U.S. AUTO PARTS NETWORK, INC.

(Exact name of registrant as specified in its charter)

 

Delaware	68-0623433
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

 

17150 South Margay Avenue

Carson, CA 90746

(Address of Principal Executive Office) (Zip Code)

 

(310) 735-0085

(Registrant’s telephone number, including area code)

 

            Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 Large Accelerated Filer  ¨                 Accelerated Filer           ¨  

Non-Accelerated Filer    ¨ (Do not check if a smaller reporting company)        Smaller Reporting Company    x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

 

As of August 8, 2008, the registrant had 29,846,757 shares of common stock, $0.001 par value, outstanding.  

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U.S. AUTO PARTS NETWORK, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2008

 

TABLE OF CONTENTS

 

		Page
PART I. FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	Condensed Consolidated Balance Sheets at June 30, 2008 (unaudited) and December 31, 2007	4
	Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2008 and 2007	5
	Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007	6
	Notes to Unaudited Condensed Consolidated Financial Statements	7
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	19
ITEM 4.	Controls and Procedures	20
PART II. OTHER INFORMATION
ITEM 1.	Legal Proceedings	21
ITEM 1A.	Risk Factors	21
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
ITEM 3.	Defaults upon Senior Securities	33
ITEM 4.	Submission of Matters to a Vote of Security Holders	33
ITEM 5.	Other Information	34
ITEM 6.	Exhibits	34

 

Unless the context requires otherwise, as used in this report, the terms “U.S. Auto Parts,” the “Company,” “we,” “us” and “our” refer to U.S. Auto Parts Network, Inc. and its subsidiaries, and the term “Partsbin” refers to All OEM Parts, Inc., ThePartsBin.com, Inc. and their affiliated companies, which we acquired and merged into our wholly-owned subsidiary, Partsbin, Inc., in May 2006.

 

U.S. Auto Parts ®, U.S. Auto Parts Network ™, PartsTrain ®, Partsbin ™, Kool-Vue ™ and Auto-Vend ™ are our United States common law trademarks. All other trademarks and trade names appearing in this report are the property of their respective owners.

 

 

ITEM 1.

Financial Statements

 

		June 30, 2008				December 31, 2007
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	34,120			$	19,399
Marketable securities			—				22,650
Accounts receivable, net			2,435				2,907
Inventory, net			13,842				11,191
Deferred income taxes			831				831
Prepaid expenses and other current assets			3,334				1,808
Total current assets			54,562				58,786
Property and equipment, net			7,307				6,945
Intangible assets, net			3,707				26,444
Goodwill			14,201				14,201
Deferred income taxes			12,014				3,562
Investments			6,726				—
Other non-current assets			119				118
Total assets		$	98,636			$	110,056
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	5,989			$	8,103
Accrued expenses			11,192				7,822
Notes payable			—				1,000
Capital leases payable, current portion			75				73
Other current liabilities			1,385				1,367
Total current liabilities			18,641				18,365
Capital leases payable, less current portion			15				48
Total liabilities			18,656				18,413
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.001 par value; 100,000,000 shares authorized at June 30, 2008 and     December 31, 2007; 29,846,757 shares issued and outstanding at June 30, 2008 and     December 31, 2007, respectively			30				30
Additional paid-in capital			144,801				143,223
Accumulated other comprehensive income			9				312
Accumulated deficit			(64,860	)			(51,922	)
Total stockholders’ equity			79,980				91,643
Total liabilities and stockholders’ equity		$	98,636			$	110,056

 

 

 

 

 

 

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Net sales		$	43,105			$	42,112			$	83,114			$	85,855
Cost of sales			28,518				28,327				54,777				58,401
Gross profit			14,587				13,785				28,337				27,454
Operating expenses:
General and administrative (1)			4,588				3,655				9,211				6,531
Marketing (1)			6,635				4,921				12,602				10,821
Fulfillment (1)			2,377				1,862				4,465				3,579
Technology (1)			787				507				1,471				956
Amortization of intangibles and impairment loss			20,541				2,100				22,640				4,154
Total operating expenses			34,928				13,045				50,389				26,041
Income (loss) from operations			(20,341)				740				(22,052)				1,413
Other income:
Other income			2				3				6				5
Interest income, net			234				545				502				265
Total other income, net			236				548				508				270
Income (loss) before income taxes			(20,105)				1,288				(21,544)				1,683
Income tax provision (benefit)			(8,042)				515				(8,606)				675
Net income (loss)		$	(12,063)			$	773			$	(12,938)			$	1,008
Basic and diluted net income per share		$	(0.40)			$	0.03			$	(0.43)			$	0.04
Shares used in computation of basic net income per share			29,846,757				29,832,927				29,846,757				26,679,905
Shares used in computation of diluted net income per share			29,846,757				29,853,346				29,846,757				28,142,830

