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 September 30, 2007 and December 31, 2006, and the consolidated
results of operations for the three and nine months ended September 30, 2007
and
2006, and cash flows for the nine months ended September 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 nine months ended September 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 accordance with 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
The
Company has historically experienced seasonality in its business. The Company
expects seasonality to continue in future years as automobile collisions
during
inclement weather generally create increased demand for auto body parts in
winter months and consumers often undertake projects to maintain and enhance
the
performance of their automobiles in the summer months. The Company anticipates
that seasonality will continue to have a material impact on its financial
condition and results of operations during any given year.
Note
2 – Investments in Marketable Securities
Investments
in marketable securities
are mainly comprised of Auction Rate Securities (“ARS”). The
underlying ARS are taxed exempt municipal bonds. In accordance with
SFAS No. 115, “Accounting for Certain Investments in Debt and Equity
Securities,” and based on the Company’s ability to market and
sell these instruments, the Company classifies ARS as available-for-sale
and
carries them at amortized cost, which approximates fair value.
During
the three months ended September 30, 2007, the carrying amount of the investment
in ARS’s approximated fair value due to the rapid turnover of the portfolio and
the highly liquid nature of these investments. Therefore, there were
no significant unrealized holding gains or losses.
Note 3—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 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 many of 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 September 30, 2007 and December 31, 2006 were
as follows:
|
|
September
30,
2007
|
|
December 31,
2006
|
|
|
(unaudited)
|
|
|
|
|
(in
thousands)
|
Gross
inventory
|
|
$ |
12,450
|
|
$ |
9,488
|
Inventory
reserves
|
|
|
(507) |
|
|
(692) |
Total
net
inventory
|
|
$ |
11,943
|
|
$ |
8,796
|
Note 4—Acquisition
On
May 19, 2006, the Company acquired substantially all of the assets and
liabilities 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. 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
September 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 has been 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 5—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 6 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 and $2.1 million for the three
months, and $6.3 million and $3.0 million for the nine months ended September
30, 2007 and 2006, respectively.
Intangibles,
excluding goodwill, consisted of the following at September 30, 2007 and
December 31, 2006:
|
|
|
September
30, 2007
(unaudited)
|
|
|
December
31, 2006
|
|
Useful
Life
|
|
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
years
|
|
$ |
28,988
|
|
|
$ |
(7,917 |
) |
|
$ |
21,071
|
|
|
$ |
28,988
|
|
|
$ |
(3,569 |
) |
|
$ |
25,419
|
Software
|
2
-
5 years
|
|
|
4,089
|
|
|
|
(1,861 |
) |
|
|
2,228
|
|
|
|
4,089
|
|
|
|
(839 |
) |
|
|
3,250
|
Vendor
agreements
|
3 years
|
|
|
2,996
|
|
|
|
(1,364 |
) |
|
|
1,632
|
|
|
|
2,996
|
|
|
|
(614 |
) |
|
|
2,382
|
Assembled
workforce
|
7 years
|
|
|
1,319
|
|
|
|
(93 |
) |
|
|
1,226
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
Purchased
domain names
|
3 years
|
|
|
165
|
|
|
|
(123 |
) |
|
|
42
|
|
|
|
165
|
|
|
|
(84 |
) |
|
|
81
|
|
|
|
|
37,557
|
|
|
|
(11,358 |
) |
|
|
26,199
|
|
|
|
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
|
|
|
$ |
39,787
|
|
|
$ |
(11,358 |
) |
|
$ |
28,429
|
|
|
$ |
38,468
|
|
|
$ |
(5,106 |
) |
|
$ |
33,362
|
Note 6—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 properly account for 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, “assembled workforce,” with a fair value of $1.3 million and
an estimated useful life of seven years. The remaining $400,000 of
the purchase price 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 after the closing date.
Note 7—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, with the exception of the items noted below. 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 trucks (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 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 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. 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.
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.
On
August
23, 2007, the Company also appealed to the United States Court of Appeals
for
the Federal Circuit, seeking a review and reversal of the portion of the
Commission’s March 20, 2007, Final Determination finding a violation of Section
337. Ford’s Petition for Review and the Company’s appeal have been
consolidated and are currently pending before the United States Court of
Appeals
for the Federal Circuit. Due to the inherent uncertainties of litigation,
the
Company cannot predict the ultimate outcome of the litigation. An
unfavorable result could have a material adverse effect on the
Company. However, the Company believes the potential liability is not
probable or reasonably estimatable and has recorded no amount related to
this
matter as of September 30, 2007.
