10-Q 1 qtwoonetxt.txt 10-Q -JUNE 30, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 000-29727 PartsBase, Inc. (Exact name of registrant as specified in its charter) Delaware 76-0604158 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 621 N.W. 53rd Street Boca Raton, Florida 33487-8242 (Address of principal executive offices) Registrant's telephone number, including area code: 561.953.0700 Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: The registrant had an aggregate of 14,003,620 shares of its common stock, no par value, outstanding as of the close of business on August 3, 2001. PARTSBASE, INC. TABLE OF CONTENTS Page PART I- FINANCIAL INFORMATION ITEM 1. Financial Statements ................................... 3 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................... 9 ITEM 3. Quantitative and Qualitative Disclosure about Market Risk 13 PART II- OTHER INFORMATION ITEM 1. Legal Proceedings ....................................... 14 ITEM 2. Changes in Securities ................................... 15 ITEM 3. Default Upon Senior Securities .......................... 15 ITEM 4. Submission of Matters to a Vote of Security Holders ..... 15 ITEM 5. Other Information ....................................... 15 ITEM 6. Exhibits and Reports on Form 8-K ........................ 15 SIGNATURES 16 PART I FINANCIAL INFORMATION Item 1. Financial Statements PARTSBASE, INC. Condensed Balance Sheets (Unaudited) June 30, December 31, 2001 2000 -------------- -------------- -------------- --------------

3 PARTSBASE, INC. Condensed Statements of Operation (Unaudited)

4 PARTSBASE, INC. Condensed Statements of Cash Flows (Unaudited)

5 PARTSBASE, INC. Notes to Condensed Financial Statements (Unaudited) The Company and Basis of Presentation PartsBase, Inc. ("PartsBase" or the "Company"), formerly known as PartsBase.com, Inc., is an online provider of Internet business-to-business e-commerce services for the aviation industry. The Company's global e-marketplace provides a means for aviation parts buyers and sellers to buy and sell new, repaired and overhauled aviation parts, list products, services and catalogs, and hold auctions for slow moving and excess inventory. The Company was incorporated in Texas on April 27, 1999 and prior to such date operated as a division of Aviation Laboratories, Inc. At the Company's Annual Meeting of Stockholders held on June 20, 2001, the stockholders approved an amendment to affect a change in the state of incorporation of the Company from Texas to Delaware. The accompanying unaudited condensed interim financial statements reflect all adjustments, which in the opinion of management are necessary for a fair presentation of the results of operations for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by Article 10 of Regulation S-X of the Securities and Exchange Commission. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Revenue Recognition PartsBase records subscription and banner advertising revenue over the life of the subscription, which is typically 12 months. Sales costs, including commissions, are expensed as incurred, and are included in the cost of revenues. Net revenue represents that portion of gross revenue that was earned during the period presented. Therefore, during quarters with significant gross revenue growth, gross margins will be negatively impacted due to the effect of sales costs being expensed in their entirety, whereas the corresponding sales are amortized over the subscription term. Cash and Cash Equivalents Cash and cash equivalents consist of highly liquid investments purchased with an original maturity of three months or less. Basic and Diluted Net Loss per Share Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares consist of the incremental common shares issuable upon the exercise of stock options and warrants (using the treasury stock method). For the three and six month periods ended June 30, 2001 and 2000, common share equivalents are not included in the computation of diluted loss per share since inclusion of such shares would be anti-dilutive. 6 Marketable Securities The Company's marketable securities, whose maturities are typically one year or less, are held to maturity and valued at amortized cost. Investments in securities are summarized as follows at June 30, 2001 and December 31, 2000:

On January 15, 2001, corporate debt securities owned by the Company, issued by a State of California electrical utility (the "Utility"), with a face value of $400,000 and maturing on January 15, 2001, were defaulted on. Moody's Investor Service subsequently lowered the securities debt rating to Caa3. The current fair value of this security as of June 30, 2001, was $292,000. The Utility is currently in negotiations with its banks and the Public Utilities Commission of California to resolve its financial difficulties and pay amounts owed to its secured and unsecured creditors. While there can be no assurances, the Company currently believes that it is probable it will be able to collect all amounts due the Company according to the contractual terms of the debt security. On April 19, 2001 outstanding accrued interest on this obligation was paid to the Company and, as a result, the decline in fair value of the debt security is judged to be temporary as of June 30, 2001. Segment Information Based on the criteria established by Statement of Financial Accounting Standards ("SFAS") No.131, "Disclosures about Segments of an Enterprise and Related Information", the Company currently operates in one principal business segment globally, the development and marketing of an online marketplace for the purchasing and distribution of products. Summarized information by revenue source as excerpted from internal management reports is as follows (in thousands): Three Months Ended Six Months June 30, Ended June 30, --------------------- ----------------------- 2001 2000 2001 2000 ------ ------ ------ ------ Net revenues: Advertising ............. $ 158 $ 68 $ 245 $ 126 Subscriptions ........... 1,194 855 2,702 1,347 Other ................... 2 12 6 11 ------ ----- ------ ------ Total .................. $ 1,354 $ 935 $ 2,953 $ 1,484 ====== ===== ====== ====== Reclassifications Certain amounts in the prior year's financial statements have been reclassified to conform to the current year presentation. 