UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q
(Mark One)
|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the quarterly period ended June 30, 2007
OR
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the transition period from
to
Commission
file number: 001-33264
U.S.
AUTO PARTS NETWORK, INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
|
68-0623433
|
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
17150
South Margay Avenue
Carson,
CA 90746
(Address
of Principal Executive Office) (Zip Code)
(310)
735-0085
(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
Accelerated Filer ¨ Accelerated
Filer ¨ Non-Accelerated
Filer x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No x
As
of
August 13, 2007, the registrant had 29,833,192 shares of common stock, $0.001
par value, outstanding.
U.S.
AUTO PARTS NETWORK, INC.
QUARTERLY
REPORT ON FORM 10-Q
FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2007
TABLE
OF CONTENTS
|
|
|
Page
|
|
PART
I. FINANCIAL INFORMATION
|
|
|
|
ITEM
1.
|
Financial
Statements:
|
|
|
|
Condensed
Consolidated Balance Sheets at June 30, 2007 (unaudited) and December
31,
2006
|
2
|
|
|
Unaudited
Condensed Consolidated Statements of Income for the Three and Six
Months
Ended June 30, 2007 and 2006
|
3
|
|
|
Unaudited
Condensed Consolidated Statements of Cash Flows for the Six Months
Ended
June 30, 2007 and 2006
|
4
|
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
5
|
|
ITEM
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
11
|
|
ITEM
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
16
|
|
ITEM
4.
|
Controls
and Procedures
|
16
|
|
PART
II. OTHER INFORMATION
|
|
|
|
ITEM
1.
|
Legal
Proceedings
|
18
|
|
ITEM 1A.
|
Risk
Factors
|
18
|
|
ITEM
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
29
|
|
ITEM
3.
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Defaults
upon Senior Securities
|
30
|
|
ITEM
4.
|
Submission
of Matters to a Vote of Security Holders
|
31
|
|
ITEM
5.
|
Other
Information
|
31
|
|
ITEM 6.
|
Exhibits
|
31
|
Unless
the context requires otherwise, as used in this report, the terms “U.S. Auto
Parts,” the “Company,” “we,” “us” and “our” refer to U.S. Auto Parts Network,
Inc. and its subsidiaries, and the term “Partsbin” refers to All OEM Parts,
Inc., ThePartsBin.com, Inc. and their affiliated companies, which we acquired
in
May 2006.
U.S.
Auto
Parts™, U.S. Auto Parts Network™, PartsTrain™, Partsbin™, Kool-Vue™ and
Auto-Vend™ are our United States common law trademarks. All other trademarks and
trade names appearing in this report are the property of their respective
owners.
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
report contains forward-looking statements that are based on our management’s
beliefs and assumptions and on information currently available to our
management. In some cases, you can identify forward-looking statements by terms
such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,”
“may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would”
and similar expressions intended to identify forward-looking statements. These
forward-looking statements include but are not limited to statements regarding
our anticipated sales, revenue, expenses, profits, capital needs, capital
deployment, product offerings, competition and the status of our facilities.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results, performance or achievements
to
be materially different from any future results, performances or achievements
expressed or implied by the forward-looking statements. We discuss many of
these
risks in greater detail under the heading “Risk Factors” in Part II,
Item 1A of this report. Given these uncertainties, you should not place
undue reliance on these forward-looking statements. You should read this report
and the documents that we reference in this report and have filed as exhibits
to
the report completely and with the understanding that our actual future results
may be materially different from what we expect. Also, forward-looking
statements represent our management’s beliefs and assumptions only as of the
date of this report. Except as required by law, we assume no obligation to
update these forward-looking statements publicly, or to update the reasons
actual results could differ materially from those anticipated in these
forward-looking statements, even if new information becomes available in the
future.
1
PART
I. FINANCIAL INFORMATION
|
ITEM 1.
|
Financial
Statements
|
U.S.
AUTO PARTS NETWORK, INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(in
thousands, except share amounts)
|
|
June
30,
2007
|
December 31,
2006
|
||||||
|
|
(unaudited)
|
|
||||||
|
ASSETS
|
|
|
||||||
|
Current
assets:
|
|
|
||||||
|
Cash
and cash equivalents
|
$ |
42,324
|
$ |
2,381
|
||||
|
Accounts
receivable, net
|
2,779
|
2,789
|
||||||
|
Inventory,
net
|
11,519
|
8,796
|
||||||
|
Deferred
income taxes
|
934
|
934
|
||||||
|
Other
current assets
|
1,912
|
1,149
|
||||||
|
Total
current assets
|
59,468
|
16,049
|
||||||
|
Property
and equipment, net
|
4,516
|
2,716
|
||||||
|
Intangible
assets, net
|
30,493
|
33,362
|
||||||
|
Goodwill
|
14,201
|
14,179
|
||||||
|
Deferred
income taxes
|
1,703
|
1,703
|
||||||
|
Other
non-current assets
|
152
|
1,901
|
||||||
|
Total
assets
|
$ |
110,533
|
$ |
69,910
|
||||
|
|
||||||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
|
Current
liabilities:
|
||||||||
|
Accounts
payable
|
$ |
10,045
|
$ |
9,091
|
||||
|
Accrued
expenses
|
3,465
|
2,912
|
||||||
|
Line
of credit
|
—
|
2,000
|
||||||
|
Notes
payable
|
1,000
|
10,805
|
||||||
|
Capital
leases payable, current portion
|
65
|
62
|
||||||
|
Other
current liabilities
|
1,442
|
2,392
|
||||||
|
Total
current liabilities
|
16,017
|
27,262
|
||||||
|
Notes
payable, less current portion, net
|
—
|
21,922
|
||||||
|
Capital
leases payable, less current portion
|
76
|
114
|
||||||
|
Total
liabilities
|
16,093
|
49,298
|
||||||
|
Commitments
and contingencies
|
||||||||
|
Stockholders’
equity:
|
||||||||
|
Preferred
stock, $0.001 par value; 10,000,000 and 11,100,000 shares authorized
at
June 30, 2007 and December 31, 2006, respectively; none and
11,055,425 shares issued and outstanding at June 30, 2007 and
December 31, 2006, respectively
|
—
|
11
|
||||||
|
Common
stock, $0.001 par value; 100,000,000 and 50,000,000 shares authorized
at
June 30, 2007 and December 31, 2006, respectively; 29,832,927 and
15,199,672 shares issued and outstanding at June 30, 2007 and
December 31, 2006, respectively
|
30
|
15
|
||||||
|
Additional
paid-in capital
|
141,692
|
68,906
|
||||||
|
Accumulated
other comprehensive income
|
35
|
5
|
||||||
|
Accumulated
deficit
|
(47,317 | ) | (48,325 | ) | ||||
|
Total
stockholders’ equity
|
94,440
|
20,612
|
||||||
|
Total
liabilities and stockholders’ equity
|
$ |
110,533
|
$ |
69,910
|
||||
See
accompanying notes to unaudited condensed consolidated financial
statements.
2
U.S. AUTO PARTS NETWORK, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in
thousands, except share and per share amounts)
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
Net
sales
|
$ |
42,112
|
$ |
26,966
|
$ |
85,855
|
$ |
44,971
|
||||||||
|
Cost
of sales
|
28,327
|
17,617
|
58,401
|
27,876
|
||||||||||||
|
Gross
profit
|
13,785
|
9,349
|
27,454
|
17,095
|
||||||||||||
|
Operating
expenses:
|
||||||||||||||||
|
General
and administrative
|
3,655
|
2,290
|
6,531
|
4,255
|
||||||||||||
|
Marketing
|
4,921
|
3,179
|
10,821
|
5,155
|
||||||||||||
|
Fulfillment
|
1,862
|
1,213
|
3,579
|
2,365
|
||||||||||||
|
Technology
|
507
|
323
|
956
|
517
|
||||||||||||
|
Amortization
of intangibles
|
2,100
|
947
|
4,154
|
951
|
||||||||||||
|
Total
operating expenses
|
13,045
|
7,952
|
26,041
|
13,243
|
||||||||||||
|
Income
from operations
|
740
|
1,397
|
1,413
|
3,852
|
||||||||||||
|
Other
income (expense):
|
||||||||||||||||
|
Loss
from disposition of assets
|
—
|
—
|
—
|
(5 | ) | |||||||||||
|
Other
income
|
3
|
3
|
5
|
157
|
||||||||||||
|
Interest
expense, net
|
545
|
(317 | ) |
265
|
(357 | ) | ||||||||||
|
Total
other income (expense)
|
548
|
(314 | ) |
270
|
(205 | ) | ||||||||||
|
Income
before income taxes
|
1,288
|
1,083
|
1,683
|
3,647
|
||||||||||||
|
Income
tax provision
|
515
|
472
|
675
|
316
|
||||||||||||
|
Net
income
|
$ |
773
|
$ |
611
|
$ |
1,008
|
$ |
3,331
|
||||||||
|
|
||||||||||||||||
|
Basic
net income per share
|
$ |
0.03
|
$ |
0.04
|
$ |
0.04
|
$ |
0.24
|
||||||||
|
Diluted
net income per share
|
$ |
0.03
|
$ |
0.03
|
$ |
0.04
|
$ |
0.18
|
||||||||
|
Shares
used in computation of basic net income per share
|
29,832,927
|
14,120,952
|
26,679,905
|
13,663,020
|
||||||||||||
|
Shares
used in computation of diluted net income per share
|
29,853,346
|
20,772,428
|
28,142,830
|
18,099,520
|
||||||||||||
See
accompanying notes to unaudited condensed consolidated financial
statements.
3
U.S.
AUTO PARTS NETWORK, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in
thousands)
|
Six
Months Ended
June 30,
|
||||||||
|
|
2007
|
2006
|
||||||
|
Operating
activities
|
|
|
||||||
|
Net
income
|
$ |
1,008
|
$ |
3,331
|
||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
|
Depreciation
and amortization
|
542
|
1,082
|
||||||
|
Amortization
of intangibles
|
4,154
|
951
|
||||||
|
Non-cash
interest expense
|
273
|
19
|
||||||
|
Loss
from disposition of assets
|
—
|
5
|
||||||
|
Share-based
compensation and other
|
1,030
|
292
|
||||||
|
Deferred
income taxes
|
—
|
(982 | ) | |||||
|
Changes
in operating assets and liabilities:
|
||||||||
|
Accounts
receivable, net
|
10
|
(2 | ) | |||||
|
Inventory,
net
|
(2,723 | ) |
1,538
|
|||||
|
Other
current assets
|
(763 | ) |
2
|
|||||
|
Other
non-current assets
|
1,749
|
(139 | ) | |||||
|
Accounts
payable and accrued expenses
|
1,469
|
703
|
||||||
|
Other
current liabilities
|
(950 | ) | (620 | ) | ||||
|
Net
cash provided by operating activities
|
5,799
|
6,180
|
||||||
|
Investing
activities
|
||||||||
|
Additions
to property, equipment and intangibles
|
(2,080 | ) | (633 | ) | ||||
|
Acquisition
of assembled workforce
|
(1,286 | ) |
—
|
|||||
|
Acquisition
of business, net of cash acquired
|
(22 | ) | (24,453 | ) | ||||
|
Net
cash used in investing activities
|
(3,388 | ) | (25,086 | ) | ||||
|
Financing
activities
|
||||||||
|
Payments
on line of credit
|
(2,000 | ) |
—
|
|||||
|
Proceeds
from notes payable, net of discount
|
—
|
31,705
|
||||||
|
Payments
on notes payable
|
(32,000 | ) | (96 | ) | ||||
|
Proceeds
from initial public offering, net of offering costs
|
71,537
|
—
|
||||||
|
Proceeds
on issuance of Series A convertible preferred stock, net of offering
costs
|
—
|
42,246
|
||||||
|
Payments
of short-term financing
|
(35 | ) | (223 | ) | ||||
|
Proceeds
from sale of common stock
|
—
|
150
|
||||||
|
Stockholder
distributions
|
—
|
(1,700 | ) | |||||
|
Recapitalization
distribution
|
—
|
(50,000 | ) | |||||
|
Net
cash provided by financing activities
|
37,502
|
22,082
|
||||||
|
|
||||||||
|
Effect
of changes in foreign currencies
|
30
|
8
|
||||||
|
Net
increase in cash and cash equivalents
|
39,943
|
3,184
|
||||||
|
Cash
and cash equivalents at beginning of period
|
2,381
|
1,353
|
||||||
|
Cash
and cash equivalents at end of period
|
$ |
42,324
|
$ |
4,537
|
||||
|
|
||||||||
See
accompanying notes to unaudited condensed consolidated financial
statements.
4
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1—Summary
of Significant Accounting Policies
Basis
of Presentation
The
condensed consolidated financial statements of U.S. Auto Parts Network, Inc.
(collectively with its subsidiaries, the “Company”) have been prepared in
accordance with accounting principles generally accepted in the United States
(“
GAAP”) for interim financial information and with the instructions to Securities
and Exchange Commission (“SEC”) Form 10-Q and Article 10 of SEC Regulation S-X.
In the opinion of management, the accompanying condensed consolidated financial
statements contain all adjustments, consisting of normal recurring adjustments,
necessary to present fairly the consolidated financial position of the Company
as of June 30, 2007 and December 31, 2006, and the consolidated results of
operations for the three and six months ended June 30, 2007 and 2006, and cash
flows for the six months ended June 30, 2007 and 2006. Certain information
and
footnote disclosures normally included in financial statements prepared in
accordance with GAAP have been condensed or omitted pursuant to the rules and
regulations of the SEC. The results of operations for the three and six months
ended June 30, 2007 are not necessarily indicative of those to be expected
for
the entire year. The accompanying consolidated financial statements should
be
read in conjunction with the Company’s Annual Report on Form 10-K for the
year ended December 31, 2006, which was filed with the SEC on April 2,
2007.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets
and
liabilities and disclosure of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of net sales and expenses
during the reporting period. Significant estimates made by management include,
but are not limited to, the valuation of inventory, valuation of deferred tax
assets and liabilities, estimated useful lives of property, equipment and
software, valuation of intangible assets, including goodwill, recoverability
of
software development costs, estimation of sales returns and allowances, and
the
provision for doubtful accounts. Actual results could differ from these
estimates.
Recent
Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair
Value Measurements” (“SFAS 157”). This standard defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements.
SFAS 157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years. The
Company is currently evaluating the impact of this statement on its consolidated
financial statements.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value
Option for Financial Assets and Financial Liabilities” (“SFAS 159”) which
permits entities to choose to measure many financial instruments and certain
other items at fair value that are not currently required to be measured at
fair
value. The objective of SFAS 159 is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported earnings caused
by measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. This statement is effective as of the
beginning of any fiscal year beginning after November 15, 2007. The Company
does not anticipate any material impact to its financial statements from the
adoption of this standard.