 

(1)	Includes share-based compensation expense as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
General and administrative		$	500			$	494			$	1,003			$	806
Marketing			112				81				196				155
Fulfillment			30				33				63				41
Technology			44				15				56				28
Total share-based compensation expense		$	686			$	623			$	1,318			$	1,030

 

 

 

 

 

 

 

		Six Months Ended June 30,
		2008				2007
Operating activities
Net income (loss)		$	(12,938)			$	1,008
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			1,758				542
Amortization of intangibles			4,195				4,154
Impairment loss on intangibles			18,445				—
Non-cash interest expense			—				273
Share-based compensation expense			1,318				1,030
Deferred income taxes			(8,452)				—
Changes in operating assets and liabilities:
Accounts receivable, net			472				10
Inventory, net			(2,651)				(2,723	)
Prepaid expense and other current assets			(1,532)				(763	)
Other non-current assets			(8)				1,749
Accounts payable and accrued expenses			1,321				1,469
Other current liabilities			19				(950	)
Net cash provided by operating activities			1,947				5,799
Investing activities
Additions to property and equipment			(1,975)				(2,080	)
Proceeds from the sale of marketable securities			21,275				—
Purchases of marketable securities			(5,500)				—
Acquisition of assembled workforce			—				(1,286	)
Acquisition of business, net of cash acquired			—				(22	)
Net cash provided by (used in) investing activities			13,800				(3,388	)
Financing activities
Payments on line of credit			—				(2,000	)
Payments on notes payable			(1,000)				(32,000	)
Proceeds received on issuance of common stock in connection with initial public offering, net of offering costs			—				71,537
Payments of short-term financing			(31)				(35	)
Net cash provided by (used in) financing activities			(1,031)				37,502
Effect of changes in foreign currencies			5				30
Net increase in cash and cash equivalents			14,721				39,943
Cash and cash equivalents at beginning of period			19,399				2,381
Cash and cash equivalents at end of period		$	34,120			$	42,324

 

 

 

 

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1—Summary of Significant Accounting Policies

 

Basis of Presentation

 

The condensed consolidated financial statements of U.S. Auto Parts Network, Inc. (collectively with its subsidiaries, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. 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 unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the consolidated financial position of the Company as of June 30, 2008 and December 31, 2007, and the consolidated results of operations for the three and six months ended June 30, 2008 and 2007, and cash flows for the six months ended June 30, 2008 and 2007. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. The Company’s results of operations for the three and six months ended June 30, 2008 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, 2007, which was filed with the SEC on April 2, 2008.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. 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 revenues and expenses during the reporting period. Significant estimates made by management include, but are not limited to, the valuation of investments, 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. These estimates are based on current facts, historical experience and various other factors that the Company believes to be reasonable under the circumstances.  Actual results could differ from these estimates.

 

Impairment of Long-Lived Assets

 

During the second quarter of 2008, the Company recorded a non-cash impairment charge on long-lived assets totaling $18.4 million as further described in Note 4 to the unaudited condensed consolidated financial statements included in this report.

 

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 the Company’s financial condition and results of operations in future years.

 

Note 2—Fair Value Measurements

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP, 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. In February 2008, the FASB issued SFAS No. 157-2, “ Effective Date of FASB Statement No. 157” (“SFAS 157-2”), which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities, except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company has adopted the provisions of SFAS 157 as of January 1, 2008 for financials assets including cash and cash equivalents and marketable securities and SFAS 157-2 as of June 30, 2008 for intangible assets.