7 Commitments and Contingencies During May 2000, the Company entered into a sublease agreement with an unaffiliated third party for 35,668 square feet of general office space. The sublease agreement expires October 31, 2006. In lieu of a security deposit, the Company has invested in Certificates of Deposit in the amounts of $434,000 and $500,000 as of June 30, 2001 and December 31, 2000, respectively, and has pledged such certificates as collateral for an irrevocable standby letter of credit in favor of the Sublessor. Such amounts are classified as a Certificate of deposit-restricted cash on the accompanying balance sheets. The standby letter of credit decreases incrementally $65,000 to $70,000 per year until lease expiration. From the commencement date of the sublease through February 28, 2001 the Company was obligated to pay rent on only 25,000 square feet. Effective March 1, 2001 the Company became obligated to pay all minimum annual rent required by the prime lease. The Company is party to a Content License and Reseller Agreement (the "Agreement") with USA Information Systems Inc. ("USAIS"), an exclusive owner of an Internet-based government parts, logistic and digital document database, whereby USAIS provides access to that database to paid subscribers through a Web site owned, operated and maintained by USAIS (the "Subscription Services"). Per the Agreement, as amended on March 15, 2001, USAIS licenses to the Company the non-exclusive rights to resell the Subscription Services and to offer access to certain segments of the USAIS content to the Company's existing customers. The Agreement commenced on June 1, 2000 and has an initial term of three years. The Agreement will be automatically renewed for two one-year terms, unless either party notifies the other in writing of its intention not to renew the Agreement within ninety-days prior to the expiration of the then current term. The Company is obligated to pay USAIS the sum of $100,000 in monthly installments through May 15, 2001. Commencing with the payment due June 15, 2001, and continuing until the expiration of the Agreement, the Company is obligated to pay USAIS $60,000 in monthly installments. In conjunction with the amended Agreement, the Company was also obligated to obtain, and delivered to, USAIS on March 20, 2001, an irrevocable, transferable standby Letter of Credit in the amount of $1,665,000, collateralized by a certificate of deposit of the same amount which is classified as Certificate of deposit- restricted cash on the balance sheet in the accompanying condensed financial statements at June 30, 2001. In September 2000, the Company sued a third party financial institution because such financial institution paid a check in the amount of $161,000 despite a stop payment order duly issued by the Company. The payee cashed the check, along with a replacement check. Before the Company learned that the payee had cashed both checks, the Company entered into a binding settlement with the payee ending the Company's business relationship with the payee. The payee refused to return the amounts and the financial institution failed to credit the Company's account. The Company filed suit, and discovery has commenced. The only claim against the Company in this matter is the financial institution's demand for legal fees if the financial institution prevails. In a separately filed lawsuit, the payee of the checks has filed an action for declaratory relief against the financial institution and the Company requesting that the court declare its settlement agreement with the Company to be valid and binding. In this declaratory relief action, the payee has requested that the Company and the financial institution reimburse it for costs and fees associated with the action. In July 2001, the separately filed lawsuit against the Company filed by the payee of the checks was dismissed, without prejudice, for lack of jurisdiction. In December 2000, a third party (the "Third Party"), unaffiliated with the Company, instituted arbitration against the Company in Dallas, Texas based upon allegations that it breached a February 18, 2000 professional services agreement. The Third Party claimed damages of $308,083 plus un-liquidated damage amounts for copyright infringement, interest, attorneys' fees and costs. The Company filed a counterclaim denying the breach and claiming entitlement to a refund of $73,496 previously paid to the Third Party plus damages of $250,000 because of the Third Party's breach of its obligations to the Company. This matter was settled on June 30, 2001, resulting in the Company making a $175,000 payment to the Third Party. This payment is included in litigation and other related costs in the statement of operations for the three and six months ended June 30, 2001. 8 In April and May 2001, the Company received notice of or has been served with three purported class action lawsuits (Foderaro vs. PartsBase.com, Inc. et al, Case No.: 01-8319 CIV- FERGUSON; IKCYBERINVESTMENTS vs. PartsBase.com, Inc. et al, Case No.: 01-8368 CIV-SEITZ; and Webb vs. PartsBase, et.al. Case No. 01-8376 CIV- GRAHAM). The lawsuits name as defendants, the Company, certain of its current and former officers and directors, and the underwriters of its initial public offering of securities. The lawsuits allege violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and allege the Company's March 2000 registration statement misrepresented and failed to disclose matters related to the Company's business operations and membership sales. The lawsuits seek damages and certification of a class consisting of purchasers of the Company's common stock in the offering during the period from March 22, 2000 through April 25, 2000. The Company believes that the allegations contained in the lawsuits are without merit and intends to vigorously defend this action. Nevertheless, an unfavorable resolution of these lawsuits could have a material adverse effect on the Company in one or more future periods. The Company maintains a director and officers' liability insurance policy that provides $3 million of coverage, with retention of $200,000. The Company fully expects its legal expenses to exceed the retention amount. Therefore at June 30, 2001, the Company has recorded a litigation reserve for $200,000 to cover the expected retention. This reserve has been classified as litigation and other related costs in the statement of operations for the three and