Seasonality
Historically,
the market for auto parts has been seasonal. Inclement weather conditions drive
the demand for automobile body parts. During the winter months or wet season,
more damage to automobiles occurs. Consumers undertake these repairs as they
occur, leading to increased demand for automobile body parts during the winter.
During the summer months, consumers often undertake projects to maintain and
enhance the performance of their automobiles. This factor increases the demand
for the Company’s engine, performance and accessories products. The Company
believes seasonality will continue to have a material impact on the Company’s
financial condition and results of operations in future years.
5
Note 2—Inventory
Inventories
consist of finished goods available-for-sale and are stated at the lower of
cost
or market value, determined using the first in, first out (“FIFO”) method. The
Company purchases inventory from suppliers both domestically and internationally
and has recently entered into supply agreements with U.S. based suppliers and
its primary drop-ship vendors. The Company believes that its inventoried
products are generally available from more than one supplier and seeks to
maintain multiple sources for its products, both internationally and
domestically.
The
Company primarily purchases products in bulk quantities to take advantage of
quantity discounts and to improve inventory availability. Inventory is reported
net of inventory reserves for excess or obsolete products, which are established
based on specific identification of slow moving items and the evaluation of
overstock considering anticipated sales levels. Gross inventory, inventory
reserves and net inventory at June 30, 2007 and December 31, 2006 are as
follows:
|
June
30,
2007
|
December 31,
2006
|
||||||
|
(unaudited)
|
|||||||
|
(in
thousands)
|
|||||||
|
Gross
inventory
|
$ |
12,055
|
$ |
9,488
|
|||
|
Inventory
reserves
|
(536 | ) | (692) | ||||
|
Total
net inventory
|
$ |
11,519
|
$ |
8,796
|
|||
Note 3—Acquisition
On
May 19, 2006, the Company acquired all of the assets of Partsbin, an online
retailer of auto parts primarily selling engine parts, performance parts and
accessories to Do-It-Yourself consumers. The acquisition has been accounted
for
as a purchase in accordance with SFAS No. 141, “Business
Combinations” and, accordingly, the acquired assets and liabilities have
been recorded at fair value.
The
total
purchase price for the acquisition was $50.0 million and consisted of $25.0
million in cash, $5.0 million in notes payable to the former stockholders of
Partsbin and 1,983,315 shares of the Company’s common stock. In addition, the
Company incurred $573,000 of direct transaction costs related to the
acquisition. Immediately following the Company’s initial public offering, the
Company repaid $4.0 million on the notes payable, resulting in $1.0 million
outstanding as of June 30, 2007. Interest expense on the notes payable was
accrued in the accompanying consolidated statement of income.
The
current allocation of the purchase price to assets acquired and liabilities
assumed and various finite and indefinite lived intangible assets as well as
goodwill is based on a preliminary valuation study. Amounts are considered
preliminary until the final purchase price allocation is approved by both the
Company and the selling stockholders of Partsbin according to the terms of
the
purchase agreement which includes the right of offset on the notes for any
indemnification claims the Company could make against the selling stockholders
of Partsbin.
The
results of operations of Partsbin and the estimated fair market values of the
acquired assets and liabilities have been included in the consolidated financial
statements from the date of the acquisition.
Note 4—Intangibles
In
May
2006, in connection with the acquisition of Partsbin, the Company recognized
goodwill with an indefinite life in the amount of $14.2 million and other
intangible assets described in the table below. In April 2007, the
Company acquired an assembled workforce, valued at $1.3 million, from its
outsourced call center provider in the Philippines, Access Worldwide which
consisted of bringing the services of 171 sales and customer service agents
in-house. See Note 5 below for further discussion regarding the
details of this transaction.
Capitalized
amounts are amortized on a straight-line basis. Amortization expense
relating to intangibles totaled $2.1 million, $947,000, $4.2 million and
$951,000 for the three and six months ended June 30, 2007 and 2006,
respectively.
Intangibles,
excluding goodwill, consisted of the following at June 30, 2007 and
December 31, 2006:
6
|
June
30, 2007
|
December
31, 2006
|
|||||||||||||||||||||||
|
Gross
Carrying
Amount
|
Accum.
Amort.
|
Net
Carrying
Amount
|
Gross
Carrying
Amount
|
Accum.
Amort.
|
Net
Carrying
Amount
|
|||||||||||||||||||
|
(in
thousands)
|
||||||||||||||||||||||||
|
Intangible
assets subject to amortization:
|
||||||||||||||||||||||||
|
Websites
(5 year useful life)
|
$ |
28,988
|
$ | (6,468 | ) | $ |
22,520
|
$ |
28,988
|
$ | (3,569) | $ |
25,419
|
|||||||||||
|
Software
(2-5 year useful life)
|
4,089
|
(1,521 | ) |
2,568
|
4,089
|
(839) |
3,250
|
|||||||||||||||||
|
Vendor
agreements (3 year useful life)
|
2,996
|
(1,114 | ) |
1,882
|
2,996
|
(614) |
2,382
|
|||||||||||||||||
|
Assembled
workforce (7 year useful life)
|
1,286
|
(45 | ) |
1,241
|
—
|
—
|
—
|
|||||||||||||||||
|
Purchased
domain names (3 year useful life)
|
165
|
(113 | ) |
52
|
165
|
(84) |
81
|
|||||||||||||||||
|
37,524
|
(9,261 | ) |
28,263
|
36,238
|
(5,106) |
31,132
|
||||||||||||||||||
| Intangible assets not subject to amortization: | ||||||||||||||||||||||||
|
Domain
names (indefinite life)
|
2,230
|
—
|
2,230
|
2,230
|
—
|
2,230
|
||||||||||||||||||
|
Total
|
$ |
39,754
|
$ | (9,261 | ) | $ |
30,493
|
$ |
38,468
|
$ | (5,106) | $ |
33,362
|
|||||||||||
Note 5—Assembled
Workforce
In
April
2007, the Company entered into a purchase agreement with its outsourced call
center provider to bring in-house certain sales and customer service employees
based in the Philippines, who were providing support to the Company through
this
provider. The purchase price to acquire this assembled workforce was
approximately $1.7 million. In order to determine the accounting impact of
this
transaction, the Company obtained an independent third party valuation of the
components of this contract. The valuation resulted in the
recognition of an intangible asset, referred to as “assembled workforce,” with a
fair value of $1.3 million and an estimated useful life of seven
years. The remaining $440,000 was recorded as marketing
expense.
Under
the
terms of the purchase agreement, approximately 182 of the provider’s employees
were given the opportunity to become U.S. Auto Parts employees. As of the
closing of this transaction, 171 of these employees agreed to transition over
to
direct employment by the Company’s Philippines subsidiary. The Company has also
entered into an agreement to lease workstations in the provider’s facility in
the Philippines for a period of six months. The Company is currently
anticipating opening its own call center facility in the Philippines in the
second half of 2007.
Note 6—Contingencies
The
Company is subject to legal proceedings and claims which arise in the ordinary
course of its business. Although occasional adverse decisions or settlements
may
occur, the potential loss, if any, cannot be reasonably estimated. However,
the
Company believes that the final disposition of such matters will not have a
material adverse effect on the financial position, results of operations or
cash
flow of the Company. The Company maintains various liability insurance coverages
to protect the Company’s assets from losses arising out of or involving
activities associated with ongoing and normal business operations.
Ford
Global Technologies, LLC
On
December 2, 2005, Ford Global Technologies, LLC (“Ford”) filed a complaint
with the United States International Trade Commission (“USITC”) against the
Company and five other named respondents, including four Taiwan-based
manufacturers. On December 12, 2005, Ford filed an amended complaint. Both
the complaint and the amended complaint charged the Company and the other
respondents with infringement of 14 design patents that Ford alleges cover
eight
parts on the 2004-2005 Ford F-150 truck (the “Ford Design Patents”). Ford asked
the USITC to issue a permanent general exclusion order excluding from entry
into
the United States all automotive parts that infringe the Ford Design Patents
and
that are imported into the United States, sold for importation in the United
States, or sold within the United States after importation. Ford also sought
a
permanent order directing the Company and the other respondents to cease and
desist from, among other things, selling, marketing, advertising, distributing
and offering for sale imported automotive parts that infringe the Ford Design
Patents. The Company filed its response to the complaint with the USITC in
January 2006 denying, among other things, that any of the Ford Design Patents
is
valid and/or enforceable and, further, denying each and every allegation of
infringement. The Company also asserted several
7
affirmative defenses,
any of which, if successful, would have precluded the USITC from granting any
of
Ford’s requested relief. Some of these defenses were struck by the
Administrative Law Judge (“ALJ”) in response to motions by Ford. Additionally,
four of the Ford Design Patents were dropped from the investigation at Ford’s
request. A hearing before the ALJ occurred in August 2006.
On
December 4, 2006, the ALJ issued an initial determination finding three of
the ten Ford Design Patents invalid, but upholding the validity and
enforceability of the other seven Ford Design Patents, and ruling that the
importation of automotive parts allegedly covered by these seven patents
violates Section 337 of the Tariff Act of 1930, as amended. This initial
determination was subject to review by the USITC. The Company and the other
respondents accordingly filed a petition urging the Commission to review and
reverse the portions of the initial determination finding seven of the ten
patents valid, enforceable, and infringed. Ford, in turn, petitioned for review
of the portion of the initial determination finding three of its design patents
invalid. The ALJ’s initial determination on all issues became the
final determination of the USITC upon notice by the USITC on March 20, 2007
of
its decision not to review the initial determination. On May 1,
2007, the Company and other respondents petitioned the USITC to reconsider
its
March 2007 ruling not to review the ALJ’s determination regarding the seven Ford
Design Patents found valid and infringed, in light of the Supreme Court’s April
30, 2007 decision in KSRInternational, Inc, v. Teleflex, Inc.
The USITC issued a “Notice of Commission Determination To Waive Reconsideration
Rule Deadline And To Extend Target Date” on May 4, 2007. In this Notice,
the USITC indicated that it would consider the petition and extended the target
date for issuing a final order to June 6, 2007. Ford and the USITC’s Office
of Unfair Import Investigations opposed the Company’s petition for
reconsideration.
On
June
6, 2007, the USITC denied the petition for reconsideration, terminated its
investigation and issued a general exclusion order. The Commission denied
Ford’s request for a cease and desist order. The general exclusion order
prohibits the importation, sale for importation, or sale in the United States
after importation of aftermarket collision parts that infringe any of the seven
Ford Design Patents previously determined to be valid. The final determination
by the USITC was subject to review by the President of the United States, who
is
authorized to disapprove Commission orders for policy considerations. The
mandatory 60-day Presidential review period ended on August 6, 2007, with the
President taking no action. The Company has sixty days from the expiration
of the Presidential review period to file a petition for review with the United
States Circuit Court of Appeals for the Federal Circuit. The
Company intends to vigorously pursue its appellate rights.
While
the
portion of the Commission’s March 20, 2007 ruling finding a violation of Section
337 did not become final appealable order until the end of the Presidential
review period, the Commission’s finding of no violation of Section 337 as to the
three of Ford’s Design Patents held invalid was not subject to Presidential
review, and became a final appealable order as of March 20,
2007. Accordingly, on May 18, 2007, Ford filed a Petition For Review
at the United States Court of Appeals for the Federal Circuit seeking review
and
reversal of the portion of the USITC’s March 20, 2007 Final Determination
finding three of the Ford Design Patents invalid. That appeal
is currently pending.
Securities
Litigation
On
March
24, 2007, a putative stockholder class action lawsuit was filed against the
Company and certain officers and directors in the U.S. District Court for the
Central District of California. The complaint alleges that the
Company filed a false Registration Statement in connection with the Company’s
initial public offering in violation of Section 11 and Section 15 of the
Securities Act of 1933, as amended (the “Securities Act”). On April
26, 2007, a second complaint containing substantially similar allegations was
filed, and also included a claim under Section 12(a)(2) of the Securities
Act. The complaints were consolidated on May 15,
2007. Plaintiffs seek compensatory damages, restitution, unspecified
equitable relief, as well as attorneys’ fees and costs. Defendants
believe they have meritorious defenses and intend to vigorously defend the
lawsuit. As such, the Company believes that a potential liability is
not probable or reasonably estimable and has recorded no amount related to
this
matter as of June 30, 2007. On August 13, 2007, the Company received a
letter from the SEC that indicated that the SEC had commenced an informal
inquiry into the events leading up to the Company's announcement on March 20,
2007 of its financial results for the fourth quarter and year ended December
31,
2006. The Company intends to fully cooperate with the SEC in this
matter.
Note 7—Comprehensive
Income
The
Company reports comprehensive income in accordance with SFAS No. 130,
“Reporting Comprehensive Income,” which defines comprehensive income as
non-stockholder changes in equity. Comprehensive income for each of the three
and six month periods ended June 30, 2007 and 2006, respectively, includes
the
following:
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
||||||||||
|
2007
|
2006
|
2007
|
2006
|
||||||||
|
(in
thousands)
|
|||||||||||
| Net income | $ | 773 | $ | 611 | $ | 1,008 | $ | 3,331 | |||
| Foreign currency translation adjustments | 21 | 10 | 30 | 8 | |||||||
|
Comprehensive
income
|
$ |
794
|
$ |
621
|
$ | 1,038 | $ |
3,339
|
|||
Note 8—Reserve
For Sales Returns
Sales
discounts are recorded in the period in which the related sale is recognized.
Credits are issued to customers for returned products. Credits amounted to
$4.9
million and $2.3 million for the three months ended June 30, 2007 and 2006,
respectively. Likewise, credits amounted to $8.9 million and $3.7
million for the six months ended June 30, 2007 and 2006, respectively. The
Company’s sales returns and allowances reserve totaled $596,000 and $1.4 million
at June 30, 2007 and December 31, 2006, respectively.
