incremental revenue in this new global market. Early signs are positive, and as we continue to ramp up, we believe it could become a top-line revenue driver. On the Amazon front, we have recently completed a pilot leveraging the Amazon Fulfillment Network to offer a selection of our private label parts. This program offers Amazon shoppers our private label products with same and next-day delivery. with prime badging to generate incremental top-line revenues at an attractive financial profile. Although this initiative is in its early days, we're seeing a double-digit lift on the products we tested. Lastly, we continue to manage and address rising freight costs by capturing optimization efficiencies and upgrading our logistics. Freight costs continue to be a headwind in the third quarter. at approximately 19.3% of sales. However, as we discussed last quarter, our efforts around inventory placement and freight optimization helped us absorb some of the impacts. On the logistics side, our old Las Vegas facility has been decommissioned, and we're excited about our new fully operational facility, which we expect to enhance operating leverage, improve process efficiencies, and boost customer conversion in the region with full savings realized starting in 2025. The facility is now shipping over 20% of our network volume, on track with our initial target. The new facility's assortment, paired with its state-of-the-art AI-powered PIC module and extensive conveyance, allows for increased gross margin through lower freight costs, as well as a significant reduction in operating costs, respectively. We will continue our focus on gross margin improvement, combined with driving efficiencies and cost savings, as we transition into a more profitable business. I'll now turn the call over to Ryan to lead us through our financial results.

Thank you, David. In Q3, we reported revenues of $144.8 million, up slightly from the prior quarter and down 13% from $166.9 million last year. The decline was driven primarily by a combination of deliberate price increases to focus on higher-value customers, support gross market expansion, a continued challenging consumer environment and industry, and one-time impacts from the CrowdStrike issue and Hurricanes Helene and Milton in the quarter. Gross profit for the quarter was $51 million, down approximately 7% compared to the prior year. Gross margin was 35.2%, up from 32.9% in the prior year period and up sequentially from 33.5% last quarter. Gross margin improvement resulted from increased prices and lower product costs resulting in expanded product margins, partially offset by higher year-over-year freight costs. Gap net loss for the quarter was $10 million compared to net loss of $2.5 million in the prior year period, primarily driven by increased marketing spend and lower net revenue resulting in lower flow through. We reported adjusted EBITDA loss of $1.2 million down from adjusted EBITDA of $3 million in the prior year period due to lower sales and expenses outside of our normal operations, which include brand awareness and marketing investments, overlapping software expenses related to our digital transformation, as well as one-time costs related to the move and setup of our Las Vegas facility. On a year-to-date basis, the total amount of expenses outside of our normal operations and other one-time costs impacting our P&L add up to approximately $6 million. We are confident that these investments will generate a significant ROI over the next few years. Turning to the balance sheet, we ended the quarter with $38 million of cash and no debt. We generated $345,000 of interest income in the third quarter. Our significant cash position and untapped revolver continues to support our business plan. The inventory balance at quarter end was $97 million. We're pleased with the work our team has done to improve inventory efficiency and Similar to previous years, we expect inventory to rise slightly as we get ready for our peak season early next year. Turning to our outlook for 2024, due to the unexpected and continued impact from the hurricanes, we are narrowing and lowering our full-year revenue guidance by $5 million to $595 to $600 million. However, we're narrowing our expected gross margin guidance to the high end of the range from 32% to 34% up to 33% to 34%.

Thanks, Ryan. We're focused on elevating CarParts.com to a leading position in the market with improvements across our entire business, from customer experience and product assortment to operational efficiencies. And we expect to see continued improvement in 2025 and beyond as we continue to target higher value customers with better unit economics. We're excited to see the early results of the investments we've made this year, including our new website, mobile app, newly expanded warehouse in Las Vegas, as well as the new higher margin products and services we've launched. In addition, as we anniversary the headcount reductions and large CapEx projects from 2024, we expect free cash flows to be significantly higher year over year in 2025. We're driving a path that we expect will result in achieving sustainable and significantly positive adjusted EBITDA in 2025 as we emerge from this low watermark year while working towards achieving a 6% to 8% adjusted EBITDA margin and enhanced free cash flow generation in the medium term. I would like to thank our global team for their hard work and commitment throughout our transformation. Thank you, everyone, for joining today's call. We'll now turn it over to the operator to open it up for questions.

