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PRTS > SEC Filings for PRTS > Form 10-Q on 6-Aug-2014All Recent SEC Filings

Show all filings for U.S. AUTO PARTS NETWORK, INC.

Form 10-Q for U.S. AUTO PARTS NETWORK, INC.


6-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement

You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this report. Certain statements in this report, including statements regarding our business strategies, operations, financial condition, and prospects are forward-looking statements. Use of the words "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would", "will likely continue," "will likely result" and similar expressions that contemplate future events may identify forward-looking statements.

The information contained in this section is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC, which are available on the SEC's website at http://www.sec.gov. The section entitled "Risk Factors" set forth in Part II, Item 1A of this report, and similar discussions in our other SEC filings, describe some of the important factors, risks and uncertainties that may affect our business, results of operations and financial condition and could cause actual results to differ materially from those expressed or implied by these or any other forward-looking statements made by us or on our behalf. You are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management's opinions only as of the date thereof. We do not assume any obligation to revise or update forward-looking statements. Finally, our historic results should not be viewed as indicative of future performance.

Overview

We are one of the largest online providers 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 stock keeping units ("SKUs"), with detailed product descriptions and photographs. Our proprietary product database maps our SKUs to product applications based on vehicle makes, models and years. We principally sell our products to individual consumers through our network of websites and online marketplaces. Our flagship websites are located at www.autopartswarehouse.com, www.jcwhitney.com and www.AutoMD.com and our corporate website is located at www.usautoparts.net. We believe our strategy of disintermediating the traditional auto parts supply chain and selling products directly to customers over the Internet allows us to more efficiently deliver products to our customers while generating higher margins.

Our History. We were formed in Delaware in 1995 as a distributor of aftermarket auto parts and launched our first website in 2000. We rapidly expanded our online operations, increasing the number of SKUs sold through our e-commerce network, adding additional websites, improving our Internet marketing proficiency and commencing sales in online marketplaces. As a result, our business has grown since 2000. Additionally, in August 2010, through our acquisition of Whitney Automotive Group, Inc. (referred to herein as "WAG"), we expanded our product-lines and increased our customer reach in the do-it-yourself ("DIY") automobile and off-road accessories market. We had declines in our revenues and incurred losses in 2011, 2012 and 2013.

International Operations. In April 2007, we established offshore operations in the Philippines. Our offshore operations allow us to access a workforce with the necessary technical skills at a significantly lower cost than comparably experienced U.S.-based professionals. Our offshore operations are responsible for a majority of our website development, catalog management, and back office support. Our offshore operations also house our main call center. We believe that the cost advantages of our offshore operations provide us with the ability to grow our business in a cost-effective manner.


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Acquisitions . From time to time, we have acquired and may in the future acquire businesses, websites, domain names, or other assets. We have no plans to pursue any acquisition opportunities in the near future. Our Credit Agreement with JPMorgan Chase Bank, N.A. ("JPMorgan") currently restricts our ability to enter into any acquisitions without prior permission from JPMorgan.

To understand revenue generation through our network of e-commerce websites and online market places, we monitor several key business metrics, including the following:

                                                Thirteen Weeks Ended                Twenty-Six Weeks Ended
                                            June 28,            June 29,          June 28,          June 29,
                                              2014                2013              2014              2013
Unique Visitors (millions) 1                     30.8                35.1               61.1             71.8
E-commerce Orders (thousands)                     541                 523              1,029            1,052
Online Marketplace Orders (thousands)             291                 187                555              354
Total Online Orders (thousands)                   832                 710              1,584            1,406
E-commerce Average Order Value             $      113          $      114        $       110        $     111
Online Marketplace Average Order Value     $       64          $       69        $        65        $      69
Total Online Average Order Value           $       96          $      102        $        94        $     101
Revenue Capture1                                 85.6 %              83.2 %             85.3 %           82.7 %
Conversion1                                      1.76 %              1.49 %             1.69 %           1.46 %