The
following table provides an analysis of the reserve for sales
returns:
|
Balance at
Beginning of
Period
|
Charged to
Revenue
|
Deductions
|
Balance at End
of
Period
|
||||||||||||
|
(in
thousands)
|
|||||||||||||||
|
Six
months ended
|
|||||||||||||||
|
Reserve
for sales returns, June 30, 2006
|
$ |
170
|
$ |
3,674
|
$ | (3,322 | ) | $ |
522
|
||||||
|
Reserve
for sales returns, June 30, 2007
|
1,408
|
8,871
|
(9,683 | ) |
596
|
||||||||||
Note 9—Income
Taxes
For
the
three and six months ended June 30, 2007, the effective tax rate for the Company
was 38.8% and 39.2%, respectively. The effective tax rate for the three and
six
months ended June 30, 2006 was 43.6% and 8.7%, respectively. The six months
ended June 30, 2006 effective tax rate is significantly lower because the
Company converted from S-corporation status to C-corporation status in March
2006. These rates differed from the statutory rates due to various permanent
non-deductible tax items, including share-based compensation and other permanent
differences. In July 2006, the FASB issued FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes—an Interpretation of FASB
Statement No. 109” (“FIN 48”), which became effective for the Company
on January 1, 2007. FIN 48 prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement
of
tax positions taken or expected to be taken in a tax return. For those benefits
to be recognized, a tax position must be more-likely-than-not to be sustained
upon examination by taxing authorities. The amount recognized is measured as
the
largest amount of benefit that is greater than 50 percent likely of being
realized upon ultimate settlement. As a result of the implementation of FIN
48,
the Company recognized no material adjustment in the liability for unrecognized
income tax benefits and no corresponding interest or penalties. The tax years
2004 through 2006 remain open to examination by the major taxing jurisdictions
to which the Company is subject.
Note 10—Net
Income Per Share
Net
income per share has been computed in accordance with FASB Statement
No. 128, “Earnings Per Share.” The following table sets forth the
computation of basic and diluted net income per share:
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
||||||||||
|
2007
|
2006
|
2007
|
2006
|
||||||||
| Net Income Per Share |
(in
thousands, except share and per share data)
|
||||||||||
| Numerator: | |||||||||||
| Net income | $ | 773 | $ | 611 | $ | 1,008 | $ | 3,331 | |||
| Denominator: | |||||||||||
| Weighted-average common shares outstanding (basic) | 29,832,927 | 14,120,952 | 26,679,905 | 13,663,020 | |||||||
| Common equivalent shares from conversion of preferred stock |
—
|
6,633,255 | 1,429,265 | 4,397,738 | |||||||
| Common equivalent shares from common stock options and warrants | 20,419 | 18,221 | 33,660 | 38,762 | |||||||
| Weighted-average common shares outstanding (diluted) | 29,853,346 | 20,772,428 | 28,142,830 | 18,099,520 | |||||||
| Basic net income per share | $ | 0.03 | $ | 0.04 | $ | 0.04 | $ | 0.24 | |||
| Diluted net income per share | $ | 0.03 | $ | 0.03 | $ | 0.04 | $ | 0.18 | |||
Note 11—Share-Based
Compensation
The
Company accounts for share-based compensation in accordance with SFAS
No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which was
adopted on January 1, 2006. No stock options were granted prior to
January 1, 2006. All stock options issued to employees are recognized as
share-based compensation expense in the financial statements based on their
respective grant date fair values, and are recognized within the statements
of
income as general and administrative, marketing, fulfillment or technology
expense, based on employee departmental classifications.
Under
this standard, the fair value of each share-based payment award is estimated
on
the date of grant using an option pricing model that meets certain requirements.
The Company uses the Black-Scholes option pricing model to estimate the fair
value of share-based payment awards. The determination of the fair value of
share-based payment awards utilizing the Black-Scholes model is affected by
the
Company’s stock price and a number of assumptions, including expected
volatility, expected life, risk-free interest rate and expected dividends.
As of
June 30, 2007, the Company did not have an adequate history of market prices
of
its common stock as the Company only recently became a public company, and
as
such the Company estimates volatility in accordance with SAB No. 107 using
historical volatilities of similar public entities. The expected life of an
award is based on a simplified method which defines the life as the average
of
the contractual term of the option and the weighted average vesting period
for
all open tranches. The risk-free interest rate assumption is based on observed
interest rates appropriate for the terms of awards. The dividend yield
assumption is based on the Company’s expectation of paying no dividends.
Forfeitures are estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those
estimates.
For
non-employees, the Company accounts for share-based compensation in accordance
with EITF No. 96-18, “Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods
or
Services.” Equity instruments awarded to non-employees are periodically
re-measured as the underlying awards vest unless the instruments are fully
vested, immediately exercisable and non-forfeitable on the date of
grant.
There
was
$8.9 million of unrecognized compensation expense related to stock options
as of June 30, 2007, which expense is expected to be recognized over a
weighted-average period of 3.3 years. The table below summarizes stock option
activity during the six months ended June 30, 2007, which resulted in
share-based compensation expense as follows:
|
Six
Months Ended
June
30, 2007
|
||||||
|
Shares
|
Weighted
Average
Exercise Price
|
|||||
|
Options
outstanding, December 31, 2006
|
2,786,532
|
$ |
8.74
|
|||
|
Granted
|
2,225,469
|
6.48
|
||||
|
Exercised
|
—
|
—
|
||||
|
Expired
|
—
|
—
|
||||
|
Forfeited
|
(145,393) |
8.88
|
||||
|
Options
outstanding, June 30, 2007
|
4,866,608
|
$ |
7.70
|
|||
|
Options
exercisable, June 30, 2007
|
2,789,139
|
$ |
8.86
|
|||
Note 12—Subsequent
Event
On
August 8, 2007, the Company's
Philippines subsidiary entered into two new lease
agreements. The Company plans to use this space to expand its current
operations. Under the terms of the first lease agreement, the Company
will add an additional 526 square meters of space for a period of twelve months,
effective September 1, 2007 for monthly rent of approximately
$3,000. Under the terms of the second lease agreement, the Company
will add an additional 214 square meters of space for a period of eleven months,
effective November 1, 2007 for monthly rent of approximately
$1,000.
|
ITEM 2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
Cautionary
Statement
You
should read the following discussion and analysis in conjunction with our
unaudited condensed consolidated financial statements and the related notes
thereto contained in Part I, Item 1 of this Report. The information
contained in this Quarterly Report on Form 10-Q is not a complete description
of
our business or the risks associated with an investment in our common stock.
We
urge you to carefully review and consider the various disclosures made by us
in
this Report and in our other reports filed with the Securities and Exchange
Commission, or SEC, including our Annual Report on Form 10-K for the year ended
December 31, 2006 and subsequent reports on Forms 10-Q and 8-K, which
discuss our business in greater detail. The section entitled “Risk Factors” set
forth below, and similar discussions in our other SEC filings, describe some
of
the important risk factors that may affect our business, results of operations
and financial condition. You should carefully consider those risks, in addition
to the other information in this Report and in our other filings with the SEC,
before deciding to purchase, hold or sell our common stock.
Overview
We
are a
leading online provider of aftermarket auto parts, including body parts, engine
parts and performance parts and accessories. Our user-friendly websites provide
customers with a broad selection of SKUs, with detailed product
descriptions and photographs. Our proprietary product database maps our SKUs
to product applications based on vehicle makes, models and years. We
principally sell our products to individual consumers through our network of
websites and online marketplaces. Our flagship websites are located at
www.partstrain.com and www.autopartswarehouse.com. We believe
our strategy of disintermediating the traditional auto parts supply channel
and
selling products directly to customers over the Internet allows us to more
efficiently deliver products to our customers while generating higher
margins.
Our
History. We were formed in 1995 as a distributor of aftermarket auto parts
and launched our first website in 2000. We rapidly expanded our online
operations, increasing the number of SKUs sold through our e-commerce network,
adding additional websites, improving our Internet marketing proficiency and
commencing sales in online marketplaces. As a result, our business has grown
consistently since 2000, generating net sales of $85.9 million for the six
months ended June 30, 2007.
International
Operations. In April 2007, we entered into a purchase agreement to bring
in-house certain sales and customer service employees based in the Philippines
who were providing support to us through our outsourced call center provider,
Access Worldwide. Under the terms of this purchase agreement, approximately
182
employees of Access Worldwide were given the opportunity to become employees
of
our Philippines subsidiary and join our existing direct employees in the
Philippines. As of the closing of this transaction, approximately 171 of the
Access employees had agreed to transition over to direct employment by our
Philippines subsidiary. The purchase price for the right to acquire this
assembled workforce was approximately $1.7 million. We are currently
planning to open a new call center in the Philippines in the second half of
2007
to accommodate the additional employees and expect to spend up to $1.0 million
on such facility in 2007. In addition to our Philippines operations, we have
outsourced call center operations in India and own a Canadian subsidiary to
facilitate sales of our products in Canada. We believe that the cost
advantages of our offshore operations provide us with the ability to grow our
business in a cost-effective manner, and we expect to continue to add headcount
and infrastructure to our offshore operations.
Partsbin
Acquisition. In May 2006, we completed the acquisition of Partsbin. As a
result of this acquisition, we expanded our product offering and product catalog
to include performance parts and accessories and additional engine parts,
enhanced our ability to reach more customers, significantly increased our net
sales and added a complementary, drop-ship order fulfillment method. Partsbin
also expanded our international operations by adding two outsourced call centers
in the Philippines and in India, as well as a Canadian subsidiary to facilitate
sales in Canada. We also augmented our technology platform and expanded our
management team. The purchase price for Partsbin consisted of $25.0 million
in
cash, promissory notes in the aggregate principal amount of $5.0 million payable
to the former stockholders of Partsbin and 1,983,315 shares of our common stock.
We continue to integrate Partsbin and we may pursue additional acquisition
opportunities in the future to increase our share of the aftermarket auto parts
market or expand our product offerings.
Critical
Accounting Policies
Our
discussion and analysis of our financial condition and results of operations
is
based upon our unaudited condensed consolidated financial statements, which
have
been prepared in accordance with U.S. generally accepted accounting principles.
The preparation of these unaudited condensed consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts
of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our estimates,
including those related to revenue recognition, sales returns and allowances,
uncollectible receivables, inventory reserves, intangible and other long-lived
assets and contingencies. We base our estimates on historical experience and
on
various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. There were no significant changes to our critical
accounting policies during the six months ended June 30, 2007, as compared
to
those policies disclosed in our annual report on Form 10-K for the fiscal year
ended December 31, 2006.
In
June
2006, the FASB issued FIN 48, which became effective for us beginning
January 1, 2007. FIN 48 addresses the determination of how tax
benefits claimed or expected to be claimed on a tax return should be recorded
in
the financial statements. Under FIN 48, we must recognize the tax benefit from
an uncertain tax position only if it is more-likely-than-not that the tax
position will be sustained on examination by the taxing authorities, based
on
the technical merits of the position. The tax benefits recognized in the
financial statements from such a position are measured based on the largest
benefit that has a greater than 50% likelihood of being realized upon ultimate
resolution. The impact of our reassessment of our tax positions in accordance
with FIN 48 did not have a material impact on our results of operations,
financial condition or liquidity. For additional information regarding the
adoption of FIN 48, see Note 9 of Notes to Unaudited Condensed Consolidated
Financial Statements in Part I, Item 1 of this report.
Results
of Operations
The
following table sets forth certain unaudited statements of income data for
the
periods indicated:
|
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(unaudited)
|
||||||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Net
sales
|
$ |
42,112
|
$ |
26,966
|
$ |
85,855
|
$ |
44,971
|
||||||||
|
Cost
of sales
|
28,327
|
17,617
|
58,401
|
27,876
|
||||||||||||
|
Gross
profit
|
13,785
|
9,349
|
27,454
|
17,095
|
||||||||||||
| Operating expenses: | ||||||||||||||||
|
General
and administrative
|
3,655 | 2,290 | 6,531 | 4,255 | ||||||||||||
|
Marketing
|
4,921 | 3,179 | 10,821 | 5,155 | ||||||||||||
|
Fulfillment
|
1,862 | 1,213 | 3,579 | 2,365 | ||||||||||||
|
Technology
|
507 | 323 | 956 | 517 | ||||||||||||
| Amortization of intangibles | 2,100 | 947 | 4,154 | 951 | ||||||||||||
| Total operating expenses | 13,042 | 7,952 | 26,041 | 13,243 | ||||||||||||
| Income from operations | 740 | 1,397 | 1,413 | 3,852 | ||||||||||||
| Other income (expense): | ||||||||||||||||
|
Loss
from disposition of assets
|
—
|
—
|
—
|
(5 | ) | |||||||||||
|
Other
income
|
3 | 3 | 5 | 157 | ||||||||||||
|
Interest
income (expense), net
|
545 | (317 | ) | 265 | (357 | ) | ||||||||||
| Total other income (expense) | 548 | (314 | ) | 270 | (205 | ) | ||||||||||
| Income before income taxes | 1,288 | 1,083 | 1,683 | 3,647 | ||||||||||||
| Income tax provision | 515 | 472 | 675 | 316 | ||||||||||||
| Net income | $ | 773 | $ | 611 | $ | 1,008 | $ | 3,331 | ||||||||
Three
and Six Months Ended June 30, 2007 Compared to Three and Six Months Ended
June
30, 2006
Net
Sales and Gross Margin
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Net
sales
|
$ |
42,112
|
$ |
26,966
|
$ |
85,855
|
$ |
44,971
|
||||||||
|
Cost
of sales
|
28,327
|
17,617
|
58,401
|
27,876
|
||||||||||||
|
Gross
profit
|
$ |
13,785
|
$ |
9,349
|
$ |
27,454
|
$ |
17,095
|
||||||||
|
Gross
margin
|
32.7 | % | 34.7 | % | 32.0 | % | 38.0 | % | ||||||||
Net
sales
increased 55.9% and 90.9% to $42.1 million and $85.9 million for the three
and
six months ended June 30, 2007, from the same periods in the previous year.
The increase in net sales in both periods was the result of organic growth
across all sales channels and the acquisition of Partsbin in May 2006. This
acquisition added a significant number of SKUs in performance parts, accessories
and engine parts to our product offering. We believe organic sales
growth in 2007 benefited from a broader product selection as well as an
increase in the number of unique monthly visitors to our websites.
Our
e-commerce sales grew by 61.3% and 111.3% to $32.1 million and $65.3
million for the three and six months ended June 30, 2007. Our online
marketplace sales grew by 48.6% and 69.6% to $5.2 million and $11.7 million
for the three and six months ended June 30, 2007. The increase in both
e-commerce and online marketplace sales included the contribution from Partsbin
product sales since May 2006.
The
total
number of e-commerce orders increased 60.0% and 111.7% to 256,000 and 525,000
orders for the three and six months ended June 30, 2007. The average
order value increased during the three months ended June 30, 2007 to $125 versus
$124 during the same period in the previous year. The average order
value for the six months ended June 30, 2007 remained stable at $125 versus
the
same period in the previous year.