Securities
Litigation
On
March
24, 2007, a putative stockholder class action lawsuit was filed against the
Company and certain officers, directors and underwriters 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. A
lead plaintiff was selected on August 9, 2007. The amended
consolidated complaint was filed on October 4, 2007, alleging violations
of
Sections 11, 12(a)(2) and 15 of the Securities Act. The amended
complaint is against the Company and certain current and former officers,
as
well as Oak Investment Partners XI, LP, and the underwriters involved in
the
initial public offering. The amended consolidated complaint alleges that
the Company’s Registration Statement failed to disclose material information and
misstated the Company’s financial results. Plaintiffs seek
compensatory damages, restitution, unspecified equitable relief, as well
as
attorneys’ fees and costs. Defendants filed a motion to dismiss the
amended consolidated complaint on October 31, 2007. The hearing on
the motion to dismiss is scheduled on December 20, 2007. Defendants
believe they have meritorious defenses and intend to vigorously defend the
lawsuit. Due to the inherent uncertainties of litigation, the Company
cannot predict the ultimate outcome of the litigation. An unfavorable
result could have a material adverse effect on the Company. However,
the Company believes the potential liability is not probable or reasonably
estimatable and has recorded no amount related to this matter as of September
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 8—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 nine month periods ended September 30, 2007 and 2006, respectively, includes
the following:
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Net
income
|
|
$ |
894
|
|
|
$ |
187
|
|
|
$ |
1,901
|
|
|
$ |
3,518
|
Foreign
currency translation adjustments
|
|
|
67
|
|
|
|
(2 |
) |
|
|
97
|
|
|
|
6
|
Comprehensive
income
|
|
$ |
961
|
|
|
$ |
185
|
|
|
$ |
1,998
|
|
|
$ |
3,524
|
Note 9—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 $3.8 million for the three months ended September 30, 2007 and
2006,
respectively. Likewise, credits amounted to $13.7 million and $7.5
million for the nine months ended September 30, 2007 and 2006, respectively.
The
Company’s sales returns and allowances reserve totaled $665,000 and $1.4 million
at September 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
|
|
(unaudited,
in thousands)
|
Reserve
for sales returns
|
|
|
|
|
|
|
|
For
the nine months ended, September 30, 2006
|
|
$ |
170
|
|
|
$ |
7,501
|
|
|
$ |
(6,806 |
) |
|
$ |
865
|
For
the nine months ended September 30, 2007
|
|
|
1,408
|
|
|
|
13,737
|
|
|
|
(14,480 |
) |
|
|
665
|
Note 10—Income
Taxes
For
the
three and nine months ended September 30, 2007, the effective tax rate for
the
Company was 41.5% and 40.8%, respectively. The effective tax rate for the
three
and nine months ended September 30, 2006 was 53.0% and 13.0%, respectively.