1 Excludes online marketplaces and media properties (e.g. AutoMD).

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. Included in the unique visitors are mobile device based customers, who are becoming an increasing part of our business. Shifting consumer behavior and technology enhancements indicates that customers are becoming more inclined to purchase auto parts through their mobile devices. User sophistication and technological advances have increased consumer expectations around the user experience on mobile devices, including speed of response, functionality, product availability, security, and ease of use. We believe enhancements to online solutions specifically catering to mobile based shopping can result in an increase in the number of orders and revenues. We believe an increase in unique visitors to our websites can 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. During the second quarter of 2014, our unique visitors reduced by 12.3% compared to the second quarter of 2013. Excluding the impact of discontinued websites, our unique visitors reduced by 0.6 million compared to the second quarter of 2013. We expect the total number of unique visitors to marginally improve during the second half of 2014, as we continue to address the challenges we are experiencing from changes search engines have made to the formulas, or algorithms, that they use to optimize their search results, as described in further detail under "Executive Summary" below.

Total Number of Orders: We monitor the total number of orders as an indicator of future revenue trends. Total orders were up by 17.2% in the second quarter of 2014 compared to the second quarter of 2013, with e-commerce and online marketplace orders improving by 3.4% and 55.6%, respectively. E-commerce orders improved through an increased conversion rate of our visitors to customers. The increase in online marketplace orders was primarily due to competitive pricing strategies. We expect the total number of orders to marginally improve throughout 2014 when compared to 2013. We recognize revenue associated with an order when the products have been delivered, consistent with our revenue recognition policy.

Average Order Value: Average order value represents our net sales on a placed orders basis for a given period of time divided by the total number of orders recorded during the same period of time. Average order value decreased by 5.9% in the second quarter of 2014, compared to the second quarter of 2013, with e-commerce and online marketplace orders decreasing by 0.9% and 7.2%, respectively. We expect this trend to continue in 2014 primarily due to increased competition, as described in further detail under "Executive Summary" below. 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 pricing, discounts offered, the order volume in certain online sales channels, macro-economic conditions, and the competition online.

Revenue Capture: Revenue capture is the amount of actual dollars retained after taking into consideration returns, credit card declines and product fulfillment. During the second quarter of 2014, our revenue capture increased by 2.9% to 85.6% compared to 83.2% in the second quarter of 2013. The increase in revenue capture was due to lower returns and credit


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card declines and improved product fulfillment in the second quarter of 2014 compared to the second quarter of 2013. We expect our revenue capture level to remain approximately the same in 2014 as we continue to improve our customers' purchase experience.

Conversion: Conversion is the number of orders as a rate to the total number of unique visitors. This rate indicates how well we convert a visitor to a customer sales order. During the second quarter of 2014, our conversion improved by 14.6% to 1.76% compared to 1.49% in the second quarter of 2013.

Executive Summary

For the second quarter of 2014, the Company generated net sales of $76.9 million, compared with $67.9 million for the second quarter of 2013, representing an increase of 13.3%. Net loss for the second quarter of 2014 was $2.2 million, or $0.07 per share. This compares to a net loss of $9.6 million, or $0.29 per share, for the second quarter of 2013. We generated net income before interest expense, net, income tax provision, depreciation and amortization expense, amortization of intangible assets, plus share-based compensation expense, impairment losses and restructuring costs ("Adjusted EBITDA") of $2.2 million in the second quarter of 2014 compared to $1.1 million in the second quarter of 2013. Adjusted EBITDA is presented because such measure is used by rating agencies, securities analysts, investors and other parties in evaluating the Company. It should not be considered, however, as an alternative to operating income, as an indicator of the Company's operating performance, or as an alternative to cash flows, as measures of the Company's overall liquidity, as presented in the Company's consolidated financial statements. Further, the Adjusted EBITDA measure shown for the Company may not be comparable to similarly titled measures used by other companies. Refer to the table presented below for reconciliation of net loss to Adjusted EBITDA.