Net
sales
of our Kool-Vue product-line and sales of other products through our wholesale
channel remained relatively constant in absolute dollars for both the three
and
six months ended June 30, 2007 compared to the same periods in the prior year,
but declined as a percentage of net sales. We anticipate that sales through
our
wholesale channel and Kool-Vue product line will continue to decline as a
percentage of net sales in the future due to our primary focus on our online
business.
We
have
historically experienced seasonality in our business. We expect seasonality
to
continue in future years as automobile collisions during inclement weather
generally creates increased demand for body parts in winter months and consumers
often undertake projects to maintain and enhance the performance of their
automobiles in the summer months. We anticipate that seasonality will continue
to have a material impact on our financial condition and results of operations
during any given year.
While
gross profit increased largely as a function of higher sales volumes, as
discussed above, the decrease in gross margins of 2.0% and 6.0% to 32.7% and
32.0% for the three and six months ended June 30, 2007 was primarily due to
the
partial inclusion of drop-ship products in the 2006 results, which
generally carry lower gross margins. For the three and six months ended June
30,
2007, cost of freight increased in absolute dollars as a result of the increase
in net sales, yet favorable shipping terms with our drop-ship suppliers caused
freight expense as a percentage of net sales to drop from 13.5% of net sales
for
the six months ended June 30, 2006 to 12.8% of net sales for the six months
ended June 30, 2007. Freight expense as a percentage of net sales for the three
months ended June 30, 2007, however increased to 12.5% from 11.9% for the same
period in the previous year.
General
and Administrative Expense
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
General
and administrative expense
|
$ |
3,655
|
$ |
2,290
|
$ |
6,531
|
$ |
4,255
|
||||||||
|
Percent
of net sales
|
8.7 | % | 8.5 | % | 7.6 | % | 9.5 | % | ||||||||
General
and administrative expense increased 59.6% and 53.5% for the three and six
months ended June 30, 2007, from the same periods in the previous year,
which was primarily due to an increase of $307,000 and $878,000, in
merchant fees related to higher online sales. Merchant fees remained relatively
constant as a percentage of net sales, however during both
periods. In addition, this increase reflects higher payroll and
related expenses in the amount of $203,000 for the three months ended June
30,
2007 and $454,000 for the six months ended June 30, 2007, which was largely
due
to additional personnel. The increase also includes $494,000 and
$806,000 of share-based compensation expense related to stock options for the
three and six months ended June 30, 2007. In addition, there
were additional expenses incurred relating to legal and professional fees
and insurance coverage not incurred in the previous year. Legal
and professional fees for the three and six months ended June 30, 2007 were
$660,000 and $873,000, respectively. The increase in legal and
professional fees relates to costs incurred for the pending securities
class action litigation and compliance related matters for operating as a public
company. The increase in general and administrative expense was partially
offset by a $351,000 reduction in software amortization for the three months
ended June 30, 2007 and $712,000 for the six months ended June 30,
2007.
During
the three and six months ended June 30, 2007, we recognized $494,000 and
$806,000 of share-based compensation, determined in accordance with SFAS 123(R).
Based on options outstanding as of June 30, 2007, we expect to recognize $8.9
million in additional expense in the following periods:
|
●
|
Remaining six months ending December 31, 2007 | $1.6 million | |
|
●
|
Year ending December 31, 2008 | $2.8 million | |
|
●
|
Year ending December 31, 2009 | $2.7 million | |
|
●
|
Year ending December 31, 2010 | $1.6 million | |
|
●
|
Five months ending May 31, 2011 | $232,000 |
We
anticipate that we will incur increased general and administrative expense
throughout 2007 and in future periods related to operating as a public company
due to increased legal and accounting fees, higher insurance premiums, higher
personnel and employee benefit costs and increased non-employee director costs.
We expect that the costs of compliance associated with the transition to and
operation as a public company, including the requirements relating to improving
and documenting our internal controls and procedures, as well as changes in
corporate governance practices, will be significant. In addition, complying
with
SEC inquiries and defending securities litigation against us could result in
substantial costs, which could cause our general and administrative expense
to
increase in the future.
Marketing
Expense
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Marketing
expense
|
$ |
4,921
|
$ |
3,179
|
$ |
10,821
|
$ |
5,155
|
||||||||
|
Percent
of net sales
|
11.7 | % | 11.8 | % | 12.6 | % | 11.5 | % | ||||||||
Marketing
expense increased 54.8% and 109.9% for the three and six months ended June
30,
2007, respectively from the same periods in the previous year primarily due
to
higher personnel costs of $1.1 million and $2.4 million, respectively related
to
the expansion in our sales and marketing team. Advertising cost
during the three months ended June 30, 2007 was $2.2 million or $301,000 higher
than the prior year period. For the six months ended June 30, 2007, advertising
cost was $5.7 million or $2.5 million higher than in the six months period
ended
June 30, 2006. The majority of the expense was incurred in the first
quarter of 2007 and we have reduced this expense in the second quarter
of 2007.
In
addition, in April 2007, we completed the acquisition of our Philippines sales
force from our outsourced call center provider. As of June 30, 2007, 171
employees had transitioned to direct employment with our Philippines subsidiary.
For the second half of 2007, we expect our personnel costs included in marketing
expense to increase as a result of this additional headcount. We anticipate
this
increase to be fully offset, however by a reduction in our outsourced services
expense as a result of bringing these capabilities in-house. The purchase
price for the assembled workforce was approximately $1.7 million. Of this
amount, approximately $420,000 was included as marketing expense during the
first three months of 2007. The approximate remaining $1.3 million was
capitalized as an intangible asset in accordance with SFAS 142 “Goodwill and
Other Intangible Assets.” This intangible will be amortized over
seven years beginning in April 2007.
Fulfillment
Expense
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Fulfillment
expense
|
$ |
1,862
|
$ |
1,213
|
$ |
3,579
|
$ |
2,365
|
||||||||
|
Percent
of net sales
|
4.4 | % | 4.5 | % | 4.2 | % | 5.3 | % | ||||||||
Fulfillment
expense increased 53.5% and 51.3% for the three and six months ended June 30,
2007 from the same periods in the previous year primarily due to $478,000 and
$909,000, in additional personnel costs. We expanded the number of
warehouse and purchasing employees during the first six months of 2007 in order
to meet increased sales volume.
Technology
Expense
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Technology
expense
|
$ |
507
|
$ |
323
|
$ |
956
|
$ |
517
|
||||||||
|
Percent
of net sales
|
1.2 | % | 1.2 | % | 1.1 | % | 1.1 | % | ||||||||
Technology
expense increased 57.0% and 84.9% for the three and six months ended June 30,
2007 from the same periods in the previous year primarily due to higher
communication fees of $145,000 and $325,000, to support the expansion of
our communications infrastructure. During 2007, we expect technology expense
as
a percent of net sales to continue to increase due to the hiring of additional
employees and increased investment in our overall technology
platform.
Amortization
of Intangibles
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
2007
|
2006
|
2007
|
2006
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Amortization
of intangibles
|
$ |
2,100
|
$ |
947
|
$ |
4,154
|
$ |
951
|
||||||||
|
Percent
of net sales
|
5.0 | % | 3.5 | % | 4.8 | % | 2.1 | % | ||||||||
Amortization
of intangibles increased 121.8% and 336.8% for the three and six months ended
June 30, 2007 primarily due to the intangible assets acquired pursuant to the
acquisition of Partsbin completed in May 2006 and the assembled workforce
acquired in April 2007. We preliminarily estimate aggregate
amortization expense related to these acquisitions will be as
follows:
|
●
|
Remaining six months ending December 31, 2007 | $4.2 million | |
|
●
|
Year ending December 31, 2008 | $8.4 million | |
|
●
|
Year ending December 31, 2009 | $6.9 million | |
|
●
|
Year ending December 31, 2010 | $6.0 million | |
|
●
|
Year ending December 31, 2011 and beyond | $2.9 million |
Other
Income (Expense), Net
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
|||||||||||||||
|
|
2007
|
2006
|
2007
|
2006
|
||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Other
income (expense), net
|
$ |
548
|
$ | (314 | ) | $ |
270
|
$ | (205 | ) | ||||||
|
Percent
of net sales
|
1.3 | % | (1.2 | %) | 0.3 | % | (0.5 | %) | ||||||||
The
increase in other income (expense), net during the three months ended June
30,
2007 was primarily due to an increase of $531,000 in interest income
related to the higher cash balances. For the six months ended June 30, 2007,
other income (expense), net included $273,000 of accelerated non-cash interest
expense from the write-off of the remaining debt discount during the first
three
months of 2007. Upon completion of our initial public offering, we reduced
our long-term indebtedness by approximately $28.0 million, which will
significantly decrease our interest expense for the balance of
2007.
We
expect
to continue to record higher interest income throughout 2007 relative to 2006
due to investing the proceeds of the initial public offering. Our
investment policy seeks to preserve principal, maintain liquidity and
provide for diversification. All investments generally will be
AAA rated to minimize credit and market risk exposure. A tax
efficient strategy may be used to maximize the ultimate return on
investments.
Liquidity
and Capital Resources
We
have
historically funded our operations from cash generated from operations, credit
facilities, bank and stockholder loans, equity financing and capital lease
financings. At June 30, 2007, the only notes payable outstanding related to
$1.0
million payable to the former stockholders of Partsbin. We had no balance
outstanding under our term loans or our bank line of credit, which expires
on
July 31, 2009 and bears interest at prime minus 0.5%.
We
had
cash and cash equivalents of $42.3 million as of June 30, 2007, representing
a
$39.9 million increase from $2.4 million as of December 31, 2006. The
increase in our cash and cash equivalents as of June 30, 2007 was primarily
due
to the net proceeds from our initial public offering that was completed in
February 2007. We received net cash proceeds from our initial public offering
of
approximately $71.5 million (after deducting the underwriting discounts and
commissions and offering expenses). Approximately $28.0 million of the net
proceeds from the offering was used to repay our outstanding indebtedness of
approximately $18.0 million and $10.0 million under two term loans to our
commercial lender. In addition, we paid $4.0 million on the notes payable to
the
former stockholders of Partsbin.
We
had
working capital of $43.5 million as of June 30, 2007, which was primarily due
to
the cash generated from our initial public offering. We anticipate that our
existing cash balances, cash generated from operations and funds available
under
our line of credit will be sufficient to meet our working capital needs and
expected capital expenditures for at least the next twelve months. Our future
capital requirements may, however, vary materially from those now planned or
anticipated. Changes in our operating plans, lower than anticipated net sales,
increased expenses or other events, including those described in “Risk Factors,”
may cause us to seek additional debt or equity financings in the future.
Financings may not be available on acceptable terms, on a timely basis, or
at
all, and our failure to raise adequate capital when needed could negatively
impact our growth plans, our financial condition, and results of
operations.
In
June
2007, we opened a new distribution center in Tennessee. This distribution
center is operated by a third party and is intended to stock and distribute
performance parts and accessories. We intend to continue to add inventory
to this location during the remainder of 2007. In
addition to this third party distribution center, we are assessing the
feasibility and economic value of opening a separate distribution facility
in
Tennessee that would be operated by us and house a broader range of product
categories. We expect to finalize our plans on this distribution center in
the second half of 2007.
Our
Philippines subsidiary entered into two new lease agreements in August
2007. This facility expansion will be used to expand our non-call
center operations including marketing, catalog, technology and administrative
personnel. We anticipate this facility to be operational by the
end of 2007. While this new facility is being setup, we are renting
workstations from a third party. We expect to spend up to $1.0
million on this facility in the second half of 2007.
Seasonality
We
believe our business is subject to seasonal fluctuations. We have historically
experienced higher sales of body parts in winter months when inclement weather
and hazardous road conditions typically result in more automobile collisions.
Engine parts and performance parts and accessories have historically experienced
higher sales in the summer months when consumers have more time to undertake
elective projects to maintain and enhance the performance of their automobiles
and the warmer weather during that time is conducive for such projects. We
expect the historical seasonality trends to continue to have a material impact
on our financial condition and results of operations.
Inflation
Inflation
has not had a material impact upon our operating results, and we do not expect
it to have such an impact in the near future. We cannot assure you that our
business will not be affected by inflation in the future.
|
ITEM 3.
|
Quantitative
and Qualitative Disclosures about Market
Risk
|
We
do not
use financial instruments for trading purposes, and do not hold any derivative
financial instruments that could expose us to significant market risk. Our
primary market risk exposure with regard to financial instruments is changes
in
interest rates. We also have some exposure related to foreign currency
fluctuations.
Interest
Rate Risk. As of June 30, 2007, our only interest rate risk involved our
line of credit with our principal lender and the $1.0 million in notes payable
to the former Partsbin stockholders. Although there were no borrowings
outstanding under our line of credit at June 30, 2007, changes in the monthly
LIBOR rate could affect the rates at which we could borrow funds under the
line
of credit. A 1% increase or decrease in LIBOR, however would result in an
immaterial change in interest expense related to these outstanding
borrowings.
Foreign
Currency Risk. Our purchases of auto parts from our Asian suppliers are
denominated in U.S. dollars, however a change in the foreign currency exchange
rates could impact our product costs over time. While our operating expenses
in
the Philippines are generally paid in Philippine pesos, and Canadian website
sales are denominated in Canadian dollars, fluctuations in currency rates have
only had a nominal impact on our operations historically.
|
ITEM 4.
|
Controls
and Procedures
|
Evaluation
of Disclosure Controls and Procedures
As
of
June 30, 2007, the end of the period covered by this periodic report, we carried
out an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls
and
procedures pursuant to Rule 13a-15 and 15d-15 of the Securities Exchange Act
of
1934, as amended (the “Exchange Act”).
Disclosure
controls and procedures are controls and procedures that are designed to ensure
that information required to be disclosed in our reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC rules and forms. Management recognizes
that a control system, no matter how well conceived and operated, can provide
only reasonable assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems,
no
evaluation of controls can provide absolute assurance that all control issues
within the Company have been detected. Therefore, assessing the costs and
benefits of such controls and procedures necessarily involves the exercise
of
judgment by management. Our disclosure controls and procedures are designed
to
provide reasonable assurance of achieving the objective of ensuring that
information required to be disclosed in our reports filed or submitted under
the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC rules and forms. In addition, our disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that the information required to be disclosed by us in the
reports we file or submit under the Exchange Act is accumulated and communicated
to management, including our principal executive and principal financial
officers or persons performing similar functions, as appropriate, to allow
timely decisions regarding required disclosure.