 

SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

 

Level 1- defined as observable inputs such as quoted prices in active markets;

 

Level 2- defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

 

Level 3- defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. 

 

7

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As of June 30, 2008, the Company held certain assets that are required to be measured at fair value on a recurring basis. These assets included the Company’s financial instruments, including investments associated with auction rate preferred securities. The Company measures the following financial assets at fair value on a recurring basis. The fair value of these financial assets was determined using the following inputs at June 30, 2008:

			Total as of June 30, 2008			Quoted Prices in Active Markets or Identical Assets (Level I)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Cash and cash equivalents (1)		$	34,120			$	34,120			$	—			$	—
Non-current investments available-for-sale (2)			6,726				—				—				6,726
Total		$	40,846			$	34,120			$	—			$	6,726

(1)	Cash and cash equivalents consist primarily of money market funds with original maturity dates of three months or less, for which we determine fair value through quoted market prices.

 

(2)

Investments available-for-sale consists of auction rate preferred securities (“ARPS”). ARPS are tax-exempt, long-term variable rate securities tied to short-term interest rates that are reset through a “Dutch Auction” process that occurs every seven days. The Company has the option to participate in the auction and sell ARPS to prospective buyers through a broker-dealer, but does not have the right to put the security back to the issuer. The investments in ARPS all had AAA credit ratings at the time of purchase and represent interests in collateralized debt obligations issued by municipal and state agencies. In the past, the auction process has allowed investors to obtain immediate liquidity if so desired by selling the securities at their face amounts. However, as has been recently reported in the financial press, the current disruptions in the credit markets have adversely affected the auction market for these types of securities. ARPS auctions “fail” when there are not enough buyers to absorb the amount of securities available for sale for that particular auction period. Historically, ARPS auctions have rarely failed since the investment banks and broker dealers have been willing to purchase the securities when investor demand was weak. However, beginning in mid-February 2008, due to uncertainty in the global credit and capital markets and other factors, investment banks and broker dealers have been less willing to support ARPS and many ARPS auctions have failed. The Company will not be able to access non-current investments until future auctions for these ARPS are successful, or until the Company sells the securities in a secondary market, which currently is not active, although there have been certain instances of redemptions at par by municipalities through the refinancing of new instruments.

 

As of June 30, 2008, the Company had invested $6.7 million in ARPS, which are classified as available for sale non-current investments and reflected at fair value. In June and July 2008, $0.9 million and $0.2 million of its investment in ARPS were redeemed, respectively.  The Company has included its investments related to ARPS in the Level 3 category. Before utilizing Level 3 inputs in its fair value measurement, the Company considered significant Level 2 observable inputs of similar assets in active and inactive markets. The Company’s broker dealer received estimated market values from an independent pricing service as of the balance sheet date, which carry these investments at par value due to the overall quality of the underlying investments and the anticipated future market for such investments. Further evidence includes the fact that these investments consist solely of collateralized debt obligations supported by municipal and state agencies; do not include mortgage-backed securities or student loans; have redemption features that call for redemption at 100% of par value; and have a current credit rating of A or AAA. However, the fact that there is not an active market to liquidate these certain investments was considered in classifying them as Level 3. Due to the uncertainty with regard to the short-term liquidity of these securities, the Company determined that it could not rely on par value to represent fair value. Therefore, the Company estimated the fair values of these securities utilizing a discounted cash flow valuation model as of June 30, 2008. This analysis considered the collateralization underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the next time the security is expected to have a successful auction. These securities were also compared, when possible, to other observable market data with similar characteristics to the securities held by the Company.

 

As a result of the temporary declines in fair value for the Company’s ARPS, which the Company attributes to liquidity issues rather than credit issues, it has recorded an unrealized loss of $149,000 to accumulated other comprehensive income. Due to the Company’s belief that the market for these collateralized instruments may take in excess of twelve months to fully recover, the Company has classified these investments as non-current and has included them in investments on the unaudited condensed consolidated balance sheet at June 30, 2008.  As of June 30, 2008, the Company continues to earn interest on all of its ARPS instruments. Any future fluctuation in fair value related to these instruments that the Company deems to be temporary, including any recoveries of previous write-downs, would be recorded to accumulated other comprehensive income. If the Company determines that any future valuation adjustment was other than temporary, it would record a charge to earnings as appropriate. The Company is not certain how long it may be required to hold each security. However, given the Company’s current cash position, liquid cash equivalents and expected cash flow from operations, it believes it has the ability to hold, and intends to continue to hold the failed ARPS as long-term investments until the market stabilizes.

