pre-ipo analysis on every deal at http://www.tradingipos.com

2007-02-01
PRTS - U.S. Auto Parts Network

PRTS - U.S. Auto Parts Network plans on offering 11.5 million shares(assuming over-allotment is exercised) at a range of $10-$12. Insiders are selling 3.5 million shares in the offering. RBC Capital and Weisel are lead managing the deal, Piper Jaffrey and JMP are co-managing. Post-offering PRTS will have 29.8 million shares outstanding for a market cap of $328 million on an $11 pricing. Approximately 40% of ipo proceeds will be utilized to repay all outstanding debt, the rest for working capital and general corporate purposes.

Oak Investment Partners, not selling any shares on ipo, will own 22% of PRTS post-ipo.Oak has had a piece of a number of ipos over the past few years including LOOP/SHOP/GMKT/CBOU/DKS.

From the prospectus:

'We are a leading online provider of aftermarket auto parts, including body parts, engine parts, performance parts and accessories. Our network of websites provides individual consumers 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.'

Websites are located at www.partstrain.com and www.autopartswarehouse.com. Each was launched in 2000. In September 2006, PRTS two sites combined had approximately 6.9 million unique visitors with autopartswarehouse.com being the more popular of the two. Average order value of purchases on the sites is approximately $120.

PRTS discusses how they are able to directly acquire from the manufacturer thus eliminating intermediaries. In essence, PRTS websites become the intermediary or 'middle-man' in the auto parts supply chain. As with many online retailers, PRTS feels the lack of brick/mortar expenses as well as their flexible fulfillment methods allow them to discount prices at attractive levels for buyers.

Industry - The US aftermarket auto parts market is $200 billion business. PRTS believes their addressable total market domestically is a little over $90 billion. Overall the US auto parts market is characterized by slow growth, specifically in recent years as auto manufacturers new car quality ratings have increased. Better built new cars, means slowing demand for aftermarket auto parts. PRTS believes the exception to this slowing growth is the online auto parts aftermarket niche. Currently just 3% of the US aftermarket auto parts market activity is done online. That % is expected to grow to 13% by 2010.

PRTS made a substantial acquisition in the first half of 2006. The acquisition was Partsbin, another online retailer of auto parts. Price was approximately $60-$70 million in cash, stock, and other considerations. The acquisition significantly increased PRTS product offerings and number of SKU's, particularly in the area of engine parts and performance parts and accessories. One of PRTS biggest challenges in first of 2007 will be continuing to profitably integrate this acquisition into their business.

Note - The PRTS acquisition did add to cash flow the back 1/2 of 2006. However Partsbin's products have historically sold at a lower gross margin the PRTS products and the acquisition resulted in amortization charges on PRTS earnings sheet. So while the acquisition is adding cash flow and appears to be a potential growth driver for PRTS, short term it is dragging down gross margins and GAAP earnings. The result of this is that PRTS is actually doing much better financially then their recent earnings reports would indicate.

Competition - While there isn't a public pure play comparable for PRTS, there is intense competition in the aftermarket auto parts business. Historically this sector has been dominated by brick and mortar retailers such as Napa, Pep Boys, AutoZone, Advance Auto Parts etc...While all of those still derive the majority of their revenues from their retail outlets, each does offer an extensive parts catalog online as well. Also auto parts wholesaler LKQX has done very well since ipo in 2003. This is a very competitive niche, which indicated by PRTS gross margins sliding a bit annually the past few years as the 'brick and mortars' focus more attention on their online businesses.

Very low barrier to entry here for the established payers to compete effectively with a company such as PRTS. In fact the established companies may indeed have two very nice advantages, name recognition and deeper advertising pockets.

Financials

$1 1/2 per share in cash, no debt. PRTS is paying off on IPO all debt incurred in the Partsbin acquisition.

For full year 2005, Partsbin's revenues were approximately 63% of PRTS. PRTS booked $60 million in 2005 revenues, Partsbin $38 million. Backing Partsbin into 2005 numbers results in total revenues for 2005 of $98 million. Gross margins for PRTS business in 2005 were 42%, for Partsbin 24%. Gross margins for the combined companies was 35%.