Our
Chief
Executive Officer and Chief Financial Officer have concluded, based on our
evaluation of our disclosure controls and procedures, that our disclosure
controls and procedures under Rule 13a-15(e) and Rule 15d-15(e) of the Exchange
Act are ineffective. A material weakness, as defined in standards established
by
the Public Company Accounting Oversight Board (United States), has been
identified. A material weakness is a deficiency in internal control over
financial reporting that results in more than a remote likelihood that a
material misstatement of the annual or interim financial statements will not
be
prevented or detected. The identified material weakness consists of inadequate
financial and accounting resources, our need to upgrade our accounting systems
and improve our documentation of our key assumptions, estimates, accounting
policies and procedures. We have also experienced certain deficiencies that
we
believe are related to our integration of Partsbin.
During
the first quarter of this year, we began the implementation of remediation
plans
in order to eliminate the material weakness, including the
following:
|
|
•
|
We
hired a Vice President of Finance, a General Counsel, a Manager of
Finance, three Senior Accountants and a Senior Financial
Analyst.
|
|
|
•
|
Additional
information systems personnel have been hired and system issues,
including
necessary alternatives, are being
evaluated.
|
|
|
•
|
We
are preparing process documentation related to our key assumptions,
estimates and accounting policies and
procedures.
|
As
of
June 30, 2007, we believe that we have remediated the material weakness related
to the lack of finance and accounting personnel. In addition, we have
made significant progress in the area of documentation surrounding our
accounting policies and procedures. We will continue to implement
remediation plans to address the identified material weakness during the third
and fourth quarters of this year.
Changes
in Internal Control Over Financial Reporting
Except
as
set forth above, we did not make any changes in our internal control over
financial reporting during the three months ended June 30, 2007 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Inherent
Limitations on Internal Control
A
control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances
of
fraud, if any, have been detected. These inherent limitations include the
realities that judgments in decision making can be faulty, and that breakdowns
can occur because of simple errors or mistakes. Additionally, controls can
be
circumvented by the individual acts of some persons, by collusion of two or
more
people, or by management override of the control. The design of any system
of
controls is also based in part upon certain assumptions about the likelihood
of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Because of
the
inherent limitations in a cost-effective control system, misstatements due
to
error or fraud may occur and not be detected.
PART
II. Other Information
|
ITEM 1.
|
Legal
Proceedings
|
The
information set forth under Note 6 of Notes to Unaudited Condensed Consolidated
Financial Statements, included in Part I, Item I of this Report, is incorporated
herein by reference.
|
ITEM 1A.
|
Risk
Factors
|
Before
deciding to purchase, hold or sell our common stock, you should carefully
consider the risks described below in addition to the other cautionary
statements and risks described elsewhere, and the other information contained,
in this Report and in our other filings with the SEC, including our subsequent
reports on Forms 10-K, 10-Q and 8-K, and any amendments thereto. The risks
and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently deem immaterial
may also affect our business. If any of these known or unknown risks or
uncertainties actually occurs with material adverse effects on us, our business,
financial condition, results of operations and/or liquidity could be seriously
harmed. In that event, the market price for our common stock will likely decline
and you may lose all or part of your investment.
Purchasers
of aftermarket auto parts may not choose to shop online, which would prevent
us
from acquiring new customers who are necessary to the growth of our
business.
The
online market for aftermarket auto parts is less developed than the online
market for many other business and consumer products. Our success will depend
in
part on our ability to attract new customers and customers who have historically
purchased auto parts through traditional retail and wholesale operations.
Furthermore, we may have to incur significantly higher and more sustained
advertising and marketing expenditures or price our products more competitively
than we currently anticipate in order to attract additional online consumers
and
convert them into purchasing customers. Specific factors that could prevent
prospective customers from purchasing from us include:
|
|
•
|
concerns
about buying auto parts without face-to-face interaction with sales
personnel;
|
|
|
•
|
the
inability to physically handle, examine and compare
products;
|
|
|
•
|
delivery
time associated with Internet
orders;
|
|
|
•
|
concerns
about the security of online transactions and the privacy of personal
information;
|
|
|
•
|
delayed
shipments or shipments of incorrect or damaged products;
and
|
|
|
•
|
the
inconvenience associated with returning or exchanging items purchased
online.
|
If
the
online market for auto parts does not gain widespread acceptance, our business
and financial results may suffer.
We
depend on search engines and other online sources to attract visitors to our
websites, and if we are unable to attract these visitors and convert them into
customers in a cost-effective manner, our business and results of operations
will be harmed.
Our
success depends on our ability to attract online consumers to our websites
and
convert them into customers in a cost-effective manner. We are significantly
dependent upon search engines, shopping comparison sites and other online
sources for our website traffic. We are included in search results as a result
of both paid search listings, where we purchase specific search terms that
will
result in the inclusion of our listing, and algorithmic searches that depend
upon the searchable content on our sites. Algorithmic listings cannot be
purchased and instead are determined and displayed solely by a set of formulas
utilized by the search engine. We rely on both algorithmic and purchased
listings to attract and direct consumers to our websites. Search engines,
shopping comparison sites and other online sources revise their algorithms
from
time to time in an attempt to optimize their search results. If one or more
of
the search engines, shopping comparison sites or other online sources on which
we rely for website traffic were to modify its general methodology for how
it
displays our websites, resulting in fewer consumers clicking through to our
websites, our financial results could be adversely affected. In particular,
in
February 2007, Yahoo! changed the manner in which it handles paid search
listings to an approach similar to the one used by Google. This change makes
it
more difficult for us to ascertain what other companies are bidding for specific
key words. The adoption of this approach by Yahoo! and other paid search
providers could significantly increase the cost of our Internet advertising.
In
addition, if any free search engine or shopping comparison site on which we
rely
begins charging fees for listing or placement, or if one or more of the search
engines, shopping comparison sites and other online sources on which we rely
for
purchased listings, modifies or terminates its relationship with us, our
expenses could rise, we could lose customers and traffic to our websites could
decrease. In addition, our success in attracting visitors who convert to
customers will depend in part upon our ability to identify and purchase relevant
search terms, provide relevant content on our sites, and effectively target
our
other marketing programs such as e-mail campaigns and affiliate programs. If
we
are unable to attract visitors to our websites and convert them to customers
in
a cost-effective manner, then our business and financial results may be
harmed.
We
are dependent upon relationships with suppliers in Taiwan, China and the United
States for the vast majority of our products.
We
acquire substantially all of our products from manufacturers and distributors
located in Taiwan, China and the United States. Our top ten suppliers
represented approximately 64% of our total product purchases during the first
six months of 2007. We do not have any long-term contracts or exclusive
agreements with our foreign suppliers that would ensure our ability to acquire
the types and quantities of products we desire at acceptable prices and in
a
timely manner. We have recently entered into supply agreements with our
U.S. based suppliers and our primary drop-ship vendors. In addition, our
ability to acquire products from our suppliers in amounts and on terms
acceptable to us is dependent upon a number of factors that could affect our
suppliers and which are beyond our control. For example, financial or
operational difficulties that some of our suppliers may face may increase the
cost of the products we purchase from them. In addition, the trend towards
consolidation among auto parts suppliers may disrupt or end our relationship
with some suppliers, and could lead to less competition and, consequently,
higher prices.
In
addition, because many of our suppliers are outside of the United States,
additional factors could interrupt our relationships or affect our ability
to
acquire the necessary products on acceptable terms, including:
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political,
social and economical instability and the risk of war or other
international incidents in Asia;
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fluctuations
in foreign currency exchange rates that may increase our cost of
products;
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tariffs
and protectionist laws and business practices that favor local
businesses;
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difficulties
in complying with import and export laws, regulatory requirements
and
restrictions; and
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natural
disasters and public health
emergencies.
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If
we do
not maintain our relationships with our existing suppliers or develop
relationships with new suppliers on acceptable commercial terms, we may not
be
able to continue to offer a broad selection of merchandise at competitive prices
and, as a result, we could lose customers and our sales could
decline.
Two
class action lawsuits have been filed against us and certain of our officers
and
directors as well as a SEC informal inquiry into this matter, which could result
in significant costs and a diversion of our management’s
efforts.
We
and
certain of our officers and directors have been served with two complaints
associated with class action lawsuits alleging violations of federal securities
law in connection with our initial public offering. While we believe we have
meritorious defenses and plan to defend vigorously any such claims made against
us, we cannot assure you that these actions will be resolved without incurring
significant costs and/or resulting in the diversion of the attention of
management and other key employees. The resolution of this pending securities
litigation and the defense of any additional litigation that may arise could
result in significant costs and any unfavorable outcome could have a material
adverse effect on our business. In August 2007, we also received a
letter from the SEC that indicated that the SEC had commenced an informal
inquiry into the events leading up to the Company's announcement on March 20,
2007 of its financial results for the fourth quarter and year ended December
31,
2007. We intend to fully cooperate with the SEC in this matter. The
preparation of any response in connection with SEC inquiry could result in
significant costs that could have a material adverse effect on the
business.
Challenges
by OEMs to the validity of aftermarket auto parts and claims of infringement
could adversely affect our business and the viability of the aftermarket auto
parts industry.
Original
equipment manufacturers have attempted to use claims of intellectual property
infringement against manufacturers and distributors of aftermarket auto parts
to
restrict or eliminate the sale of aftermarket auto parts that are the subject
of
the claims. We have received in the past, and we anticipate we may in the future
receive, communications alleging that certain products we sell infringe
third-party patents, copyrights, trademarks and trade names or other
intellectual property rights. For example, in December 2005, Ford Global
Technologies, LLC filed a complaint with the United States International Trade
Commission, or USITC, against us and five other named respondents, including
four Taiwan-based manufacturers. Ford alleged in this action that we and the
other respondents infringed 14 design patents (four of which were subsequently
dropped from the investigation at Ford’s request) that Ford claims cover eight
parts for the 2004-2005 Ford F-150 truck. Ford asked the USITC to issue a
permanent general exclusion order excluding from entry into the United States
all auto parts that infringe the ten Ford design patents and that are imported
into the United States, sold for importation in the United States, or sold
within the United States after importation. Ford also sought a permanent order
directing us and the other respondents to cease and desist from, among other
things, selling, marketing, advertising, distributing and offering for sale
imported auto parts that infringe the design patents. The administrative law
judge issued an initial determination on December 4, 2006 finding three of
the
ten Ford Design Patents invalid, but upholding the validity and
enforceability of the other seven Ford Design Patents. The judge further ruled
that the importation of automotive parts allegedly covered by these seven
patents violates Section 337 of the Tariff Act of 1930, as amended. This
initial determination was subject to review by the USITC but became final upon
notice by the USITC in March 2007 of its decision not to review the
determination made by the administrative law judge.
On
May 1, 2007, we and other respondents petitioned the USITC to reconsider
its March 2007 ruling not to review the determination made by the ALJ regarding
the seven Ford Design Patents found valid and infringed, in light of the Supreme
Court’s April 30, 2007 decision in KSR International, Inc, v. Teleflex, Inc. The
USITC issued a “Notice of Commission Determination To Waive Reconsideration Rule
Deadline And To Extend Target Date” on May 4, 2007. In this Notice, the
USITC indicated that it would consider the petition and extended the target
date
for issuing a final order to June 6, 2007. On June 6, 2007, the
USITC denied the petition for reconsideration, terminated its investigation
and
issued a general exclusion order. The commission denied Ford’s
request for a cease and desist order. The general exclusion order prohibits
the
importation, sale for importation, or sale in the United Stated after
importation of aftermarket collision parts that infringe any of Ford’s seven
design patents previously determined to be valid. The final determination by
the
USITC was subject to review by the President of the United States, who is
authorized to disapprove Commission orders for policy
considerations. The mandatory 60-day Presidential review period,
ended on August 6, 2007, with the President taking no
action. We have sixty days from the expiration of the
Presidential review period to file a petition for review with the United States
Circuit Court of Appeals for the Federal Circuit. We intend to
vigorously pursue our appellate rights.
While
the
portion of the Commission’s March 20, 2007 ruling finding a violation of Section
337 did not become final appealable order until the end of the Presidential
review period, the Commission’s finding of no violation of Section 337 as to the
three of Ford’s Design Patents held invalid was not subject to Presidential
review, and became a final appealable order as of March 20,
2007. Accordingly, on May 18, 2007, Ford filed a Petition For Review
at the United States Court of Appeals for the Federal Circuit seeking review
and
reversal of the portion of the USITC’s March 20, 2007 Final Determination
finding three of the Ford Design Patents invalid. That appeal
is currently pending.
To
date,
our sales of these parts have been minimal, but as the design for the 2004
model
is incorporated into later year models of the F-150 and these trucks have been
on the road longer, sales of aftermarket replacement parts for these trucks
may
increase substantially. Furthermore, if Ford continues to pursue, expands or
escalates its claims against us, or if other OEMs commence similar actions,
and
any of them are successful in these actions, we could be restricted or
prohibited from selling certain aftermarket products and the aftermarket auto
parts industry could decline significantly, which could have a material adverse
effect on our business, financial condition and results of
operations.
Future
infringement claims could also result in increased costs of doing business
arising from increased legal expenses, adverse judgments or settlements or
changes to our business practices required to settle such claims or satisfy
any
judgments. Litigation could result in interpretations of the law that require
us
to change our business practices or otherwise increase our costs and harm our
business. We do not maintain insurance coverage to cover the types of claims
that could be asserted. If a successful claim were brought against us, it could
expose us to significant liability.
Our
integration of Partsbin has been time consuming and expensive and may not be
successful in the long run, if at all.
In
May
2006, we completed the acquisition of Partsbin, an online retailer of
aftermarket auto parts. As a result of the acquisition, we added 47 employees,
and our available SKUs and net sales increased significantly. The acquisition
of
Partsbin has involved significant costs, has resulted in challenges integrating
the diverse technologies used by each company and has placed, and may continue
to place, pressures on our operational and financial infrastructure. We cannot
assure you that our current cost structure or infrastructure will be adequate
for the combined companies. To successfully integrate Partsbin, we anticipate
that we will need to improve our operational and financial systems, procedures
and controls and maintain our cost structure at appropriate levels.
The
Partsbin acquisition also expanded our product offerings, particularly in the
area of engine parts and performance parts and accessories, and significantly
increased our use of drop-ship as a method of fulfillment. We cannot assure
you
that we can effectively manage this new fulfillment model or address the market
for these additional auto parts.