 

8

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As of June 30, 2008, the Company held certain assets that are measured at fair value on a non-recurring basis. These included the Company’s long-lived and indefinite lived intangible assets. The fair value of these non-financial assets was determined using the following inputs at June 30, 2008:

		Total as of June 30, 2008				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total (Losses)
Intangible assets		$	3,707			$	—			$	—			$	3,707			$	(18,445	)
Total		$	3,707			$	—			$	—			$	3,707			$	(18,445	)

    In accordance with the provisions of SFAS No. 144 (“SFAS 144”) “Accounting for the Impairment or Disposal of Long-Lived Assets”, intangible assets subject to amortization with a carrying value of $19.9 million were written down to their fair value of $2.2 million, resulting in an impairment charge of $17.7 million, which was included in earnings for the period and is further described in Note 4 to the Company’s unaudited condensed consolidated financial statements included in this report.

In accordance with the provisions of SFAS No. 142 (“SFAS 142”) “Goodwill and other Intangible Assets”, indefinite lived intangible assets with a carrying value of $2.2 million were written down to their fair value of $1.5 million, resulting in an impairment charge of $0.7 million, which was included in earnings for the period and is further described in Note 4 to the Company’s unaudited condensed consolidated financial statements included in this report.

 

The following table presents the Company’s assets measured at fair value on a recurring and non-recurring basis using significant unobservable inputs (Level 3) as defined in SFAS 157 at June 30, 2008:

		Investments in Marketable Securities				Intangibles  Assets
		(in thousands)
Balance at December 31, 2007		$	—			$	—
Transfers to Level 3			7,750				22,152
Redemption			(875	)
Unrealized losses recorded to other comprehensive income			(149	)
Impairment loss on intangible assets			—				(18,445	)
Balance at June 30, 2008		$	6,726			$	3,707

    In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits companies to choose to measure at fair value certain financial instruments and other items that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008 and elected not to measure any additional financial instruments or other items at fair value.

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 have recently entered into supply agreements with U.S. based suppliers and its primary drop-ship vendors. The Company believes that its inventoried products are generally available from more than one supplier and seeks to maintain multiple sources for its products, both internationally and domestically.

 

The Company primarily purchases products in bulk quantities to take advantage of quantity discounts and to improve inventory availability. Inventory is reported net of inventory reserves for excess or obsolete products, which are established based on specific identification of slow moving items and the evaluation of overstock considering anticipated sales levels. Gross inventory, inventory reserves and net inventory at June 30, 2008 and December 31, 2007 are as follows:

 

		June 30, 2008 (unaudited)				December 31, 2007
		(in thousands)
Gross inventory		$	14,696			$	11,794
Inventory reserves			(854	)			(603	)
Total net inventory		$	13,842			$	11,191

 

9

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 Note 4—Intangibles

 

Intangibles subject to amortization are expensed on a straight-line basis. Amortization expense relating to intangibles totaled $4.2 million for the six months ended June 30, 2008 and 2007. Included in the intangible assets, assembled workforce was decreased by $116,000 and increased by $159,000 due to foreign currency fluctuations as of June 30, 2008 and December 31, 2007, respectively.

 

