Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following management’s discussion and analysis of financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements, together with the related notes thereto, included in Part I, Item 1 of this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2020 (our “2020 Form 10-K”).

For the purposes of this section, “we,” “us,” “our,” “Onyx,” the “Company” and “PARTS iD” each refer to Onyx prior to the closing of the Business Combination and PARTS iD, Inc. following the closing of the Business Combination, as the context indicates, unless the context otherwise refers to Legacy Acquisition Corp.

Overview

The success of the Company has inspired pursuit of our long-term strategy to scale into similar markets via our proprietary built, modular digital commerce technology platform. While our core focus continues to be automotive, in August 2018, we launched seven new verticals (including BOATiD.com, MOTORCYCLEiD.com, CAMPERiD.com and more) which demonstrates fungibility of our technology platform. These verticals address similar market challenges and focus on the enthusiasts’ needs through our seamless shopping experience using proprietary tools and techniques.

Although the ongoing COVID-19 pandemic has caused economic disruptions on a global scale, and created significant uncertainty, it increased the adoption of online shopping by consumers, which has had an overall positive effect on the Company’s revenue since the onset of the pandemic. Most recently, however, there was a decline in traffic in the third quarter due primarily to an increase in the average cost-per-click in the Company’s search advertising programs that adversely impacted marketing productivity. We also experienced increased order cancellations in the third quarter due to supply chain disruptions. These factors were partially offset by increases in the conversion rate and average order value, but revenue for the three months ended September 30, 2021, decreased compared to the same period in the prior year. Nonetheless, net revenue for the nine months ended September 30, 2021, revenue was up compared to the corresponding period in 2020.

COVID-19 and related containment measures have disrupted the supply chain, negatively affecting the Company and our industry. The recent spikes in the price of steel and other materials, workforce shortages and shipping and seaport delays have led to increases in the cost of goods sold and low in-stock rates with our key suppliers. Increasing supply chain challenges have led to increased order cancellations and shipping costs. Our real-time multi-sourced inventory model helped us mitigate some of the impact by sourcing certain products from secondary and tertiary sources during the third quarter of 2021, but this resulted in increased costs. We began to pass a portion of the increased costs through to our customers, while balancing the need to maintain price competitiveness.

Management continues to focus on efforts to drive growth, including product cultivation, vendor optimization, distribution network expansion and marketing diversification, with a greater emphasis on the new verticals, original equipment (“OE”) and repair parts business. We also recently filled a number of key executive positions to support this growth, including hiring leaders for our key categories of Boating and Marine and RV/Camper.

Key Financial and Operating Metrics

We measure our business using financial and operating metrics, as well as non-GAAP financial measures. See “Results of Operations – Non-GAAP Financial Measures” below for more information on non-GAAP financial measures. We monitor several key business metrics to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions, including the following:

For the nine months ended September 30,

We use the metrics above to gauge our ability to acquire targeted traffic and keep users engaged. This information informs us of how effective our proprietary technology, data, and content is, and helps us define our strategic roadmap and key initiatives.

Revenue

Revenue for the three months ended September 30, 2021 decreased by $20.6 million, or 16.7%, compared to the same prior year period, primarily attributable to lower traffic resulting from an increase in the average cost-per-click in search advertising programs that adversely impacted marketing productivity, as well as increased order cancellations due to supply chain disruptions. Compared to the same prior year period, traffic declined by 28.9% in the three-month period ended September 30, 2021, while the site conversion rate and average order value increased by 8.9% and 11.3% respectively.

For the nine months ended September 30, 2021, revenue increased by $34.3 million, or 11.2%, compared to the same prior year period. The revenue increase was primarily due to an increase in the number of orders, with increases in the site conversion rate and average order value of 16.1% and 12.9%, respectively, being partially offset by a decline in traffic of 16.5%, as well as increased order cancellations due to supply chain disruptions in the third quarter.

Supply chain disruptions related to COVID-19 also adversely impacted revenue in both periods, as cancellations of sales orders increased by 10.4% and 27.2% in three and nine month periods ended September 30, 2021, respectively, as compared to the same prior year periods.