Total sales increased in the second quarter of 2014 compared to the same period in 2013 primarily due to our online sales. Net sales increased to $76.9 million for Q2 2014 compared to $67.9 million for Q2 2013. Our Q2 2014 net sales consisted of online sales, representing 91.3% of the total (compared to 91.0% in Q2 2013), and offline sales, representing 8.7% of the total (compared to 9.0% in Q2 2013). The net sales increase was due to an increase of $8.4 million, or 13.6%, in online sales and by a $0.6 million, or 9.8%, increase in offline sales. The $8.4 million increase in online sales was primarily driven by a $11.2 million, or 19.3%, increase from continuing online sales channels offset by a reduction in online sales from websites we discontinued of $2.7 million. The continuing online sales channels growth is the result of a $5.7 million or 12.1% increase in our continuing e-commerce sales channels and a $5.5 million or 48.9% increase in our online marketplaces. The $11.2 million increase in our continuing e-commerce sales channels was driven by a 14.6% increase in conversion and partially offset by a 12.3% decrease in traffic and 0.9% decline in average order value. The discontinued websites resulted in a 2.5 million reduction in unique visitors in Q2 2014 compared with Q2 2013. Our offline sales for the second quarter of 2014 increased by $0.6 million, or 9.8%, to $6.7 million compared to the second quarter of 2013. Going forward we anticipate the closure of the Carson Distribution Facility will have a negative impact on offline sales as we adjust to operating in Southern California without a warehouse. We estimate sales could drop by between $2.8 to $3.8 million during the second half of 2014. For additional details related to the Carson Distribution Facility closure, refer to "Note 12-Restructuring Costs" of the Notes to Consolidated Financial Statements, included in Part I, Item 1 of this report.

Prior to the first quarter of fiscal 2014, year-over-year quarterly revenue declined for six consecutive quarters beginning in the third quarter of 2012. The highest decline occurred during the first quarter of 2013 (25%) as compared to the first quarter of 2012, and the least in the fourth quarter of 2013 compared to the fourth quarter of 2012 (5%). The table below presents quarterly revenues (in thousands) and the change in quarterly year-over-year revenues.

                                        Year over year quarterly sales
Thirteen weeks ended    Net Sales            Thirteen weeks ended            Net sales       % increase (decline)
Mar. 30, 2013          $    65,405                        Mar. 31, 2012     $    87,436                      (25.2 )%
Jun. 29, 2013          $    67,889                        Jun. 30, 2012     $    80,719                      (15.9 )%
Sept. 28, 2013         $    61,724                        Sep. 29, 2012     $    73,014                      (15.5 )%
Dec. 28, 2013          $    59,735                        Dec. 29, 2012     $    62,848                       (5.0 )%
Mar. 29, 2014          $    68,028                        Mar, 30, 2013     $    65,405                        4.0 %
Jun.. 28, 2014         $    76,947                        Jun. 29, 2013     $    67,889                       13.3 %

Like most e-commerce retailers, our success depends on our ability to attract online consumers to our websites and convert them into customers in a cost-effective manner. Historically, marketing through search engines provided the most


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efficient opportunity to reach millions of on-line auto part buyers. We are included in search results through 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 websites. Since 2013, we have decreased the amount we spent on paid search listings, as we have determined that it does not generate a sufficient amount of revenues to justify the expense. Algorithmic listings cannot be purchased and instead are determined and displayed solely by a set of formulas utilized by the search engine. We have had a history of success with our search engine marketing techniques, which gave our different websites preferred positions in search results. But search engines, like Google, revise their algorithms from time to time in an attempt to optimize their search results. Since 2011, Google has released changes to Google's search results ranking algorithm aimed to lower the rank of certain sites and return other sites near the top of the search results based upon the quality of the particular site as determined by Google. Google made additional updates throughout fiscal year 2012 and 2013. We were negatively impacted by the changes in methodology for how Google displayed or selected our different websites for customer search results. This reduced our unique visitor count which adversely affected our financial results. Our unique visitor count decreased by 4.3 million, or 12.3%, for the second quarter of 2014 to 30.8 million unique visitors compared to 35.1 million unique visitors in the second quarter of 2013. We believe we were affected by these search engine algorithm changes due to the use of our product catalog across multiple websites. To address this issue we consolidated to a significantly smaller number of websites to ensure unique catalog content. As we are significantly dependent upon search engines for our website traffic, if we are unable to attract unique visitors, our business and results of operations will be harmed.