The
nine months ended September 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 has greater than 50 percent likelihood 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 11—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
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
Net
Income Per Share
|
|
(unaudited,
in thousands, except share and per share data)
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
894
|
|
|
$ |
187
|
|
|
$ |
1,901
|
|
|
$ |
3,518
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
common shares outstanding (basic)
|
|
|
29,837,538
|
|
|
|
15,199,681
|
|
|
|
27,744,016
|
|
|
|
14,180,869
|
Common
equivalent shares from conversion of preferred stock
|
|
|
—
|
|
|
|
6,633,255
|
|
|
|
947,608
|
|
|
|
5,151,099
|
Common
equivalent shares from common stock options and warrants
|
|
|
172,353
|
|
|
|
43,932
|
|
|
|
57,897
|
|
|
|
30,221
|
Weighted-average
common shares outstanding (diluted)
|
|
|
30,009,891
|
|
|
|
21,876,868
|
|
|
|
28,749,521
|
|
|
|
19,362,189
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
net income per share
|
|
$ |
0.03
|
|
|
$ |
0.01
|
|
|
$ |
0.07
|
|
|
$ |
0.25
|
Diluted
net income per share
|
|
$ |
0.03
|
|
|
$ |
0.01
|
|
|
$ |
0.07
|
|
|
$ |
0.18
|
Note 12—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
September 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 expected life of the 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 $7.4 million of unrecognized compensation expense related to stock
options as of September 30, 2007, which expense is expected to be
recognized over a weighted-average period of 3.1 years. The table below
summarizes stock option activity during the nine months ended September 30,
2007, which resulted in share-based compensation expense as
follows:
|
|
Nine
Months Ended
September
30, 2007 (unaudited)
|
|
|
Shares
|
|
|
Weighted
Average
Exercise Price
|
Options
outstanding, December 31, 2006
|
|
|
2,786,532
|
|
|
$ |
8.74
|
Granted
|
|
|
2,563,469
|
|
|
|
6.76
|
Exercised
|
|
|
(13,830 |
) |
|
|
6.78
|
Expired
|
|
|
—
|
|
|
|
—
|
Forfeited
|
|
|
(939,484 |
) |
|
|
8.27
|
Options
outstanding, September 30, 2007
|
|
|
4,396,687
|
|
|
$ |
7.69
|
Options
exercisable, September 30, 2007
|
|
|
2,221,561
|
|
|
$ |
8.80
|
Note 13—
Subsequent Events
On
October 11, 2007, the Company's Philippines subsidiary entered into a new
lease agreement for additional space to expand its current
operations. Under the terms of the lease, the Company will add
approximately 10,000 square feet of space for a period of three years, effective
September 1, 2007, for monthly rent of approximately
$9,000.
On
October 15, 2007, the Board of Directors adopted the 2007 New Employee Incentive
Plan, without stockholder approval pursuant to Section 4350 (i)(1)(A)(iv)
of the
Nasdaq Marketplace Rules, and reserved 2,000,000 shares of common stock for
issuance thereunder solely to new employees.
On
October 12, 2007, the Company appointed Shane Evangelist as its Chief Executive
Officer and entered into an Employment Agreement and two non-qualified stock
option agreements with Mr. Evangelist to purchase up to an aggregate of one
million shares of the Company’s common stock. The two option
agreements were issued pursuant to the 2007 New Employee Incentive
Plan. The first option entitles Mr. Evangelist to purchase up to
750,000 shares of the Company’s common stock, which vest over a four year period
and a performance-based option to purchase up to an aggregate of 250,000
shares
of the Company’s common stock, which vest based upon the attainment of certain
stock price metrics.
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 chain
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
since 2000, generating net sales of $123.6 million for the nine months ended
September 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 in the
process of opening a new call center in the Philippines to accommodate the
additional employees and expect to spend up to $1.4 million on such facility
in
2007. We anticipate completing this new call center in the fourth quarter
of
this year. 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 a call center in the
Philippines and an outsourced call center 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.
New
Chief Executive Officer. Shane Evangelist succeeds Mehran Nia, who has
served as the Company’s President and Chief Executive Officer since founding the
Company in 1995 until October 12, 2007. Mr. Nia will continue to
serve on the Board of Directors of the Company and will be working with Mr.
Evangelist to facilitate an orderly transition of his responsibilities. Prior
to
joining U.S. Auto Parts, Mr. Evangelist served as Senior Vice President and
General Manager of Blockbuster Online where he was responsible for leading
the
creation, development and launch of Blockbuster’s online movie rental
service.