During the quarter ended June 30, 2008, the Company recorded, in accordance with SFAS 142 and SFAS 144, a non-cash impairment charge totaling $18.4 million related to the intangibles associated with the Partsbin business, which the Company acquired in May 2006.  The impairment was comprised of $16.7 million for its websites; $0.1 million for software; $0.9 million for vendor agreements; and $0.7 million for domain names. The interim impairment charge was primarily the result of:  i) the recent deterioration in the economic environment and the Company’s stock price, ii) lower sales and profitability which generated losses from certain Partsbin websites, iii) deficiencies in the software platform also acquired from Partsbin, and iii) the termination of volume discounts and marketing co-ops from certain vendor agreements.  Given the indicators of impairment and the excess of carrying value over the undiscounted cash flows associated with these intangibles, the Company utilized a discounted cash flow approach in determining fair value for both the websites and vendor agreement intangible assets.  The decrease in future cash flows from certain acquired websites and vendor agreements resulted in the long-lived assets being impaired, as the carrying value of the website assets and vendor agreement assets exceeded the fair value of those assets.  Fair value is determined as the net present value of future projected cash flows.  The software and domain name assets’ fair value was determined using a relief from royalty approach which also resulted in a lower fair value than the carrying value.   As of June 30, 2008, the Company did not record an impairment charge related to goodwill.  The intangible assets listed below as of June 30, 2008 represent the adjusted basis after the impairment loss.

 

Intangibles, excluding goodwill, consisted of the following at June 30, 2008 and December 31, 2007:

			June 30, 2008 (unaudited)												December 31, 2007
	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	0 years		$	—			$	—			$	—			$	28,988			$	(9,367	)		$	19,621
Software	2 - 5 years			1,040				—				1,040				4,089				(2,202	)			1,887
Vendor agreements	3 years			—				—				—				2,996				(1,613	)			1,383
Assembled workforce	7 years			1,330				(237	)			1,093				1,446				(155	)			1,291
Purchased domain names	3 years			175				(157	)			18				175				(143	)			32
				2,545				(394	)			2,151				37,694				(13,480	)			24,214
Intangible assets not subject to amortization:
Domain names	indefinite life			1,556				—				1,556				2,230				—				2,230
Total			$	4,101			$	(394	)		$	3,707			$	39,924			$	(13,480	)		$	26,444

 

 

 

	Three Months Ended June 30,								Six Months Ended June 30,
	2008				2007				2008				2007
	(in thousands)
Net income (loss)		$	(12,063	)		$	773			$	(12,938	)		$	1,008
Foreign currency translation adjustments			(114	)			21				(154	)			30
Unrealized loss in investments			—				—				(149	)			—
Comprehensive income (loss)		$	(12,177	)		$	794			$	(13,241	)		$	1,038

 

 

 

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, 2007 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 automotive parts, 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 channels and selling products directly to customers over the Internet allows us to more efficiently deliver products to our customers while generating higher margins.

 

Our History. We were formed in 1995 as a distributor of aftermarket auto parts and launched our first website in 2000. We rapidly expanded our online operations, increasing the number of SKUs sold through our e-commerce network, adding additional websites, improving our Internet marketing proficiency and commencing sales in online marketplaces. As a result, our business has grown consistently since 2000, generating net sales of $161.0 million for the year ended December 31, 2007.

 

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. We may pursue additional acquisition opportunities in the future to increase our share of the aftermarket auto parts market or expand our product offerings.  

 

International Operations. Since 2003, we have maintained operations in the Philippines.  As our ability to manage offshore operations has improved, we have increased our offshore capacity.  In the Philippines, we operate in a call center, information systems, application and web development, category management, and  internet marketing, all supported by Philippine based accounting and human resources.  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.

 

New Management. Following the appointment of Shane Evangelist, our new Chief Executive Officer in October 2007, we have added several new members to our management team.  These additions include a new Chief Information Officer and Chief Technology Officer focused on improving our technology platform.  We have also added leadership in our distribution center operations, product sourcing, business analytics, category management and marketing.

 

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 (“U.S. GAAP”). 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, uncollectible receivables, 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 three and six  months ended June 30, 2008, as compared to those policies disclosed in our annual report on Form 10-K for the fiscal year ended December 31, 2007 except as noted below.

 

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In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “ Fair Value Measurements ” (“SFAS 157”) which defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. We have adopted the provisions of SFAS 157 as of January 1, 2008, for financial assets. SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1-defined as observable inputs such as quoted prices in active markets; Level 2-defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3-defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. We have evaluated both Level 2 and Level 3 evidence to measure the fair value of our $6.7 million of auction rate preferred securities (“ARPS”) as of June 30, 2008. These investments consist solely of collateralized debt obligations supported by municipal and state agencies; do not include mortgage-backed securities or student loans; have redemption features that call for redemption at 100% of par value; and have a current credit rating of A or AAA. In June and July 2008, we received partial redemptions at par on our investments totaling $0.9 million and $0.2 million, respectively. The fact that there is not an active market as of June 30, 2008 to liquidate 100% of these certain investments was the final determination in classifying them as Level 3. We used a discounted cash flow valuation model to estimate the fair value of the securities. As a result of the temporary declines in fair value of our ARPS, which we attribute to liquidity issues rather than credit issues, we have recorded an unrealized loss of $149,000 to accumulated other comprehensive income.