Barriers to entry in the automotive aftermarket industry are low, and current and new competitors can launch websites at a relatively low cost. We experienced significant competitive pressure from certain of our suppliers as they are now selling their products online. Since our suppliers have access to merchandise at very low costs, they were able to sell products at lower prices and maintain higher gross margins, thus our gross margin percentage was negatively impacted by the increased level of competition. Total orders for the second quarter of 2014 went up by 17.2% compared to the second quarter of 2013 while our average order value decreased by $6, or 5.9%, for the second quarter of 2014 to $113 compared to $114 in the second quarter of 2013 as a result of increased pricing competition. Our current and potential customers may decide to purchase directly from our suppliers. Continuing increased competition from our suppliers that have access to products at lower prices than us could result in reduced sales, lower operating margins, reduced profitability, loss of market share and diminished brand recognition. In addition, some of our competitors have used and may continue to use aggressive pricing tactics. We expect that competition will further intensify in the future as Internet use and online commerce continue to grow worldwide.

Total expenses, which primarily consisted of cost of sales and operating costs, decreased during the second quarter of 2014 compared to the same period in 2013. Components of our cost of sales and operating costs are described in further detail under - "Basis of Presentation" below. Going forward we anticipate the closure of the Carson Distribution Facility will reduce cost of sales and certain operating expenses, specifically fulfillment which includes rent and personnel costs. We estimate expenses could drop by between $2.8 to $3.8 million during the second half of 2014. For additional details related to the Carson Distribution Facility closure, refer to "Note 12-Restructuring Costs" of the Notes to Consolidated Financial Statements, included in Part I, Item 1 of this report.

Our personnel costs declined in the second quarter of 2014 compared to the second quarter of 2013. Our employees at the end of the second quarter of 2014 decreased to 1,042 as compared to 1,126 at the end of the second quarter of 2013. In 2014 and 2013, as part of the Company's initiatives to reduce labor costs and improve operating efficiencies in response to the challenges in the marketplace and general market conditions, we reduced our workforce by 77 and 176 employees, respectively (for additional details, refer to "Note 12-Restructuring Costs" of the Notes to Consolidated Financial Statements, included in Part I, Item 1 of this report). While we have and continue to undertake several initiatives to improve revenues and reduce the losses in 2014, if the downward revenue and loss trend observed in 2012 and 2013 continue in the second half of 2014, we may be required to further reduce our labor costs.

Revenues increased during the second quarter of 2014, when compared to the second quarter of 2013, and we expect our revenues to continue to improve for all the quarters of fiscal year 2014 when compared to comparable quarters of fiscal year 2013. We expect to incur a net loss in fiscal year 2014 that is substantially less than the net losses incurred in fiscal year 2013 and 2012. If a downward trend experienced in 2012 and 2013 recurs in the back half of 2014 and is more negative than we expect, it could severely impact our liquidity as we may not be able to provide positive cash flows from operations in order to meet our working capital requirements. We may need to borrow additional funds from our credit facility, which under certain circumstances may not be available, sell additional assets or seek additional equity or additional debt financing in the future. Refer to "Liquidity and Capital Resources" section below for additional details. There can be no assurance that we would be able to raise such additional financing or engage in such asset sales on acceptable terms, or at all. If we do experience the downward trend in revenues and the net loss we experienced in 2012 and 2013 recurs because our strategies to return to positive sales growth and profitability are not successful or otherwise, and if we are not able to raise adequate additional financing or proceeds from additional asset sales to continue to fund our ongoing operations, we will need to defer, reduce or eliminate significant planned expenditures, restructure or significantly curtail our operations.


