Carparts.Com, Inc. quarterly report, Q3 FY2011

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Business context and reporting period

Filing identity differs from the request metadata: the supplied 10-Q is for U.S. Auto Parts Network, Inc., not Carparts.com, Inc. It covers the thirteen and thirty-nine weeks ended October 1, 2011, compared with periods ended October 2, 2010; it is not a 2010 Q3 filing. The company distributes aftermarket auto parts, mainly through online channels. Results include its 2010 acquisition of WAG.

Financial performance and position

Amounts below are in millions of dollars unless noted otherwise.

  • Third-quarter revenue: $78.6, up 8.6% year over year. Excluding WAG, revenue rose 1.2% to $59.4. E-commerce sales were about 80% of total sales and declined 1.0% year over year.
  • Third-quarter profitability: gross profit was $24.3, with a 31.0% gross margin versus 33.2% a year earlier. Operating loss was $5.2 versus $2.0; net loss was $5.3, or $0.17 per share, versus $13.0, or $0.43 per share. The prior-year net loss included a $11.0 income-tax provision, primarily related to a deferred-tax valuation allowance.
  • Year-to-date performance: revenue was $249.8, up 37.4%; excluding WAG, it increased 8.6%. Gross margin fell to 33.3% from 34.2%. Operating loss was $7.4 versus operating income of $1.2; net loss was $8.1 versus $11.0.
  • Costs and adjusted measure: third-quarter marketing expense increased to $14.0 (17.8% of sales, versus 15.4%). The company reported third-quarter Adjusted EBITDA of $3.1 versus $4.1; excluding WAG, it was $4.0. This non-GAAP measure includes specified add-backs and is not a substitute for operating income or cash flow.
  • Cash flow: year-to-date operating cash flow was $10.4 versus $1.6. Investing cash outflow was $8.3, including $11.1 of property and equipment additions; financing cash outflow was $4.5, including $4.6 of debt payments. Cash declined $2.4 to $15.2. Operating cash flow less property and equipment additions was approximately negative $0.7.
  • Liquidity and debt at October 1, 2011: working capital was $12.4; cash was $15.2 and short-term investments $1.1. The company also held $2.1 of illiquid auction-rate securities classified as long-term investments. Term debt was $19.4, with no revolver borrowings and up to $10.0 available under the revolving line. Current ratio was approximately 1.20.
  • Balance sheet: total assets were $147.8, total liabilities $80.6, and stockholders’ equity $67.2. Cash was down from $17.6 at January 1, 2011; inventory was $45.7 versus $48.1.

Material changes and management commentary

  • Revenue growth includes WAG, acquired in August 2010; the company’s own business grew more modestly. In Q3, unique visitors rose 9.7%, but conversion rate fell 4.5%, revenue capture fell 2.9%, and average order value fell 0.8%.
  • Management attributed lower gross margin to a sales mix shift from body parts to engine parts and higher freight costs. Marketing costs also rose, including online advertising and other marketing services.
  • WAG contributed a reported Q3 loss of $5.5, including $3.8 of restructuring and integration costs. Year-to-date acquisition and integration costs were $6.6. A $1.5 charge for terminating WAG’s former Chicago office sublease was recorded in Q3; most was paid in October.
  • The company entered a new five-year Carson, California sublease beginning November 1, 2011, with monthly rent rising from approximately $26,300 in year one to $32,300 in year five. Management expects consolidation to reduce rent and potentially improve warehouse efficiency.
  • Management said cash on hand and operating cash generation should meet working-capital needs, expected capital expenditures, and debt service for at least twelve months. It also expects covenant compliance through the loan’s remaining term, while warning that lower-than-forecast EBITDA could cause a breach.

Risks, contingencies, and unusual items

  • The lender waived fixed-charge-coverage covenant noncompliance at January 1 and October 1, 2011, with WAG-related add-backs permitted in the covenant calculation. The company reported compliance after amendment, but a future uncured breach could allow acceleration of debt. Reported covenant ratios at October 1 included a 1.30 debt-to-EBITDA ratio and 1.80 fixed-charge-coverage ratio after amendments.
  • Auction-rate securities remain illiquid because of failed auctions; the company may have to hold them for an uncertain period. A further decline deemed other-than-temporary could result in an earnings charge.
  • In the Parts Geek litigation, the company had appealed an adverse ruling and had not accrued approximately $1.1 of potential legal fees and costs, stating that an accrual was not required at the time. Oral argument was pending.
  • The company settled a California Air Resources Board inquiry on catalytic converters on October 26, 2011, agreeing to a non-material cash penalty, partly offset by supplier contributions, without admitting liability.
  • The company disclosed supplier concentration, dependence on online search traffic and third-party fulfillment, competitive and seasonal pressures, foreign-exchange exposure, and risks from acquisition integration. A 10% change in the Philippine peso/U.S. dollar exchange rate was estimated to affect year-to-date operating expenses by approximately $0.9.
  • An immaterial $1.5 balance-sheet reclassification moved accounts receivable to goodwill and did not affect reported earnings or cash flows. Disclosure controls were judged effective; no material internal-control change was reported.

Most important facts for investors to verify

  1. Confirm the intended issuer and period: this document is U.S. Auto Parts Network’s 2011 Q3 10-Q, not a 2010 Q3 Carparts.com filing.
  2. Assess underlying growth excluding WAG and whether online traffic can translate into improved conversion, revenue capture, and order value.
  3. Track gross-margin recovery, freight costs, and the sustainability of marketing and acquisition-related spending.
  4. Review liquidity against capital expenditures and debt maturities, and monitor covenant headroom and any future lender waivers.
  5. Verify the status and valuation of the illiquid auction-rate securities and the outcomes of the Parts Geek appeal and other contingencies.