The increase in site conversion rates in both periods was primarily attributable to search engine bidding automation and optimization, pricing initiatives, product cultivation, and continued e-commerce adoption. The increase in average order values in both periods was primarily attributable to increases in the average numbers of items per order and changes in the mix of categories of items sold in the relevant periods.

Cost of Goods Sold

Cost of goods sold is composed of product cost, the associated fulfillment and handling costs charged by vendors, if any, and shipping costs. In the three months ended September 30, 2021, cost of goods sold decreased by $13.4 million, or 14.0%, compared to the same prior year period. This decrease in cost of goods sold was primarily driven by decreases in the number of orders or products sold and related shipping costs, partially offset by increases in product costs and shipping costs due to supply chain disruptions. In the nine months ended September 30, 2021, cost of goods sold increased by $31.9 million, or 13.2%, compared to the same prior year period. This increase in cost of goods sold was primarily driven by an increase in the number of orders or products sold, as well as increases in product costs and shipping costs due to supply chain disruptions.

For the three and nine months ended September 30, 2021, cost of goods sold was 80.2% and 79.8% of revenue, respectively, compared to 77.7% and 78.3% of revenue in the respective prior year periods. The 2.5% and 1.5% increases in cost of goods sold as a percentage of revenue were primarily attributable to ongoing supply chain disruptions associated with the COVID-19 pandemic. During these 2021 periods, we had to source some products from alternate vendors at higher price points, and had to balance the need to maintain price competitiveness as we began to pass a portion of the increased costs through to our customers. Management expects these cost pressures to materially ease only if and when the COVID-19 pandemic and related containment measures abate, which cannot be currently predicted with any certainty.

Gross Profit and Gross Margin

Gross profit decreased by $7.2 million, or 26.1%, for the three months ended September 30, 2021 compared to the same prior year period, primarily due to a 16.7% decrease in revenue and increases in product and shipping costs associated with supply chain disruptions. Gross profit increased by $2.4 million, or 3.6%, for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020. This change was primarily attributable to a 11.2% increase in revenue in the nine months ended September 30, 2021, partially offset by increases in product and shipping costs associated with supply chain disruptions.

Gross margins of 19.8% and 20.2% in the three and nine months ended September 30, 2021, respectively, were lower than gross margins of 22.3% and 21.7% for the three and nine months ended September 30, 2020, primarily attributable to increases in product and shipping costs associated with ongoing supply chain disruptions as discussed above.

Operating Expenses

Advertising expenses increased $0.1 million, or 1.1%, and $6.1 million, or 24.5%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020. These increases in advertising costs were primarily attributable to increases in the average cost-per-click, a change in the mix of advertising channels used, testing new advertising campaigns and content development. Management believes investment in advertisement is one of the key drivers of revenue, and measures advertising efficiency in terms of revenue per advertisement dollar spent.

Decreases in overall available searches and increasing competition, coupled with additional campaigns being transitioned to automated bidding from manual bidding, led to higher costs-per-click in the three and nine months ended September 30, 2021 as compared to the same prior year periods.

The consequent higher advertising cost was partly offset by an increase in the site conversion rate and average order value in both periods. Management is taking steps to diversify advertising in new channels, such as paid social and customer retention programs, to drive growth.

Selling, general and administrative (“SG&A”) expenses increased $2.8 million, or 27.4%, and $8.0 million, or 27.6%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020. These increases were primarily attributable to increases in non-cash share-based expenses ($2.0 million and $3.3 million, respectively), public company operating expenses ($1.1 million and $3.3 million, respectively), and, for the nine-month period, merchant services provider processing fees of $1.1 million.

Depreciation expenses increased $0.2 million, or 9.3%, and $0.4 million, or 8.9%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

Interest Expense

Interest expense decreased by $634, or 73.5%, and by $570, or 7.4%, for the three and nine months ended September 30, 2021, respectively, compared to the three and nine months ended September 30, 2020.

Income Tax Expense

Income tax benefit was $0.9 million for each of the three and nine months ended September 30, 2021, compared to income tax expense of $1.2 million and $1.7 million for the three and nine months ended September 30, 2020, respectively. For the three and nine months ended September 30, 2021, the effective income tax rate was 21.4% and 20.9%, respectively, compared to 19.7% and 21.1% for the three and nine months ended September 30, 2020, respectively. The changes in rates were primarily attributable to changes in state taxes and expenses not deductible for income tax purposes.

