S-1 1 ds1.htm FORM S-1 FOR U.S. AUTO PARTS NETWORK, INC. Form S-1 for U.S. Auto Parts Network, Inc.
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As filed with the Securities and Exchange Commission on November 2, 2006

Registration No. 333-            

 


U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


Form S-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

 


U.S. Auto Parts Network, Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware   5531   68-0623433

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Number)

 

(I.R.S. Employer

Identification No.)

17150 South Margay Avenue

Carson, CA 90746

(310) 719-8666

(Address, Including Zip Code and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 


Michael J. McClane

Chief Financial Officer, Vice President of Finance and Treasurer

U.S. Auto Parts Network, Inc.

17150 South Margay Avenue

Carson, CA 90746

(310) 719-8666

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 


Copies to:

 

Ellen S. Bancroft, Esq.
Scott R. Santagata, Esq.

J.R. Kang, Esq.

Jason R. Wisniewski, Esq.

Dorsey & Whitney LLP
38 Technology Drive
Irvine, CA 92618
(949) 932-3600

 

Michael J. Sullivan, Esq.

Julia Vax, Esq.
David Tang, Esq.
Howard Rice Nemerovski Canady Falk
& Rabkin, A Professional Corporation
Three Embarcadero Center, Seventh Floor

San Francisco, CA 94111-4024
(415) 434-1600

 


Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

(continued on next page)


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If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

CALCULATION OF REGISTRATION FEE

 


Title of Each Class of
Securities to be Registered
   Proposed Maximum
Aggregate Offering Price(1)(2)
   Amount of Registration Fee

Common Stock, $0.001 par value

   $100,000,000    $10,700

(1)   Includes the offering price attributable to shares that the Underwriters have the option to purchase solely to cover over-allotments, if any.
(2)   Estimated solely for the purpose of computing the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 


 


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The information in this prospectus is not complete and may be changed. We cannot sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to completion, dated November 2, 2006

PROSPECTUS

            Shares

LOGO

Common Stock

 


This is U.S. Auto Parts Network, Inc.’s initial public offering. U.S. Auto Parts Network, Inc. is selling all of the shares of common stock offered by this prospectus.

We expect the public offering price to be between $            and $            per share. Currently, no public market exists for the shares. After pricing the offering, we expect that the common stock will be traded on the NASDAQ Global Market under the symbol “PRTS.”

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 9.

 


PRICE $     PER SHARE

 


 

     Per Share    Total

Public offering price

   $                     $                 

Underwriting discounts and commissions

   $      $  

Net proceeds, before expenses, to U.S. Auto Parts

   $      $  

The underwriters may also purchase up to an additional             shares from us at the public offering price, less the underwriting discounts and commissions, within 30 days from the date of this prospectus to cover over-allotments, if any.

The underwriters expect to deliver the shares on or about                 , 2006.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

RBC CAPITAL MARKETS  

THOMAS WEISEL PARTNERS LLC

 

 

 

PIPER JAFFRAY   JMP SECURITIES

                                , 2006.


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You should rely only on the information contained in this prospectus. We have not authorized any other person to provide you with different information. If anyone provides you different or inconsistent information, you should not rely on it. We are offering to sell and seeking offers to buy shares of our common stock only in jurisdictions where offers or sales are permitted. The information in this prospectus is only accurate as of the date of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

This prospectus contains market data and industry forecasts and projections, which we have obtained from third party market research, publicly available information and industry publications. These sources generally state that the information they provide has been obtained from sources believed to be reliable, but that the accuracy and completeness of the information are not guaranteed. The forecasts and projections are based on industry surveys and the preparers’ experience in the industry, and we cannot assure you that any of the projected amounts will be achieved. Similarly, we believe that the surveys and market research others have performed are reliable, but we have not independently verified the information.

For investors outside the United States: Neither we nor any of the underwriters for the offering of our common stock have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about, and to observe any restrictions relating to, our offering and the distribution of this prospectus.

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


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PROSPECTUS SUMMARY

This summary highlights the information contained elsewhere in this prospectus. This summary is not complete and may not contain all the information you should consider before investing in our common stock. You should read the entire prospectus carefully, including the “Risk Factors” and the consolidated financial statements and related notes before making an investment decision.

Our Business

Overview

We are a leading online provider of aftermarket auto parts, including body parts, engine parts, performance parts and accessories. Our user-friendly websites provide customers with a comprehensive selection of approximately 550,000 products, identified as stock keeping units or SKUs. We have developed a proprietary product database that maps our 550,000 SKUs to over 4.3 million 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, and our corporate website is located at www.usautoparts.com.

Our online sales channel and relationships with suppliers enable us to eliminate several intermediaries in the traditional auto parts supply chain, allowing us to acquire many of our products directly from manufacturers and sell them to our customers. Additionally, as an online retailer, we do not incur many of the costs associated with operating brick and mortar stores. We believe that our ability to disintermediate the auto parts supply chain, combined with our efficient e-commerce platform, enables us to sell products at competitive prices while achieving higher operating margins and return on invested capital than many traditional automotive parts retailers.

Our business has grown consistently since we launched our first website in 2000. In the year ended December 31, 2005 and the nine months ended September 30, 2006, we generated net sales of $59.7 million and $83.7 million, respectively. In the year ended December 31, 2005 and for the nine months ended September 30, 2006, we generated net income of $6.8 million and $3.5 million, respectively. During the same periods, we also generated Adjusted EBITDA of $8.8 million and $10.2 million, respectively. In addition, we have experienced continued growth in the number of monthly unique visitors to our websites. In September 2006, approximately 6.8 million unique visitors visited our websites. The number of orders placed through all of our e-commerce websites has also increased from approximately 288,000 orders for the year ended December 31, 2005 to approximately 505,000 orders for the nine months ended September 30, 2006. The average order value of purchases on our websites for the nine months ended September 30, 2006 was approximately $120.

Industry Overview

The United States automotive aftermarket industry is forecasted to be $204 billion in 2006 according to the Automotive Aftermarket Industry Association, or AAIA, an independent trade association. Our addressable market is forecasted by AAIA to be approximately $91.3 billion, which consists of approximately $37.8 billion in sales to Do-It-Yourself, or DIY, customers, and approximately $53.5 billion in sales to Do-It-For-Me, or DIFM, customers. While the U.S. auto parts aftermarket is a large market characterized by modest growth, we believe there is an opportunity for e-commerce aftermarket auto parts retailers to grow faster than the overall market.

 

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According to Forrester Research, an independent market research firm, online purchases by U.S. consumers are expected to grow from approximately $172 billion in 2005 to approximately $329 billion by 2010, representing a 13.9% compound annual growth rate. Additionally, according to Forrester Research, the percentage of U.S. households shopping online is projected to grow from 39% in 2005 to 48% in 2010.

In 2006, the online and mail order portion of aftermarket auto part sales is forecasted to be $2.7 billion according to the AAIA. While the portion of online and mail order sales is a relatively small percentage of our addressable market at approximately 3%, we believe online penetration rates of aftermarket auto parts consumers will continue to increase and, as a result, sales for online aftermarket auto parts are expected to continue to grow at a faster rate than the overall auto parts market.

The auto parts market has traditionally been fragmented and inefficient, with multiple intermediaries, including importers, wholesalers, distributors and retailers, between manufacturers and consumers. Furthermore, auto parts retailers who operate brick and mortar stores generally stock only a small percentage of the products that are available for sale. As a result, consumers must often visit several retailers to find a part or have a retailer order the part for future delivery. The fragmented nature of the auto parts market has also meant an absence of a centralized database or a comprehensive, master catalog of products, which maps all aftermarket auto parts to all relevant applications for such parts. We believe this inadequacy of information leads to inefficiencies in the sale and purchase process for both the retailer and the consumer.

Our Solution

We believe our solution addresses the problems faced in the traditional auto parts market and provides additional benefits for our customers. The key components of our solution include:

Disintermediation of the Auto Parts Supply Chain. We have developed an online sales channel that enables us to sell aftermarket auto parts to our customers while eliminating several intermediaries in the traditional auto parts supply chain. Disintermediating the traditional supply chain allows us to offer auto parts to our customers at competitive prices and allows us to more efficiently deliver products to our customers while generating higher profit margins.

Leading Network of Websites. We have developed a network of websites to offer our broad selection of aftermarket auto parts. Our flagship websites for e-commerce are located at www.partstrain.com and www.autopartswarehouse.com. We believe that we provide an intuitive online shopping experience that enables us to cost-effectively attract an increasing number of visitors to our sites while reducing the number of product returns and exchanges.

Proprietary Product Catalog. We have invested significant resources and time over several years to build a proprietary product catalog that maps our 550,000 SKUs to over 4.3 million product applications based on vehicle makes, models and years. By creating a master catalog of individual auto parts and accessories mapped to multiple vehicle makes, models and years, we increase our sales potential while reducing inventory management expense. We believe that there is no other online catalog of aftermarket body parts, engine parts, performance parts and accessories currently available today that offers the same breadth, accuracy and detail.

Flexible Fulfillment Methods. We fulfill customer orders using two primary methods: (i) stock-and-ship, where we take physical delivery of a part and store it in one of our distribution centers until it is shipped to a customer, and (ii) drop-ship, where the part is shipped directly to the customer from

 

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the supplier. We believe that the flexibility of fulfilling orders via two different fulfillment methods allows us to offer a broader selection of products, optimize product inventory and enhance business profitability.

Low Cost Operations. Our offshore and outsourced operations in the Philippines and India, which are responsible for a majority of the development and maintenance of our websites and product catalog, allow us to access a qualified workforce at a significantly lower cost than comparably experienced U.S.-based professionals.

Long-Standing Supplier Relationships. We source products from manufacturers and distributors located in Asia and the United States. We have developed strong relationships with our suppliers, some of whom have been working with us for over a decade. Our supplier relationships and our understanding of the market enable us to set competitive pricing for our products and ensure product availability.

Benefits to Customers

We believe our solution provides multiple benefits to our customers, including:

Broad Product Selection and Availability. Our proprietary product catalog provides our customers with the ability to select from over 4.3 million product applications, based on vehicle makes, models and years.

Competitive Pricing. We are able to offer our customers lower prices relative to original equipment manufacturer, or OEM, parts retailers and traditional aftermarket retailers by eliminating several intermediaries in the aftermarket auto parts supply chain, leveraging our long-term supplier relationships and establishing an efficient online cost structure that capitalizes on relatively inexpensive labor.

Prompt Order Fulfillment. Our proprietary order fulfillment system allows us to efficiently process and ship items from our distribution centers or from our suppliers, ensuring timely delivery of products to our customers.

Detailed Product Information. We provide detailed product descriptions and photographs, specific vehicle applications, part numbers for aftermarket parts, pricing information and related part and brand suggestions for the parts offered on our websites so our customers can make an informed purchasing decision on every order.

Satisfying Shopping Experience and Knowledgeable Customer Service. Our easy to navigate websites are accessible from the convenience of the customer’s home or office or anywhere with an Internet connection. Our customer support staff is available to provide assistance to our customers throughout the purchase process 24 hours a day, seven days a week, via phone, live-chat or e-mail.

Our Growth Strategy

Our primary objective is to continue our growth and to strengthen our position as a leading online provider of aftermarket auto parts. The key elements of our strategy are as follows:

Expand Our Product Offering. We will continue to expand our product selection by adding new SKUs from existing suppliers, adding new suppliers and optimizing our distribution centers to create additional capacity for new items.

Cost-Effectively Increase the Number of Visitors to Our Websites. We intend to increase the number of visitors to our websites by continuing to enhance our site content and layout, so that our websites will be included as a relevant search result when consumers use Internet search engines to find aftermarket auto parts.

 

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Increase Our Visitor Conversion Rate. We seek to increase the conversion rate of visitors to our websites by improving our existing website designs and online purchase processes, and by continuing to focus on customer service.

Increase Repeat Customers. We intend to increase the number of customers who make repeat purchases from our websites by continuing to offer a broad range of products at competitive prices, improving the overall customer shopping experience, focusing on customer service and rapid fulfillment of orders, and by further enhancing the features and functionality of our websites.

Expand e-Commerce Distribution Channels. We plan to build and strengthen partnerships with auction sites, large online marketplaces, complementary niche websites and comparison shopping sites in order to expand the distribution channels for our products.

Pursue Strategic Acquisitions that Augment Our Business. We intend to selectively pursue acquisition opportunities to increase our share of the aftermarket auto parts market and expand our product offering.

Corporate Information

We were formed as a California corporation in 1995 and reincorporated in Delaware in March 2006. Our executive offices are located at 17150 South Margay Avenue, Carson, California 90746, and our telephone number is (310) 719-8666. Our corporate website is located at www.usautoparts.com. Our flagship retail websites are located at www.partstrain.com and www.autopartswarehouse.com. The information contained in, or that can be accessed through, our websites does not constitute a part of this prospectus. Unless the context requires otherwise, as used in this prospectus, the terms “U.S. Auto Parts,” “we,” “us” and “our” refer to U.S. Auto Parts Network, Inc. and its subsidiaries, and the term “Partsbin” refers to All OEM Parts, Inc., ThePartsBin.com, Inc. and their affiliated companies, which we acquired in May 2006.

 

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The Offering

 

Common stock offered by us

             shares

 

Common stock to be outstanding after this offering

             shares

 

Use of proceeds

For repayment of approximately $35.0 million of indebtedness and for working capital and other general corporate purposes, including expanding our infrastructure and sales and marketing activities. In addition, we may use a portion of the net proceeds for acquisitions and investments in complementary businesses, technologies and strategic relationships. See “Use of Proceeds.”

 

Risk Factors

See “Risk Factors” and the other information included in this prospectus for a discussion of factors you should consider carefully before investing in shares of our common stock.

 

Proposed NASDAQ Global Market symbol

PRTS

The number of shares of common stock outstanding after this offering is based on 36,388,226 shares outstanding as of September 30, 2006, which assumes the conversion of all of our outstanding preferred stock into 11,055,425 shares of common stock immediately prior to the completion of this offering, and does not include, as of such date:

 

  Ÿ   4,027,560 shares of common stock issuable upon the exercise of outstanding options at a weighted average exercise price of $4.92 per share;

 

  Ÿ                shares of common stock reserved for future grant or issuance under our stock option plans;

 

  Ÿ   140,554 shares of common stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $4.38 per share; and

 

  Ÿ   the effect of a             -for-             reverse stock split, which is expected to be effected prior to the completion of this offering.

Unless otherwise indicated, all information in this prospectus assumes:

 

  Ÿ   the underwriters will not exercise their over-allotment option to purchase up to              additional shares of common stock;

 

  Ÿ   no other person will exercise any other outstanding options or warrants; and

 

  Ÿ   the initial public offering price will be $             per share.

 

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Summary Consolidated Financial Data

The following tables summarize our consolidated financial data for the periods presented and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. The summary consolidated financial data for the years ended December 31, 2003, 2004 and 2005 are derived from our audited consolidated financial statements. We have also included data from our unaudited consolidated financial statements for the nine months ended September 30, 2005 and 2006.