 

    In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits companies to choose to measure at fair value certain financial instruments and other items that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008 and elected not to measure any additional financial instruments or other items at fair value.

 

    The Company recorded, in accordance with SFAS No. 142, “Goodwill and Intangible Assets” (“SFAS 142”) and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), an impairment charge totaling $18.4 million on intangible assets associated with the Partsbin business, which we acquired in May 2006.  The impairment charge related to its websites, software, vendor agreements and domain name intangible assets. The interim impairment charge was primarily the result of:  i) the recent deterioration in the economic environment and the Company’s stock price, ii) lower sales and profitability which generated losses from certain Partsbin websites, iii) deficiencies in the software platform also acquired from Partsbin, and iii) the termination of volume discounts and marketing co-ops from certain vendor agreements.  Given the indicators of impairment and the excess of the carrying value over the undiscounted cash flows associated with these intangibles, the Company utilized a discounted cash flow approach in determining fair value for both the websites and vendor agreement intangible assets.  The decrease in future cash flows from certain acquired websites and vendor agreements resulted in the long-lived assets being impaired, as the carrying value of the website assets and vendor agreement assets exceeded the fair value of those assets determined as the net present value of future projected cash flows.  The software and domain name assets’ fair value was determined using a relief from royalty approach which also resulted in a lower fair value than the carrying value of the assets.

 

Results of Operations 

 

The following table sets forth certain unaudited statements of operations data for the periods indicated: 

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Net sales			100.0	%			100.0	%			100.0	%			100.0	%
Cost of sales			66.2				67.3				65.9				68.0
Gross profit			33.8				32.7				34.1				32.0
Operating expenses:
General and administrative			10.6				8.6				11.0				7.6
Marketing			15.4				11.7				15.2				12.6
Fulfillment			5.5				4.4				5.4				4.2
Technology			1.8				1.2				1.8				1.1
Amortization of intangibles			47.7				5.0				27.2				4.8
Total operating expenses			81.0				30.9				60.6				30.3
Income (loss) from operations			(47.2	)			1.8				(26.5	)			1.7
Other income (expense):
Other income			0.0				0.0				0.0				0.0
Interest income (expense), net			0.5				1.3				0.6				0.3
Other income (expense), net			0.5				1.3				0.6				0.3
Income (loss) before income taxes			(46.7	)			3.1				(25.9	)			2.0
Income tax provision (benefit)			(18.7	)			1.3				(10.3	)			0.8
Net income (loss)			(28.0	)%			1.8	%			(15.6	)%			1.2	%

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Three and Six Months Ended June 30, 2008 Compared to Three and Six Months Ended June 30, 2007

 

Net Sales and Gross Margin

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
		(in thousands)
Net sales		$	43,105			$	42,112			$	83,114			$	85,855
Cost of sales			28,518				28,327				54,777				58,401
Gross profit		$	14,587			$	13,785			$	28,337			$	27,454
Gross margin			33.8%				32.7%				34.1%				32.0%

 

Net sales increased 2.4% to $43.1 million and decreased 3.2% to $83.1 million for the three and six months ended June 30, 2008, respectively, compared to the same periods in the previous year.  The three month quarter over quarter increase was primarily due to a 4.2% increase in our online business, which consists of our e-commerce and online marketplaces channels.  Our e-commerce channel includes a network of e-commerce websites, supported by our call-center sales agents who generate cross-sell and up-sell opportunities. We also sell our products through our online marketplaces, which primarily consist of auction and other third-party websites.  The six month year over year decrease was primarily due to 3.1% decrease in our online business and a 3.8% decrease in our offline business, which consists of our wholesale operations.