Note the acquisition of Partsbin will mean approximately $0.25 in amortization charges for PRTS in 2006/2007/2008. This will not effect cash flow, but will impact the GAAP bottom line by that $0.25 annually.

2006 - Through first nine months combined PRTS/Partsbin revenues appear on track for $140-$145 million a strong 45% increase over the combined PRTS/Partsbin 2005 revenues. Gross margins have slipped a bit for the combined entity to 33%. Really though not much of a drop for the % revenue increase. It would appear then that much of the revenue increase has been organic and not a result of PRTS slashing prices heftily to boost revenues.

Folding out the amortization charges, operating expenses look to be 25% of revenues. This is an improvement on 2005's 27% which covers for the gross margin erosion.

GAAP and non-GAAP. For a small online ipo, that $0.25 in annual amortization charges due to the Partsbin acquisition is really going to impact GAAP earnings. We'll take a look at the net margins and earnings with and without that amortization charge. Normally I like to only look at the official bottom line number, however the Partsbin acquisition appears as if it will 1) grow PRTS business/reach nicely, 2) add products PRTS has previously not offered, 3) not add any debt to PRTS balance sheet thanks to the ipo, 4) add to cash flows as the business is integrated. To me the potential positives here outweigh the anchor of the $0.25 annual amortization charge through 2008.

2006 net margins and earnings without amortization charge: Through first 9 months, net margins appear as if they will be 6%-6 1/2%. Net for full year of approximately $0.30. On an $11 pricing, PRTS would be trading 37 X's 2006 earnings.

2006 with amortization charges: net margins of 2 1/2% and earnings per share of $0.12. In my opinion the $0.30 number is more reflective of PRTS current operations then the $0.12 number.

2007 - the 2006 revenue growth for the combined entity was outstanding. I would not expect similar 45% growth in 2007. However based on the strong 9/06 quarter of nearly $40 million in revenues, PRTS would appear to be gaining strong traction in the online aftermarket auto parts niche. Their growth the past three years has easily outpaced the sector and it appears the Partsbin acquisitions has opened up new customer bases for the company. I would be surprised if PRTS is not able to hit $180 million in 2007 revenues. As always I prefer to be a bit conservative with projections, especially since we've yet to see the 12/06 quarter. I would expect a bit more gross margin contraction, which should be made up on operating expense decline. Without amortization charges then PRTS could quite conservatively earn $0.40-$0.45 in 2007. On an $11 pricing, PRTS would be trading approximately 25 X's current year earnings. Official earnings will be much less of course with the amortization charges, $0.20 or so.

Note - 2007 estimates are a ballpark projection. We'll have a much better idea after the 12/06 quarter, which should be released in the next month or so. Also, once again, keep in mind PRTS through 2008 will actually be doing much better operationally then the official GAAP earnings number.

Conclusion - Lot of competition in this sector and PRTS does not appear to have anything proprietary to push revenue growth. However PRTS continues to rapidly grow revenues. The 2006 revenue growth was simply outstanding. This with even backing in the Partsbin acquisition as if it occurred 1/1/05. The revenue growth here is what interests me. They've managed to grow in a competitive niche without killing their gross margins. That revenue growth would seem to indicate the company is doing something very 'right' to attract business. Yes I'm concerned with the brand name brick & mortar operations competing online with PRTS. As of now though, PRTS is more then weathering that competition, they're organically growing revenues in the face of it. This is an ipo whose quarterly reports must be watched very closely for signs of gross margin deterioration. However I'm recommending this deal in range, based entirely on their 2006 revenue ramp in a very competitive sector.

note - for first 2 years public due to the amortization charges, PRTS will appear much more expensive on a PE ratio then the underlying business actually represents. I would imagine this perceived 'pricey-ness' would tend to grow the short interest here on any move up.

Analysis pieces on all 13 of this week's ipos available at http://www.tradingipos.com

2007-02-01
CHIP - VeriChip

CHIP - VeriChip plans on offering 4.95 million shares at a range of $6 1/2 - $8 1/2. Merriman Curhan Ford is lead managing the deal, Kaufman and CE Unterberg are co-managing. As far as I can tell, Merriman as currently structured has not led an offering previously. Post-offering CHIP will have 11 million shares outstanding for a market cap of $82.5 million on a $7 1/2 pricing. IPO proceeds will be used by CHIP to market their VeriMed system as well as for general corporate purposes.