 

    Years Ended December 31,     Nine Months Ended September 30,  
    2003     2004   2005     Pro Forma
2005(1)
    2005     2006     Pro Forma
2006(1)
 
                    (unaudited)     (unaudited)     (unaudited)     (unaudited)  
    (in thousands, except share and per share data)  

Consolidated Statement of Income Data:

             

Net sales

  $31,657     $40,658   $59,698     $97,993     $43,979     $83,665     $107,524  

Cost of sales

  17,814     21,334   34,829     64,227     25,876     53,779     71,469  
                                       

Gross profit

  13,843     19,324   24,869     33,766     18,103     29,886     36,055  

Operating expenses:

             

General and administrative(2)

  2,284     3,599   7,254     10,325     5,555     7,081     8,694  

Marketing(2)

  3,617     4,526   5,802     10,862     4,315     10,313     13,539  

Fulfillment(2)

  3,246     2,990   4,357     4,407     3,162     3,589     3,608  

Technology(2)

  405     776   868     1,431     596     992     1,305  

Amortization of intangibles

      8   17     8,176     13     3,037     6,174  
                                       

Total operating expenses

  9,552     11,899   18,298     35,201     13,641     25,012     33,320  

Income (loss) from operations

  4,291     7,425   6,571     (1,435 )   4,462     4,874     2,735  

Other income (expense), net

  (42 )   36   85     (1,852 )   97     (800 )   (1,529 )
                                       

Income (loss) before income taxes

  4,249     7,461   6,656     (3,287 )   4,559     4,074     1,206  

Income tax provision (benefit)

  478     328   (163 )   (195 )   (199 )   539     (110 )
                                       

Net income (loss)

  $3,771     $7,133   $6,819     $(3,092 )   $4,758     $3,535     $1,316  
                                       

Basic net income (loss) per share

  $0.20     $0.32   $0.31     $(0.12 )   $0.22     $0.15     $0.05  

Diluted net income (loss) per share

  $0.20     $0.32   $0.31     $(0.12 )   $0.22     $0.11     $0.04  

Pro forma basic net income per share(5)

      $0.21         $0.10    

Shares used in computation of basic net income (loss) per share

  18,794,793     22,000,000   22,000,000     25,305,529     22,000,000     23,634,781     25,317,816  

Shares used in computation of diluted net income (loss) per share

  18,794,793     22,000,000   22,000,000     25,305,529     22,000,000     32,270,315     33,953,350  

Shares used in the computation of pro forma basic net income per share(5)

      33,055,425         34,690,206    

Non-GAAP Financial Measures:

             

EBITDA(3)

  4,382     7,961   8,755     8,888     6,095     9,589     10,520  

Adjusted EBITDA(3)

  4,382     7,961   8,755     8,888     6,095     10,193     11,124  

Unaudited Pro Forma Statement of Income Data(4):

             

Income (loss) before income taxes

  4,249     7,461   6,656     (3,287 )   4,559     4,074     1,206  

Pro forma provision (benefit) for income taxes

  1,729     2,964   2,657     (1,301 )   1,822     1,728     586  
                                       

Pro forma net income (loss)

  $2,520     $4,497   $3,999     $(1,986 )   $2,737     $2,346     $620  
                                       

Pro forma basic net income (loss) per share

  $0.13     $0.20   $0.18     $(0.08 )   $0.12     $0.10     $0.02  

Pro forma diluted net income (loss) per share

  $0.13     $0.20   $0.18     $(0.08 )   $0.12     $0.07     $0.02  

(see footnotes on next page)

 

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(footnotes to prior page)

 

(1)   The pro forma financial information gives effect to the acquisition of Partsbin as if the acquisition occurred on January 1, 2005.

 

(2)   Includes share-based compensation expense related to option grants, as follows:

 

     Years Ended December 31,    Nine Months Ended September 30,
     2003    2004    2005    Pro Forma
2005(1)
   2005    2006    Pro Forma
2006(1)
                    (unaudited)    (unaudited)    (unaudited)    (unaudited)
     (in thousands)

General and administrative

   $    $    $    $    $    $ 359    $ 359

Marketing

                              126      126

Fulfillment

                              16      16

Technology

                              103      103
                                                
   $    $    $    $    $    $ 604    $ 604
                                                

 

(3)   EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures. GAAP means generally accepted accounting principles in the United States. EBITDA is equal to net income plus (a) interest expense, net; (b) income tax provision (benefit); (c) amortization of intangibles; and (d) depreciation and amortization. Our definition of Adjusted EBITDA is different from EBITDA because we further adjust EBITDA to exclude share-based compensation expense. A reconciliation of these non-GAAP financial measures to net income is set forth in the related table under “— Non-GAAP Financial Measures” below.

 

(4)   Presents pro forma provision for income taxes and pro forma net income as if we operated as a C corporation in all periods presented. See Note 1 and Note 7 of the Notes to our Consolidated Financial Statements included elsewhere in this prospectus for an explanation of the unaudited pro forma statement of income data.

 

(5)   Pro forma basic net income per share for the latest year end and interim period only has been computed to give effect to the conversion of the Series A convertible preferred stock into common stock upon the closing of the Company’s initial public offering on an if-converted basis.

The pro forma as adjusted consolidated balance sheet data below give effect to the conversion of all of our outstanding preferred stock into 11,055,425 shares of our common stock immediately prior to the closing of this offering, as well as the receipt of the estimated proceeds from the sale of the              shares in this offering at an assumed initial offering price of $             per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, and the repayment after the closing of this offering of $35.0 million of indebtedness incurred in connection with our acquisition of Partsbin.

 

    

As of

September 30, 2006

     Actual     Pro Forma
As Adjusted
     (unaudited)
     (in thousands)

Consolidated Balance Sheet Data:

    

Cash and cash equivalents

   $ 3,287    

Working capital

     (4,528 )  

Total assets

     68,505    

Total debt, including current portion, capital lease obligations and notes payable to stockholders

     34,888    

Stockholders’ equity

     20,229    

 

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Non-GAAP Financial Measures

Regulation G, “Conditions for Use of Non-GAAP Financial Measures,” and other provisions of the Securities Exchange Act of 1934, as amended, define and prescribe the conditions for use of certain non-GAAP financial information. We provide “EBITDA” and “Adjusted EBITDA,” which are non-GAAP financial measures, because we believe such measures are important supplemental information for investors. We calculate EBITDA as net income before (a) interest expense, net; (b) income tax provision (benefit); (c) amortization of intangibles; and (d) depreciation and amortization. Adjusted EBITDA further adjusts EBITDA to exclude share-based compensation expense related to our grant of stock options and other equity instruments. These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. These non-GAAP financial measures reflect an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business.

We use EBITDA and Adjusted EBITDA:

 

  Ÿ   as measurements of our operating performance because they assist us in comparing our operating performance on a consistent basis by removing the impact of items not directly resulting from our core operations;

 

  Ÿ   for planning purposes, including the preparation of our internal budget;

 

  Ÿ   to allocate resources to enhance the financial performance of our business;

 

  Ÿ   to evaluate the effectiveness of our operational strategies; and

 

  Ÿ   to evaluate our capacity to fund capital expenditures and expand our business.

We also believe that analysts and investors use EBITDA and Adjusted EBITDA as supplemental measures to evaluate the overall operating performance of companies in our industry.

Management strongly encourages investors to review our consolidated financial statements in their entirety and to not rely on any single financial measure. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. For information about our financial results as reported in accordance with GAAP, see our consolidated financial statements and related notes included in this prospectus.

The table below reconciles net income (loss) to EBITDA and Adjusted EBITDA for the periods presented:

 

   

Years Ended December 31,

    Nine Months Ended September 30,  
    2003   2004   2005     Pro Forma
2005(1)
    2005     2006   Pro Forma
2006(1)
 
                  (unaudited)     (unaudited)     (unaudited)   (unaudited)  
   

(in thousands)

 

Net income (loss)

  $ 3,771   $ 7,133   $ 6,819     $ (3,092 )   $ 4,758     $ 3,535   $ 1,316  

Interest expense, net

    13     44     106       1,931       68       950     1,657  

Income tax provision (benefit)

    478     328     (163 )     (195 )     (199 )     539     (110 )

Amortization of intangibles

        8     17       8,176       13       3,037     6,174  

Depreciation and amortization

    120     448     1,976       2,068       1,455       1,528     1,483  
                                                 

EBITDA

    4,382     7,961     8,755       8,888       6,095       9,589     10,520  

Share-based compensation

                              604     604  
                                                 

Adjusted EBITDA

  $ 4,382   $ 7,961   $ 8,755     $ 8,888     $ 6,095     $ 10,193   $ 11,124  
                                                 

(1)   The pro forma financial information gives effect to the acquisition of Partsbin as if the acquisition occurred on January 1, 2005.

 

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RISK FACTORS

You should consider carefully the following risks before you decide to purchase our common stock. Additional risks and uncertainties not presently known to us or that we currently believe are not important may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the value of our common stock could decline and you may lose all or part of your investment.

Risks Relating to Our Business

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 promotional expenditures or price our products more competitively than we currently anticipate in order to attract additional online consumers to our websites and convert them into purchasing customers. Specific factors that could prevent prospective customers from purchasing from us include:

 

  Ÿ   concerns about buying auto parts without face-to-face interaction with sales personnel;

 

  Ÿ   the inability to physically handle, examine and compare products;

 

  Ÿ   delivery time associated with Internet orders;

 

  Ÿ   concerns about the security of online transactions and the privacy of personal information;

 

  Ÿ   delayed shipments or shipments of incorrect or damaged products; and

 

  Ÿ   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 use a variety of methods to attract visitors to our websites, but 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. If any free search engine or shopping comparison site on which we rely begins charging

 

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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 five suppliers represented approximately 47.4% of our total product purchases in 2005 and 55.5% for the nine months ended September 30, 2006. Although we have long standing business relationships with many of our suppliers, we do not have any long-term contracts or exclusive agreements with our suppliers that would ensure our ability to acquire the types and quantities of products we desire at acceptable prices and in a timely manner. 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:

 

  Ÿ   political, social and economical instability and the risk of war or other international incidents in Asia;

 

  Ÿ   fluctuations in foreign currency exchange rates that may increase our cost of products;

 

  Ÿ   tariffs and protectionist laws and business practices that favor local businesses;

 

  Ÿ   difficulties in complying with import and export laws, regulatory requirements and restrictions; and

 

  Ÿ   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.

We recently acquired Partsbin and the integration of our businesses may be time consuming and expensive and may not be immediately successful, 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.

 

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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 may involve the consolidation of diverse business cultures, require substantial time and expenses, and distract management from other business matters. In addition, this acquisition may include significant intangible assets that are subject to periodic impairment testing which could result in substantial accounting charges. If we are unable to integrate Partsbin in an efficient and timely manner, our business and operating results will be harmed.

We face intense competition and operate in an industry with limited barriers to entry, and some of our competitors may have greater resources than us and may be better positioned to capitalize on the growing e-commerce auto parts market

The auto parts industry is competitive and highly fragmented, with products distributed through multi-tiered and overlapping channels. We compete with both online and offline retailers who offer OEM and aftermarket auto parts to either the DIY or DIFM customer segments. Current or potential competitors include the following:

 

  Ÿ   national auto parts retailers such as Advance Auto Parts, AutoZone, CSK Auto, Napa Auto Parts, O’Reilly Automotive and Pep Boys;

 

  Ÿ   large online marketplaces such as Amazon.com and eBay;

 

  Ÿ   local independent retailers or niche auto parts online retailers; and

 

  Ÿ   wholesale auto parts distributors such as Keystone Automotive and LKQ Corporation.

Barriers to entry are low, and current and new competitors can launch websites at a relatively low cost. Many of our current and potential offline competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing, technical, management and other resources than we do. In addition, some of our competitors have used and may continue to use aggressive pricing tactics and devote substantially more financial resources to website and system development than we do. We expect that competition will further intensify in the future as Internet use and online commerce continue to grow worldwide. Increased competition may result in reduced operating margins, reduced profitability, loss of market share and diminished brand recognition.

We would also experience significant competitive pressure if any of our suppliers were to sell their products directly to customers. Since our suppliers have access to merchandise at very low costs, they could sell products at lower prices and maintain higher gross margins on their product sales than we can. In this event, our current and potential customers may decide to purchase directly from these suppliers. Increased competition from any supplier capable of maintaining high sales volumes and acquiring products at lower prices than us could significantly reduce our market share and adversely impact our financial results.

We rely on key personnel and may need additional personnel for the success and growth of our business

Our business is largely dependent on the personal efforts and abilities of key personnel including Mehran Nia, our Chief Executive Officer and President, and Michael McClane, our Chief Financial Officer, Executive Vice President of Finance, Treasurer and Secretary. Messrs. Nia 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

 

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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.

We must continue to develop and maintain our brands, which is costly and may not generate corresponding revenue

Although we sell our products through a network of websites, our flagship websites are located at www.partstrain.com and www.autopartswarehouse.com, and our corporate website is located at www.usautoparts.com. Maintaining and strengthening these brands is an important factor in attracting new customers and building customer loyalty to generate repeat business. Accordingly, we intend to continue to implement promotional strategies to enhance our brand and attract new customers to our websites. These initiatives require significant expenditures and may not have a material positive impact on our brand identity or result in a commensurate increase in sales. In addition, building our brand will depend upon our ability to continue to provide a broad range of auto parts at competitive prices combined with high quality customer service. If we are unsuccessful in our branding efforts, the strength of our brands may decline and our sales could decline.

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. The factors that could cause our operating results to fluctuate include, but are not limited to:

 

  Ÿ   fluctuations in the demand for aftermarket auto parts;

 

  Ÿ   price competition on the Internet or among offline retailers for auto parts;

 

  Ÿ   our ability to attract visitors to our websites and convert those visitors into customers;

 

  Ÿ   our ability to maintain and expand our supplier and distribution relationships;

 

  Ÿ   the effects of seasonality on the demand for our products;

 

  Ÿ   our ability to accurately forecast demand for our products and maintain appropriate inventory levels;

 

  Ÿ   our ability to build and maintain customer loyalty;

 

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  Ÿ   the success of our brand-building and marketing campaigns;

 

  Ÿ   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;

 

  Ÿ   technical difficulties, system downtime or Internet brownouts; and

 

  Ÿ   the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure.