Thank you. As a reminder to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Ryan Sigdahl from Craig Hallam Capital Group.

Hey, good afternoon, David Ryan.

Hey, how are you doing?

Good, good. I want to start with the revenue. I'll work our way down. But what caused the acceleration or growth sequentially? Historically, just seasonality. Sales are usually down from Q2 to Q3. Combine that with price increases that you took, likely giving up some volume for margins. I guess I'm surprised there. So I guess where are you guys seeing success and what really drove that?

Hey Ryan, it's David. Yeah, definitely the first time that Q3 is higher than Q2. I think a lot of it is just inventory driven, pricing action, some of the marketing initiatives, the new website. It's just relentless execution across the board. I think obviously we would have liked to do more, but most of it is blocking and tackling.

So then moving kind of that relentless execution, I guess moving down really nice gross margin, but we get to OPEX and it was several million dollars higher than expected. I mean, five million more than us. I heard higher freight, which seems like a consistent something we hear every quarter. So I guess curious how systemic that is versus your ability and confidence that you can actually get that under control. And then what else is really in OPEX causing that big sequential increase?

Yeah, so if you look at, so on the gross margin, Q2 was higher than Q1 and Q3 was higher than Q2. If you unpack OPEX, you know, you got about $2.2 million of expenses that are outside of normal operations. And without those, we would have been profitable. So the majority of it was brand awareness, marketing investments, as well as the setup and the transfer to the new building in Vegas. On top of that, we took some of the money, some of the extra margin that we generated, we reinvested into performance marketing. So during the quarter, we saw increased competition on performance marketing, and some of it is due to just soft consumer demand. But we're also seeing a lot of the retailers fighting to capture the same dollars from consumers. And on top of that, it's obviously an election year. It's about 100 basis points of additional marketing dollars that we spent that we took from gross margin. So you take the $2.2 million of the OPEX and then you take an extra 100 basis points that kind of walks you to that number. But, you know, election is definitely a component, I think, because we're seeing a lot of competition on performance marketing.

And you think that's a good tradeoff, I guess, leaning in on performance marketing while leaning in on price to hopefully offset or partially offset it?

Yeah, I mean, it's always a balance in terms of cutting price to increase conversion in the short term or making additional marketing investments. You know, we have a pretty good repeat purchase rate. So a lot of it is making an investment to acquire a customer that we think is going to come back. You know, the mobile app is probably one of the best evidence points to look at. You know, we launched it last year. We're now up to 550,000 organic downloads. And if you unpack the numbers of the mobile app, you have call it 8% of revenue. So it's about $25 million of revenue going through the app. The conversion is higher. The AOV is higher average order value. The repeat purchase rate is higher. So I feel pretty good about increasing marketing a little bit in the short term to capture that customer so that we can remarket to them in the future, especially during peak season.

Uh, one more for me. Uh, good to see kind of the adjacencies with tires with Canada. and Amazon. You've also talked about kind of protection plans, subscriptions, memberships. I guess where are we at with kind of the adjacent opportunities to upsell customers?

Yeah, I'm glad you bring this up. And it ties into the pressures for performance marketing, but also freight. So if you look at our business, just being an e-commerce company, the two main drivers of profitability are performance marketing and freight. And obviously, these are always going to be challenges. And so what we think is the big opportunity is to leverage the traffic that we get on carparts.com and the mobile app. And you're talking about 100 million users. You're talking about 3 to 4 million customers that place orders every year on carparts.com. And how do we generate incremental revenue from these customers? At a very high margin. And so fee income in all these adjacent spaces, whether it's product protection, shipping protection, membership loyalty program eventually potentially a credit card wheels and tires that's very high margin income that flows through the bottom line so unfortunately we have some challenges with our website historically now we're completely done we've replatformed our website completely and now we can start rolling out new features almost every couple of weeks so we just launched product protection shipping protection the wheels and tires And over time, I think there's going to be a big opportunity for us to get incremental profitability with that fee income. And you don't need as much transactions because it's pure margin.

Thanks, guys. Turn it over to the others. Good luck. Thank you, Ryan.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. At this time, I am showing no further questions. This concludes today's conference call. Thank you for participating. You may now disconnect.