Applied Digital Solutions will own a little over 50% of CHIP's outstanding shares post-ipo. CHIP Chairman of the Board and CEO, Scott R. Silverman was CEO of ADSX from 3/03 - 12/06. He resigned that position in order to take the CEO position with CHIP. Note that Mr. Silverman received a substantial pay package in 2006 as part of this switch. Total 2006 compensation for Mr.Silverman was approximately $4.7 million. ADSX 2006 revenues were a little under $30 million. Yes, approximately $3.5 million of this compensation was part of a deal in which Mr. Silverman waived certain accrued incentives/options with ADSX. Still this was quite a nice payout for the CEO of such a small operation as CHIP. Note also, that Mr. Silverman has a $100,000+ annual expense allowance as CEO of CHIP. This is over/above his salary, bonus and stock awards.

From the prospectus:

'We are primarily engaged in the development, marketing and sale of radio frequency identification, or RFID, systems used to identify, locate and protect people and assets. The healthcare industry represents the principal market for our radio frequency identification systems. Our goal is to become the leading provider of radio frequency identification systems in the healthcare industry.'

CHIP had no revenues really through 2004. They exist as a combination of two Canadian operations purchased and put together by ADSX.

CHIP derives nearly all their revenues from two RFID based lines and plans to begin marketing a third:

1) Infant protection systems that help to prevent mother-baby mismatching and infant abduction.

2) Wander prevention systems that help to protect and locate residents in nursing homes and assisted living facilities. This one has raised a number of protests as it can involve implants into those being monitored.

3) CHIP has just begun marketing an asset/staff location and identification system to hospitals and other healthcare facilities. Thus far they've sold three of these systems.

RFID Technology - Involves the use of radio frequency, or RF, transmissions, typically achieved through communication between a microchip-equipped transponder and a receiver, for identification, location and other purposes. A 'tag' containing a microchip is attached to the item to be identified or located which wirelessly transmits stored information to a receiver.

VeriMed Patient Identification System:

CHIP is also in the process of rolling out what can be described as a somewhat controversial product, the VeriMed Patient Identification system. This system is the first and only human-implantable radio frequency transponder system cleared for use for patient identification and health information purposes. Yep, chips implanted under the skin in a person’s upper right arm. Unlike in other CHIP products, these implantable chips would be 'passive' meaning they would not transmit to a receiver intermittently. Instead they would only be 'turned on' when scanned by a receiver. The chips would also not contain any patient information themselves, only a 16 digit identification number. That number would then link to medical/identification information stored in the receiver database. Note that CHIP is currently trying to create the market for this device; they've not derived revenues from this thus far.

Target market for The VeriMed system consists of people who are more likely to require emergency medical care, persons with cognitive impairment, persons with chronic diseases and related conditions, and persons with implanted medical devices. CHIP believes their system will be of use for emergency personnel and first responders. Personally, I foresee a myriad of technology issues here. If these systems are sold to healthcare plans, hospitals or individual potential patients, to hold any value whatsoever the unresponsive future patient would have to be at or taken to a facility using the database with that patient’s information. If these were purchased by facilities, they're already going to have medical information readily available for their patients in their existing databases. This system would only have value if a patient is brought in 'cold' meaning a hospital or facility would have no existing information on this patient. That is the entire purpose of reading the implanted chip. In that case, what really would be the odds that an implanted patient would just happen to end up being taken to a facility or hospital that bought the system and has access to the database linking the patients implanted chip with the patient information????

Say this chip was implanted in someone in the target market with say 'cognitive impairment'. How many potential future emergency rooms or first responders are actually going to work for operations that bought this system and able to read the implantable chip in case of emergency? If the person is institutionalized, that institution will already have information readily available for this person in case of an emergency, so an implant would be of little added help. These would work and be of use only in situations in which the responders had no information on an unresponsive patient...and would require a lot of luck in matching up an implanted patient with a facility that purchased access to the database.