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 outsourced call centers in both India and the Philippines. These international operations include development and maintenance of our websites, software development, enhancements of our online marketing technologies, 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:

 

  Ÿ   difficulties and costs of staffing and managing foreign operations;

 

  Ÿ   restrictions imposed by local labor practices and laws on our business and operations;

 

  Ÿ   exposure to different business practices and legal standards;

 

  Ÿ   unexpected changes in regulatory requirements;

 

  Ÿ   the imposition of government controls and restrictions;

 

  Ÿ   political, social and economic instability and the risk of war, terrorist activities or other international incidents;

 

  Ÿ   natural disasters and public health emergencies;

 

  Ÿ   potentially adverse tax consequences;

 

  Ÿ   the failure of local laws to provide a sufficient degree of protection against infringement of our intellectual property; and

 

  Ÿ   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. Although we recently added a complementary drop-ship fulfillment method, largely for our Partsbin products, the majority of orders for our other products are filled from our inventory through 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 nine months ended September 30, 2006, we fulfilled 11.4% of our net sales through a single supplier. Our agreements with this supplier may be terminated at any time by either party, with 120 to 365 days’ notice. In addition, we do not have definitive agreements with many of our primary international suppliers. 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, and our agreements with most of our distributors do not require them to set aside any amount of inventory to fulfill our orders or to give our orders priority over other resellers to whom they sell. 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 434 employees as of September 30, 2006. Our net sales have increased from $31.7 million in 2003 to $83.7 million for the nine months ended September 30, 2006. Our strategy for growth includes efforts to increase our operating efficiencies. Our recent expansion and planned growth have

 

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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:

 

  Ÿ   expand our domestic and international operations;

 

  Ÿ   increase our technology and development efforts to enhance and maintain our websites and technology infrastructure;

 

  Ÿ   hire additional personnel, including customer service specialists, sales and marketing professionals, and financial professionals;

 

  Ÿ   upgrade our operational and financial systems, procedures and controls; and

 

  Ÿ   assume the responsibilities and costs of being a public company.

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.

Challenges by OEMs to the validity of aftermarket auto parts and claims of infringement could adversely affect our business

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 currently alleges in this action that we and the other respondents infringed ten design patents that Ford claims cover eight parts for the 2004-2005 Ford F-150 truck (see “Business — Legal Proceedings”). Ford has 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 seeks 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. To date, our sales of these parts have been minimal, but as the design for the 2004 model is incorporated into later year models of the F-150 and these trucks have been on the road longer, sales of aftermarket replacement parts for these trucks may increase substantially. Furthermore, if Ford continues to pursue, expands or escalates its claims against us, or if other OEMs commence similar actions, and any of them are successful in these actions, we could be restricted or prohibited from selling certain aftermarket products and the aftermarket auto parts industry could decline significantly, which could have a material adverse effect on our business, financial condition and results of operations.

Future infringement claims could also result in increased costs of doing business arising from increased legal expenses, adverse judgments or settlements or changes to our business practices required to

 

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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.

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

Key components of our growth strategy include expanding our product offerings, increasing our customer base and improving the customer experience. In pursuit 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. We have limited experience in making acquisitions, and we compete with larger, better financed companies in identifying and completing acquisitions. We cannot assure you that we will be able to identify or consummate any future acquisitions on favorable terms, or at all. Integrating any newly acquired businesses, technologies or services is likely to be expensive and time consuming. To finance any acquisitions, it may 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. If we do complete any acquisitions, we may be unable to operate the acquired businesses profitably, realize the anticipated synergies from the acquisition or otherwise implement our strategy successfully. If we are unable to integrate any newly acquired entities, technologies or services effectively or retain the key employees of any acquired companies, our business and results of operations will suffer. The time and expense associated with finding suitable and compatible businesses, technologies or services could also disrupt our ongoing business and divert our management’s attention. 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 have no current plans, agreements or commitments with respect to any acquisitions.

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

 

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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.

If we are unable to provide satisfactory customer support, our reputation would be harmed and we could lose customers

We believe that our experienced customer support personnel provide us with a key competitive advantage by providing a positive shopping experience for our customers. We maintain customer support centers in California and have outsourced call centers in the Philippines and India. Any material disruption or slowdown in our customer support services resulting from telephone or Internet failures, power or service outages, natural disasters, labor disputes, or other events could make it difficult or impossible to provide adequate customer support. Furthermore, we may be unable to attract and retain an adequate number of competent customer support representatives, which is essential in creating a favorable customer experience. In addition, because our outsourced call centers are located in the Philippines and India, we may experience difficulties in training our support team or monitoring the level of support provided. If we are unable to continually provide adequate and trained staffing for our customer support operations, our reputation could be seriously harmed and our sales could decline. Further, we cannot assure you that call volumes will not exceed our present system capacities. If this occurs, we could experience delays in accepting orders, responding to customer inquiries and addressing customer concerns. Because our success depends in large part on keeping our customers satisfied, any failure to provide satisfactory levels of customer support would likely impair our reputation and we could lose customers.

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.

 

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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 does not perform to our customers’ satisfaction. Any Internet network interruptions or problems with our websites could:

 

  Ÿ   prevent customers from accessing our websites;

 

  Ÿ   reduce our ability to fulfill orders or bill customers;

 

  Ÿ   reduce the number of products that we sell;

 

  Ÿ   cause customer dissatisfaction; or

 

  Ÿ   damage our brand and reputation.

We have experienced brief computer system interruptions in the past, and we believe they will continue to occur from time to time in the future. Our systems and operations are also vulnerable to damage or interruption from a number of sources, including a natural disaster or other catastrophic event such as an earthquake, typhoon, volcanic eruption, fire, flood, terrorist attack, power loss, telecommunications failure, physical and electronic break-ins and other similar events. For example, our headquarters and the majority of our infrastructure, including some of our servers, are located in Southern California, a seismically active

 

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region. We also maintain offshore and outsourced operations in the Philippines, an area that was recently subjected to a typhoon and a volcanic eruption. In addition, California has in the past experienced power outages as a result of limited electrical power supplies. Such outages, natural disasters and similar events may recur in the future and could disrupt the operation of our business. Our technology infrastructure is also vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. Although the critical portions of our systems are redundant and back up 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, but because we do not have written long-term agreements with any of these third parties, 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. 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

 

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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, brand and could result in a decline in our net sales and profitability.

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 federally-registered and common law trademarks, as well as pending federal trademark registrations for several marks. Even if we obtain approval of such pending registrations, the resulting registrations may not adequately cover our inventions or protect us against infringement by others. Effective trademark, service mark, copyright, patent and trade secret protection may not be available in every country in which our products and services may be made available online. We also currently own or control a number of Internet domain names, including www.usautoparts.com, www.partstrain.com and www.autopartswarehouse.com. We may be unable to protect these domain names or acquire or maintain

 

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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, including our Kool-Vue mirrors, from suppliers in Taiwan and China. 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

 

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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 Taiwan or China 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.

Risks Relating to this Offering and Ownership of Our Common Stock

No public market for our common stock currently exists and an active trading market may not develop or be sustained following this offering

No public market for our common stock currently exists, and we cannot be certain that an active trading market for our common stock will develop or be sustained following this offering. Further, we cannot be certain that the market price of our common stock will not decline below the initial public offering price. The initial public offering price was determined by negotiation among us and the underwriters based upon several factors and may not be indicative of future market prices for our common stock.

Our stock price may 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 prospectus and other factors beyond our control such as fluctuations in the operations or valuations of companies perceived by investors to be comparable to us and conditions or trends in the Internet or auto parts industries.

The stock markets have historically experienced significant price and trading volume fluctuations. These fluctuations, as well as general economic and political conditions unrelated to our performance, may adversely affect the price of our common stock. In particular, following initial public offerings, the market prices for stocks of Internet and technology-related companies often reach levels that bear no established relationship to the operating performance of these companies. These market prices are generally not sustainable and could vary widely. 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. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

We have broad discretion as to the use of proceeds from this offering and may not use the proceeds effectively

We estimate the net proceeds of this offering to be approximately $            million. Our management will retain broad discretion as to the allocation of the proceeds and may spend these proceeds in ways in which our stockholders may not agree. The failure of our management to apply these funds effectively could result in unfavorable returns and uncertainty about our prospects, each of which could cause the price of our common stock to decline.

Our principal stockholders, executive officers and directors own a significant percentage of our stock and will continue to have significant control of our management and affairs after this offering

Upon completion of this offering, our executive officers and directors and entities that are affiliated with them will beneficially own approximately         % of our outstanding shares of common stock. This

 

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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. After this offering, we will have outstanding             shares of common stock. This includes the             shares we are selling in this offering, which may be resold in the public market immediately. All of the remaining 36,388,226 shares outstanding after the offering will become available for resale in the public market 180 days after the date of this prospectus (subject to extension in certain circumstances) due to agreements these stockholders have with us or the underwriters. However, the underwriters can waive this restriction and allow these stockholders to sell their shares at any time. 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. For a more detailed description, see “Shares Eligible for Future Sale.”

New stockholders will incur substantial and immediate dilution as a result of this offering

The initial public offering price is substantially higher than the book value per share of our outstanding common stock. As a result, investors purchasing common stock in this offering will incur substantial and immediate dilution. At the initial public offering price of $            per share, purchasers in this public offering will experience immediate and substantial dilution of approximately $            per share, representing the difference between our historical net tangible book value per share after giving effect to this offering and the initial public offering price. In addition, purchasers of common stock in this offering will have contributed approximately             % of the aggregate price paid by all purchasers of our stock but will own only approximately             % of our common stock outstanding after this offering. In addition, we have issued options to acquire common stock at prices significantly below the public offering price. To the extent such options are ultimately exercised, there will be further dilution to investors in this offering.

If we fail to maintain an effective system of internal control over financial reporting or are not able to adequately address certain identified significant deficiencies 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 significant deficiencies 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 the documentation of our key assumptions, estimates, accounting policies and procedures. If we fail to adequately address these significant deficiencies 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 a public companies in the United States. Furthermore, it is possible that our auditors will identify material weaknesses or additional significant deficiencies in the future in our system of internal control over financial reporting. Our failure to

 

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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 present 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 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. It is also possible that our independent auditors may not be in a position to adequately assess our compliance with Section 404 on a timely basis, which could lead to our inability to comply with our reporting requirements under the Exchange Act of 1934, as amended (the “Exchange Act”). 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.

We will incur increased costs and compliance risks as a result of being a public company

As a public company, we expect to incur significant legal, accounting and other expenses that we did not incur as a private company. These expenses are associated with our public company reporting requirements and certain corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and the new rules implemented by the SEC and the NASDAQ Stock Market. We expect that compliance with these rules and regulations, in particular Section 404 of the Sarbanes-Oxley Act of 2002, will substantially increase our legal and financial compliance costs and will likely require us to hire additional personnel and/or consultants. Like many smaller public companies, we expect to face a significant impact from required compliance with Section 404 of the Sarbanes-Oxley Act of 2002. The process of strengthening our internal control and complying with Section 404 will be expensive and time consuming, and will require significant time and attention from our management team. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

We also expect these new rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers.

We do not intend to pay dividends on our common stock

We currently intend to retain any future earnings and do not expect to pay any cash dividends on our capital stock for the foreseeable future.

 

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Our charter documents could deter a takeover effort, which could inhibit your ability to receive an acquisition premium for your shares

Provisions of our certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. For a more detailed discussion of these provisions, see “Description of Capital Stock — Anti-Takeover Provisions.”

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements.

Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in this prospectus in greater detail under the heading “Risk Factors.” Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

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USE OF PROCEEDS

The net proceeds from our sale of             shares of common stock in this offering are estimated to be approximately $            based on an assumed initial public offering price of $            per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

We presently intend to use the net proceeds of this offering as follows:

 

  Ÿ   Approximately $30.0 million will be used to repay our outstanding indebtedness under two term loans for approximately $20.0 million and $10.0 million, payable to our commercial lender. These loans bear interest at LIBOR plus 1.75% per annum and LIBOR plus 1.50% per annum (except during the first year in which the rate is 4.58%), respectively, and are due and payable beginning June 30, 2007 and March 31, 2007, respectively. Both loans have four year terms with the principal payable monthly over three years. However, the loans become due and payable in full upon the closing of an initial public offering. The proceeds of the loans borrowed were used to fund the acquisition of Partsbin, to fund the stockholder distribution made in connection with the March 2006 recapitalization, and for general working capital needs.

 

  Ÿ   Approximately $5.0 million will be used to repay our outstanding indebtedness under certain promissory notes payable to the former stockholders of Partsbin. The notes bear interest at LIBOR and are due and payable in equal quarterly installments beginning in the quarter ending June 30, 2007, with the final payment due in the quarter ending March 31, 2008. However, the notes become due and payable in full upon the closing of an initial public offering. The amounts outstanding under these promissory notes were used to fund the acquisition of Partsbin.

 

  Ÿ   The remainder of the net proceeds will be used for working capital and for general corporate purposes, including the introduction of new product categories, the expansion of existing product categories and expansion into complementary businesses.

We may also use a portion of the net proceeds of this offering to acquire or invest in complementary businesses, products, websites or technologies, or to enter into strategic marketing relationships with third parties. From time to time, in the ordinary course of business, we expect to evaluate potential acquisitions of these businesses, services or technologies and strategic relationships. Currently, we do not have any understandings, commitments or agreements with respect to any such acquisitions.

As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to be received upon the completion of this offering, and the amounts we actually spend could be outside of the ranges set forth above. The amounts actually expended for the purposes listed above will depend upon 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. Accordingly, our management will retain broad discretion in the allocation of the net proceeds of this offering. Pending their use, we anticipate that the net proceeds of this offering will be invested in short-term, interest-bearing, investment-grade securities.

 

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DIVIDEND POLICY

Concurrently with our recapitalization and termination of our S corporation status in March 2006, we paid a cash distribution to our stockholders in an aggregate amount of $51.7 million, which included our final S corporation distribution in the amount of $1.7 million. We currently intend to retain any future earnings to finance the growth and development of our business, and we do not anticipate that we will declare or pay any cash dividends on our common stock in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon our financial condition, results of operations, capital requirements, restrictions under any existing indebtedness and other factors the board of directors deems relevant. Our bank loan documents currently prohibit us from paying any cash dividends on our common stock without the prior written consent of our lender.

 

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CAPITALIZATION

The following table indicates our capitalization at September 30, 2006:

 

  Ÿ   on an actual basis;

 

  Ÿ   on a pro forma basis to reflect the conversion of all of our outstanding preferred stock into an aggregate of 11,055,425 shares of common stock immediately prior to the completion of this offering; and

 

  Ÿ   on a pro forma as adjusted basis to reflect (a) the conversion of all of our outstanding preferred stock into an aggregate of 11,055,425 shares of common stock immediately prior to the completion of this offering; (b) the issuance of              shares of common stock at an assumed initial public offering price of $             per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us; and (c) the repayment after the offering of $35.0 million of indebtedness incurred in connection with the Partsbin acquisition.

This table should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     September 30, 2006
     Actual     Pro Forma     Pro Forma
As Adjusted
          

(unaudited)

     
     (in thousands, except share data)

Cash and cash equivalents

   $ 3,287     $ 3,287     $             

Total debt, including current portion and capital lease obligations and notes payable to stockholders

     34,888       34,888    

Stockholders’ equity :

      

Preferred stock, $0.001 par value; 11,100,000 shares authorized; 11,055,425 shares issued and outstanding, actual and pro forma; no shares issued and outstanding, pro forma as adjusted

     11          

Common stock, $0.001 par value; 50,000,000 shares authorized; 25,332,801 shares issued and outstanding, actual; 36,388,226 shares issued and outstanding, pro forma shares issued and outstanding, pro forma as adjusted

     25       36    

Additional paid-in capital, excluding share-based compensation

     63,048       63,048    

Share-based compensation

     604       604    

Accumulated other comprehensive income

     6       6    

Accumulated deficit

     (43,465 )     (43,465 )  
                      

Total stockholders’ equity

     20,229       20,229    
                      

Total capitalization

   $ 55,117     $ 55,117     $  
                      

The table above excludes, as of September 30, 2006:

 

  Ÿ   4,027,560 shares of common stock issuable upon the exercise of outstanding options at a weighted average exercise price of $4.92 per share;

 

  Ÿ                  shares of common stock reserved for future grant or issuance under our stock option plans; and

 

  Ÿ   140,554 shares of common stock issuable upon the exercise of warrants outstanding at a weighted average exercise price of $4.38 per share.