six months ended June 30, 2001. During the quarter, $83,935 of invoices related to this matter were received and applied against this reserve. The Company does not intend to file further Current Reports on Form 8-K or other disclosures describing additional lawsuits, if any, purporting class action status, in either federal or state court, which are based on allegations substantially similar to those contained in the lawsuits described above. Two other litigation matters, relating to the providing of services by information technology vendors, were resolved during the quarter in the amounts of $40,000 and $12,500. An additional reserve was established for $30,000 relating to a lawsuit filed and served on the Company in July 2001 by a third information technology vendor claiming damages resulting from the Company's alleged breach of a software sales and service contract. These amounts, totaling $82,500, are included in litigation and other related costs in the statement of operations for the three and six months ended June 30, 2001. The Company intends to vigorously defend the allegations contained in this third lawsuit. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding the Company's expectations, beliefs, intentions or future strategies that are signified by the words "expects", "anticipates", "intends", "believes", or similar language. All forward-looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors including but not limited to those set forth under "Risk Factors" included in Exhibit 99.1 elsewhere in this report. Overview PartsBase, Inc. ("PartsBase" or the "Company") formerly known as PartsBase.com, Inc., is an online provider of Internet business-to-business e-commerce services for the aviation industry. The Company's global e-marketplace provides a means for aviation parts buyers and sellers to buy and sell new, repaired and overhauled aviation parts, list products, services and catalogs, and hold auctions for slow moving and excess inventory. The Company was incorporated in Texas on April 27, 1999 and prior to such date operated as a division of Aviation Laboratories, Inc. At the Company's Annual Meeting of Stockholders held on June 20, 2001, the stockholders approved an amendment to affect a change in the state of incorporation of the Company from Texas to Delaware. Results of Operations Net Revenues Net revenues consist of subscription fees charged to subscribers and, to a lesser extent, banner-advertising and product listings revenue. Net revenues were $1,353,833 and $2,953,066 for the second quarter and first half of 2001, 9 respectively, compared to $935,113 and $1,484,137 for the same periods in 2000, an increase of 45% and 99%, respectively. During the second quarter and first half of 2001, PartsBase signed up 459 and 1,153 new subscribers at an average subscription fee of $1,785 and $1,730, respectively. During the same periods, 291 and 728 subscribers renewed their subscription for another year at an average subscription fee of $1,331 and $1,232, respectively. The aggregate average subscription fee of both new and renewal subscribers during the second quarter and first half of 2001 was $1,609 and $1,538, respectively. During the second quarter and first half of 2000, PartsBase signed up 887 and 2,115 new subscribers at an average subscription fee of $1,225 and $1,074, respectively. The average subscription fee increased in 2001 over the same periods in 2000, due to higher prices charged for competing services, and PartsBase's ability to offer additional value added services to its subscribers, such as government procurement data. Given the finite size of the aerospace community, the number of new subscribers signed up in 2001 decreased compared to 2000. At June 30, 2001, PartsBase had 4,056 paying subscribers as compared to 4,837 paying subscribers at March 31, 2001, 4,756 paying subscribers at December 31, 2000, and 4,067 paying subscribers at June 30, 2000. The subscriber count decreased during the second quarter of 2001 compared to the prior quarter, as PartsBase was unable to acquire new subscribers at a sufficient rate to replace current customers whose subscriptions expired or were deactivated during their subscription period due to non-payment of their invoice. The renewal rate for customers renewing their subscription for a second year was approximately 51%. During the second half of 2001, some customers will begin renewing for their third year. The Company expects that the renewal rate for third year subscriptions will be higher than that experienced for second year renewals, although there can be no assurances that future renewal rates will be higher than that experienced for the second year. A paid subscriber is defined as a member of the PartsBase web site who has purchased a subscription that is currently active, and therefore, does not include subscribers whose subscriptions have expired, or potential subscribers who are trialing the service. Gross revenues were $1,207,019 and $2,867,116 for the second quarter and first half of 2001, respectively, compared to $1,302,916 and $2,614,063 for the same periods in 2000, a decrease of 7% and an increase of 10%, respectively. A portion of the decrease in gross revenue during the current quarter compared to the prior quarter is attributable to the small number of subscriptions sold in May through July of the prior year. This negatively impacted renewal revenue in the current quarter as renewals typically are sold the month prior to a subscription's expiration date. PartsBase records earned subscription and banner advertising revenue over the life of the subscription, which is typically 12 months. Gross revenue represents total subscription and advertising sales made during the period presented, of which a portion is deferred and recognized as earned. Net revenues represent that portion of gross revenues of all periods that was earned during the current period presented. Sales costs, including commissions, are expensed as incurred, and are included in the cost of revenues. Deferred revenue, net decreased to $2,730,784 at June 30, 2001, compared to $3,219,422 as of December 31, 2000, and increased from $2,323,915 at June 30, 2000. 10 The following table sets forth gross revenue by product line for the last five quarters, as well as operating data and sequential quarter-to-quarter revenue growth percentages for the same period.