I'm at a real loss here in trying to determine where revenues will be derived from this implantable VeriMed Patient Identification System. Apparently so is CHIP. The system was cleared in 2004, yet to date, CHIP has been unable to generate really any revenues from this implantable system. From the prospectus: 'To date, we have only generated approximately $0.1 million in revenue from sales of the microchip inserted kits, significantly less than we had projected at the beginning of 2006'. Note that CHIP does not expect more than nominal revenues from the VeriMed Patient Identification System over the next 18 months. Between the lines: CHIP thought they were onto something, projected sales for this product to begin ramping in 2006. It hasn't happened and now CHIP doesn't expect much revenue from this system through 2008. Not pretty. CHIP however will be devoting substantial expenses to the implantable system.

In the prospectus, CHIP mentions negative publicity as one reason for the lack of revenues from this implantable system. To me, logistics are the big problem here. It just isn't workable as designed and for the cases in which it would be workable, the facilities don't need an implantable system as they've already got information/identification for their patients readily accessible. Really, the CHIP business plan for these implantable systems seems quite poorly constructed. According to CHIP- ' Our plan also anticipates our deriving significant and growing recurrent revenue from subscriptions to our database by persons implanted with our microchip.' Somehow chronically ill and/or those with mental illness and/or incapacitated will somehow pay CHIP annually for this service? Really, huh. Good luck with that one CHIP. This is one of the more ridiculous business plans I've ever seen. These are the people most likely unable to pay for additional medical costs, let alone monthly for one, on the random and unlikely chance that in case of emergency they'll be taken to a hospital emergency room that just happens to have access to the CHIP database! This company is really building a business around this plan??????

There is also another reason why this implantable system of CHIP's is dead on arrival: cost of the microchip implant procedure is not covered by Medicare, Medicaid or private health insurance. If that doesn't change (and it doesn't appear imminent) CHIP will never derive significant revenues from their implantable system. No health care operator will buy and operate this identification system without third party payer reimbursement, period. Really that is the end of the story with this ipo and CHIP's grand plans for their implantable system. The fact that internally CHIP apparently projected significant revenues from this product in 2006 without 3rd party reimbursement would lead me to question management.

CEO and Chairman of the Board, Mr. Silverman really seems to be 'earning' his $4.7 million in 2006 compensation and that additional $100,000 annual expense allotment.

Patent rights to the VeriMed technology appear hazy. It doesn't appear as if CHIP is infringing on patents, but CHIP also will not have any patent protection in this area either.

Financials

$2 per share in cash.

Revenues again have been thus far derived almost entirely from the infant bracelet protection systems and the nursing home and assisted facility wander prevention bracelets. It appears revenue for 2007/2008 will also be derived predominantly from these two.

Revenues for 2005 (assuming the companies added were purchased 1/1/05) were $25 million. For 2006, revenues were $27 million, actually slowing in the back half of the year. Gross margins for 2005/2006 were 58%. GSA expenses ate up all gross margins each year. CHIP lost $0.55 per share in 2005 and $0.50-$0.55 per share in 2006.

I would not expect revenues to grow much at all here next few years as their revenue drivers are in mature slower growing businesses. CHIP does not expect to make money over the next few years. In fact they should continue to lose at least $0.50 per share through 2008.

Conclusion - Market cap here is quite small and VeriChip has apparently gained some sort of cult status out there. For the life of me I can't see why anyone would take their implantable system seriously as it really looks to me to be built upon a number of faulty assumptions... plus it is a moot point anyway without 3rd party reimbursement, which it does not have nor appears to be coming anytime in the foreseeable future. What CHIP does have is a stable business selling RFID monitoring systems for infant monitoring and to nursing homes and long-term care facilities. Unfortunately CHIP appears set on throwing a lot of expense money into their implantable system, which should ensure significant losses per share into the foreseeable future. This ipo is ugly, simply for the fact I don't see the implantable system of CHIP's ever gaining traction or bringing in much in revenue. Pass here. Note: this is a micro cap small float single digit ipo with some attention focused on it. It is conceivable it does okay in the short term due to this, however this is as shaky a business model/plan as I've seen for a company coming public.