For additional information regarding our capital structure, see “Management — Employee Benefit Plans,” “Description of Capital Stock” and Note 5 of the Notes to the Consolidated Financial Statements of U.S. Auto Parts.

 

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DILUTION

Our pro forma net tangible book value as of September 30, 2006 was approximately $             million, or $             per share of common stock. Pro forma tangible book value per share represents our total tangible assets less total liabilities divided by the number of shares of common stock outstanding as of September 30, 2006 after giving effect to the conversion of all of our outstanding preferred stock into common stock immediately prior to the closing of this offering. After giving effect to (a) the conversion of all of our outstanding preferred stock into common stock immediately prior to the closing of this offering; (b) our sale of              shares of common stock offered by this prospectus at an assumed offering price of $             per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us; and (c) the repayment of $35.0 million of our indebtedness upon completion of this offering, our pro forma net tangible book value as of September 30, 2006 would have been $             million, or $             per share of common stock. This represents an immediate increase in pro forma net tangible book value of $             per share to existing stockholders and an immediate dilution in pro forma net tangible book value of $             per share to investors purchasing common stock in this offering.

The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

      $             

Pro forma net tangible book value per share as of
September 30, 2006

   $                

Increase per share attributable to new investors

     

Pro forma net tangible book value per share after this offering

     

Dilution per share to new investors

      $  

The following table summarizes, on an as adjusted basis as of September 30, 2006, the difference between the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing stockholders and by new investors, assuming an initial public offering price of $             per share and before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us:

 

     Shares Purchased   Total Consideration     Average
Price per
Share
     Number    Percent   Amount     Percent      

Existing stockholders

              %             %     $             

New investors

           
                       

Total

        100 %   100 %  
                       

The foregoing discussion and tables assume no exercise of any stock options or warrants outstanding as of September 30, 2006. To the extent that these options are exercised, new investors will experience further dilution. As of September 30, 2006, options to purchase 4,027,560 shares of common stock were outstanding at a weighted average exercise price of $4.92 per share and warrants to purchase 140,554 shares of common stock were outstanding at a weighted average exercise price of $4.38 per share. Assuming all of our outstanding options and warrants are exercised, new investors will own approximately         % of our outstanding shares while contributing approximately         % of the total amount paid to fund our company.

 

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SELECTED CONSOLIDATED FINANCIAL DATA OF U.S. AUTO PARTS

The consolidated statement of income data of U.S. Auto Parts for the years ended December 31, 2003, 2004 and 2005 and the consolidated balance sheet data as of December 31, 2004 and 2005 have been derived from, and are qualified by reference to, our audited consolidated financial statements included in this prospectus. The consolidated statement of operations data for the year ended December 31, 2002 and the consolidated balance sheet data as of December 31, 2002 and 2003 have been derived from our audited consolidated financial statements that are not included in this prospectus. The consolidated statement of operations data for the nine months ended September 30, 2005 and 2006 and the consolidated balance sheet data as of September 30, 2006 have been derived from, and are qualified by reference to, our unaudited consolidated financial statements that are included in this prospectus. The consolidated statement of operations data for the year ended December 31, 2001 and the consolidated balance sheet data as of December 31, 2001 have been derived from our unaudited consolidated financial statements that are not included in this prospectus. The unaudited consolidated financial statements have been prepared on a basis consistent with our audited consolidated financial statements and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, that management considers necessary for the fair presentation of the information for the unaudited periods. Historical results are not necessarily indicative of future results. The following data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this prospectus.

 

    Years Ended December 31,    

Nine Months Ended

September 30,

 
    2001     2002     2003     2004     2005     2005     2006  
    (unaudited)           (unaudited)  
    (in thousands, except share and per share data)  

Consolidated Statement of Income:

             

Net sales

  $ 9,473     $ 17,936     $ 31,657     $ 40,658     $ 59,698     $ 43,979     $ 83,665  

Cost of sales

    6,202       12,275       17,814       21,334       34,829       25,876       53,779  
                                                       

Gross profit

    3,271       5,661       13,843       19,324       24,869       18,103       29,886  

Operating expenses:

             

General and administrative(1)

    1,528       1,090       2,284       3,599       7,254       5,555       7,081  

Marketing(1)

    467       1,685       3,617       4,526       5,802       4,315       10,313  

Fulfillment(1)

    934       2,473       3,246       2,990       4,357       3,162       3,589  

Technology(1)

    111       259       405       776       868       596       992  

Amortization of intangibles

                      8       17       13       3,037  
                                                       

Total operating expenses

    3,040       5,507       9,552       11,899       18,298       13,641       25,012  
                                                       

Income from operations

    231       154       4,291       7,425       6,571       4,462       4,874  

Other income (expense):

             

Loss from disposition of assets

    (4 )           (62 )                       (5 )

Other income

    6       85       33       80       191       165       155  

Interest expense, net

    (44 )     (21 )     (13 )     (44 )     (106 )     (68 )     (950 )
                                                       

Other income (expense), net

    (42 )     64       (42 )     36       85       97       (800 )

Income before income taxes

    189       218       4,249       7,461       6,656       4,559       4,074  

Income tax provision (benefit)

    3       3       478       328       (163 )     (199 )     539  
                                                       

Net income

  $ 186     $ 215     $ 3,771     $ 7,133     $ 6,819     $ 4,758     $ 3,535  
                                                       

Basic net income per share

  $ 0.01     $ 0.01     $ 0.20     $ 0.32     $ 0.31     $ 0.22     $ 0.15  

Diluted net income per share

  $ 0.01     $ 0.01     $ 0.20     $ 0.32     $ 0.31     $ 0.22     $ 0.11  

Shares used in computation of basic net income per share

    18,332,600       18,332,600       18,794,793       22,000,000       22,000,000       22,000,000       23,634,781  

Shares used in computation of diluted net income per share

    18,332,600       18,332,600       18,794,793       22,000,000       22,000,000       22,000,000       32,270,315  

EBITDA(2)

  $ 274     $ 333     $ 4,382     $ 7,961     $ 8,755     $ 6,095     $ 9,589  

Adjusted EBITDA(2)

  $ 274     $ 333     $ 4,382     $ 7,961     $ 8,755     $ 6,095     $ 10,193  

(see footnotes on next page)

 

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(footnotes to prior page)

 

(1)   Includes share-based compensation expense related to option grants, as follows:

 

    

Years Ended December 31,

   Nine Months
Ended
September 30,
     2001    2002    2003    2004    2005    Pro Forma
2005(1)
   2005    2006
                              (unaudited)    (unaudited)
     (in thousands)

General and administrative

   $         —    $         —    $         —    $         —    $         —    $         —    $         —    $       359

Marketing

                                        126

Fulfillment

                                        16

Technology

                                        103
                                                       
   $    $    $    $    $    $    $    $ 604
                                                       

 

(2)   EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures. EBITDA is equal to net income plus (a) interest expense, net; (b) income tax provision (benefit); (c) amortization of intangibles; and (d) depreciation and amortization. Our definition of Adjusted EBITDA is different from EBITDA because we further adjust EBITDA to exclude share-based compensation expense. See “— Non-GAAP Financial Measures” for a table that reconciles these non-GAAP financial measures to net income.

 

    December 31,   

September 30,

2006

 
    2001      2002        2003        2004      2005   
    (unaudited)                        (unaudited)  
    (in thousands)  

Consolidated Balance Sheet Data:

                

Cash and cash equivalents

  $       281    $       252    $       2,117    $       2,130    $       1,353    $       3,287  

Working capital

    1,091      744      3,391      1,662      3,136      (4,528 )

Total assets

    2,963      4,290      8,289      13,111      14,484      68,505  

Long-term debt (excluding notes payable to stockholders and current portion)

    205      408      80      83      357      25,437  

Notes payable to stockholders

                             5,000  

Stockholders’ equity

    1,027      1,142      4,543      5,960      5,239      20,229  

Non-GAAP Financial Measures

Regulation G, “Conditions for Use of Non-GAAP Financial Measures,” and other provisions of the Securities Exchange Act of 1934, as amended, define and prescribe the conditions for use of certain non-GAAP financial information. We provide “EBITDA” and “Adjusted EBITDA,” which are non-GAAP financial measures, because we believe such measures are important supplemental information for investors. We calculate EBITDA as net income before (a) interest expense, net; (b) income tax provision (benefit); (c) amortization of intangibles; and (d) depreciation and amortization. Adjusted EBITDA further adjusts EBITDA to exclude share-based compensation expense related to our grant of stock options and other equity instruments. These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. These non-GAAP financial measures reflect an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business.

 

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We use EBITDA and Adjusted EBITDA:

 

  Ÿ   as measurements of our operating performance because they assist us in comparing our operating performance on a consistent basis by removing the impact of items not directly resulting from our core operations;

 

  Ÿ   for planning purposes, including the preparation of our internal budget;

 

  Ÿ   to allocate resources to enhance the financial performance of our business;

 

  Ÿ   to evaluate the effectiveness of our operational strategies; and

 

  Ÿ   to evaluate our capacity to fund capital expenditures and expand our business.

We also believe that analysts and investors use EBITDA and Adjusted EBITDA as supplemental measures to evaluate the overall operating performance of companies in our industry.

Management strongly encourages investors to review our consolidated financial statements in their entirety and to not rely on any single financial measure. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. For information about our financial results as reported in accordance with GAAP, see our consolidated financial statements and related notes included in this prospectus.

The table below reconciles net income to EBITDA and Adjusted EBITDA for the periods presented:

 

     Years Ended December 31,    

Nine Months Ended

September 30,

     2001    2002    2003    2004    2005     2005     2006
     (unaudited)                         (unaudited)
Consolidated Statement
of Operations Data:
   (in thousands)      

Net income

   $       186    $       215    $     3,771    $     7,133    $     6,819     $     4,758     $ 3,535

Interest expense, net

     44      21      13      44      106       68       950

Income tax provision (benefit)

     3      3      478      328      (163 )     (199 )     539

Amortization of intangibles

                    8      17       13       3,037

Depreciation and amortization

     41      94      120      448      1,976       1,455       1,528
                                                  

EBITDA

     274      333      4,382      7,961      8,755       6,095       9,589

Share-based compensation

                                     604
                                                  

Adjusted EBITDA

   $ 274    $ 333    $ 4,382    $ 7,961    $ 8,755     $ 6,095     $ 10,193
                                                  

 

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SELECTED COMBINED FINANCIAL DATA OF PARTSBIN

The combined statement of operations data of All OEM Parts, Inc., ThePartsBin.com, Inc. and their affiliated companies (collectively, “Partsbin”) for the years ended December 31, 2003, 2004 and 2005 and the combined balance sheet data as of December 31, 2004 and 2005 have been derived from, and are qualified by reference to, the audited combined financial statements of Partsbin that are included in this prospectus. The combined balance sheet data as of December 31, 2002 and 2003 and the combined statement of operations data for the year ended December 31, 2002 have been derived from Partsbin’s audited combined financial statements that are not included in this prospectus. The combined statement of operations data for the three months ended March 31, 2005 and 2006 and the combined balance sheet data as of March 31, 2006 have been derived from, and are qualified by reference to, Partsbin’s unaudited combined financial statements that are included in this prospectus. The combined balance sheet data as of December 31, 2001 and the combined statement of operations data for the year then ended have been derived from Partsbin’s unaudited combined financial statements that are not included in this prospectus. The unaudited combined financial statements of Partsbin have been prepared on a basis consistent with our audited consolidated financial statements and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for the fair presentation of the information for the unaudited periods. Historical results are not necessarily indicative of future results. The following data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the combined financial statements and related notes included elsewhere in this prospectus.

 

    Years Ended December 31,     Three Months Ended
March 31,
 
    2001     2002     2003     2004     2005         2005             2006      
    (unaudited)                             (unaudited)  
    (in thousands)  

Combined Statement of Operations Data:

             

Net sales

  $       3,627     $     10,636     $     17,763     $     23,679     $     38,295     $       7,470     $     13,665  

Cost of sales

    2,771       8,409       13,596       18,148       29,398       5,746       10,255  
                                                       

Gross profit

    856       2,227       4,167       5,531       8,897       1,724       3,410  
                                                       

Operating expenses:

             

General and administrative

    632       904       1,189       1,480       3,111       665       998  

Marketing

    226       1,278       2,417       3,804       5,172       1,077       1,332  

Fulfillment

          10       31       36       50       13       11  

Technology

    44       345       318       319       563       113       238  
                                                       

Total operating expenses

    902       2,537       3,955       5,639       8,896       1,868       2,579  
                                                       

Income (loss) from operations

    (46 )     (310 )     212       (108 )     1       (144 )     831  

Other income (expense):

             

Loss from disposition of assets

          (3 )     (9 )                        

Interest income

          1       2       2       2              

Interest expense

                (1 )     (2 )     (11 )     (1 )     (6 )
                                                       

Other income (expense), net

          (2 )     (8 )           (9 )     (1 )     (6 )
                                                       

Income (loss) before income taxes

    (46 )     (312 )     204       (108 )     (8 )     (145 )     825  

Income tax provision

                                         
                                                       

Net income (loss)

  $ (46 )   $ (312 )   $ 204     $ (108 )   $ (8 )   $ (145 )   $ 825  
                                                       

EBITDA(1)

  $ (30 )   $ (276 )   $ 238     $ (42 )   $ 123     $ (120 )   $ 865  

(see footnotes on next page)

 

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(footnotes to prior page)

 

(1)   EBITDA is a supplemental non-GAAP financial measure. EBITDA is equal to net income (loss) plus (a) interest expense, net; (b) income tax provision (benefit); (c) amortization of intangibles; and (d) depreciation and amortization. See “Selected Consolidated Financial Data of U.S. Auto Parts — Non-GAAP Financial Measures” for additional information regarding our use of this non-GAAP financial measure. This non-GAAP financial measure should not be relied upon to the exclusion of GAAP financial measures.

The table below reconciles net income (loss) to EBITDA for the periods presented:

 

     Years Ended December 31,     Three Months Ended
March 31,
     2001     2002     2003     2004     2005         2005             2006    
     (unaudited)                             (unaudited)
     (in thousands)

Net income (loss)

   $ (46 )   $ (312 )   $ 204     $ (108 )   $ (8 )   $ (145 )   $   825

Interest expense, net

           (1 )     (1 )           9       1       6

Income tax provision

                                        

Amortization of intangibles

                                        

Depreciation and amortization

            16              37              35             66             122             24             34
                                                      

EBITDA

   $ (30 )   $ (276 )   $ 238     $ (42 )   $ 123     $ (120 )   $ 865
                                                      

 

     December 31,        
     2001     2002     2003     2004     2005     March 31,
2006
 
     (unaudited)                             (unaudited)  
     (in thousands)  

Combined Balance Sheet Data:

            

Cash and cash equivalents

   $       11     $     308     $     436     $     558     $     328     $ 1,061  

Working capital (deficiency)

     (120 )     (357 )     (442 )     (964 )     (1,705 )     (892 )

Total assets

     191       462       962       1,569       2,366       3,220  

Long-term debt

     4             21       21       355       353  

Stockholders’/members’ equity (deficiency)

     (48 )     (357 )     (151 )     (239 )     (498 )     327  

 

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UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS

The following unaudited pro forma combined financial information reflects the acquisition of Partsbin on May 19, 2006, which was accounted for as a purchase business combination as defined by SFAS No. 141, “Business Combinations.” The following unaudited pro forma combined statements of operations for the year ended December 31, 2005 and for the nine months ended September 30, 2006 give effect to the acquisition of Partsbin as if it occurred on January 1, 2005.