Cost of Revenues Cost of revenues consists of compensation for sales and marketing personnel, telephone expenses, amortization and maintenance of web site development costs, contract payments to a third party for procurement data functionality and a proportion of rent and office expenses. Compensation costs for sales and marketing personnel are incurred in the month paid while the revenue is pro-rated over the related subscription period, generally a 12-month period. Therefore, during quarters with negative gross revenue growth, gross margins will be positively impacted due to the effect of a smaller pool of sales commissions being expensed in their entirety during the quarter, whereas sales from prior quarters with larger gross revenues are being amortized over the subscription term. Costs of revenues were $1,076,041 and $2,564,801 for the second quarter and first half of 2001, respectively, compared to $947,584 and $2,206,545 for the same periods in 2000. As a percent of net revenues, costs of revenues were 79% and 87% for the second quarter and first half of 2001, respectively, compared to 101% and 149% for the same period periods in 2000. Salesperson compensation in the second quarter and first half of 2001 as a percentage of gross revenue was 40% and 42%, respectively. This compares to 27% and 38%, respectively, in the second quarter and first half of 2000. Although salesperson compensation as a percentage of gross revenue is starting to trend back downwards, the percentage is higher during 2001 due to higher commission rates paid to salespersons compared to the same periods in 2000. At June 30, 2001, PartsBase employed 113 persons in sales and customer service, compared to 103 persons at June 30, 2000. Additionally, included in cost of revenues in the second quarter and first half of 2001 was $260,000 and $560,000, respectively, for contract payments to a third party for government procurement data. These costs were not incurred in the same periods in 2000. In the second quarter and first half of 2000, $253,444 and $270,005, respectively, was incurred for initial start-up costs relating to transactional software the Company had purchased. Such costs were not incurred in the same periods in 2001. General and Administrative Expenses General and administrative expenses were $2,050,310 or 151% of net revenues, for the second quarter of 2001, and $2,101,093, or 225% of net revenues, for the second quarter of 2000, respectively. General and administrative expenses consisted primarily of personnel costs of $1,144,513 and $1,177,978, rent expense of $166,753 and $130,572, advertising costs of $27,449 and $235,798, bad debt expense of $339,091 and $92,483, and other costs totaling $372,504 and $464,262 consisting of professional fees, utilities, supplies and other related administrative costs, for the second quarter of 2001 and 2000, respectively. 11 General and administrative expenses were $4,314,567 or 146% of net revenues, for the first half of 2001, and $3,521,887 or 237% of net revenues, for the first half of 2000, respectively. General and administrative expenses consisted primarily of personnel costs of $2,573,618 and $1,676,091, rent expense of $379,358 and $147,090, advertising costs of $38,602 and $463,935, bad debt expense of $551,244 and $109,313, and other costs totaling $771,745 and $1,125,458 consisting of professional fees, utilities, supplies and other related administrative costs, for the first half of 2001 and 2000, respectively. The decrease in other costs for the six months ended June 30, 2001, compared to the same period of the prior year, is primarily attributable to a decrease of $245,059 in amortization of deferred financing costs and a decrease of $114,020 in placement fees. The increase in personnel costs for the current six-month period, compared to the same period of the prior year, is due to an increase in sales training and information technology related salaries. The Company made significant personnel reductions during the first half of 2001. In addition, during the first half of 2001, depending on salary level, all remaining salaried personnel took a pay reduction, ranging from 5%-30%. The Company expects that its personnel costs will continue to decrease during the second half of 2001. The increase in bad debt expense for current quarter and first half of the year, compared to the same periods of the prior year, relates to the Company's policy of paying sales commissions upon signing a Company sales order, rather than upon cash receipt, thereby increasing the probability that sales orders of lesser quality could be submitted. Although the Company can recover commissions paid to sales representatives if the customer does not pay, the Company's high turnover has made it difficult to collect on a portion of subscriptions sold. During the second quarter, the Company significantly tightened its deal verification processes, and expects that its bad debt expense will begin to decrease during the second half of 2001. At June 30, 2001, PartsBase employed 17 persons in administrative and executive management positions, compared to 30 persons at June 30, 2000. Stock-Based Compensation Expense In connection with the issuance of employee stock options issued prior to our IPO, stock-based compensation expense of $134,993 and $1,016,938 was recognized in the second quarter 2001 and 2000, respectively, and $178,004 and $2,479,171 during the first half of 2001 and 2000, respectively. The significant decrease in the current quarter and first half compared to the same periods of the prior year was a result of a decrease in the number of shares vesting by employees. Stock based compensation expense will continue to decrease each quarter until fully recognized by April 2002. Litigation and Other Related Costs Litigation and other related costs of $457,500 and $0 for the quarter ended and six months ended June 30, 2001 and 2000, respectively, consist of a provision for $200,000 to cover expected retention costs associated with class action lawsuits the Company is party to, as well as $257,500 to settle or accrue for litigation and other related costs. Other Income, Net Other income, net, consisting primarily of interest income, was $299,014 and $797,100 for the second quarter and first half of 2001, respectively, compared to $599,430 and $616,338 for the first quarter and second half of 2000, respectively. The decrease in other income, net for the current periods compared to the comparable periods of the prior year is attributable to lower cash balances and interest rates on the Company's investments and cash equivalents. Net Loss As a result of the foregoing, the net loss decreased to $2,065,997 and $3,764,706 for the second quarter and first half of 2001, compared to $2,531,072 and $6,107,128 for same periods in 2000. Liquidity and Capital Resources Financial Condition As of June 30, 2001, the Company had $21,513,576 of cash and cash equivalents, restricted cash totaling $2,215,265, and $4,025,756 of marketable debt securities. At June 30, 2001, the Company had $23,062,525 of working capital. 