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 nine months ended September 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, 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
10 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
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Net
sales
|
|
$
|
37,787
|
|
|
$
|
38,324
|
|
|
$
|
123,642
|
|
|
$
|
83,295
|
Cost
of sales
|
|
|
24,096
|
|
|
|
25,903
|
|
|
|
82,497
|
|
|
|
53,779
|
Gross
profit
|
|
|
13,691
|
|
|
|
12,421
|
|
|
|
41,145
|
|
|
|
29,516
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and
administrative
|
|
|
3,184
|
|
|
|
2,758
|
|
|
|
9,715
|
|
|
|
7,013
|
Marketing
|
|
|
4,917
|
|
|
|
4,979
|
|
|
|
15,738
|
|
|
|
10,134
|
Fulfillment
|
|
|
1,920
|
|
|
|
1,224
|
|
|
|
5,499
|
|
|
|
3,589
|
Technology
|
|
|
438
|
|
|
|
381
|
|
|
|
1,394
|
|
|
|
898
|
Amortization
of intangibles
|
|
|
2,097
|
|
|
|
2,086
|
|
|
|
6,251
|
|
|
|
3,037
|
Total
operating expenses
|
|
|
12,556
|
|
|
|
11,428
|
|
|
|
38,597
|
|
|
|
24,671
|
Income
from operations
|
|
|
1,135
|
|
|
|
993
|
|
|
|
2,548
|
|
|
|
4,845
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from disposition of assets
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(5)
|
Other
income (expense)
|
|
|
3
|
|
|
|
(2)
|
|
|
|
8
|
|
|
|
155
|
Interest
income (expense), net
|
|
|
389
|
|
|
|
(593)
|
|
|
|
654
|
|
|
|
(950)
|
Total
other income (expense)
|
|
|
392
|
|
|
|
(595)
|
|
|
|
662
|
|
|
|
(800)
|
Income
before income taxes
|
|
|
1,527
|
|
|
|
398
|
|
|
|
3,210
|
|
|
|
4,045
|
Income
tax provision
|
|
|
633
|
|
|
|
211
|
|
|
|
1,309
|
|
|
|
527
|
Net
income
|
|
$
|
894
|
|
|
$
|
187
|
|
|
$
|
1,901
|
|
|
$
|
3,518
|
Three
and Nine Months Ended September 30, 2007 Compared to Three and Nine Months
Ended
September 30, 2006
Net
Sales and Gross Margin
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Net
sales
|
|
$
|
37,787
|
|
|
$
|
38,324
|
|
|
$
|
123,642
|
|
|
$
|
83,295
|
Cost
of sales
|
|
|
24,096
|
|
|
|
25,903
|
|
|
|
82,497
|
|
|
|
53,779
|
Gross
profit
|
|
$
|
13,691
|
|
|
$
|
12,421
|
|
|
$
|
41,145
|
|
|
$
|
29,516
|
Gross
margin
|
|
|
36.2%
|
|
|
|
32.4%
|
|
|
|
33.3%
|
|
|
|
35.4%
|
Net
sales
decreased 1.3% and increased 48.4% to $37.8 million and $123.6 million for
the
three and nine months ended September 30, 2007, respectively, from the same
periods in the previous year. The quarter over quarter decrease was primarily
driven by lower e-commerce sales while the nine month increase from the same
period in the prior year was primarily the result of 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.
Our
e-commerce sales decreased 3.3% and grew 55.1% to $29.0 million and $94.3
million for the three and nine months ended September 30, 2007 compared to
$30.0
million and $60.8 million for the three and nine months ended September 30,
2006, respectively. Our online marketplace sales remained stable at
$4.6 million and grew 42.6% to $16.4 million for the three and nine months
ended
September 30, 2007, respectively. The decrease in sales for the three
months reflects the strategic decision to continue to focus on higher margin
sales to drive improved profitability. During the third quarter,
unprofitable revenue streams including international sales and special order
sales were reduced, further strategic pricing increases were implemented
and
advertising spend was decreased to optimize marketing return on investment
“ROI”
in our paid search efforts. These strategies resulted in the desired
consequences of gross margin improvement and higher profitability. In
addition, the initial roll-out of significant website navigation changes
related
to the implementation of the Unified Catalog negatively impacted sales, which
is
typical of this kind of complex roll-out. The increase in both e-commerce
and online marketplace sales for the nine months included the contribution
from
Partsbin product sales since May 2006.
The
total
number of e-commerce orders decreased 9.7% and increased 48.5% to 243,000
and
768,000 orders for the three and nine months ended September 30, 2007,
respectively. The average order value increased during the three
months ended September 30, 2007 to $120 versus $111 during 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 constant at $3.6 million and increased 8.3% to $11.8 million,
respectively for the three and nine months ended September 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 auto 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.
Gross
profit increased during the three months ended September 30, 2007 due to
higher product margins and during the nine months ended September 30,
2007 due to higher sales volumes compared to the same periods in the prior
year.