The unaudited pro forma combined financial information includes certain reclassifications to conform the presentation of the historical results of operations of Partsbin to our historical results of operations and do not reflect any adjustments for the effect of non-recurring items or operating synergies that we may realize as a result of the acquisition. The unaudited pro forma combined financial information does not purport to represent the actual results of operation that would have been achieved if the acquisition had taken place on January 1, 2005, and are not necessarily indicative of the results of operations that may be achieved in the future.

The unaudited pro forma adjustments made in preparing the pro forma combined statements of operations are based on the preliminary purchase price allocations and on certain management judgments. These preliminary allocations are based on an analysis of the estimated fair values of assets acquired and liabilities assumed, including identifiable tangible and intangible assets, deferred tax assets and liabilities, and estimates of the useful lives of tangible and amortizable intangible assets.

 

     Year Ended December 31, 2005  
     U.S. Auto
Parts
    Partsbin     Pro Forma
Adjustments(1)
    Pro Forma
Combined
 
                 (unaudited)  
     (in thousands, except share and per share data)  

Consolidated Statement of Income Data:

        

Net sales

   $ 59,698     $ 38,295     $     $ 97,993  

Cost of sales

     34,829       29,398             64,227  
                                

Gross profit

     24,869       8,897             33,766  

Operating expenses:

        

General and administrative

     7,254       3,111       (40 )(f)(g)     10,325  

Marketing

     5,802       5,172       (112 )(a)     10,862  

Fulfillment

     4,357       50             4,407  

Technology

     868       563             1,431  

Amortization of intangibles

     17             8,159 (b)     8,176  
                                

Total operating expenses

     18,298       8,896       8,007       35,201  
                                

Income (loss) from operations

     6,571       1       (8,007 )     (1,435 )

Other income (expense):

        

Other income

     191             (112 )(a)     79  

Interest expense, net

     (106 )     (9 )     (1,816 )(c)(g)     (1,931 )
                                

Other income (expense), net

     85       (9 )     (1,928 )     (1,852 )

Income (loss) before income taxes

     6,656       (8 )     (9,935 )     (3,287 )

Income tax benefit

     (163 )           (32 )(e)     (195 )
                                

Net income (loss)

   $ 6,819     $ (8 )   $ (9,903 )   $ (3,092 )
                                

Basic and diluted net income per share

   $ 0.31         $ (0.12 )

Shares used in computation of basic and diluted net income per share

     22,000,000         3,305,529 (d)     25,305,529  

(see footnotes on next page)

 

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(footnotes to prior page)

(1)   The pro forma adjustments reflect (a) the elimination of commission income received from Partsbin for website licensing fees (which was recorded as an expense in Partsbin’s statement of operations) prior to the business combination; (b) the assumed amortization related to the acquired Partsbin intangibles as if the Partsbin acquisition occurred on January 1, 2005; (c) the assumed interest expense related to the notes payable obtained as part of the acquisition (includes interest related to the $22.0 million secured debt, the $5.0 million notes payable to the former stockholders of Partsbin, and the warrants issued to the lender); (d) the assumed number of shares that would have been issued to the former Partsbin stockholders if the Partsbin acquisition occurred on January 1, 2005; (e) taxes as if both companies operated as a combined S corporation subject to California franchise taxes as of January 1, 2005; (f) the conforming of Partsbin’s accounting policies related to the depreciation and amortization of fixed assets as if we had amortized these assets using straight line amortization rather than according to Partsbin’s double declining balance method and had estimated lives in accordance with our accounting policies; and (g) the exclusion of the operations of TPB Real Estate, LLC, which we did not acquire as part of the Partsbin acquisition.

 

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Table of Contents
     Nine Months Ended September 30, 2006  
     U.S. Auto
Parts
    Partsbin(1)     Pro Forma
Adjustments(2)
    Pro Forma
Combined
 
     (unaudited)  
     (in thousands, except share and per share data)  

Consolidated Statement of Income Data:

        

Net sales

   $ 83,665     $ 23,859     $     $ 107,524  

Cost of sales

     53,779       17,690             71,469  
                                

Gross profit

     29,886       6,169             36,055  

Operating expenses:

        

General and administrative

     7,081       1,594       19 (e)(g)(h)     8,694  

Marketing

     10,313       3,419       (193 )(a)(e)     13,539  

Fulfillment

     3,589       19             3,608  

Technology

     992       413       (100 )(e)     1,305  

Amortization of intangibles

     3,037             3,137 (b)     6,174  
                                

Total operating expenses

     25,012       5,445       2,863       33,320  
                                

Income from operations

     4,874       724       (2,863 )     2,735  

Other income (expense):

        

Other income (expense)

     150       1       (23 )(a)     128  

Interest expense, net

     (950 )     (2 )     (705 )(c)     (1,657 )
                                

Other income (expense), net

     (800 )     (1 )     (728 )     (1,529 )

Income before income taxes

     4,074       723       (3,591 )     1,206  

Income tax provision (benefit)

     539             (649 )(f)     (110 )
                                

Net income (loss)

   $ 3,535     $ 723     $ (2,942 )   $ 1,316  
                                

Basic net income per share

   $ 0.16         $ 0.05  

Diluted net income per share

   $ 0.12         $ 0.04  

Shares used in computation of basic net income per share

     22,012,287         3,305,529 (d)     25,317,816  

Shares used in computation of diluted net income per share

     30,647,821         3,305,529 (d)     33,953,350  

(1)   The Partsbin data reflects the period from January 1, 2006 through May 19, 2006, the effective date of the Partsbin acquisition.

 

(2)   The pro forma adjustments reflect (a) the elimination of commission income received from Partsbin for website licensing fees (which was recorded as an expense in Partsbin’s statement of operations) prior to the business combination; (b) the assumed amortization related to the acquired Partsbin intangibles as if the Partsbin acquisition occurred on January 1, 2005; (c) the assumed interest expense related to the notes payable obtained as part of the acquisition (includes interest related to the $22.0 million secured debt, the $5.0 million notes payable to the former stockholders of Partsbin, and the warrants issued to the lender); (d) the assumed number of shares that would have been issued to the former Partsbin stockholders if the Partsbin acquisition occurred on January 1, 2005; (e) the deal related bonus paid to Partsbin employees on May 18, 2006; (f) taxes as if both companies operated as a combined S corporation subject to California franchise taxes as of January 1, 2005 and operated as a C corporation subsequent to March 3, 2006; (g) the exclusion of the operations of TPB Real Estate, LLC, which we did not acquire as part of the Partsbin acquisition; and (h) the conforming of Partsbin’s accounting policies related to depreciation and amortization of fixed assets as if we had amortized such costs using straight-line amortization rather than according to Partsbin’s double declining balance method and had estimated lives in accordance with our accounting policies.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with our selected consolidated financial data and the consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under the section entitled “Risk Factors” and elsewhere in this prospectus, our actual results may differ materially from those anticipated in these forward-looking statements.

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 approximately 550,000 SKUs, with detailed product descriptions and photographs. Our proprietary product database maps our 550,000 SKUs to over 4.3 million 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 $59.7 million for the year ended December 31, 2005 and $83.7 million for the nine months ended September 30, 2006.

Recent 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 and added a complementary, drop-ship order fulfillment method. Partsbin also expanded our international operations by adding two outsourced call centers in the Philippines and in India, as well as a Canadian subsidiary to facilitate sales in Canada. We also augmented our technology platform and expanded our management team. The purchase price for Partsbin consisted of $25.0 million in cash, promissory notes in the aggregate principal amount of $5.0 million payable to the former stockholders of Partsbin and 3,305,529 shares of our common stock. The acquisition of Partsbin did not result in a new operating segment for financial reporting purposes.

Recent Initiatives. We have recently made several new investments to enhance the value of our business. Since June 30, 2005, we have hired additional key employees, including our Chief Financial Officer and Chief Information Officer, as well as additional sales and marketing, technology and operations personnel. During 2006, we upgraded our accounting system and made significant software development efforts on our operational systems to support our expected future growth. We have added additional space to our distribution facilities to accommodate the stocking of additional products. We have also modified our product catalog to increase the number of applications available on our websites and have reformatted the catalog to more easily integrate with the Partsbin catalog.

International Operations. In addition to the call center capability in the Philippines and in India that we acquired in connection with the Partsbin acquisition, we own a Philippine subsidiary, which is partially

 

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responsible for software development, Internet marketing, customer service and sales functions. We believe 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 to our offshore operations. We also acquired a Canadian subsidiary in connection with our acquisition of Partsbin to facilitate sales of our products in Canada.

Basis of Presentation

Net Sales. We generate net sales primarily through the sale of auto parts to consumers through our network of e-commerce websites and online marketplaces. We also sell auto parts to auto body shops and collision repair shops located in Southern California through our wholesale sales channel, and we sell our Kool-Vue private label mirror line to auto parts distributors nationwide. To understand revenue generation through our network of e-commerce websites, we monitor several key business metrics, including the following:

 

  Ÿ   Unique Visitors. A unique visitor to a particular website represents a user with a distinct IP address that visits that particular website. We define the total number of unique visitors in a given month as the sum of unique visitors to each of our websites during that month. We measure unique visitors to understand the volume of traffic to our websites and to track the effectiveness of our online marketing efforts. The number of unique visitors has historically varied based on a number of factors, including our marketing activities and seasonality. We believe an increase in unique visitors to our websites will result in an increase in the number of orders. We seek to increase the number of unique visitors to our websites by attracting repeat customers and improving search engine marketing and other Internet marketing activities.

 

  Ÿ   Total Number of Orders. We closely monitor the total number of orders as an indicator of revenue trends. We recognize revenue associated with an order when the products have been shipped, consistent with our revenue recognition policy discussed in “Critical Accounting Policies” below. Orders are typically processed and shipped within one business day after a customer places an order.

 

  Ÿ   Average Order Value. Average order value represents our net sales for a given period of time divided by the total number of orders recorded during the same period of time. We seek to increase the average order value as a means of increasing net sales. Average order values vary depending upon a number of factors, including the components of our product offering, the order volume in certain online sales channels and the general level of competition online.

Cost of Sales. Cost of sales consists of the direct costs associated with procuring parts from suppliers and delivering products to customers. These costs include product costs offset by purchase discounts, freight and shipping costs and warehouse supplies.

General and Administrative Expense. General and administrative expense consists primarily of administrative payroll and related expenses, credit card and other transaction processing fees, legal and professional fees, amortization of software and other administrative costs. Following this offering, we anticipate we will incur increased general and administrative expenses related to operating as a public company, such as increased legal and accounting fees and expenses, higher insurance premiums, and increased personnel and employee benefit costs and non-employee director costs. We expect that the costs of compliance associated with the transition to and operation as a public company, including the requirements relating to improving and documenting our internal controls and procedures, as well as changes in corporate governance practices, will be significant.

Marketing Expense. Marketing expense consists of Internet marketing costs and fees, Internet commerce facilitator fees and other advertising costs, as well as payroll and related expenses associated

 

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with our marketing and customer service personnel, including the call centers. These costs are generally variable and are typically a function of net sales.

Fulfillment Expense. Fulfillment expense consists primarily of payroll and related costs associated with our warehouse employees, facility rent, building maintenance, depreciation and other costs associated with inventory management and our wholesale operations.

Technology Expense. Technology expense consists primarily of payroll and related expenses of our information technology personnel, the cost of hosting our servers, communications expenses and Internet connectivity costs, computer support and software development.

Amortization of Intangibles. Amortization of intangibles consists primarily of the amortization expense associated with certain intangibles recorded as a result of the Partsbin acquisition, in addition to the amortization expense of our capitalized domain names.

Other Income (Expense), Net. Other income (expense), net consists primarily of interest expense on our outstanding loan balances and capital leases.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales, costs and expenses, as well as the disclosure of contingent assets and liabilities and other related disclosures. 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 carrying values of our assets and liabilities that are not readily apparent from other sources. In many instances, we could have reasonably used different accounting estimates. Actual results could differ from those estimates, and we include any revisions to our estimates in our results for the period in which the actual amounts become known.

We believe the critical accounting policies described below affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our historical consolidated financial condition and results of operations:

Revenue Recognition. We recognize revenue from product sales when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable and collectibility is reasonably assured.

We evaluate the criteria of EITF 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent,” in determining whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as commissions. When we are the primary party obligated in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers or have several but not all of these indicators, revenue is recorded gross.

Product sales and shipping revenues, net of promotional discounts and return allowances, are recorded when the products are shipped and title passes to customers. Retail items sold to customers are made pursuant to terms and conditions that provide for transfer of both title and risk of loss upon our delivery to the carrier. Return allowances, which reduce product revenue by our best estimate of expected product returns, are estimated using historical experience. We generally require payment by credit card at the point of sale. Amounts received prior to when we ship goods to customers are recorded as deferred revenue.

 

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We periodically provide incentive offers to our customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off of current purchases and other similar offers. Current discount offers, when accepted by our customers, are treated as a reduction to the purchase price of the related transaction. Current discount offers and inducement offers are classified as an offsetting amount in “Net sales.”

Inventory. Inventory consists of finished goods available-for-sale and is stated at the lower of cost or market value, determined using the first in, first out (“FIFO”) method. We purchase inventory from suppliers both domestically and internationally, primarily in Taiwan and China. We believe that our products are generally available from more than one supplier, and we maintain multiple sources for many of our products, both internationally and domestically. We offer a broad line of auto parts for automobiles from model years 1965 to 2006. Because of the continued demand for our products, we primarily purchase products in bulk quantities to take advantage of quantity discounts and to ensure inventory availability. Inventory is reported net of inventory reserves for slow moving, obsolete or scrap product, which are established based on specific identification of slow moving items and the evaluation of overstock considering anticipated sales levels. If actual market conditions are less favorable than those anticipated by management, additional reserves may be required. Historically, our recorded reserve for returns has been adequate to provide for actual returns.

Website and Software Development Costs. We capitalize certain costs associated with software developed for internal use according to EITF No. 00-2, “Accounting for Website Development Costs” (“EITF 00-2”) and Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). Under the provisions of EITF 00-2 and SOP 98-1, we capitalize costs associated with website development and software developed for internal use when both the preliminary project design and testing stage are completed and management has authorized further funding for the project, which it deems probable of completion and to be used for the function intended. Capitalized costs include amounts directly related to website development and software development such as payroll and payroll-related costs for employees who are directly associated with, and who devote time to, the internal-use software project. Capitalization of these costs ceases when the project is substantially complete and ready for its intended use.