The
integration of Partsbin has, and may continue to, involve the consolidation
of
diverse business cultures, require substantial time and expenses, and distract
management from other business matters. In addition, this acquisition includes
significant intangible assets that are subject to periodic impairment testing
which could result in substantial accounting charges. We have recently
discovered some integration issues related to the Partsbin acquisition that
were
largely related to lower than expected order fill rates from drop-ship vendors
in the fourth quarter of 2006 and lower pricing levels on our performance parts
and accessories product category in the first quarter of 2007, which negatively
impacted our gross margins during the first half of 2007. We cannot assure
you
that we will be able to adequately address these or other integration issues
related to this acquisition. If we are unable to complete the integration of
Partsbin in an efficient and timely manner, our business and operating results
will be harmed.
We
rely on a single provider for the majority of our outsourced call center
operations in the Philippines, and our net sales, profit margins and customer
satisfaction may decline if this relationship is
terminated.
In
connection with our acquisition of Partsbin, we expanded our outsourced call
center operations in the Philippines and rely on a single provider for
substantially all of such operations. In April 2007, we entered into a contract
with such outsourced provider to transition many of their employees to us.
This
resulted in a payment by the Company to acquire this assembled workforce of
approximately $1.7 million. Under the terms of the agreement, approximately
182
of the provider’s employees were given the opportunity to become U.S. Auto Parts
employees. As of June 30, 2007, 171 of these employees had transitioned over
to
direct employment by our Philippines subsidiary. In addition, we have entered
into an agreement to lease workstations in the provider’s facility in the
Philippines for a period of six months. We expect this transition will
ultimately result in lower operating costs to us once complete, but we cannot
assure you that we will be able to transition the employees on a timely basis,
or at a reasonable cost. Any delay or decline in service by this provider or
the
termination of this relationship could harm our reputation, result in a
significant decline in our net sales and increase our operating
expenses.
We
face intense competition and operate in an industry with limited barriers to
entry, and some of our competitors may have greater resources than us and may
be
better positioned to capitalize on the growing e-commerce auto parts
market.
The
auto
parts industry is competitive and highly fragmented, with products distributed
through multi-tiered and overlapping channels. We compete with both online
and
offline retailers who offer OEM and aftermarket auto parts to either the DIY
or
DIFM customer segments. Current or potential competitors include the
following:
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national
auto parts retailers such as Advance Auto Parts, AutoZone, CSK Auto,
Napa
Auto Parts, O’Reilly Automotive and Pep
Boys;
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large
online marketplaces such as Amazon.com and
eBay;
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local
independent retailers or niche auto parts online retailers;
and
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wholesale
auto parts distributors such as Keystone Automotive and LKQ
Corporation.
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Barriers
to entry are low, and current and new competitors can launch websites at a
relatively low cost. Many of our current and potential offline competitors
have
longer operating histories, larger customer bases, greater brand recognition
and
significantly greater financial, marketing, technical, management and other
resources than we do. In addition, some of our competitors have used and may
continue to use aggressive pricing tactics and devote substantially more
financial resources to website and system development than we do. We expect
that
competition will further intensify in the future as Internet use and online
commerce continue to grow worldwide. Increased competition may result in reduced
operating margins, reduced profitability, loss of market share and diminished
brand recognition.
We
would
also experience significant competitive pressure if any of our suppliers were
to
sell their products directly to customers. Since our suppliers have access
to
merchandise at very low costs, they could sell products at lower prices and
maintain higher gross margins on their product sales than we can. In this event,
our current and potential customers may decide to purchase directly from these
suppliers. Increased competition from any supplier capable of maintaining high
sales volumes and acquiring products at lower prices than us could significantly
reduce our market share and adversely impact our financial results.
We
rely on key personnel and may need additional personnel for the success and
growth of our business.
Our
business is largely dependent on the personal efforts and abilities of key
personnel including Mehran Nia, our Chief Executive Officer and President,
Howard Tong, our Chief Operating Officer, and Michael McClane, our Chief
Financial Officer, Executive Vice President of Finance, Treasurer and Secretary.
Messrs. Nia, Tong and McClane, as well as any of our other key employees, can
terminate their employment relationship with us at any time. We do not maintain
key person life insurance on any officer or employee. Our performance also
depends on our ability to identify, attract, retain and motivate highly skilled
technical, managerial, merchandising, marketing and customer service personnel.
Competition for such personnel is intense, and we cannot assure you that we
will
be successful in attracting and retaining such personnel. The loss of any key
employee or our inability to attract or retain other qualified employees could
harm our business and results of operations.
If
our product catalog database is stolen or misappropriated or if a competitor
is
able to create a substantially similar catalog without infringing our rights,
then we may lose an important competitive advantage.
We
have
invested significant resources and time to build and maintain our product
catalog, which is maintained in the form of an electronic database, and maps
SKUs to relevant product applications based on vehicle makes, models and years.
We believe that our product catalog provides us with an important competitive
advantage in both driving traffic to our websites and converting that traffic
to
revenue by enabling customers to quickly locate the products they require.
We
cannot assure you that we can protect our product catalog from unauthorized
copying or theft by a third party. In addition, it is possible that a competitor
could develop a catalog or database that is similar to or more comprehensive
than ours, without infringing our rights. In the event our product catalog
is
stolen, copied or otherwise replicated by a competitor, whether lawfully or
not,
we may lose an important competitive advantage and our business could be
harmed.
Our
future operating results may fluctuate and may fail to meet market expectations,
which could adversely affect the market price of our common
stock.
We
expect
that our revenue and operating results will continue to fluctuate from quarter
to quarter due to various factors, many of which are beyond our control. If
our
quarterly revenue or operating results fall below the expectations of investors
or securities analysts, the price of our common stock could significantly
decline. In March 2007, our stock price recently decreased by approximately
45%
following our announcement that our financial results for the quarter ended
December 31, 2006 did not meet analysts’ expectations. The factors that
could cause our operating results to continue to fluctuate include, but are
not
limited to:
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fluctuations
in the demand for aftermarket auto
parts;
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price
competition on the Internet or among offline retailers for auto
parts;
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our
ability to attract visitors to our websites and convert those visitors
into customers;
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our
ability to maintain and expand our supplier and distribution
relationships;
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the
effects of seasonality on the demand for our
products;
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our
ability to accurately forecast demand for our products, price our
products
at market rates and maintain appropriate inventory
levels;
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our
ability to build and maintain customer
loyalty;
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the
success of our brand-building and marketing
campaigns;
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government
regulations related to use of the Internet for commerce, including
the
application of existing tax regulations to Internet commerce and
changes
in tax regulations;
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technical
difficulties, system downtime or Internet brownouts;
and
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the
amount and timing of operating costs and capital expenditures relating
to
expansion of our business, operations and
infrastructure.
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Economic
conditions may have an adverse effect on the demand for aftermarket auto parts
and could adversely affect our sales and operating
results.
We
sell
aftermarket auto parts consisting of body and engine parts used for repair
and
maintenance, performance parts used to enhance performance or improve aesthetics
and accessories that increase functionality or enhance a vehicle’s features.
Demand for our products may be adversely affected by general economic
conditions. In declining economies, consumers often defer regular vehicle
maintenance and may forego purchases of nonessential performance products,
which
can result in a decrease in demand for auto parts in general. In expanding
economies, consumers may be more likely to purchase new vehicles instead of
repairing existing vehicles or they may be less price sensitive, leading to
an
increase in OEM parts sales at dealerships, either of which could also result
in
a decline in our sales. If such decreases in demand for our products are not
offset by other factors, such as the deferral of new car purchases in declining
economies, which may result in more required repairs for older vehicles, or
the
purchase of performance parts and accessories in expanding economies, our
financial condition and results of operations would suffer.
If
we are unable to manage the challenges associated with our international
operations, the growth of our business could be limited and our business could
suffer.
We
maintain business operations in the United States and the Philippines and an
outsourced call center in India. These international operations include
development and maintenance of our websites, software development, enhancements
of our online marketing technologies, and sales and customer support services.
We also operate a Canadian subsidiary to facilitate sales in Canada. We are
subject to a number of risks and challenges that specifically relate to our
international operations. Our international operations may not be successful
if
we are unable to meet and overcome these challenges, which could limit the
growth of our business and may have an adverse effect on our business and
operating results. These risks and challenges include:
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difficulties
and costs of staffing and managing foreign
operations;
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restrictions
imposed by local labor practices and laws on our business and
operations;
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exposure
to different business practices and legal
standards;
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unexpected
changes in regulatory requirements;
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the
imposition of government controls and
restrictions;
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political,
social and economic instability and the risk of war, terrorist activities
or other international incidents;
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natural
disasters and public health
emergencies;
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potentially
adverse tax consequences;
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the
failure of local laws to provide a sufficient degree of protection
against
infringement of our intellectual property;
and
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fluctuations
in foreign currency exchange rates.
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If
our fulfillment operations are interrupted for any significant period of time
or
are not sufficient to accommodate increased demand, our sales would decline
and
our reputation could be harmed.
Our
success depends on our ability to successfully receive and fulfill orders and
to
promptly deliver our products to our customers. The majority of orders for
our
body parts products are filled from our inventory in our distribution centers,
where all our inventory management, packaging, labeling and product return
processes are performed. Increased demand and other considerations may require
us to expand our distribution centers or transfer our fulfillment operations
to
larger facilities in the future.
Our
distribution centers are susceptible to damage or interruption from human error,
fire, flood, power loss, telecommunications failures, terrorist attacks, acts
of
war, break-ins, earthquakes and similar events. We do not currently maintain
back-up power systems at our fulfillment centers. We do not presently have
a
formal disaster recovery plan and our business interruption insurance may be
insufficient to compensate us for losses that may occur in the event operations
at our fulfillment center are interrupted. Any interruptions in our fulfillment
operations for any significant period of time, including interruptions resulting
from the expansion of our existing facilities or the transfer of operations
to a
new facility, could damage our reputation and brand and substantially harm
our
business and results of operations. In addition, if we do not successfully
expand our fulfillment capabilities in response to increases in demand, we
may
not be able to substantially increase our net sales.
We
are dependent upon third parties for distribution and fulfillment operations
with respect to many of our products.
For
a
number of the products that we sell, we outsource the distribution and
fulfillment operation and are dependent on our distributors to manage inventory,
process orders and distribute those products to our customers in a timely
manner. For the first six months of 2007, 11.6% of purchases were through a
single supplier. Our agreement with this supplier may be terminated at any
time
by either party, with written notice and the appropriate notice period. If
we do
not maintain our existing relationships with our distributors on acceptable
commercial terms, we will need to obtain other suppliers and may not be able
to
continue to offer a broad selection of merchandise at competitive prices, and
our sales may decrease.
In
addition, because we outsource to distributors a number of these traditional
retail functions relating to those products, we have limited control over how
and when orders are fulfilled. We also have limited control over the products
that our distributors purchase or keep in stock. Our distributors may not
accurately forecast the products that will be in high demand or they may
allocate popular products to other resellers, resulting in the unavailability
of
certain products for sale on our websites. Any inability to offer a broad array
of products at competitive prices and any failure to deliver those products
to
our customers in a timely and accurate manner may damage our reputation and
brand and could cause us to lose customers.
Our
ability to sustain or increase our profitability will suffer if we fail to
manage our growth effectively.
In
recent
years, we have experienced rapid growth that has placed, and will continue
to
place, pressures on our operational and financial infrastructure. Our workforce
has increased from 114 employees as of December 31, 2003 to 739 employees
as of June 30, 2007. Our net sales have increased from $31.7 million in 2003
to
$120.1 million in 2006 and to $85.9 million for the six months ended June 30,
2007. Our recent expansion and planned growth have placed, and are expected
to
continue to place, a strain on our infrastructure, operations and managerial
resources. We intend to further increase the size of our operations, and we
expect our operating expenses to increase, as we, among other
things:
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expand
our domestic and international
operations;
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increase
our technology and development efforts to enhance and maintain our
websites and technology
infrastructure;
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hire
additional personnel, including customer service specialists, sales
and
marketing professionals, and financial
professionals;
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upgrade
our operational and financial systems, procedures and controls;
and
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assume
the responsibilities and costs of being a public
company.
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Our
success depends upon our ability to manage our operations and our growth
effectively. To be successful, we will need to improve our operational and
financial systems, procedures and controls, maintain our cost structure at
appropriate levels, manage international operations, and hire additional
personnel. We cannot assure you that our efforts will be successful or that
we
can improve our systems, procedures and controls in a timely manner. Delays
or
problems associated with any improvements or expansion of our systems,
procedures and controls could harm our business and operating results. In
addition, we may fail to accurately estimate and assess our increased operating
expenses as we grow. As our operating expenses increase, we will need to grow
our revenue in order to maintain and increase our profitability.
If
we fail to offer a broad selection of products and brands at competitive prices
to meet our customers’ demands, our revenue could
decline.
In
order
to expand our business, we must successfully offer, on a continuous basis,
a
broad selection of auto parts that meet the needs of our customers. Our auto
parts are used by consumers for a variety of purposes, including repair,
performance, improved aesthetics and functionality. In addition, to be
successful, our product offerings must be broad and deep in scope, competitively
priced, well-made, innovative and attractive to a wide range of consumers.
We
cannot predict with certainty that we will be successful in offering products
that meet all of these requirements. If our product offerings fail to satisfy
our customers’ requirements or respond to changes in customer preferences, our
revenue could decline.
Future
acquisitions could disrupt our business and harm our financial
condition.
As
part
of our growth strategy, we expect that we will selectively pursue acquisitions
of businesses, technologies or services in order to expand our capabilities,
enter new markets or increase our market share. Integrating any newly acquired
businesses, technologies or services is likely to be expensive and time
consuming. For example, our acquisition of Partsbin has resulted in significant
costs and a number of challenges, including retaining employees of the acquired
company, integrating our order processing and credit processing, integrating
our
product pricing strategy, and integrating the diverse technologies and differing
e-commerce platforms and accounting systems used by each company. If we are
unable to successfully complete this integration, we may not realize the
synergies from the acquisition, and our business and results of operations
could
suffer. To finance any future acquisitions, it may also be necessary for us
to
raise additional capital through public or private financings. Additional funds
may not be available on terms that are favorable to us, and, in the case of
equity financings, would result in dilution to our stockholders. Future
acquisitions by us could also result in large and immediate write-offs,
assumption of debt and unforeseen liabilities and significant adverse accounting
charges, any of which could substantially harm our business, financial condition
and results of operations.
We
may be subject to liability for sales and other taxes and penalties, which
could
have an adverse effect on our business.