Gross margins increased for the three month period by 3.8% to 36.2% and
decreased 2.2% to 33.3% for the nine months ended September 30, 2007 compared
to
the same period in the prior year. The increase in gross margin
during the three month period ended September 30, 2007 was primarily due
to the
reduction of unprofitable revenue streams, continued strategic pricing
improvements, and added volume from the Tennessee distribution
center. The decrease in gross margin during the nine months ended
September 30, 2007 was due to the full inclusion of Partsbin drop-ship products
which generally carry lower gross margins, while for the nine months ended
September 30, 2006 Partsbin was included since May 2006. For
the nine month period ended September 30, 2007, freight expense as a
percentage of net sales was 12.5% compared to 12.2% of net sales for the
nine months ended September 30, 2006. Freight expense as a percentage of
net
sales for the three months ended September 30, 2007 increased to 11.6% from
10.7% for the same period in the previous year.
General
and Administrative Expense
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
General
and administrative expense
|
|
$
|
3,184
|
|
|
$
|
2,758
|
|
|
$
|
9,715
|
|
|
$
|
7,013
|
Percent
of net sales
|
|
|
8.4%
|
|
|
|
7.2%
|
|
|
|
7.9%
|
|
|
|
8.4%
|
General
and administrative expense increased 15.4% and 38.5% for the three and nine
months ended September 30, 2007, respectively from the same periods in the
previous year primarily due to the following: Increased payroll
and related expenses in the amount of $90,000 for the three months ended
September 30, 2007 and $500,000 for the nine months ended September 30, 2007,
related to the hiring of additional personnel. Merchant fees for the
three month period decreased by $100,000 relative to the same period in the
prior year due to lower online sales and increased $700,000 for the nine
months
ended September 30, 2007 due to higher online sales but as a percentage of
net
sales, remained relatively constant during both the three and nine month
periods. The increase in general and administrative expense
also included higher share-based compensation of $200,000 and $900,000 for
the
three and nine months ended September 30, 2007, respectively. In the
current year, we incurred additional expenses relating to legal and
professional fees and insurance coverage not incurred in the previous
year. Legal and professional fees for the three and nine months ended
September 30, 2007, were $500,000 and $1.4 million, respectively. The
increase in legal and professional fees primarily relates to costs incurred
for the defense of our 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 $200,000 reduction in software
amortization for the three months ended September 30, 2007, and $900,000
for the
nine months ended September 30, 2007.
During
the three and nine months ended September 30, 2007, share-based compensation
expense increased by $200,000 and $1.1 million,
respectively. Share-based compensation expense was determined in
accordance with SFAS 123(R). Based on options outstanding as of September
30,
2007, we expect to recognize $7.4 million in additional expense in the following
periods:
●
|
|
Three
months ending December 31, 2007
|
$700,000
|
●
|
|
Year
ending December 31, 2008
|
$2.5
million
|
●
|
|
Year
ending December 31, 2009
|
$2.4
million
|
●
|
|
Year
ending December 31, 2010
|
$1.5
million
|
●
|
|
Nine
months ending September 30, 2011
|
$300,000
|
We
anticipate that we will incur increased general and administrative expense
for
the remainder of 2007 and in future periods as a result of operating as a
public company including 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 our
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
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Marketing
expense
|
|
$
|
4,917
|
|
|
$
|
4,979
|
|
|
$
|
15,738
|
|
|
$
|
10,134
|
Percent
of net sales
|
|
|
13.0%
|
|
|
|
13.0%
|
|
|
|
12.7%
|
|
|
|
12.2%
|
Marketing
expense decreased 1.2% for the three month period and increased 55.3% for
the
nine months ended September 30, 2007, from the same periods in the previous
year. Marketing personnel costs increased during the three and nine
month periods ending September 30, 2007 by $600,000 and $3.2 million due
to the
expansion of our sales and marketing team, offset by lower advertising expense
of $800,000 for the three months, yet higher advertising of $1.7 million
for the
nine months.
In
addition, in April 2007, we completed the acquisition of our Philippines
sales
force from our outsourced call center provider. As of September 30, 2007,
171 employees had transitioned to direct employment with our Philippines
subsidiary. Going forward, 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 by a reduction in our outsourced services expense
as
a result of bringing these employees in-house. The purchase price for the
assembled workforce was approximately $1.7 million. Of this amount,
approximately $400,000 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.” The intangible will be amortized over seven years
beginning in April 2007.