Long-Lived Assets and Intangibles. We have adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Asset” (“SFAS No. 142”). Under SFAS No. 142, intangible assets with indefinite useful lives are subject to reduction only when their carrying amounts exceed their estimated fair values based on impairment tests established by SFAS No. 142 that must be made at least annually. Capitalized amounts are amortized on a straight-line basis over their estimated useful lives. During the year ended December 31, 2004, we acquired intangibles in the amount of $50,000 relating to Internet domain names. In May 2006, we acquired approximately $52.3 million of intangibles related to the acquisition of Partsbin. We preliminarily allocated $29.0 million to websites, $2.3 million to domain names, $4.1 million to software assets, $3.0 million to long-term, favorable supplier relationships and $13.9 million to goodwill. Domain names are generally not amortized, capitalized websites are amortized over five years, and software assets and supplier relationships are amortized over three years.

In accordance with SFAS No. 142 and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we assess long-lived assets, including goodwill and intangibles subject to amortization, and indefinite live intangibles for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable based on the undiscounted estimated future cash flows expected to result from its use and eventual disposition. We recognize impairment in our operating results to the extent that the carrying value exceeds the discounted cash flows of future operations. We did not recognize any impairment losses for the years ended December 31, 2003, 2004 or 2005. If our key assumptions used to determine estimated discounted cash flows change in the future, we may be required to record impairment charges.

 

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Income Taxes. In 1996, we elected to be taxed as an S corporation for income tax purposes under provisions of the Internal Revenue and California Taxation Codes, which require that our income or loss be reported on the individual income tax returns of our stockholders; however, one of our former consolidated entities, MBS Marketing, Inc., was historically subject to federal income taxes and income taxes in California and Tennessee at statutory rates since its inception. In connection with our recapitalization, our S corporation status was terminated in March 2006, and we became a Delaware C corporation. MBS Marketing, Inc. was merged into us in June 2005 and consolidated with us for all periods presented for financial reporting purposes.

We account for income taxes for MBS Marketing, incorporated as a C corporation, and after March 3, 2006, for U.S. Auto Parts, in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). Under SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. When appropriate, we establish a valuation reserve to reduce deferred tax assets, which includes tax credits and loss carry forwards, to the amount that is more likely than not to be realized. Should future income be less than anticipated by management, we may be required to record a valuation allowance against our deferred tax assets.

Share-Based Compensation. We did not issue any stock options prior to March 2006. Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) requires that all share-based compensation to employees, including grants of employee stock options, be recognized in our financial statements based on their respective grant date fair values. 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. We currently use the Black-Scholes option pricing model to estimate the fair value of our share-based payment awards. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We do not have a history of market prices of our common stock as we are not a public company, and as such we estimate volatility in accordance with SAB No. 107 using historical volatilities of similar public entities. The expected life of the awards is based on a simplified method which defines the life as the average of the contractual term of the options and the weighted average vesting period for all open tranches. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our awards. The dividend yield assumption is based on our history and 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. Share-based compensation expense recognized in our financial statements in 2006 and thereafter is based on awards that are ultimately expected to vest. If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. Future share-based compensation expense and unearned share-based compensation will increase to the extent that we grant additional equity awards to employees or we assume unvested equity awards in connection with acquisitions.

Valuation at the Time of Grant. We have granted to our employees options to purchase common stock at exercise prices equal to the fair market value of the underlying common stock at the time of each grant, as determined by our board of directors.

 

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In valuing our common stock, our board of directors considered a number of factors, including:

 

  Ÿ   the illiquidity of our capital stock as a private company;

 

  Ÿ   the vesting restrictions imposed upon the equity awards;

 

  Ÿ   the business risks we faced;

 

  Ÿ   the liquidation preferences and other rights, preferences and privileges of our outstanding preferred stock;

 

  Ÿ   the likelihood of a financing event, such as a public offering;

 

  Ÿ   valuation indicators for our common stock price, primarily established through preferred stock issuances to third parties for cash and issuance values used as consideration for the acquisition of Partsbin;

 

  Ÿ   valuation estimates supported by independent third party valuations;

 

  Ÿ   our actual financial condition and results of operations relative to our formal operating plan during the relevant period;

 

  Ÿ   forecasts of our financial results, market conditions affecting the e-commerce sector, and changes in our management team;

 

  Ÿ   the closing of our Series A convertible preferred stock financing; and

 

  Ÿ   the closing date of the Partsbin acquisition as well as the date of a contemporaneous independent, third party valuation.

At the date of each option grant, our board of directors determined that the exercise price for each option was equal to the then-existing fair value of our common stock.

During the nine months ended September 30, 2006, we recognized share-based compensation of $604,000, determined in accordance with SFAS No. 123(R). Based on options outstanding as of September 30, 2006 and assuming that all employees remain employed by us for their remaining vesting periods, we expect to recognize an aggregate of approximately $367,000 of share-based compensation expense during the remainder of 2006 and an additional $1.5 million of share-based compensation expense during each of 2007 and 2008. The total compensation costs related to unvested stock options as of September 30, 2006 was $5.8 million.

Recent Accounting Pronouncements

FIN 48. In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes  an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We will adopt this interpretation as required. We are currently evaluating the impact of this interpretation on our consolidated financial statements.

 

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Results of Operations

The following table sets forth selected statement of income data for the periods indicated, expressed as a percentage of net sales:

 

     Years Ended December 31,     Nine Months Ended
September 30,
 
         2003             2004             2005             2005             2006      

Net sales

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of sales

   56.3     52.5     58.3     58.8     64.3  
                              

Gross profit

   43.7     47.5     41.7     41.2     35.7  

Operating expenses:

          

General and administrative

   7.2     8.9     12.2     12.6     8.5  

Marketing

   11.4     11.1     9.7     9.8     12.3  

Fulfillment

   10.3     7.4     7.3     7.2     4.3  

Technology

   1.3     1.9     1.5     1.4     1.2  

Amortization of intangibles

   —       0.0     0.0     0.0     3.6  
                              

Total operating expenses

   30.2     29.3     30.7     31.0     29.9  
                              

Income from operations

   13.6     18.3     11.0     10.2     5.8  

Other income (expense):

          

Loss from disposition of assets

   (0.2 )               (0.0 )

Other income

   0.1     0.2     0.3     0.4     0.2  

Interest income (expense), net

   (0.0 )   (0.1 )   (0.2 )   (0.2 )   (1.1 )
                              

Other income (expense), net

   (0.1 )   0.1     0.1     0.2     (0.9 )

Income before income taxes

   13.4     18.3     11.1     10.4     4.9  

Income tax provision (benefit)

   1.5     0.8     (0.3 )   (0.4 )   0.7  
                              

Net income

   11.9 %   17.5 %   11.4 %   10.8 %   4.2 %
                              

Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2006

Net Sales and Gross Margin

 

    

Nine Months Ended

September 30,

            
     2005     2006     $ Change    % Change  
     (in thousands)             

Net sales

   $ 43,979     $ 83,665     $ 39,686    90.2 %

Cost of sales

     25,876       53,779       27,903    107.8 %
                         

Gross profit

   $ 18,103     $ 29,886     $ 11,783    65.1 %

Gross margin

     41.2 %     35.7 %      (5.5 )%

Net sales increased due to a 119.8% increase in our online business that was principally driven by the acquisition of Partsbin, which was completed on May 19, 2006. The Partsbin acquisition significantly increased the number of engine parts, performance parts and accessories offered on our websites. The total number of our e-commerce orders increased from 207,000 orders for the nine months ended September 30, 2005 to 505,000 orders in the corresponding period of 2006, and our average order value for the nine months ended September 30, 2006 was $120. The increase in net sales also reflected a $3.7 million increase in our online marketplace sales, which included the contribution of Partsbin sales through this channel. Net

 

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sales of our Kool-Vue product line and sales of other products through our wholesale channel remained relatively constant in absolute dollars for the nine months ended September 30, 2006 as compared to the corresponding period of 2005 but declined as a percentage of net sales. We anticipate that sales through our wholesale channel will continue to decline as a percentage of net sales in the future due to our primary focus on our online business.

While gross profit increased largely as a function of the increase in net sales, gross margin declined in the nine months ended September 30, 2006 primarily due to the introduction of lower gross margins for products sold in our e-commerce channel through our drop-ship distribution method, which distribution method largely commenced in connection with the Partsbin acquisition. While this distribution method has generated lower product margins than our stock-and-ship distribution method, we expect that this new distribution method will provide us with a broader product selection and a more scalable business. Cost of freight increased in absolute dollars as a result of the increase in net sales, which increase was partially offset due to favorable shipping terms with our drop-ship suppliers. The decline in gross margin was also due in part to the expansion of sales in our online marketplaces to include additional lower gross margin products.

General and Administrative Expense

 

     Nine Months Ended
September 30,
            
     2005     2006     $ Change    % Change  
     (in thousands)             

General and administrative expense

   $ 5,555     $ 7,081     $ 1,526    27.5 %

Percent of net sales

     12.6 %     8.5 %      (4.1 )%

The increase in general and administrative expense in the current period was primarily due to an increase of $861,000 in merchant fees related to higher online sales; however, merchant fees remained relatively constant as a percentage of net sales. The increase in general and administrative expense reflects higher payroll and related expenses in the amount of $750,000, which was largely due to the hiring of nine additional administrative personnel, as well as higher compensation payable to such personnel. This increase was partially offset by a $483,000 reduction in legal fees in the current period, which was primarily related to an aborted financing transaction in 2005. This increase also includes $359,000 of share-based compensation related to options granted in the current period.

Marketing Expense

 

     Nine Months Ended
September 30,
            
     2005     2006     $ Change    % Change  
     (in thousands)             

Marketing expense

   $ 4,315     $ 10,313     $ 5,998    139.0 %

Percent of net sales

     9.8 %     12.3 %      2.5 %

The increase in marketing expense for the nine months ended September 30, 2006 was primarily due to a $3.8 million increase in advertising costs related to the expansion of our online marketing efforts, as well as higher sales commissions related to the increase in net sales in the current period of 2006. Marketing expense increased $1.7 million due to the addition of 141 employees, which increased our total number of employees from 148 in the prior year to 289 in the current period.

 

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Fulfillment Expense

 

     Nine Months Ended
September 30,
            
         2005             2006         $ Change    % Change  
     (in thousands)             

Fulfillment expense

   $ 3,162     $ 3,589     $ 427    13.5 %

Percent of net sales

     7.2 %     4.3 %      (2.9 )%

The increase in fulfillment expense in the current period was primarily due to a $325,000 increase in personnel costs related to the addition of 15 employees. In addition, depreciation expense increased by $111,000 as a result of the addition in depreciable warehouse equipment in the current year.

Technology Expense

 

     Nine Months Ended
September 30,
            
         2005             2006         $ Change    % Change  
     (in thousands)             

Technology expense

   $ 596     $ 992     $ 396    66.4 %

Percent of net sales

     1.4 %     1.2 %      (0.2 )%

The increase in technology expense was primarily due to higher communication fees to support the expanded communications infrastructure and the addition of $103,000 of share-based compensation expense.

Amortization of Intangibles

 

     Nine Months Ended
September 30,
          
         2005             2006         $ Change    % Change
     (in thousands)           

Amortization of intangibles

   $ 13     $ 3,037     $ 3,024    Not meaningful

Percent of net sales

     0.0 %     3.6 %     

3.6%

The increase in amortization of intangibles in the current period was primarily due to the intangible assets acquired pursuant to the acquisition of Partsbin completed in May 2006. We preliminarily estimate aggregate amortization expense for the years ending December 31, 2007 and 2008 will be approximately $8.2 and $8.2 million, respectively.

Other Income (Expense), Net

 

     Nine Months Ended
September 30,
           
         2005             2006         $ Change     % Change
     (in thousands)            

Other income (expense), net

   $ 97     $ (800 )   $ (897 )   Not meaningful

Percent of net sales

     0.2 %     (0.9 )%     (1.1)%

The increase in other income (expense), net in the current period was primarily due to an $964,000 increase in interest expense from the notes payable incurred during 2006 as part of the recapitalization and acquisition of Partsbin. This increase was partially offset by increase in interest income during the current period as a result of generally higher cash balances.

 

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Year Ended December 31, 2004 Compared to Year Ended December 31, 2005

Net Sales and Gross Margin

 

     Years Ended December 31,             
          2004               2005          $ Change    % Change  
     (in thousands)             

Net sales

   $ 40,658     $ 59,698     $ 19,040    46.8 %

Cost of sales

     21,334       34,829       13,495    63.3 %
                         

Gross profit

   $ 19,324     $ 24,869     $ 5,545    28.7 %

Gross margin

     47.5 %     41.7 %      (5.8 )%

Net sales increased due to a 66.4% increase in our online business, which was principally driven by the expansion of our online marketplaces, which generated net sales of $10.3 million in 2005 but had nominal sales prior to 2005. Our e-commerce sales increased $7.8 million, or 29%, to $34.9 million in 2005, primarily as a result of an increase of 43.2% in the number of orders in 2005, which was partially offset by a $14 decrease in the average order value in 2005. While sales of our Kool-Vue product line increased $2.0 million in 2005, sales of other products through our wholesale channel declined both in absolute dollars and as a percentage of net sales due to our primary focus on our online business.

While gross profit increased largely as a function of the increase in net sales, gross margin declined in 2005 primarily due to a 2.9% increase in shipping and freight expense as a percent of net sales to 15.2% in 2005 compared to 12.3% in 2004. This increase in shipping and freight expense as a percent of net sales was primarily the result of increased sales in our online marketplaces that have a higher ratio of shipping costs to product sales. Gross margin also decreased as a result of a 4.7% decrease in the gross margin of our e-commerce channel, which was primarily attributable to increased online competition. In addition, the gross margins for product sales in 2005 on our online marketplaces were 6.4% lower than the gross margins for product sales on our e-commerce channel in 2004. Due to the expansion of our online marketplaces, which accounted for 17.8% of net sales in 2005, our overall gross margins declined. Our wholesale channel gross margin was generally stable from 2004 to 2005.

General and Administrative Expense

 

     Years Ended December 31,             
         2004             2005         $ Change    % Change  
     (in thousands)             

General and administrative expense

   $ 3,599     $ 7,254     $ 3,655    101.6 %

Percent of net sales

     8.9 %     12.2 %      3.3 %

The increase in general and administrative expense in 2005 primarily reflects the amortization of software in the amount of $1.8 million related to our purchase of software in late 2004, higher payroll and related costs associated with higher average compensation in 2005, as well as an increase of $980,000 in legal and professional fees in 2005 principally related to an aborted financing transaction. We expect general and administrative expenses to continue to increase in absolute dollars and as a percent of net sales as we expand our sales, increase our staff, and incur additional costs related to the growth of our business and compliance requirements associated with being a public company.

 

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Marketing Expense

 

     Years Ended December 31,             
         2004             2005         $ Change    % Change  
     (in thousands)             

Marketing expense

   $ 4,526     $ 5,802     $ 1,276    28.2 %

Percent of net sales

     11.1 %     9.7 %      (1.4 )%

The increase in marketing expense in 2005 primarily reflects increased Internet marketing costs of $867,000, auction fees related to sales in our online marketplaces, which largely commenced in 2005, higher sales commissions related to the increase in net sales in 2005 and higher payroll and related costs associated with the addition of nine marketing employees in 2005.