E-commerce sales increased 1.9% from $32.6 million for the three months ended June 30, 2007 to $33.2 million for the three months ended June 30, 2008. The total number of placed orders in our e-commerce channel increased from 306,000 orders in the second quarter of 2007 to 334,000 orders in the second quarter of 2008 primarily due a higher conversion rate.  For the six months ended June 30, 2007 and 2008, ecommerce sales were $65.9 million and $64.4 million, respectively.  The 2.3% decrease for the six months ended June 30, 2008 compared to the six months ended 2007 was due to higher product pricing in the 2007 period.

Online marketplaces net sales increased 18.9% from $5.2 million for the three months ended June 30, 2007 to $6.2 million for the three months ended June 30, 2008.  This increase was primarily due to the successful launch of a new channel strategy.   For the six months ended June 30, 2007 and 2008, online marketplaces sales were $11.8 million and $10.9 million, respectively.  The 7.6% decrease for the six months ended June 30, 2008 compared to the same period in the prior year was primarily due to the timing of the new strategy rollout in 2008.

Net sales from our Wholesale operations decreased 14.3% to $3.6 million and 3.8% to $7.9 million for the three and six months ended June 30, 2008, respectively, which reflects our previously announced focus on our online business.

We anticipate that sales from our wholesale operations will decline as a percentage of net sales in the future primarily due to focus on our online business. In addition, a significant customer decreased its purchases from us in the second quarter.  We expect sales from this significant customer to continue to decline in the future.

Gross profit increased during the three and six months ended June 30, 2008 due to an increase in sales from in stock products and higher prices on products from our e-commerce channel compared to the same periods in the prior year. Gross margins increased by 1.1% to 33.8% and 2.1% to 34.1% for the three and six months ended June 30, 2008, respectively, compared to the same periods in the prior year. The increase in gross margins for both periods was primarily due to a mix shift to in stock distribution, lower direct product costs from certain suppliers, partially offset by higher outbound freight expense.

General and Administrative Expense

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
		(in thousands)
General and administrative expense		$	4,588			$	3,655			$	9,211			$	6,531
Percent of net sales			10.6%				8.6%				11.0%				7.6%

 

General and administrative expense increased 25.5% and 41.0% for the three and six months ended June 30, 2008, from the same periods in the previous year. The increase for the three months ended June 30, 2008 primarily reflects higher payroll and related expenses in the amount of $400,000 due to increased headcount; increased amortization expense of $300,000; an increase of $200,000 related to administrative operating expenses related to public company compliance costs; partially offset by $300,000 of legal costs that the Company incurred in the prior year period.  The increase for the six months ended June 30, 2008 primarily reflects higher payroll and related expenses in the amount of $1.1 million due to increased headcount; an increase of $200,000 of share-based compensation expense related to stock options; an increase of $900,000 of administrative operating costs; increased amortization expense of $500,000; partially offset by a decrease of $300,000 in legal costs.

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During the three and six months ended June 30, 2008, we recognized $700,000 and $1.3 million, respectively, of share-based compensation, determined in accordance with SFAS 123(R). Based on options outstanding as of June 30, 2008, we expect to recognize $8.0 million in additional share based compensation expense over a weighted average period of 2.9 years.

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 Sales of Unregistered Securities

None.

 

Use of Proceeds from Sales of Registered Securities

 

    On February 14, 2007, we completed the initial public offering of our common stock, pursuant to which we sold 8,000,000 shares of our common stock and the selling stockholders sold an aggregate of 3,500,000 shares of our common stock (which included 1,500,000 shares sold by the selling stockholders pursuant to the exercise of the underwriters’ over-allotment option) at the initial public offering price of $10.00 per share. The shares of common stock sold in the offering were registered under the Securities Act on a registration statement on Form S-1 (File. No. 333-138379) that was declared effective by the SEC on February 8, 2007. RBC Capital Markets Corporation, Thomas Weisel Partners LLC, Piper Jaffray & Co. and JMP Securities LLC were the co-managing underwriters for the offering.

 

    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 additional expenses 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, $5.0 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 investment-grade securities and cash equivalents. 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 invest in our business.

 

 

ITEM 3.

Defaults Upon Senior Securities.