12 The Company currently anticipates that its operating expenses will be a material use of its cash resources. Additionally, the Company will continue to evaluate possible acquisitions of, or investments in, businesses, products, and technologies that are complementary to those of the Company's, which may require the use of cash. The Company believes that its existing cash and cash equivalents and marketable debt securities will be sufficient to meet its anticipated cash needs for working capital and capital expenditures for at least the next twelve months. Cash Flows Net cash used in operating activities totaled $2,775,064 for the six months ended June 30, 2001 compared to net cash used in operating activities of $2,910,206 for the comparable period of the prior year. The current period decrease reflects a decrease of $673,006 in accounts receivable, primarily the result of improvements in collecting customer balances, offset by a decrease of $460,397 in accounts payable due to increased pay downs of vendor balances and an overall contraction in Company spending. Net cash provided by investing activities totaled $1,859,767 for the six months ended June 30, 2001 compared to net cash used in investing activities of $6,950,225 for the comparable period of the prior year. The current period increase of $8,809,992 in cash provided is primarily the result of a significant reduction in capital expenditures along with proceeds received from marketable securities that matured. Net cash used in financing activities totaled $616,618 for the six months ended June 30, 2001, compared to net cash provided by financing activities totaling $40,878,948 for the comparable period of 2000. The decrease of $41,495,566 in cash provided during the current period is primarily the result of net proceeds received by PartsBase in connection with the issuance of common stock related to the Company's IPO during the comparable period of the prior year. In addition, during the six months ended June 30, 2001, the Company repurchased shares of its no par common stock at a cost of $795,544. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company is exposed to the impact of interest rate changes. Interest Rate Risk The primary objective of investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. At June 30, 2001, PartsBase's portfolio consisted of investments in institutional money market funds and corporate bonds rated A or higher at the time of purchase. PartsBase's investment policy is focused on ensuring that PartsBase has liquid cash balances available to meet its day-to-day operating cash needs. The policy establishes guidelines for the investment of surplus cash balances that will maximize return with minimum credit and liquidity risk. All investments are held in U.S. Dollars. Specific instruments approved for inclusion in the portfolio are limited to: obligations issued by the U.S. Treasury and U.S. Federal Agencies, obligations of U.S. commercial banks such as bankers' acceptances and certificates of deposit and obligations of major corporations and bank holding companies such as direct issue commercial paper and medium term notes. The Company intends to hold its investments until maturity; however, it is exposed to the impact of interest rate changes and change in the market values of its investments. Investments in both fixed rate and floating rate interest earning instruments carries a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company's future investment income may fall short of expectations due to changes in interest rates or the Company may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. Foreign Exchange Risk The Company has minimal exposure to foreign exchange risk as all of its sales to customers outside of the United States are collected in U.S. dollars. 13 PART II---OTHER INFORMATION Item 1. Legal Proceedings In September 2000, the Company sued a third party financial institution because such financial institution paid a check in the amount of $161,000 despite a stop payment order duly issued by the Company. The payee cashed the check, along with a replacement check. Before the Company learned that the payee had cashed both checks, the Company entered into a binding settlement with the payee ending the Company's business relationship with the payee. The payee refused to return the amounts and the financial institution failed to credit the Company's account. The Company filed suit, and discovery has commenced. The only claim against the Company in this matter is the financial institution's demand for legal fees if the financial institution prevails. In a separately filed lawsuit, the payee of the checks has filed an action for declaratory relief against the financial institution and the Company requesting that the court declare its settlement agreement with the Company to be valid and binding. In this declaratory relief action, the payee has requested that the Company and the financial institution reimburse it for costs and fees associated with the action. In July 2001, the separately filed lawsuit against the Company filed by the payee of the checks was dismissed, without prejudice, for lack of jurisdiction. In December 2000, a third party (the "Third Party"), unaffiliated with the Company, instituted arbitration against the Company in Dallas, Texas based upon allegations that the Company breached a February 18, 2000 professional services agreement. The Third Party claimed damages of $308,083 plus un-liquidated damage amounts for copyright infringement, interest, attorneys' fees and costs. The Company filed a counterclaim denying the breach and claiming entitlement to a refund of $73,496 previously paid to the Third Party plus damages of $250,000 because of the Third Party's breach of its obligations to the Company. This matter was settled on June 30, 2001, resulting with the Company making a $175,000 payment to the Third Party. This payment is classified as a litigation expense in the statement of operations for the three and six months ended June 30, 2001. In April and May 2001, the Company received notice of or has been served with three purported class action lawsuits (Foderaro vs. PartsBase.com, Inc. et al, Case No.: 01-8319 CIV- FERGUSON; IKCYBERINVESTMENTS vs. PartsBase.com, Inc. et al, Case No.: 01-8368 CIV-SEITZ; and Webb vs. PartsBase, et.al. Case No. 01-8376 CIV- GRAHAM). The lawsuits name as defendants, the Company, certain of its current and former officers and directors, and the underwriters of its initial public offering of securities. The lawsuits allege violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and allege the Company's March 2000 registration statement misrepresented and failed to disclose matters related to the Company's business operations and membership sales. The lawsuits seek damages and certification of a class consisting of purchasers of the Company's common stock in the offering during the period from March 22, 2000 through April 25, 2000. The Company believes that the allegations contained in the lawsuits are without merit and