Non-GAAP Financial Measures

EBITDA and Adjusted EBITDA

This report includes non-GAAP financial measures that differ from financial measures calculated in accordance with U.S. generally accepted accounting principles (“GAAP”). These non-GAAP financial measures may not be comparable to similar measures reported by other companies and should be considered in addition to, and not as a substitute for, or superior to, other measures prepared in accordance with GAAP. Management uses non-GAAP financial measures internally to evaluate the performance of the business. Additionally, management believes certain non-GAAP measures provide meaningful incremental information to investors to consider when evaluating the performance of the Company.

To this end, we provide EBITDA and Adjusted EBITDA, which are non-GAAP financial measures. EBITDA consists of net income (loss) plus (a) interest expense; (b) income tax provision (or less benefit); and (c) depreciation expense. Adjusted EBITDA consists of EBITDA plus costs, fees, expenses, write-offs and other items that do not impact the fundamentals of our operations, as described further below following the reconciliation of these metrics. Management believes these non-GAAP measures provide useful information to investors in their assessment of the performance of our business. The exclusion of certain expenses in calculating EBITDA and Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis as these costs may vary independent of business performance. Accordingly, we believe that EBITDA and Adjusted EBITDA provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

EBITDA and Adjusted EBITDA have limitations as an analytical tool, and you should not consider these measures in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

Because of these limitations, you should consider EBITDA and Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income (loss) and our other GAAP results.

The following table reflects the reconciliation of net income (loss) to EBITDA and Adjusted EBITDA for each of the periods indicated.

Net income decreased by $8.1 million for the three months ended September 30, 2021, as compared to the same prior year period, primarily driven by incremental public company operating expenses of $1.1 million and an increase in non-cash stock compensation of $2.0 million, as well as a decrease in gross profit of $7.2 million. Net income decreased by $9.6 million for the nine months ended September 30, 2021, as compared to the same prior year period, primarily driven by an increase in advertising costs of $6.1 million, incremental public company operating expenses of $3.3 million, and an increase in non-cash stock compensation of $3.3 million. The year-over-year decreases in Adjusted EBITDA for the three and nine months ended September 30, 2021 as compared to the same prior year periods were attributable to these decreases in net income, partially offset by Business Combination transaction expenses, founders compensation and other items which did not recur in the 2021 periods.

Free Cash Flow

To provide investors with additional information regarding our financial results, we disclose free cash flow, a non-GAAP financial measure that we calculate as net cash provided by operating activities less capital expenditures. Capital expenditures consist of purchases of property and equipment, purchases of intangible assets and website and software development costs. We have provided a reconciliation below of free cash flow to net cash provided by operating activities, the most directly comparable GAAP financial measure.

Free cash flow is an important indicator of our liquidity as it measures the amount of cash we generate. Accordingly, we believe that free cash flow provides useful information to investors and others to aid in understanding and evaluating our operating results in the same manner as management.

Free cash flow has limitations as a financial measure, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. There are limitations to using non-GAAP financial measures, including that other companies, including companies in our industry, may calculate free cash flow differently. Because of these limitations, you should consider free cash flow alongside other financial performance measures, including net cash provided by (used in) operating activities, capital expenditures and our other GAAP results.  

The following table presents a reconciliation of net cash provided by operating activities to free cash flow for each of the periods indicated.

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand of $23.5 million as of September 30, 2021, cash generated from operations and changes in operating assets and liabilities. We believe our current resources will be sufficient to fund our cash needs for current operations for at least the next 12 months. Our primary use of cash is for investment in website and software development.

The following table summarizes the key cash flow metrics from our statements of cash flows for the nine months ended September 30, 2021 and 2020:

Cash Flows from Operating Activities

The net cash provided by operating activities consists of net income (loss), adjustments for certain non-cash items, including depreciation, and the effect of changes in working capital and other activities. Operating cash flows can be volatile and are sensitive to many factors, including changes in working capital and our net income (loss). We have a negative working capital model where current liabilities exceed current assets. Any profitable growth in revenue results in incremental cash for the Company. We receive funds when customers place orders on the website, while accounts payable are paid over a period of time. Vendor terms range on average from one week to eight weeks.