We
currently collect sales or other similar taxes only on the shipment of goods
to
the states of California, New Jersey and Tennessee. The U.S. Supreme Court
has
ruled that vendors whose only connection with customers in a state is by common
carrier or the U.S. mail are free from state-imposed duties to collect sales
and
use taxes in that state. However, states could seek to impose additional income
tax obligations or sales tax collection obligations on out-of-state companies
such as ours, which engage in or facilitate online commerce, based on their
interpretation of existing laws, including the Supreme Court ruling, or specific
facts relating to us. If sales tax obligations are successfully imposed upon
us
by a state or other jurisdiction, we could be exposed to substantial tax
liabilities for past sales and penalties and fines for failure to collect sales
taxes. We could also suffer decreased sales in that state or jurisdiction as
the
effective cost of purchasing goods from us increases for those residing in
that
state or jurisdiction.
In
addition, a number of states, as well as the U.S. Congress, have been
considering various initiatives that could limit or supersede the Supreme
Court’s apparent position regarding sales and use taxes on Internet sales. If
any of these initiatives are enacted, we could be required to collect sales
and
use taxes in additional states and our revenue could be adversely affected.
Furthermore, the U.S. Congress has not yet extended a moratorium, which was
first imposed in 1998 but has since expired, on state and local governments’
ability to impose new taxes on Internet access and Internet transactions. The
imposition by state and local governments of various taxes upon Internet
commerce could create administrative burdens for us as well as substantially
impair the growth of e-commerce and adversely affect our revenue and
profitability. Since our service is available over the Internet in multiple
states, these jurisdictions may require us to qualify to do business in these
states. If we fail to qualify in a jurisdiction that requires us to do so,
we
could face liabilities for taxes and penalties.
We
could be liable for breaches of security on our
websites.
A
fundamental requirement for e-commerce is the secure transmission of
confidential information over public networks. Anyone who is able to circumvent
our security measures could misappropriate proprietary information or cause
interruptions in our operations. Although we have developed systems and
processes that are designed to protect consumer information and prevent
fraudulent credit card transactions and other security breaches, failure to
mitigate such fraud or breaches may adversely affect our operating results.
We
may be required to expend significant capital and other resources to protect
against potential security breaches or to alleviate problems caused by any
breach. We rely on licensed encryption and authentication technology to provide
the security and authentication necessary for secure transmission of
confidential information, including credit card numbers. Advances in computer
capabilities, new discoveries in the field of cryptography, or other events
or
developments may result in a compromise or breach of the algorithms that we
use
to protect customer transaction data. In the event someone circumvents our
security measures, it could seriously harm our business and reputation and
we
could lose customers. Security breaches could also expose us to a risk of loss
or litigation and possible liability for failing to secure confidential customer
information.
The
success of our business depends on the continued growth of the Internet as
a
retail marketplace and the related expansion of the Internet
infrastructure.
Our
future success depends upon the continued and widespread acceptance and adoption
of the Internet as a vehicle to purchase products. If customers or manufacturers
are unwilling to use the Internet to conduct business and exchange information,
our business will fail. The commercial acceptance and use of the Internet may
not continue to develop at historical rates, or may not develop as quickly
as we
expect. The growth of the Internet, and in turn the growth of our business,
may
be inhibited by concerns over privacy and security, including concerns regarding
“viruses” and “worms,” reliability issues arising from outages or damage to
Internet infrastructure, delays in development or adoption of new standards
and
protocols to handle the demands of increased Internet activity, decreased
accessibility, increased government regulation, and taxation of Internet
activity. In addition, our business growth may be adversely affected if the
Internet infrastructure does not keep pace with the growing Internet activity
and is unable to support the demands placed upon it, or if there is any delay
in
the development of enabling technologies and performance
improvements.
If
we do not respond to technological change, our websites could become obsolete
and our financial results and conditions could be adversely
affected.
We
maintain a network of websites which requires substantial development and
maintenance efforts and entails significant technical and business risks. To
remain competitive, we must continue to enhance and improve the responsiveness,
functionality and features of our websites. The Internet and the e-commerce
industry are characterized by rapid technological change, the emergence of
new
industry standards and practices and changes in customer requirements and
preferences. Therefore, we may be required to license emerging technologies,
enhance our existing websites, develop new services and technology that address
the increasingly sophisticated and varied needs of our current and prospective
customers, and adapt to technological advances and emerging industry and
regulatory standards and practices in a cost-effective and timely manner. Our
ability to remain technologically competitive may require substantial
expenditures and lead time and our failure to do so may harm our business and
results of operations.
System
failures, including failures due to natural disasters or other catastrophic
events, could prevent access to our websites, which could reduce our net sales
and harm our reputation.
Our
sales
would decline and we could lose existing or potential customers if they are
not
able to access our websites or if our websites, transaction processing systems
or network infrastructure do not perform to our customers’ satisfaction. Any
Internet network interruptions or problems with our websites could:
|
|
•
|
prevent
customers from accessing our
websites;
|
|
|
•
|
reduce
our ability to fulfill orders or bill
customers;
|
|
|
•
|
reduce
the number of products that we
sell;
|
|
|
•
|
cause
customer dissatisfaction; or
|
|
|
•
|
damage
our brand and reputation.
|
We
have
experienced brief computer system interruptions in the past, and we believe
they
will continue to occur from time to time in the future. Our systems and
operations are also vulnerable to damage or interruption from a number of
sources, including a natural disaster or other catastrophic event such as an
earthquake, typhoon, volcanic eruption, fire, flood, terrorist attack, power
loss, telecommunications failure, physical and electronic break-ins and other
similar events. For example, our headquarters and the majority of our
infrastructure, including some of our servers, are located in Southern
California, a seismically active region. We also maintain offshore and
outsourced operations in the Philippines, an area that was recently subjected
to
a typhoon and a volcanic eruption. In addition, California has in the past
experienced power outages as a result of limited electrical power supplies.
Such
outages, natural disasters and similar events may recur in the future and could
disrupt the operation of our business. Our technology infrastructure is also
vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions. Although the critical portions of our systems are redundant and
backup copies are maintained offsite, not all of our systems and data are fully
redundant. We do not presently have a formal disaster recovery plan in effect
and may not have sufficient insurance for losses that may occur from natural
disasters or catastrophic events. Any substantial disruption of our technology
infrastructure could cause interruptions or delays in our business and loss
of
data or render us unable to accept and fulfill customer orders or operate our
websites in a timely manner, or at all.
Capacity
constraints on our technology infrastructure would harm our business, prospects,
results of operations and financial condition.
If
the
volume of traffic on our websites or the number of purchases made by customers
increases substantially, we may need to further expand and upgrade our
technology, transaction processing systems and network infrastructure. Capacity
constraints can cause unanticipated system disruptions, slower response times,
degradation in levels of customer service, impaired quality and delays in
reporting accurate financial information.
We
may be
unable to project accurately the rate or timing of traffic increases or
successfully and cost-effectively upgrade our systems and infrastructure in
time
to accommodate future traffic levels on our websites. Any such upgrades to
our
systems and infrastructure will require substantial expenditures. In addition,
we may be unable to upgrade and expand our transaction processing systems in
an
effective and timely manner or to integrate any newly developed or purchased
functionality with our existing systems. Any inability to efficiently upgrade
our systems and infrastructure in a timely manner to account for such growth
and
integrations may cause unanticipated system disruptions, slower response times,
degradation in levels of customer service, impaired quality, delayed order
fulfillment, any of which could result in a decline in our sales and harm our
reputation.
We
depend on third-party delivery services to deliver our products to our customers
on a timely and consistent basis, and any deterioration in our relationship
with
any one of these third parties or increases in the fees that they charge could
adversely affect our business and financial
condition.
We
rely
on third parties for the shipment of our products and we cannot be sure that
these relationships will continue on terms favorable to us, or at all. Increases
in shipping costs could harm our business, prospects, financial condition and
results of operations by increasing our costs of doing business and resulting
in
reduced gross margins. Our average cost per shipment with our primary carrier
increased in January 2007. In addition, if our relationships with these third
parties are terminated or impaired, or if these third parties are unable to
deliver products for us, whether through labor shortage, slow down or stoppage,
deteriorating financial or business condition, responses to terrorist attacks
or
for any other reason, we would be required to use alternative carriers for
the
shipment of products to our customers. Changing carriers could have a negative
effect on our business and operating results due to reduced visibility of order
status and package tracking and delays in order processing and product delivery,
and we may be unable to engage alternative carriers on a timely basis, upon
terms favorable to us, or at all.
We
face exposure to product liability lawsuits.
The
automotive industry in general has been subject to a large number of product
liability claims due to the nature of personal injuries that result from car
accidents or malfunctions. As a distributor of auto parts, we could be held
liable for the injury or damage caused if the products we sell are defective
or
malfunction. While we carry insurance against product liability claims, if
the
damages in any given action were high or we were subject to multiple lawsuits,
the damages and costs could exceed the limits of our insurance coverage. If
we
were required to pay substantial damages as a result of these lawsuits, it
may
seriously harm our business and financial condition. Even defending against
unsuccessful claims could cause us to incur significant expenses and result
in a
diversion of management’s attention. In addition, even if the money damages
themselves did not cause substantial harm to our business, the damage to our
reputation and the brands offered on our websites could adversely affect our
future reputation and our brand, and could result in a decline in our net sales
and profitability.
If
we fail to maintain an effective system of internal control over financial
reporting or are not able to adequately address certain identified material
weaknesses in our system of internal controls or comply with Section 404 of
the Sarbanes-Oxley Act of 2002, we may not be able to accurately report our
financial results or prevent fraud, and our stock price could
decline.
Our
auditors have identified certain material weaknesses in our system of internal
control over financial reporting that are primarily related to our need to
hire
additional financial and accounting employees, as well as our need to upgrade
our accounting systems and improve our documentation of our key assumptions,
estimates, accounting policies and procedures. We have also experienced certain
deficiencies that we believe are related to our integration of Partsbin,
including the credit processing and pricing functions. If we fail to adequately
address these material weaknesses and are not able to staff our accounting
and
finance department with the appropriate complement of experienced employees,
we
may not be able to improve our system of internal control over financial
reporting to comply with the reporting requirements applicable to public
companies in the United States. Furthermore, it is possible that we or our
auditors will identify additional material weaknesses or significant
deficiencies in the future in our system of internal control over financial
reporting. Our failure to address any deficiencies or weaknesses in our internal
control over financial reporting or to properly maintain an effective system
of
internal control over financial reporting could impact our ability to prevent
fraud or to issue our financial statements in a timely manner that presents
fairly our financial condition and results of operations. The existence of
any
such deficiencies or weaknesses, even if cured, may also lead to the loss of
investor confidence in the reliability of our financial statements, could harm
our business and negatively impact the trading price of our common stock. Such
deficiencies or material weaknesses may also subject us to lawsuits,
investigations and other penalties.
In
addition, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to
evaluate and report on our internal control over financial reporting beginning
with our Annual Report on Form 10-K for the year ending December 31, 2007,
and have our independent auditors attest to our evaluation, beginning with
our
Annual Report on Form 10-K for the year ending December 31, 2008. We have
prepared an internal plan of action for compliance with Section 404 and for
strengthening and testing our system of internal control to provide the basis
for our report, but we cannot assure you that this plan of action will be
sufficient to meet the rigorous requirements of Section 404, and our
independent auditors may issue an adverse opinion regarding management’s
assessment of Section 404 compliance. Our failure to comply with
Section 404 or our reporting requirements would reduce investors’
confidence in our financial statements and harm our stock price and could
subject us to a variety of administrative sanctions, including the suspension
or
delisting of our common stock from the NASDAQ Global Market and the inability
of
registered broker/dealers to make a market in our common stock, which could
also
reduce our stock price.
Existing
or future government regulation could expose us to liabilities and costly
changes in our business operations and could reduce customer demand for our
products and services.
We
are
subject to federal and state consumer protection laws and regulations, including
laws protecting the privacy of customer non-public information and regulations
prohibiting unfair and deceptive trade practices, as well as laws and
regulations governing businesses in general and the Internet and e-commerce.
Additional laws and regulations may be adopted with respect to the Internet,
the
effect of which on e-commerce is uncertain. These laws may cover issues such
as
user privacy, spyware and the tracking of consumer activities, marketing e-mails
and communications, other advertising and promotional practices, money
transfers, pricing, content and quality of products and services, taxation,
electronic contracts and other communications, intellectual property rights,
and
information security. Furthermore, it is not clear how existing laws such as
those governing issues such as property ownership, sales and other taxes,
trespass, data mining and collection, and personal privacy apply to the Internet
and e-commerce. To the extent we expand into international markets, we will
be
faced with complying with local laws and regulations, some of which may be
materially different than U.S. laws and regulations. Any such foreign law or
regulation, any new U.S. law or regulation, or the interpretation or application
of existing laws and regulations to the Internet or other online services,
may
have a material adverse effect on our business, prospects, financial condition
and results of operations by, among other things, impeding the growth of the
Internet, subjecting us to fines, penalties, damages or other liabilities,
requiring costly changes in our business operations and practices, and reducing
customer demand for our products and services. We do not maintain insurance
coverage to cover the types of claims or liabilities that could arise as a
result of such regulation.
If
we are unable to protect our intellectual property rights, our reputation and
brand could be impaired and we could lose customers.
We
regard
our trademarks, trade secrets and similar intellectual property as important
to
our success. We rely on trademark and copyright law, and trade secret
protection, and confidentiality and/or license agreements with employees,
customers, partners and others to protect our proprietary rights. We cannot
be
certain that we have taken adequate steps to protect our proprietary rights,
especially in countries where the laws may not protect our rights as fully
as in
the United States. In addition, third parties may infringe or misappropriate
our
proprietary rights, and we could be required to incur significant expenses
to
preserve them. We have common law trademarks, as well as pending federal
trademark registrations for several marks. Even if we obtain approval of such
pending registrations, the resulting registrations may not adequately cover
our
inventions or protect us against infringement by others. Effective trademark,
service mark, copyright, patent and trade secret protection may not be available
in every country in which our products and services may be made available
online. We also currently own or control a number of Internet domain names,
including www.usautoparts.net, www.partstrain.com and
www.autopartswarehouse.com. We may be unable to protect these domain
names or acquire or maintain relevant domain names in the United States and
in
other countries. If we are not able to protect our trademarks, domain names
or
other intellectual property, we may experience difficulties in achieving and
maintaining brand recognition and customer loyalty.
Our
e-commerce system is dependent on open-source software, which exposes us to
uncertainty and potential liability.