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During the second quarter of 2014 we continued to make positive strides to pursue strategies to return to positive sales growth and profitability that we initiated during the last half of 2013:

We continue to work to return to positive e-commerce growth by providing unique catalog content and providing better content on our websites thereby improving our ranking on the search results. We expect this to increase unique visitors to our website and help us grow our revenues. We expect revenue trends to continue to improve for the back half of 2014 as compared to 2013.

We continue to work to improve the website purchase experience for our customers by (1) helping our customers find the parts they want to buy by reducing failed searches and increasing user purchase confidence; (2) selling more highly customized accessories by partnering with manufacturers to build custom shopping experiences; (3) increasing order size across our sites through improved recommendation engines; and (4) completing the roll out of high quality images and videos with emphasis on accessory product lines. In addition, we intend to build mobile enabled websites to take advantage of shifting consumer behaviors. These efforts may increase the conversion rate of our visitors to customers, total number of orders and average order value, and contribute to our revenue growth.

We continue to work to becoming one of the best lowest priced options in the market. We expect this to help improve the conversion rate for our visitors to our website and grow our revenues. While revenues are expected to grow, based on our pricing strategy, we expect our gross margin percentage for the rest of fiscal 2014 to remain consistent with the second quarter of 2014, excluding the impact of the Carson closure. While we plan to transition away from lower margin stock ship branded products and expand our private label mix, which provides higher margins, we expect to see improvements in our branded business due to our pricing strategy described above.

Increase product selection by being the first to market with new SKUs. We will seek to add new categories and expand our existing specialty categories. We expect this to increase the total number of orders and contribute to our revenue growth.

Be the consumer advocate for auto repair through AutoMD.com. We will continue to devote resources to AutoMD.com and its system development. We expect this to improve our brand recognition and contribute to our revenue growth.

Continue to implement cost saving measures.

As we redesign our approach to attracting customers through search engines, we hope to offset much of the revenue loss by pursuing revenue opportunities in third-party online marketplaces, a number of which are growing significantly. Auto parts buyers are finding third-party online marketplaces to be a very attractive environment, for many reasons, the top four being: (1) the security of their personal information; (2) the ability to easily compare product offerings from multiple sellers; (3) transparency (consumers can leave positive or negative feedback about their experience); and (4) favorable pricing. Successful selling in these third-party online marketplaces depends on product innovation, and strong relationships with suppliers, both of which we believe to be our core competencies.

There are various macro-economic factors that indirectly affect our business, including the slow recovery in the United States from the recession, continued high unemployment, and other challenging economic conditions. These factors decrease the overall discretionary spending of our customers and we believe it becomes more likely that consumers will keep their current vehicles longer, thus will need replacement parts as a result of general wear and tear, and perform repair and maintenance in order to keep those vehicles well maintained. At the same time, higher gas prices are negatively impacting the industry as consumers drive less and reduce the wear and tear on their vehicles. Given the nature of these factors, and the volatility of the overall economic environment, we cannot predict whether or for how long these trends will continue, nor can we predict to what degree these trends will impact us in the future.


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Non-GAAP measures

EBITDA and Adjusted EBITDA are presented because such measures are used by rating agencies, securities analysts, investors and other parties in evaluating the Company. It should not be considered, however, as an alternative to operating income, as an indicator of the Company's operating performance, or as an alternative to cash flows, as measures of the Company's overall liquidity, as presented in the Company's consolidated financial statements. Further, the EBITDA and Adjusted EBITDA measures shown for the Company may not be comparable to similarly titled measures used by other companies. Refer to the table presented below for reconciliation of net loss to EBITDA and Adjusted EBITDA.

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

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