Fulfillment
Expense
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Fulfillment
expense
|
|
$
|
1,920
|
|
|
$
|
1,224
|
|
|
$
|
5,499
|
|
|
$
|
3,589
|
Percent
of net sales
|
|
|
5.1%
|
|
|
|
3.2%
|
|
|
|
4.4%
|
|
|
|
4.3%
|
Fulfillment
expense increased 56.9% and 53.2% for the three and nine months ended September
30, 2007, respectively from the same periods in the previous year primarily
due
to $400,000 and $1.3 million in additional personnel costs. We expanded the
number of warehouse and purchasing employees during the first nine months
of
2007.
Technology
Expense
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Technology
expense
|
|
$
|
438
|
|
|
$
|
381
|
|
|
$
|
1,394
|
|
|
$
|
898
|
Percent
of net sales
|
|
|
1.2%
|
|
|
|
1.0%
|
|
|
|
1.1%
|
|
|
|
1.1%
|
Technology
expense increased 15.0% and 55.2% for the three and nine months ended September
30, 2007 from the same periods in the previous year. The primary
reason for the increase in the three month period was an increase in
computer related support expense of $50,000 and the nine month period increase
was due to higher communication expense of $300,000. Both increases
were to support the expansion of our communications infrastructure. For the
remainder of 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
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Amortization
of intangibles
|
|
$
|
2,097
|
|
|
$
|
2,086
|
|
|
$
|
6,251
|
|
|
$
|
3,037
|
Percent
of net sales
|
|
|
5.5%
|
|
|
|
5.4%
|
|
|
|
5.1%
|
|
|
|
3.6%
|
Amortization
of intangibles remained consistent for the three month period and increased
105.8% for the nine month period ended September 30, 2007, compared to the
same
period in the prior year primarily due to the intangible assets acquired
pursuant to the acquisition of Partsbin in May 2006 and the assembled workforce
acquired in April 2007. We preliminarily estimate aggregate
amortization expense related to these intangibles as follows:
●
|
|
Three
months ending December 31, 2007
|
$2.1
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
|
$2.8
million
|
Other
Income (Expense), Net
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
(unaudited,
in thousands)
|
Other
income (expense), net
|
|
$
|
392
|
|
|
$
|
(595)
|
|
|
$
|
662
|
|
|
$
|
(800)
|
Percent
of net sales
|
|
|
1.0%
|
|
|
|
(1.6)%
|
|
|
|
0.5%
|
|
|
|
(1.0)%
|
The
increase in other income (expense), net during the three and nine months
ended
September 30, 2007 was primarily due to an increase of $400,000 and $1.2
million, respectively in interest income related to higher cash balances.
For
the nine months ended September 30, 2007, other income (expense), net included
$273,000 of 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 has and is expected to continue to 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, provide
for diversification and prohibits investments in any subprime issuance.
Investments are generally tax exempt AAA rated auction rate securities to
minimize credit and market risk exposure.
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 September 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 $17.2 million and short-term investments in
auction
rate securities of $25.0 million for a total of $42.2 million in highly liquid
assets as of September 30, 2007, representing a $39.8 million increase from
$2.4
million in cash and cash equivalents as of December 31, 2006. The increase
in our cash and cash equivalents and short-term investments as of September
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 $46.1 million as of September 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 products.
We
expect to finalize our plans
on this distribution center in the fourth quarter
of
2007. We also are assessing
the feasibility
of opening or relocating our distribution center in California, potentially
resulting in moving the facility to a new location.
Our
Philippines subsidiary entered into two new lease agreements in August
2007 and one additional lease in October 2007. These facility
expansions will be used to expand our call center operations as well as non-call
center operations including marketing, catalog, technology and administrative
personnel. We anticipate these facilities to be operational by
the end of 2007. While these new facilities are being finished, we
are renting workstations from a third party. We expect to capitalize
as leasehold improvements, up to $1.4 million on these facilities in the
remainder of 2007.
Seasonality
We
believe our business is subject to seasonal fluctuations. We have historically
experienced higher sales of auto 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 in any
given year.
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, however 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
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 and risk associated with holding
auction rate securities. We also have some exposure related to foreign currency
fluctuations.
Interest
Rate Risk. As of September 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 September 30, 2007, changes in the
monthly LIBOR rate could affect the rate we pay on the $1.0 million notes
payable and 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 our 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, due to the low
nominal
dollars associated with the foreign operations.