Net cash provided by operating activities in the nine months ended September 30, 2021 was $7.0 million, comprised of a net loss of $3.4 million and cash provided by (i) a change in operating assets and liabilities of $2.5 million, primarily driven by increases in accounts payable and customer deposits, (ii) depreciation expense of $5.5 million, and (iii) non-cash share-based compensation expense of $3.3 million. These amounts were partially offset by a change in the non-cash deferred tax benefit of $0.9 million.

Net cash provided by operating activities in the nine months ended September 30, 2020 was $28.9 million, comprised of net income of $6.2 million, and cash provided by (i) changes in operating assets and liabilities of $16.3 million, primarily driven by increases in accounts payable and customer deposits, (ii) depreciation expense of $5.0 million, and (iii) a change in non-cash deferred income tax expense of $1.4 million.

Cash Flows from Investing Activities

Net cash used in investing activities was $5.7 million for the nine months ended September 30, 2021, consisting of website and software development costs and purchases of property and equipment. Cash used in investing activities varies depending on the timing of technology and product development cycles.

Net cash used in investing activities was $5.2 million for the nine months ended September 30, 2020, consisting primarily of website and software development costs.

Cash Flows from Financing Activities

Net cash used in financing activities for the nine months ended September 30, 2021 was $15,956, compared to $390,892 in the nine months ended September 30, 2020. The decrease was primarily related to cessation of payments of preferred stock dividends.

Critical Accounting Estimates

SEC guidance defines critical accounting estimates as those estimates made in accordance with GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operation of the registrant. There were no significant changes in our critical accounting estimates from those discussed in our 2020 Form 10-K, except as disclosed below. See Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements for our other significant accounting policies and accounting pronouncements that may impact the Company’s consolidated financial position, earnings, cash flows or disclosures.

Revenue Recognition

Our revenue recognition is impacted by estimates of unshipped and undelivered orders at the end of the applicable reporting period. As we ship a large volume of packages through multiple carriers, actual delivery dates may not always be available, and as such we estimate delivery dates based on historical data. If actual unshipped and undelivered orders are not consistent with our estimates, the impact on our revenue for the applicable reporting period could be material. Unshipped and undelivered orders as of September 30, 2021 and December 31, 2020 were $18.0 million and $16.2 million, respectively, which are reflected as customer deposits on our balance sheets.

The outstanding days from the order date of our unshipped and undelivered orders were, on average, estimated at 13.0 days as of September 30, 2021, based on our actual determinations of 13.0 days as of June 30, 2021 and of 12.7 days as of December 31, 2020.

Sales discounts earned by customers at the time of purchase and taxes collected from customers, which are remitted to governmental authorities, are deducted from gross revenue in determining net revenue. Allowances for sales returns are estimated and recorded based on historical experience and reduce product revenue, inclusive of shipping fees, by expected product returns. Our estimated net allowances for sales returns at September 30, 2021 and 2020 were $766,646 and $664,886, respectively.

If actual sales returns are not consistent with our estimates, or if we have to make adjustments, we may incur future losses or gains that could be material. Adjustments to our estimated net allowances for sales returns over the three months and nine months ended September 30, 2021 and 2020 were as follows:

Website and Software Development

We capitalize certain costs associated with website and software (technology platform including the catalog) developed for internal use in accordance with Accounting Standards Codification (“ASC”) 350-50, Intangibles — Goodwill and Other — Website Development Costs, and ASC 350-40, Intangibles — Goodwill and Other — Internal Use Software, when both the preliminary project design and the 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 and software development such as contractors’ fees, payroll and payroll-related costs for employees who are directly associated with and who devote time to our internal-use software. Capitalization of such costs ceases when the project is substantially complete and ready for its intended use. Capitalized costs are amortized over a three-year period commencing on the date that the specific module or platform is placed in service. Costs incurred during the preliminary stages of development and ongoing maintenance costs are expensed as incurred. Determinations as to when a project is substantially complete and what constitutes ongoing maintenance require judgments and estimates by management. We periodically review the carrying values of capitalized costs and makes judgments as to ultimate realization. The amount of capitalized software costs for the nine months ended September 30, 2021 and 2020 were as follows:

Off-Balance Sheet Arrangements

PARTS iD is not a party to any off-balance sheet arrangements.