CarParts.com, Inc. Q3 FY2024 earnings call

• Refocused strategy on driving gross and net margin, accelerating efficiency/effectiveness for improved profitability, and achieving sustainable growth with strong long-term free cash flow. Pre-freight margins increased to 54.6% in Q3 from 50.8% prior year due to lower input costs, pricing/customer acquisition strategy updates. - Re-platformed CarParts.com to cloud-based infrastructure for faster feature rollouts. Mobile app has over 550,000 organic downloads, 80% of customers shop on mobile. - Launched eBay store in Canada with mechanical parts, completed Amazon pilot for private label parts. - Improved logistics with new Vegas facility, expect operating leverage and cost savings. - Invested in product segments: OE premium, European brands, and wholesale commercial sales showed positive early results.

In the third quarter, the OE premium brands saw a 24% year-over-year increase, European brands had a 23% year-over-year increase, and the wholesale commercial sales channel (excluding Vegas move impact) was up mid-single digits. These three categories accounted for approximately 5% of the overall business in the quarter.

• Lowered full-year revenue guidance by $5M to $595M-$600M due to hurricane impact. - Narrowed gross margin guidance to 33%-34% (previously 32%-34%). - Expect significantly higher free cash flow in 2025 compared to 2024. - Target adjusted EBITDA margin of 6%-8% in the medium term and enhanced free cash flow generation.

• Impact from hurricanes Helene and Milton on business. - Freight costs remaining a headwind at ~19.3% of sales. - Competitive performance marketing landscape and increased spend due to election year affecting margins.

Q: Hey, good afternoon, David, Ryan. I want to start with the revenue, and we’ll work our way down. But what caused the acceleration of 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?

A: Hey Ryan, it’s David. Yes, definitely, the first time that Q3 is higher than Q2. I think a lot of it is just inventory driven, pricing actions, 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 it’s – most of it is blocking and tackling.

Q: 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, $5 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 OpEx causing that big sequential increase?

A: Yes. 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 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. So 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 election is definitely a component, I think, because we're seeing a lot of competition on performance marketing.

Q: One more for me. 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?

A: Yes, 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 million 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, a 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 had some challenges with our website historically. Now we're completely done. We've re-platformed 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