ITEM 4.
|
Controls
and
Procedures
|
Evaluation
of Disclosure Controls and Procedures
As
of
September 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.
Beginning
with the first quarter of this year, we implemented 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, have been evaluated and revised or
corrected.
|
|
•
|
We
have prepared process documentation related to our key assumptions,
estimates and accounting policies and
procedures.
|
•
|
We
added an internal audit department.
|
As
of
September 30, 2007, we believe that we have remediated the material weakness
related to the lack of finance and accounting personnel and improved process
documentation surrounding our accounting policies and procedures. We
will continue to implement remediation plans to address the identified material
weakness relating to technology and accounting systems during the fourth
quarter
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 September 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 7 of Notes to Unaudited Condensed Consolidated
Financial Statements, included in Part I, Item I of this report, is incorporated
herein by reference.
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
nine 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 continue to enter 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:
|
•
|
political,
social and economical
instability and the risk of war or other international incidents
in
Asia;
|
|
•
|
fluctuations
in foreign currency
exchange rates that may increase our cost of
products;
|
|
•
|
tariffs
and protectionist laws
and business practices that favor local
businesses;
|
|
•
|
difficulties
in complying with
import and export laws, regulatory requirements and restrictions;
and
|
|
•
|
natural
disasters and public
health emergencies.
|
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 and there is an 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, directors, and underwriters 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 our announcement on March 20, 2007
of our
financial results for the fourth quarter and year ended December 31, 2006.
We intend to fully cooperate with the SEC in this matter. The preparation
of any
response in connection with SEC inquiry and any unfavorable outcome 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, or the Ford 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
U.S.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.
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.
On
August
23, 2007, the Company also appealed to the United States Court of Appeals
for
the Federal Circuit, seeking a review and reversal of the portion of the
Commission's March 20, 2007, Final Determination finding a violation of Section
337. Ford's Petition for Review and the Company's appeal have been
consolidated and are currently pending before the United States Court of
Appeals
for the Federal Circuit.
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, if there is an unfavorable outcome of the
pending appeal, 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 second 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 September 30, 2007, 171 of these employees had transitioned
over to direct employment by our Philippines subsidiary. In addition, we
entered
into an agreement to lease workstations in the provider’s facility in the
Philippines for a period of six months that we are looking to renew on favorable
terms. 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
do-it-yourself or do-it-for-me 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 Shane Evangelist, our Chief Executive
Officer, and Michael McClane, our Chief Financial Officer, Executive
Vice President of Finance, Treasurer and Secretary. Messrs. Evangelist, 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 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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The
failure of telecommunications and connectivity
infrastructure;
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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
auto 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 nine months of 2007, 10.3% 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 735
employees as of September 30, 2007. Our net sales have increased from $31.7
million in 2003 to $120.1 million in 2006 and to $123.6 million for the nine
months ended September 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:
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prevent
customers from accessing
our websites;
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reduce
our ability to fulfill
orders or bill customers;
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reduce
the number of products
that we sell;
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cause
customer dissatisfaction;
or
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damage
our brand and
reputation.
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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 has been subjected
to a
typhoon and a volcanic eruption in the past. In addition, California has
in the
past experienced power outages as a result of limited electrical power supplies
due to recent fires in the southern part of the state. 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 and one registered mark. 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. Earlier this year, we and
certain of our officers and directors and investment partner were served
with
two 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. In addition, the SEC
commenced an informal inquiry 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
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
have and expect to continue 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:
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•
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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
|
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. 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.
ITEM 3.
|
Defaults
Upon Senior
Securities.
|
None.
ITEM 4.
|
Submission
of Matters to a Vote of Security
Holders
|
ITEM 5.
|
Other
Information
|
None.
The
following exhibits are filed herewith.
Exhibit
No.
|
Description
|
|
|
10.1
|
Lease
Agreement, dated October 11, 2007, by and between MBS Tek Corporation
and
Averon Holding Corporation.
|
31.1
|
Certification
of the principal executive officer required by Rule 13a-14(b) of
the
Securities Exchange Act of 1934, as amended
|
|
|
31.2
|
Certification
of the principal financial officer required by Rule 13a-14(b) 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
|