Fulfillment Expense

 

     Years Ended December 31,             
         2004             2005         $ Change    % Change  
     (in thousands)             

Fulfillment expense

   $ 2,990     $ 4,357     $ 1,367    45.7 %

Percent of net sales

     7.4 %     7.3 %      (0.1 )%

The increase in fulfillment expense in 2005 primarily reflects higher payroll and related costs associated with the addition of 27 warehouse and shipping employees in 2005, as well as additional rent and moving expenses related to the opening of a second warehouse in Carson, California in September 2004, which only had four months of activity in 2004 compared to a full year in 2005.

Technology Expense

 

     Years Ended December 31,             
         2004             2005         $ Change    % Change  
     (in thousands)             

Technology expense

   $ 776     $ 868     $ 92    11.9 %

Percent of net sales

     1.9 %     1.5 %      (0.4 )%

The increase in technology expense in 2005 primarily reflects an increase in communication infrastructure expense of $115,000, which was partially offset by a $53,000 decrease in computer support services.

Other Income (Expense), Net

 

     Years Ended December 31,             
     2004     2005     $ Change    % Change  
     (in thousands)             

Other income (expense), net

   $ 36     $ 85     $ 49    136.1 %

Percent of net sales

     0.1 %     0.1 %      0.0 %

The increase in other income (expense), net in 2005 primarily reflects a $111,000 increase in website rental income, which was offset by a $62,000 increase in interest expense related to higher average borrowings in 2005.

 

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Year Ended December 31, 2003 Compared to Year Ended December 31, 2004

Net Sales and Gross Margin

 

     Years Ended December 31,             
         2003             2004         $ Change    % Change  
     (in thousands)             

Net sales

   $ 31,657     $ 40,658     $ 9,001    28.4 %

Cost of sales

     17,814       21,334       3,520    19.8 %
                             

Gross profit

   $ 13,843     $ 19,324     $ 5,481    39.6 %

Gross margin

     43.7 %     47.5 %      3.8 %

Net sales increased primarily due to a 24.9% increase in our e-commerce sales, which was largely driven by an increase in the number of orders from online customers by $58,000 from $143,000 in 2003 to $201,000 in 2004. In addition, sales in our wholesale channel increased 18.9%, or $1.1 million, to $6.9 million in 2004 primarily due to an increase in the number of DIFM customers purchasing our products, as well as an increase in the number of products offered to our customers. Our Kool-Vue sales also increased by $1.3 million, which was primarily due to increased purchases from our existing customers.

Gross profit increased as a result of the 28.4% increase in net sales and a 3.8% increase in gross margin. The gross margin increase in 2004 was primarily attributable to a 7.6% increase in the local wholesale gross margin due to a customer mix shift away from high volume, low margin customers to a broader customer base with higher gross margin sales. In addition, outbound freight expense as a percentage of net sales decreased by 0.9% to 12.3% of net sales.

General and Administrative Expense

 

     Years Ended December 31,             
         2003             2004         $ Change    % Change  
     (in thousands)             

General and administrative expense

   $ 2,284     $ 3,599     $ 1,315    57.6 %

Percent of net sales

     7.2 %     8.9 %      1.7 %

The increase in general and administrative expense in 2004 primarily reflects higher payroll and related costs associated with the addition of eight administrative employees in 2004 and employee bonuses. General and administrative expense in 2004 also includes the amortization of software in the amount of $326,000 related to our purchase of software in late 2004.

Marketing Expense

 

     Years Ended December 31,             
         2003             2004         $ Change    % Change  
     (in thousands)             

Marketing expense

   $ 3,617     $ 4,526     $ 909    25.1 %

Percent of net sales

     11.4 %     11.1 %      (0.3 )%

The increase in marketing expense in 2004 primarily reflects higher payroll and related costs associated with the addition of 13 marketing employees in 2004 and higher commissions related to the increase in net sales in 2004, as well as an increase of $1.4 million in Internet marketing costs. These increases were offset by a $1.1 million decline in web development consulting fees, primarily as a result of our software purchase in 2004, enabling us to conduct these marketing activities internally.

 

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Fulfillment Expense

 

     Years Ended December 31,              
         2003             2004         $ Change     % Change  
     (in thousands)              

Fulfillment expense

   $ 3,246     $ 2,990     $ (256 )   (7.9 )%

Percent of net sales

     10.3 %     7.4 %     (2.9 )%

The decrease in fulfillment expense in 2004 primarily reflects a decrease in the number of warehouse and shipping employees in 2004 to 62 from 67 such employees in 2003 and a decline in bad debt expense. In 2003, we incurred bad debt expense of approximately $274,000 related to non-payment by larger wholesale distributor customers whose services were subsequently terminated, for which there was not a similar bad debt expense incurred in 2004. The decrease in fulfillment expense in 2004 was partially offset by increased rental expense and moving expenses relating to the move of our principal warehouse and corporate office in October 2003.

Technology Expense

 

     Years Ended December 31,             
         2003             2004         $ Change    % Change  
     (in thousands)             

Technology expense

   $ 405     $ 776     $ 371    91.6 %

Percent of net sales

     1.3 %     1.9 %      0.6 %

The increase in technology expense primarily reflects an increase of $198,000 in costs associated with computer support services and higher payroll and related costs associated with the addition of one technical employee in 2004, as well as an increase in communications and access fees largely related to increased traffic to our websites and inbound sales calls.

Other Income (Expense), Net

 

     Years Ended December 31,           
          2003               2004          $ Change    % Change
     (in thousands)           

Other income (expense), net

   $ (42 )   $ 36     $ 78    Not meaningful

Percent of net sales

     (0.1 )%     0.1 %      Not meaningful

The increase in other income (expense), net was primarily due to a $47,000 increase in website commissions and a $62,000 loss on asset disposition. The website commissions related to website licensing fees, which fees terminated in April 2006. This increase was partially offset by a $32,000 increase in interest expense associated with capital leases.

 

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Quarterly Results of Operations

The following tables present unaudited quarterly results of operations, in dollar amounts and as a percentage of net sales, for the last seven quarters. This information has been derived from our unaudited consolidated financial statements and has been prepared by us on a basis consistent with our audited consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, which management considers necessary for a fair presentation of the information for the periods presented. Our quarterly financial results, including our net sales, gross profit and income from operations, have fluctuated in the past and may continue to fluctuate in the future based on a number of factors, many of which are beyond our control. Factors that may cause our revenue and operating results to vary or fluctuate include those discussed in the “Risk Factors” section of this prospectus.

 

    Three Months Ended  
    March 31,
2005
   

June 30,

2005

    Sept. 30,
2005
   

Dec. 31,

2005

    March 31,
2006
   

June 30,

2006

    Sept. 30,
2006
 
    (in thousands, except share and per share data)  

Consolidated Statement of Income Data:

             

Net sales

    $14,186       $15,238       $14,555       $15,719       $18,005       $26,966       $38,694  

Cost of sales

    7,860       9,410       8,606       8,953       10,259       17,617       25,903  
                                                       

Gross profit

    6,326       5,828       5,949       6,766       7,746       9,349       12,791  

Operating expenses:

             

General and administrative (1)

    1,966       1,905       1,684       1,699       1,969       2,326       2,786  

Marketing (1)

    1,273       1,507       1,535       1,487       2,014       3,240       5,059  

Fulfillment (1)

    950       1,087       1,125       1,195       1,152       1,213       1,224  

Technology (1)

    183       211       202       272       167       345       480  

Amortization of intangibles

    5       4       4       4       4       947       2,086  
                                                       

Total operating expenses

    4,377       4,714       4,550       4,657       5,306       8,071       11,635  

Income from operations

    1,949       1,114       1,399       2,109       2,440       1,278       1,156  

Other income (expense):

             

Other income (expense)

    83       43       39       26       149       3       (2 )

Interest expense, net

    (20 )     (18 )     (31 )     (37 )     (40 )     (317 )     (593 )
                                                       

Other income (expense), net

    63       25       8       (11 )     109       (314 )     (595 )

Income before income taxes

    2,012       1,139       1,407       2,098       2,549       964       561  

Income tax provision (benefit)

    34       (256 )     24       35       (163 )     425       277  
                                                       

Net income

    $  1,978       $  1,395       $  1,383       $  2,063       $  2,712       $  539       $  284  
                                                       

Basic net income per share

    $0.09       $0.06       $0.06       $0.09       $0.12       $0.02       $0.01  

Diluted net income per share

    $0.09       $0.06       $0.06       $0.09       $0.11       $0.02       $0.01  

Shares used in computation of basic net income per share

    22,000,000       22,000,000       22,000,000       22,000,000       22,000,000       23,534,919       25,332,801  

Shares used in computation of diluted net income per share

    22,000,000       22,000,000       22,000,000       22,000,000       25,637,235       34,620,713       36,461,475  

EBITDA

    $2,505       $1,645       $1,945       $2,660       $3,121       $2,777       $3,691  

Share-based compensation

                            5       225       374  
                                                       

Adjusted EBITDA

    $2,505       $1,645       $1,945       $2,660       $3,126       $3,002       $4,065  

(1)    Includes share-based compensation expense related to option grants, as follows:

 

      

    Three Months Ended  
   

March 31,

2005

   

June 30,

2005

    Sept. 30,
2005
    Dec. 31,
2005
    March 31,
2006
   

June 30,

2006

    Sept. 30,
2006
 
    (in thousands)  

General and administrative

  $     $     $     $     $ 3     $ 124     $ 232  

Marketing

                            2       56       68  

Fulfillment

                                  8       8  

Technology

                            0       37       66  
                                                       
  $     $     $     $     $ 5     $ 225     $ 374  

 

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     Three Months Ended  
     March 31,
2005
    June 30,
2005
    Sept. 30,
2005
    Dec. 31,
2005
    March 31,
2006
    June 30,
2006
    Sept. 30,
2006
 

As a Percent of Net Sales:

              

Net sales

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of sales

   55.4     61.8     59.1     57.0     57.0     65.3     66.9  
                                          

Gross profit

   44.6     38.2     40.9     43.0     43.0     34.7     33.1  

Operating expenses:

              

General and administrative

   13.9     12.5     11.6     10.8     10.9     8.6     7.2  

Marketing

   9.0     9.9     10.6     9.5     11.2     12.0     13.1  

Fulfillment

   6.7     7.1     7.7     7.6     6.4     4.5     3.2  

Technology

   1.3     1.4     1.4     1.7     0.9     1.3     1.3  

Amortization of Intangibles

   0.0     0.0     0.0     0.0     0.0     3.5     5.4  
                                          

Total operating expenses

   30.9     30.9     31.3     29.6     29.4     29.9     30.2  

Income from operations

   13.7     7.3     9.6     13.4     13.6     4.8     2.9  

Other income (expense):

              

Other income

   0.6     0.3     0.3     0.1     0.8     0.0     (0.0 )

Interest expense, net

   (0.2 )   (0.1 )   (0.2 )   (0.2 )   (0.2 )   (1.2 )   (1.5 )
                                          

Other income (expense), net

   0.4     0.2     0.1     (0.1 )   0.6     (1.2 )   (1.5 )

Income before income taxes

   14.1     7.5     9.7     13.3     14.2     3.6     1.4  

Income tax provision (benefit)

   0.2     (1.7 )   0.2     0.2     (0.9 )   1.6     0.7  
                                          

Net income

   13.9 %   9.2 %   9.5 %   13.1 %   15.1 %   2.0 %   0.7 %
                                          

EBITDA

   17.7 %   10.8 %   13.4 %   16.9 %   17.3 %   10.3 %   9.5 %

Share-based compensation

                   0.1     0.8     1.0  
                                          

Adjusted EBITDA

   17.7 %   10.8 %   13.4 %   16.9 %   17.4 %   11.1 %   10.5 %

In May 2006, we completed the acquisition of Partsbin, which resulted in lower gross margins related to the introduction of Partsbin’s drop-ship fulfillment method, higher general and administrative expenses resulting from integration costs, higher marketing expense, higher interest expense related to the acquisition indebtedness and higher amortization of intangibles recognized in the second and third quarter of 2006. The termination of our S corporation status in March 2006 also resulted in higher income tax provision in subsequent quarters.

Non-GAAP Financial Measures

We provide “EBITDA” and “Adjusted EBITDA,” which are non-GAAP financial measures because we believe such measures are important supplemental information for investors. See “Selected Consolidated Financial Data of U.S. Auto Parts — Non-GAAP Financial Measures” for additional information regarding our use of EBITDA and Adjusted EBITDA.

 

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The table below provides a quantitative reconciliation of our non-GAAP financial measures to the most comparable GAAP financial measures. For information about our financial results as reported in accordance with GAAP, see our consolidated financial statements and the related notes starting on page F-1.

 

     Three Months Ended
     March 31,
2005
   June 30,
2005
    September 30,
2005
   December 31,
2005
   March 31,
2006
    June 30,
2006
   September 30,
2006
     (unaudited)
     (in thousands)

Net income

   $ 1,978    $ 1,395     $ 1,383    $ 2,063    $ 2,712     $ 539    $ 284

Interest expense, net

     20      18       31      37      40       317      593

Income tax provision (benefit)

     34      (256 )     24      35      (163 )     425      277

Depreciation and amortization

     468      484       503      521      528       549      451

Amortization of intangibles

     5      4       4      4      4       947      2,086
                                                  

EBITDA

     2,505      1,645       1,945      2,660      3,121       2,777      3,691

Share-based compensation

                          5       225      374
                                                  

Adjusted EBITDA

   $ 2,505    $ 1,645     $ 1,945    $ 2,660    $ 3,126     $ 3,002    $ 4,065
                                                  

Liquidity and Capital Resources

We have historically funded our operations from cash generated from operations, credit facilities, bank and stockholder loans, an equity financing and capital lease financings.

In March 2006, we completed a recapitalization pursuant to which we issued and sold 11,055,425 shares of our Series A convertible preferred stock in a private placement for an aggregate purchase price of $45.0 million and borrowed $10.0 million pursuant to a bank term loan. At the closing of the private placement, we terminated our S corporation status under the Internal Revenue Code of 1986, as amended, and became subject to taxation as a C corporation beginning in March 2006. The term loan bears interest at the rate of 4.58% for the first 12 months of the loan and interest accrues thereafter at LIBOR plus 1.5%. Only interest is payable on this loan until March 31, 2007, and thereafter, the remaining principal and any accrued, unpaid interest are payable monthly over the remaining three years of the term. Notwithstanding the foregoing, the term loan will become due and payable upon completion of this offering. Concurrently with this recapitalization, we made stockholder distributions in the aggregate amount of $51.7 million, which included $1.7 million representing our final S corporation distribution.