We
utilize open-source software such as Linux, Apache, MySQL, PHP, Fedora and
Perl
throughout our web properties and supporting infrastructure. Open-source
software is maintained and upgraded by a general community of software
developers under various open-source licenses, including the GNU General Public
License, or GPL. These developers are under no obligation to maintain, enhance
or provide any fixes or updates to this software in the future. Additionally,
under the terms of the GPL and other open-source licenses, we may be forced
to
release to the public source-code internally developed by us pursuant to such
licenses. Furthermore, if any of these developers contribute any code of others
to any of the software that we use, we may be exposed to claims and liability
for intellectual property infringement. A number of lawsuits are currently
pending against third parties over the ownership rights to the various
components within some open-source software that we use. If the outcome of
these
lawsuits is unfavorable, we may be held liable for intellectual property
infringement based on our use of these open-source software components. We
may
also be forced to implement changes to the code-base for this software or
replace this software with internally developed or commercially licensed
software.
We
rely on bandwidth and data center providers and other third parties to provide
products to our customers, and any failure or interruption in the services
provided by these third parties could disrupt our business and cause us to
lose
customers.
We
rely
on third-party vendors, including data center and bandwidth providers. Any
disruption in the network access or co-location services, which are the services
that house and provide Internet access to our servers, provided by these
third-party providers or any failure of these third-party providers to handle
current or higher volumes of use could significantly harm our business. Any
financial or other difficulties our providers face may have negative effects
on
our business, the nature and extent of which we cannot predict. We exercise
little control over these third-party vendors, which increases our vulnerability
to problems with the services they provide. We also license technology and
related databases from third parties to facilitate elements of our e-commerce
platform. We have experienced and expect to continue to experience interruptions
and delays in service and availability for these elements. Any errors, failures,
interruptions or delays experienced in connection with these third-party
technologies could negatively impact our relationship with our customers and
adversely affect our business.
Our
systems also heavily depend on the availability of electricity, which also
comes
from third-party providers. If we were to experience a major power outage,
we
would have to rely on back-up generators. These back-up generators may not
operate properly through a major power outage, and their fuel supply could
also
be inadequate during a major power outage. Information systems such as ours
may
be disrupted by even brief power outages, or by the fluctuations in power
resulting from switches to and from backup generators. This could disrupt our
business and cause us to lose customers.
The
United States government may substantially increase border controls and impose
restrictions on cross-border commerce that may substantially harm our
business.
We
purchase a substantial portion of our products from foreign manufacturers and
other suppliers who source products internationally. Restrictions on shipping
goods into the United States from other countries pose a substantial risk to
our
business. Particularly since the terrorist attacks on September 11, 2001,
the United States government has substantially increased border surveillance
and
controls. If the United States were to impose further border controls and
restrictions, impose quotas, tariffs or import duties, increase the
documentation requirements applicable to cross border shipments or take other
actions that have the effect of restricting the flow of goods from other
countries to the United States, we may have greater difficulty acquiring our
inventory in a timely manner, experience shipping delays, or incur increased
costs and expenses, all of which would substantially harm our business and
results of operations.
Our
stock price has been and may continue to be volatile, which may result in losses
to our stockholders.
The
market prices of technology and e-commerce companies generally have been
extremely volatile and have recently experienced sharp share price and trading
volume changes. The trading price of our common stock is likely to be volatile
and could fluctuate widely in response to, among other things, the risk factors
described in this report and other factors beyond our control such as
fluctuations in the operations or valuations of companies perceived by investors
to be comparable to us, our ability to meet analysts’ expectations, or
conditions or trends in the Internet or auto parts industries.
Since
the
completion of our initial public offering in February 2007, the trading price
of
our common stock has been volatile, declining from a high closing sales price
of
$12.49 per share to a low closing sales price per share of $5.12. We have also
experienced significant fluctuations in the trading volume of our common stock.
General economic and political conditions unrelated to our performance, may
also
adversely affect the price of our common stock. In the past, following periods
of volatility in the market price of a public company’s securities, securities
class action litigation has often been initiated. Recently, we and certain
of
our officers and directors have been served with three complaints associated
with a class action lawsuit alleging violations of federal securities law in
connection with our initial public offering, which could subject us to
significant costs and liability.
Our
executive officers and directors own a significant percentage of our
stock.
As
of the
closing of our initial public offering in February 2007, our executive officers
and directors and entities that are affiliated with them beneficially owned
approximately 57.2% of our outstanding shares of common stock. This significant
concentration of share ownership may adversely affect the trading price for
our
common stock because investors often perceive disadvantages in owning stock
in
companies with controlling stockholders. Also, these stockholders, acting
together, will be able to control our management and affairs and matters
requiring stockholder approval including the election of our entire board of
directors and certain significant corporate actions such as mergers,
consolidations or the sale of substantially all of our assets. As a result,
this
concentration of ownership could delay, defer or prevent others from initiating
a potential merger, takeover or other change in our control, even if these
actions would benefit our other stockholders and us.
A
large number of additional shares may be sold into the public market in the
near
future, which may cause the market price of our common stock to decline
significantly, even if our business is doing well.
Sales
of
a substantial amount of common stock in the public market, or the perception
that these sales may occur, could adversely affect the market price of our
common stock. As of the closing of our initial public offering in February
2007,
we had 29,832,927 shares of common stock outstanding, of which the 11,500,000
shares we and the selling stockholders sold in such offering may be resold
in
the public market immediately. The remaining outstanding shares are all subject
to lock-up agreements with the underwriters for our initial public offering
and
with us. Pursuant to such agreements, of these remaining shares, 6,649,618
shares will become available for resale in the public market 12 months after
the
date of effectiveness of the registration statement filed with respect to such
offering and 11,683,309 shares will become available for resale in the public
market 18 months after such date. However, we and the underwriters can waive
the
lock-up restriction and allow these stockholders to sell their shares at any
time, subject to applicable securities law and limitations. As restrictions
on
resale end, the market price could drop significantly if the holders of these
restricted shares sell them or are perceived by the market as intending to
sell
them.
We
will incur increased costs and compliance risks as a result of being a public
company.
We
completed our initial public offering in February 2007. As a public company,
we
expect to incur significant legal, accounting and other expenses that we did
not
incur as a private company. These expenses are associated with our public
company reporting requirements and certain corporate governance requirements,
including requirements under the Sarbanes-Oxley Act of 2002 and the new rules
implemented by the SEC and the NASDAQ Stock Market. We expect that compliance
with these rules and regulations, in particular Section 404 of the
Sarbanes-Oxley Act of 2002, will substantially increase our legal and financial
compliance costs and will likely require us to hire additional personnel and/or
consultants. Like many smaller public companies, we expect to face a significant
impact from required compliance with Section 404 of the Sarbanes-Oxley Act
of 2002. The process of strengthening our internal control and complying with
Section 404 will be expensive and time consuming, and will require
significant time and attention from our management team. We are currently
evaluating and monitoring developments with respect to these new rules, and
we
cannot predict or estimate the amount of additional costs we may incur or the
timing of such costs.
We
also
expect these new rules and regulations may make it more difficult and more
expensive for us to obtain director and officer liability insurance and we
may
be required to accept reduced policy limits and coverage or incur substantially
higher costs to obtain the same or similar coverage. As a result, it may be
more
difficult for us to attract and retain qualified individuals to serve on our
board of directors or as executive officers.
We
do not intend to pay dividends on our common stock.
We
currently intend to retain any future earnings and do not expect to pay any
cash
dividends on our capital stock for the foreseeable future.
Our
charter documents could deter a takeover effort, which could inhibit your
ability to receive an acquisition premium for your
shares.
Provisions
in our certificate of incorporation and bylaws could make it more difficult
for
a third party to acquire us, even if doing so would be beneficial to our
stockholders. Such provisions include the following:
|
|
•
|
our
board of directors are authorized, without prior stockholder approval,
to
create and issue preferred stock which could be used to implement
anti-takeover devices;
|
|
|
•
|
advance
notice is required for director nominations or for proposals that
can be
acted upon at stockholder meetings;
|
|
|
•
|
our
board of directors is classified such that not all members of our
board
are elected at one time, which may make it more difficult for a person
who
acquires control of a majority of our outstanding voting stock to
replace
all or a majority of our directors;
|
|
|
•
|
stockholder
action by written consent is prohibited except with regards to an
action
that has been approved by the
board;
|
|
|
•
|
special
meetings of the stockholders are permitted to be called only by the
chairman of our board of directors, our chief executive officer or
by a
majority of our board of directors;
|
|
|
•
|
stockholders
are not be permitted to cumulate their votes for the election of
directors; and
|
|
|
•
|
stockholders
are permitted to amend certain provisions of our bylaws only upon
receiving at least 66 2/3% of the votes entitled to be cast by holders
of
all outstanding shares then entitled to vote generally in the election
of
directors, voting together as a single
class.
|
|
ITEM 2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
|
|
Sales
of Unregistered Securities
|
None.
Use
of Proceeds from Sales of Registered Securities
On
February 14, 2007, we completed the initial public offering of our common
stock, pursuant to which we sold 8,000,000 shares of our common stock and the
selling stockholders sold an aggregate of 3,500,000 shares of our common stock
(which included 1,500,000 shares sold by the selling stockholders pursuant
to
the exercise of the underwriters’ over-allotment option) at the initial public
offering price of $10.00 per share. The shares of common stock sold in the
offering were registered under the Securities Act on a registration statement
on
Form S-1 (File. No. 333-138379) that was declared effective by the SEC on
February 8, 2007.
The
aggregate purchase price of the shares sold by us in the offering was $80.0
million. The aggregate purchase price of the shares sold by the selling
stockholders was $35.0 million. We and the selling stockholders paid to the
underwriters underwriting discounts and commissions totaling $5.6 million and
$2.5 million, respectively, in connection with the offering. In addition, we
incurred offering costs of approximately $2.9 million in connection with the
offering. After deducting the underwriting discounts and commissions and
offering expenses, we received net proceeds from the offering of approximately
$71.5 million. We did not receive any proceeds from the sale of shares by the
selling stockholders.
Approximately
$28.0 million of the net proceeds from the offering was used to repay our
outstanding indebtedness under two term loans for approximately $18.0 million
and $10.0 million, payable to our commercial lender. In addition, $4.0 million
of the net proceeds from the offering has been paid on the notes payable to
the
former stockholders of Partsbin, including Richard Pine, one of our directors
and who is also an officer. Except for the payment of such debt, none of the
net
proceeds from the offering were paid directly or indirectly to any of our
directors or officers (or their associates) or persons owning ten percent or
more of any class of our equity securities or to any other affiliate, other
than
in the form of wages or salaries and bonuses paid out in the ordinary course
of
business. The remaining net proceeds from the offering have been invested in
money market accounts. We will retain broad discretion over the use of the
net
proceeds received from our initial public offering. The amount and timing of
our
actual expenditures may vary significantly depending on a number of factors,
including the growth of our sales and customer base, the type of efforts we
make
to build our brand and competitive developments in e-commerce. For the period
ending June 30, 2007 we did not make any business acquisition that would require
use of such proceeds.
|
ITEM 3.
|
Defaults
Upon Senior Securities.
|
None.
|
ITEM 4.
|
Submission
of Matters to a Vote of Security
Holders
|
Our
Annual Meeting of Stockholders was held on June 22, 2007. The
following two items were voted on and approved at the Annual
Meeting:
|
(i)
|
Election
of two Class 1 directors to hold office for the term of three years
or
until their respective successor is elected and qualified. The
nominees for election were:
|
|
Nominee
|
Votes
For
|
Votes
Withheld
|
||||
|
Mehran
Nia
|
27,088,826
|
1,146,526
|
||||
|
Ellen
F. Siminoff
|
28,116,738
|
118,616
|
The
Company’s directors whose terms
continued after the Annual Meeting are:
|
·
|
Robert
J. Majteles
|
|
·
|
Sol
Khazani
|
|
·
|
Fredric
W. Harman
|
|
·
|
Richard
Pine
|
|
(ii)
|
Ratify
the appointment of Ernst & Young LLP as our independent registered
public accounting firm for the fiscal year ending December 31,
2007.
|
|
Votes
|
|||
|
For
|
28,208,353
|
||
|
Against
|
26,001
|
||
|
Abstain
|
1,000
|
||
|
Broker
Non-Votes
|
—
|
|
ITEM 5.
|
Other
Information
|
None.
|
ITEM 6.
|
Exhibits
|
|
(a)
|
Exhibits
|
The
following exhibits are filed herewith.
| Exhibit No. | Description |
|
10.1
|
Lease
Agreements, dated August 8, 2007, by and among MBS Tek Corporation
and
Roshan Commercial Corp.
|
|
10.2
|
Form
of Suppliers' Agreement entered into between U.S. Auto Parts Network,
Inc.
and certain of its U.S. based suppliers and primary drop-ship
vendors
|
|
31.1
|
Certification
of the principal executive officer required by Rule 13a-14(a) or
15d-14(a)
of the Securities Exchange Act of 1934, as amended
|
|
31.2
|
Certification
of the principal financial officer required by Rule 13a-14(a) or
15d-14(a)
of the Securities Exchange Act of 1934, as amended
|
|
32.1
|
Certification
of the Chief Executive Officer required by 18 U.S.C. Section 1350,
as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
32.2
|
Certification
of the Chief Financial Officer required by 18 U.S.C. Section 1350,
as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
Dated:
August 14, 2007
|
|
U.S.
AUTO PARTS NETWORK, INC.
|
||
|
|
|
|
(Registrant)
|
|
|
|
|
|
By
|
/s/
MEHRAN NIA
|
|
|
|
|
|
Mehran
Nia,
|
|
|
|
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
By
|
/s/
MICHAEL J. McCLANE
|
|
|
|
|
|
Michael
J. McClane,
|
|
|
|
|
|
Chief
Financial Officer
|
|
|
|
|
|
(Principal
Accounting Officer)
|
EXHIBIT
INDEX
| Exhibit No. | Description |
|
10.1
|
Lease
Agreements, dated August 8, 2007, by and among MBS Tek Corporation
and
Roshan Commercial Corp.
|
| 10.2 | Form of Suppliers’ Agreement entered into between U.S. Auto Parts Network, Inc. and certain of its U.S. based suppliers and primary drop-ship vendors |
|
31.1
|
Certification
of the principal executive officer required by Rule 13a-14(a) or
15d-14(a)
of the Securities Exchange Act of 1934, as amended
|
|
31.2
|
Certification
of the principal financial officer required by Rule 13a-14(a) or
15d-14(a)
of the Securities Exchange Act of 1934, as amended
|
|
32.1
|
Certification
of the Chief Executive Officer required by 18 U.S.C. Section 1350,
as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
32.2
|
Certification
of the Chief Financial Officer required by 18 U.S.C. Section 1350,
as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|