intends to vigorously defend this action. Nevertheless, an unfavorable resolution of these lawsuits could have a material adverse effect on the Company in one or more future periods. The Company maintains a director and officers' liability insurance policy that provides $3 million of coverage, with retention of $200,000. The Company fully expects its legal expenses to exceed the retention amount. Therefore at June 30, 2001, the Company has recorded a litigation reserve for $200,000 to cover the expected retention. This reserve has been included in litigation and other related costs in the statement of operations for the three and six months ended June 30, 2001. During the quarter, $83,935 of invoices related to this matter were received and applied against this reserve. The Company does not intend to file further Current Reports on Form 8-K or other disclosures describing additional lawsuits, if any, purporting class action status, in either federal or state court, which are based on allegations substantially similar to those contained in the lawsuits described above. Two other litigation matters, relating to the providing of services by information technology vendors, were resolved during the quarter in the amounts of $40,000 and $12,500. An additional reserve was established for $30,000 relating to a lawsuit filed and served on the Company in July 2001 by a third information technology vendor claiming damages resulting from the Company's alleged breach of a software sales and service contract. These amounts, totaling $82,500, are included in litigation and other related costs in the statement of operations for the three and six months ended June 30, 2001. The Company intends to vigorously defend the allegations contained in this third lawsuit. 14 Item 2. Changes in Securities On September 27, 2000 the Company's Board of Directors authorized the Company to repurchase up to 500,000 shares of its outstanding no par common stock from time to time on the open market over the next twelve months at the prevailing market price. Once purchased, such shares would become treasury stock. At June 30, 2001, the Company had completed the repurchase of the 500,000 shares of common stock. The stock was repurchased at an aggregate purchase price of $752,065 inclusive of brokerage fees, of which 208,100 shares at an aggregate cost of $231,397 had been purchased during the quarter ended June 30, 2001. On May 7, 2001, the Company's Board of Directors authorized the Company to repurchase as treasury stock an additional 500,000 shares of its outstanding no par common stock. At June 30, 2001, the Company had completed the repurchase of 154,065 shares of common stock. The stock was repurchased at an aggregate purchase price of $178,253 inclusive of brokerage fees. During the six months ended June 30, 2001, 534,285 shares of treasury stock, with a value of $983,123, were retired. During the quarter ended June 30, 2001, pursuant to the exercise of stock options granted pursuant to the Company's 1999 Stock Option Plan (the " 1999 Plan") the Company issued 23,383 shares of its common stock. In connection with these exercises, the Company generated gross exercise proceeds of $14,731. For the six months ended June 30, 2001, the Company generated gross exercision proceeds of $178,296. In March 2001, pursuant to the 1999 Plan, the Company granted to several of its employees non-qualified stock options to acquire an aggregate of 315,000 shares of the Company's common stock at a per share exercise price of $5.00 per share. The options vest on a pro-rata basis over a 48-month period from the date of grant and expire 10 years from the date of the grant. Additionally, a member of the Board of Directors was granted the option to acquire 20,000 shares of the Company's common stock at an exercise price of $3.00 per share at any time through March 2011. In June 2001, pursuant to the 1999 Plan, the Company granted to several of its employees, as a result of the implementation of pay reductions, non-qualified stock options to acquire an aggregate of 360,600 shares of the Company's common stock at a per share exercise price of $2.00 per share, including 271,000 shares to officers of the Company. The options vest on a pro-rata basis over a 12-month period from the date of grant and expire 10 years from the date of the grant. The Company also granted to several of its other employees non-qualified stock options to acquire an aggregate of 51,000 shares of the Company's common stock at a per share exercise price of $2.00 per share. The options vest on a pro-rata basis over a 48-month period from the date of grant and expire 10 years from the date of the grant. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders On June 20, 2001, the Company held its Annual Meeting of Stockholders. At the meeting, the stockholders elected as directors Robert Hammond, Pierre Narath, Thomas Van Hare, Edward McCartin, Kenneth Corriea, and John Menefee (with 13,594,515 shares voting for and 8,250 votes withheld). The stockholders also approved an amendment to effect a change in the state of incorporation of the Company from Texas to Delaware by approving a Plan of Reorganization and Merger. As part of the Plan of Reorganization and Merger, the Company's name was changed to PartsBase, Inc. (with 9,971,191 shares voting for, 7,050 voting against, 500 votes withheld, and 3,624,024 no-votes). The stockholders also ratified the adoption of the Company's 2001 Stock Option Plan (with 9,936,950 shares voting for, 7,050 voting against, 500 votes withheld, and 3,624,024 no-votes). The stockholders also ratified the appointment of Deloitte & Touche LLP as the independent auditors for the Company for the year ending December 31, 2001 (with 13,601,115 shares voting for, 1,050 voting against, and 600 votes withheld). Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K None. 15 Signatures In accordance with the requirements of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: August 3, 2001 /s/ Robert A. Hammond --------------------- ROBERT A. HAMMOND, JR. President, Chief Executive Officer, And Chairman (Principal Executive Officer) Date: August 3, 2001 /s/ Michael W. Siegel --------------------- MICHAEL W. SIEGEL Chief Financial Officer (Principal Financial Accounting Officer) 16 PARTSBASE, INC. Index to Exhibits Title Exhibit No. ------------------------------- ------------- Safe Harbor Compliance Statement 99.1 1 Exhibit 99.1 SAFE HARBOR COMPLIANCE STATEMENT The Company believes that the following risks could cause the Company's actual results to differ materially. RISKS RELATING TO OUR COMPANY AND OUR BUSINESS WE HAVE NEVER BEEN PROFITABLE, ANTICIPATE CONTINUED LOSSES AND CANNOT GUARANTEE PROFITABILITY IN THE FUTURE. We have never been profitable and expect to continue to incur operating losses until at least the end of fiscal 2001. We may be unable to ever achieve profitability in the future. We have incurred net losses in each accounting period since we began operations in April 1996, totaling $24,981,364 as of June 30, 2001. We will need to generate