In May 2006, we completed the acquisition of Partsbin. The purchase price for Partsbin of approximately $50.0 million 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 3,305,529 shares of our common stock. We funded this acquisition through the notes payable to the former stockholders of Partsbin and a $22.0 million bank term loan, which loan accrues interest at LIBOR plus 1.75% (7.07% at September 30, 2006). Only interest is payable on this term loan until March 31, 2007 and the remaining principal and any accrued, unpaid interest are payable monthly over the remaining three years of the term. The stockholder notes payable bear interest at LIBOR and are due and payable in four equal quarterly installments of principal and interest commencing June 30, 2007.

We currently maintain a $7.0 million bank line of credit, which expires on May 19, 2007 and bears interest at LIBOR plus 1.75% (7.07% at September 30, 2006). As of September 30, 2006, we did not have any amounts outstanding under this line of credit. The bank line of credit and term loans referenced above are with the same commercial lender and are secured by substantially all of our assets. The notes payable to the former stockholders of Partsbin are also are secured by substantially all of our assets.

 

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Upon completion of this offering, we intend to use a portion of the proceeds of this offering to repay the outstanding indebtedness under (i) the bank term loans, of which approximately $30.0 million was outstanding as of September 30, 2006, and (ii) the $5.0 million notes payable to stockholders incurred in connection with the Partsbin acquisition.

We had cash and cash equivalents of $3.3 million as of September 30, 2006, representing a $1.9 million increase from $1.4 million as of December 31, 2005. The increase in our cash and cash equivalents as of September 30, 2006 was primarily due to the $7.4 million in net cash provided by our operations during the nine months ended September 30, 2006, as well as the issuance of our Series A convertible preferred stock and proceeds from the two term loans. This increase was offset by distributions to stockholders and payments related to the acquisition of Partsbin. The December 31, 2005 cash balance represented a decrease of $0.8 million from the December 31, 2004 cash balance of $2.1 million. The decrease in cash as of December 31, 2005 was primarily due to the stockholder distributions and payments on our credit line, which was offset by cash generated from operations.

We had negative working capital of $4.5 million as of September 30, 2006, which was primarily due to an increase in accounts payable and accrued expenses and notes payable to stockholders related to the acquisition of Partsbin. Our working capital of $3.1 million as of December 31, 2005 represented an increase of $1.4 million from December 31, 2004. This increase was primarily due to an increase in our inventory, which was offset by an increase in accounts payable and accrued expenses. Due to the historical seasonality in our business during the fourth and first calendar quarters of each year, cash and cash equivalents, inventory and accounts payable are generally higher in these quarters, resulting in fluctuations in our working capital. We anticipate that funds 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 and our financial condition and results of operations.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Contractual Obligations

The following table sets forth our contractual cash obligations and commercial commitments as of December 31, 2005.

 

     Payment Due By Period

Contractual Obligations:

   Total    Less than
1 year
   1-3 years    3-5 years    More than
5 years
     (in thousands)

Capital lease obligations

   $ 592    $ 203    $ 382    $ 7    $

Notes payable

     96      96               

Operating lease obligations

     1,723      694      1,029          

Commitments under capital leases obligations relate to our leases for telephone and computer equipment, and the operating lease obligations for our principal facility in Carson, California.

 

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Quantitative and Qualitative Disclosures about Market Risk

We do not use financial instruments for trading purposes, and do not hold any derivative financial instruments that could expose us to significant market risk. Our primary market risk exposure with regard to financial instruments is changes in interest rates. We also have some exposure related to foreign currency fluctuations.

Interest Rate Risk. Pursuant to the terms of our term loans and line of credit with our principal lender, changes in the monthly LIBOR rate could affect the existing rate of our outstanding loans and the rates at which we could borrow funds under our line of credit. At September 30, 2006, we had outstanding borrowings in the aggregate amount of $30.0 million under our term loans with our principal lender and none outstanding under our line of credit with this lender. Additionally, we had outstanding borrowings in the aggregate amount of $5.0 million under the notes to the former Partsbin stockholders. A 1% increase or decrease in LIBOR would result in a $350,000 increase or decrease, respectively, in interest expense related to these outstanding borrowings.

Foreign Currency Risk. Our purchases of auto parts from our Asian suppliers are denominated in U.S. dollars, however, a change in the foreign currency exchange rates could impact our product costs over time. While our Philippine operational expenses are 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.

Change in Accountants

On October 11, 2005, upon the authorization of our Board of Directors, we changed our independent auditors from Stonefield Josephson, Inc. to Ernst & Young LLP. During the years ended December 31, 2004 and 2003, and the subsequent period from January 1, 2005 to October 11, 2005, Stonefield Josephson, Inc. did not have any disagreement with us on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Stonefield Josephson, Inc., would have caused them to make reference to the subject matter of the disagreement in connection with their reports on our financial statements for such years. The reports of Stonefield Josephson, Inc. on our consolidated financial statements for the years ended December 31, 2004, 2003 and 2002 did not contain an adverse opinion or disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles. We did not consult with Ernst & Young LLP on any financial or accounting reporting matters before its appointment.

Seasonality

We believe our business is subject to seasonal fluctuations. We have historically experienced higher sales of body parts in winter months when inclement weather and hazardous road conditions typically result in more automobile collisions and an increased demand for body parts. Partsbin, with its focus on engine parts, performance parts and accessories, has historically experienced higher sales in the summer vacation months when consumers have more time to undertake elective projects to maintain and enhance the performance of their automobiles and the warmer weather during that time is conducive for such projects. We expect the historical seasonality trends to continue to have a material impact on our financial condition and results of operations.

Inflation

Inflation has not had a material impact upon our operating results, and we do not expect it to have such an impact in the near future. We cannot assure you that our business will not be so affected by inflation in the future.

 

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Internal Controls Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting and for the timeliness and reliability of the information disclosed. During 2006, we have been documenting and reviewing the design and effectiveness of our internal controls over financial reporting in anticipation of the requirement to comply with Section 404 of the Sarbanes-Oxley Act. Based on current regulations, we are required to be compliant with Section 404 for the year ending December 31, 2008. Continuous review and monitoring of our business processes will likely identify other possible changes to our internal controls in the future. If we are unable to comply with Section 404 of the Sarbanes-Oxley Act, our share price may be negatively impacted. In addition, we expect our general and administrative expenses to increase substantially as we incur expenses associated with comprehensively analyzing, documenting and testing our system of internal control over financial reporting in anticipation of our compliance with Section 404 of the Sarbanes-Oxley Act.

 

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BUSINESS

Overview

We are a leading online provider of aftermarket auto parts, including body parts, engine parts, performance parts and accessories. Our user-friendly websites provide customers with a comprehensive selection of approximately 550,000 SKUs with detailed product descriptions and photographs. We have developed a proprietary product database which maps our 550,000 SKUs to over 4.3 million 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. Our corporate website is located at www.usautoparts.com.

Our online sales channel and relationships with suppliers enable us to eliminate several intermediaries in the traditional auto parts supply chain, allowing us to acquire many of our products directly from manufacturers and sell them to our customers. Additionally, as an online retailer, we do not incur many of the costs associated with operating brick and mortar stores. We believe that our ability to disintermediate the auto parts supply chain, combined with our efficient e-commerce platform, enables us to sell products at competitive prices while achieving higher operating margins and return on invested capital than many traditional automotive parts retailers.

Our business has grown consistently since we launched our first website in 2000. In the year ended December 31, 2005 and the nine months ended September 30, 2006, we generated net sales of $59.7 million and $83.7 million, respectively. In the year ended December 31, 2005 and for the nine months ended September 30, 2006, we generated net income of $6.8 million and $3.5 million, respectively. During the same periods, we also generated Adjusted EBITDA of $8.8 million and $10.2 million, respectively. In addition, we have experienced continued growth in the number of monthly unique visitors to our websites. In September 2006, approximately 6.8 million unique visitors visited our websites. The number of orders placed through all of our e-commerce websites has also increased from approximately 288,000 orders for the year ended December 31, 2005 to approximately 505,000 orders for the nine months ended September 30, 2006. The average order value of purchases on our websites for the nine months ended September 30, 2006 was approximately $120.

We were incorporated 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 on online marketplaces. In May 2006, we acquired Partsbin, an online retailer focused on selling engine parts and performance parts and accessories. This acquisition significantly expanded our product offerings and enhanced our ability to reach more customers and attain greater flexibility in our fulfillment operations.

Industry Overview

Growth in the Aftermarket Auto Parts Market

According to the AAIA’s 2006/2007 Aftermarket Factbook, the United States automotive aftermarket industry is projected to be $204 billion in 2006. Our addressable market is forecasted by AAIA to be approximately $91.3 billion in 2006, which consists of approximately $37.8 billion in sales to the Do-It-Yourself (“DIY”) customers, who independently maintain, repair or improve their vehicles, and $53.5 billion in sales to the Do-It-For-Me (“DIFM”) segment, which includes sales to entities such as collision and repair shops.

 

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We believe industry growth has been driven by several factors, including the:

 

  Ÿ   increased number and age of vehicles in the United States and increased number of miles driven annually;

 

  Ÿ   increased number of licensed drivers; and

 

  Ÿ   increased demand for performance auto parts.

While the U.S. auto parts aftermarket is characterized by modest growth, we believe there is an opportunity for e-commerce aftermarket auto part retailers to grow faster than the overall market due to consumer trends related to the Internet and e-commerce.

Growth of e-Commerce and Online Purchasing

Internet use and online commerce continue to grow worldwide. According to a September 2005 research report, US eCommerce: 2005 to 2010 issued by Forrester Research, online purchases by U.S. consumers are expected to grow from approximately $172 billion in 2005 to approximately $329 billion by 2010, representing a 13.9% compound annual growth rate. We believe several factors will contribute to this anticipated growth, including the increased awareness of the convenience, selection and product information available through online shopping, continued improvement in network infrastructure and payment security and growing access to high speed Internet connections that make online shopping increasingly efficient and attractive to consumers. According to Nielsen/NetRatings, broadband use at home has surpassed dial-up connectivity in the U.S., reaching 72% of residential Internet users in May 2006. In addition, the percentage of U.S. households shopping online is projected to grow from 39% in 2005 to 48% in 2010, according to Forrester Research.

As a percentage of overall retail sales, e-commerce sales today remain relatively small, having grown from 0.9% in the second quarter of 2000 to 2.3% in the second quarter of 2005 according to the U.S. Department of Commerce. However, e-commerce growth continues to increase at a much faster rate than overall retail sales growth. The U.S. Department of Commerce recently reported that online retail sales increased from $27.6 billion in 2000 to $87.8 billion in 2005, representing a 26.1% compound annual growth rate, compared to 4.5% for the overall retail market. According to Forrester Research, e-commerce sales are expected to represent a 13% share of total retail sales by 2010 as Internet and e-commerce growth trends continue to drive a shift from traditional sales channels to online sales channels.

In 2006, the online and mail order portion of aftermarket auto part sales is forecasted to be $2.7 billion according to the AAIA. While the portion of online and mail order sales is a relatively small percentage of our addressable market at approximately 3%, we believe online penetration rates of aftermarket auto parts consumers will continue to increase. As a result, we anticipate that sales for online aftermarket auto parts will continue to grow at a faster rate than the sales in the overall auto parts market.

Market Opportunity

The auto parts market has traditionally been fragmented and inefficient, with multiple intermediaries including importers, distributors and wholesalers between manufacturers and consumers. The involvement of each additional middleman typically leads to an increase in the price that a customer pays for a particular part. Furthermore, auto parts retailers who operate brick and mortar stores generally stock only a small percentage of the products that are available for sale. As a result, consumers must often visit several retailers to find a part or have a retailer order the part for future delivery.

The fragmented nature of the auto parts market has also meant an absence of a centralized database or a comprehensive, master catalog of products, which maps all aftermarket auto parts to all relevant applications

 

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for such parts, including applicable OEM part numbers. This inadequacy of information leads to inefficiencies in the sale and purchase process for both the retailer and the consumer, especially in view of the multiple makes, models and years of various vehicles for which parts are available.

Our Solution

We believe our solution addresses the problems faced in the traditional auto parts market and provides additional benefits for our customers. The key components of our solution include:

Disintermediation of the Auto Parts Supply Chain

We have developed an online sales channel that enables us to sell aftermarket auto parts to our customers while eliminating several intermediaries in the traditional auto parts supply chain. Traditional purchases of auto parts typically involve manufacturers, importers, wholesalers, distributors and retailers. We disintermediate the traditional auto parts supply chain by either obtaining products directly from manufacturers or sourcing products directly from wholesalers to fulfill customer orders. Disintermediating the traditional supply chain allows us to offer auto parts to our customers at competitive prices and allows us to more efficiently deliver products to our customers while generating higher profit margins.

The following diagram illustrates how we disintermediate the traditional supply chain:

LOGO

Leading Network of Websites

We have developed a network of websites to offer our broad selection of aftermarket auto parts. Our flagship websites for e-commerce are located at www.partstrain.com and www.autopartswarehouse.com. Our websites allow customers to search for parts in several ways, including by automobile make, model and year, by specific part name such as bumper or mirror, or by product category such as body or engine part. Our websites also include detailed product information, photographs and other online content, including informative articles and answers to frequently asked questions, in order to enhance the shopping experience. We believe that by providing an intuitive online shopping experience combined with useful auto part information and content, we are able to cost-effectively attract an increasing number of visitors to our sites, maintain high levels of customer satisfaction among our existing customers, and reduce the number of product returns and exchanges.

 

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Proprietary Product Catalog

We have invested significant resources and time over several years to build a proprietary product catalog, or electronic database, that maps SKUs to relevant applications for such parts, correlating the SKUs to applicable vehicle makes, models and years. We conduct our own research and testing as well as aggregate information from both offline and online data sources in order to accurately correlate SKUs to relevant vehicle makes, models and years. We have also developed proprietary technology and have trained personnel to compile and continuously update our product catalog. By creating a master catalog of individual auto parts and accessories mapped to multiple vehicle makes, models and years, we increase our sales potential while reducing inventory management expense. We believe that there is no other online catalog of aftermarket body parts, engine parts, performance parts and accessories currently available that offers the same breadth, accuracy and detail.

Flexible Fulfillment Methods

We fulfill customer orders using two primary methods: (i) stock-and-ship, where we take physical delivery of a part and store it in one of our distribution centers until it is shipped to a customer, and (ii) drop-ship, where the part is shipped directly to the customer from the supplier. We believe that the flexibility of fulfilling orders via two different fulfillment methods allows us to offer a broader selection of products, optimize product inventory, determine optimal pricing and enhance overall business profitability.

Low Cost Operations

Our offshore and outsourced operations in the Philippines and India allow us to access a qualified workforce at a significantly lower cost than comparably experienced U.S.-based professionals and provide us with flexibility and scalability in managing our operations. Our offshore and outsourced operations are responsible for a majority of the development and maintenance of our websites, continuous updates to our product catalog, software development, enhancements of our online marketing technologies and customer service.

Long-Standing Supplier Relationships

We source products from manufacturers and distributors located in Asia and the United States. We have developed strong relationships with our suppliers, some of whom have been working with us for over a decade. Many of our aftermarket products are available from more than one supplier, and we secure secondary sources for most of our top selling products. We continually research and analyze our market to understand how our suppliers are changing their product mix, part availability and pricing. Our supplier relationships and our understanding of the market enable us to set competitive pricing for our products and ensure product availability.

Benefit to Customers

We believe our solution pro