significant revenues and reduce our expenses to achieve profitability. Although our revenues have grown in recent periods, we cannot assure you that we will achieve sufficient revenues for profitability. Even if we do achieve profitability, we cannot assure you that we can sustain or increase profitability on a quarterly or annual basis in the future. If revenues grow slower than we anticipate, or if operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be materially and adversely affected. WE CANNOT PREDICT OUR SUCCESS BECAUSE OUR BUSINESS MODEL IS UNPROVEN AND WE HAVE OPERATED OUR BUSINESS FOR ONLY A SHORT PERIOD OF TIME. Our business model is new to the aviation industry and our ability to generate revenues or profits is unproven. We have a limited operating history, which will make it difficult for you to evaluate our performance. Our prospects will be dependent upon our ability to effectively implement our business model and adapt to changes in the business-to-business e-commerce market. If our business model is not viable or if we are unable to identify and address changes in our markets, we will not be able to grow our business, compete effectively or achieve profitability. These factors could cause our stock price to fall significantly. WE PRIMARILY RELY ON REVENUE FROM SUBSCRIPTIONS AND WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR MEMBERSHIP BASE OR ESTABLISH ADDITIONAL REVENUE SOURCES. We currently generate revenues from e-commerce customers in the aviation industry who subscribe to our service. Our success will be dependent on our ability to expand our membership base within the aviation industry. While we have experienced increases in our subscriber base, there can be no assurance that our recent growth in subscriber base can be continued. In addition, our success will depend on our ability to generate additional revenues through the introduction of a transaction-based model and/or the expansion into new markets and industries. We cannot assure you that we will be successful in any efforts to generate additional revenues. WE RECEIVE SUBSTANTIALLY ALL OF OUR REVENUE FROM PARTICIPANTS IN THE AVIATION INDUSTRY, SO A DOWNTURN IN THE AVIATION INDUSTRY COULD DAMAGE OUR BUSINESS. We receive substantially all of our revenue from members associated with the aviation industry, and we expect these revenues will account for substantially all of our revenues for the foreseeable future. Our dependence on members associated with the aviation industry makes us vulnerable to downturns in that industry. A downturn could lead our members to reduce their level of activity on our e-marketplace and cause some to cancel their subscription. INTENSE COMPETITIVE PRESSURES IN THE BUSINESS-TO-BUSINESS E-COMMERCE MARKET MAY IMPEDE OUR ABILITY TO ESTABLISH A SUBSTANTIAL MARKET SHARE THAT WOULD ALLOW US TO BE PROFITABLE. The business-to-business e-commerce market is new, rapidly evolving, and intensely competitive, and we expect competition to further intensify in the future. Barriers to entry are minimal, and competitors may develop and offer services similar to ours in the future. Recent entrants into the business-to-business aviation parts market include an alliance of prominent aircraft parts manufacturers and aviation industry participants that have superior capital resources and established reputations in the industry. In addition, we expect that additional companies will offer competing e-commerce solutions in the future, and our business could be severely harmed if we are not able to compete successfully against current or future competitors. In addition, our members and partners may become competitors in the future. Increased competition is likely to result in price reductions, reduced gross margins and/or loss of market share, any of which could harm our business. Our actual and potential competitors varyin size and in the scope and breadth of the services they offer. 1 QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors, not all of which are in our control. These factors include: subscriber and advertiser demand for our solutions; user traffic levels and activity on our e-marketplace; seasonal fluctuations in Internet usage; changes in the growth rate of Internet usage; the commitment of e-commerce customers in the aviation industry who subscribe to our service; the timing and amount of costs relating to the expansion of our operations; changes in our pricing policies or those of our competitors; the introduction of new solutions by us or our competitors; costs related to acquisitions of technology or businesses; and general economic and market conditions. Our revenues for the foreseeable future will remain dependent on user traffic levels and the commitment of e-commerce customers in the aviation industry who subscribe to our service. Such future revenues are difficult to forecast. In addition, we plan to continue our expansion, to upgrade and enhance our technology, and to market and support our solutions. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. If we have a shortfall in revenues in relation to our expenses, or if our expenses precede increased revenues, then our business, results of operations and financial condition would be materially and adversely affected. Such a result would likely affect the market price of our common stock in a manner which may be unrelated to our long-term operating performance. Due to all of the foregoing factors and the other risks discussed in this section, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is possible that in some future periods our results of operations may be below the expectations of public market analysts and investors. In this event, the price of our common stock may fall. IF WE FAIL TO EFFECTIVELY MANAGE OUR RAPIDLY EXPANDING OPERATIONS AND THE INCREASING USE OF OUR SERVICES, WE MAY LOSE MEMBERS OR INCUR SIGNIFICANT EXPENSES. Our success depends on effective planning and growth management. We will need to continue to improve our financial and managerial controls, reporting systems, and procedures, and we will need to continue to expand, train and manage our workforce. We continue to increase the scope of our operations and we have grown our workforce substantially. Our rapid growth has placed, and will continue to place, a significant strain on our management and operational systems and resources. If we do not successfully implement and integrate these new systems or if we fail to scale these systems to our growth, the performance of our Web site may suffer which would cause us to lose members. In addition, any failure could make us unable to operate with adequate, accurate and timely financial and operational information which could result in us incurring unnecessary and possibly damaging expenses. BECAUSE OUR REVENUE IS DERIVED FROM PROVIDING E-MARKETPLACE ACCESS TO SUBSCRIBERS FOR AN ANNUAL SUBSCRIPTION FEE, THE CANCELLATION OR NON-RENEWAL OF THESE SUBSCRIPTIONS WOULD HURT OUR BUSINESS. We have generated substantially all of our revenues to date through subscriber fees for access to our e-marketplace. Generally, our subscription fees are paid on an annual basis, and these subscriptions may be terminated on short-term notice. We have expended significant financial and personnel resources and have expanded our operations on the assumption that our subscribers will renew these annual subscriptions. We do not have a sufficiently long history of operations to be able to predict renewal rates. If our subscribers fail to continuously renew, or if they terminate, their subscriptions, our revenues would be significantly reduced and our business could suffer dramatically. THERE IS A FINITE NUMBER OF POTENTIAL SUBSCRIBERS AND WE MAY BE UNABLE TO DEVELOP OTHER MEANS OF GENERATING REVENUE, SO OUR GROWTH MAY BE LIMITED. A major element of our growth strategy is the expansion of our subscriber base. The number of participants in the aviation market limits our potential subscriber 2 base. Additionally, the barriers to entry that exist in the aviation market may limit the entry of additional subscribers into our e-marketplace. Accordingly, the number of potential subscribers to our e-marketplace is likely finite, in which case our revenues may be similarly limited if we cannot generate revenue through other means. IF OUR SELLERS DO NOT PROVIDE TIMELY, PROFESSIONAL AND LAWFUL DELIVERY OF PRODUCTS TO OUR BUYERS, OUR MEMBERSHIP MAY DECREASE AND WE MAY HAVE LIABILITY. We rely on our sellers to deliver purchased parts and products to our buyers in a professional, safe and timely manner. If our sellers do not deliver the parts and products to our buyers in a professional, safe and timely manner, then our service will not meet customer expectations and our reputation and brand will be damaged. In addition, deliveries that are nonconforming, late or are not accompanied by information required by applicable laws or regulations, could expose us to liability or result in decreased adoption and use of our solution, which could have a negative effect on our business, results of operations and financial condition. WE CANNOT GUARD AGAINST HARM TO OUR BUSINESS FROM THE FRAUDULENT ACTIVITIES OF THIRD PARTIES ON OUR WEB SITE. Our future success will depend largely upon sellers reliably delivering and accurately representing their listed products and buyers paying the agreed purchase price. We do not take responsibility for the delivery of payment or goods to any member. We have received in the past, and anticipate that we will receive in the future, communications from members who did not receive the purchase price or the products that were to be exchanged. While we can suspend the privileges of members who fail to fulfill their delivery or payment obligations, we do not currently have the ability to require sellers to deliver products or buyers to make payments. We do not compensate members who believe they have been defrauded by other members. Any negative publicity generated as a result of fraudulent or deceptive conduct by members of our e-marketplace could damage our reputation and diminish the value of our brand name. We may in the future receive requests from members for reimbursement or threats of legal action against us if no reimbursement is made. Any resulting litigation could be costly for us, divert management attention, result in increased costs of doing business, lead to adverse judgments, or otherwise harm our business. IF WE ARE UNABLE TO IMPLEMENT ADEQUATE MEASURES TO MAINTAIN THE VALUE OF OUR INTELLECTUAL PROPERTY AND INTERNET DOMAIN NAME, OUR ABILITY TO COMPETE MAY BE SEVERELY HARMED. As an Internet company, our current and future copyrights, service marks, trademarks, patents, trade secrets, domain name and similar intellectual property, if any, are especially vital to our success. Despite our precautions, unauthorized third parties may infringe or misappropriate our intellectual property, copy portions of our services or reverse engineer or obtain and use information that we regard as proprietary. Any infringement or misappropriation of our intellectual property or proprietary information could make it difficult for us to compete. In addition, we currently hold various Internet Web addresses relating to our network, including the domain name "PARTSBASE.COM." If we are not able to prevent third parties from acquiring Web addresses that are similar to our addresses, third parties could acquire similar domain names which could create confusion that diverts traffic away from our e-marketplace to other competing Web sites. OTHER PARTIES MAY ASSERT CLAIMS AGAINST US THAT WE ARE INFRINGING UPON THEIR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD HARM OUR FINANCIAL CONDITION AND ABILITY TO COMPETE. We cannot be certain that our services do not infringe upon the intellectual property rights of others. Because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to services similar to those offered by us. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. If our services violate third-party proprietary rights, we cannot assure you that we would be able to obtain licenses to continue offering such services on commercially reasonable terms, or at all. Any claims against us relating to the infringement of third-party proprietary rights, even if not meritorious, could result in the expenditure of significant financial and managerial resources and for injunctions preventing us from distributing these services. Such claims could severely harm our financial condition and ability to compete. IF WE ARE UNABLE TO LICENSE THIRD-PARTY TECHNOLOGIES OR EFFECTIVELY INTEGRATE THEM, WE MAY EXPERIENCE DELAYS IN DEVELOPMENT OR EXPANSION OF OUR BUSINESS. The e-commerce market is rapidly evolving and we have and will depend on third-party software and other technology for the effective operation of our Web site and business. We may not be able to license or renew the license for these 3 technologies on terms favorable to us or at all. Our inability to obtain necessary third-party licenses could delay the continued development of our business and services which could result in a loss of members, slow our growth and severely harm our business. In addition, even if we are able to license needed technology, we may not be able to successfully integrate such technology into our operations which could also result in a loss of members, slow our growth and severely harm our business. RISKS RELATED TO THE INTERNET AND E-COMMERCE INDUSTRIES OUR GROWTH MAY BE IMPAIRED IF THE INTERNET IS UNABLE TO ACCOMMODATE GROWTH IN E-COMMERCE. Our success depends on the widespread use of and growth in the use of the Internet for retrieving, sharing and transferring information among buyers and sellers in the aviation parts market. If the Internet cannot accommodate growth in e-commerce or experiences periods of poor performance, the growth of our business may suffer. Our ability to sustain and improve our services is limited, in part, by the speed and reliability of the networks operated by third parties. Consequently, the emergence and growth of the market for our services is dependent on improvements being made to the Internet infrastructure to alleviate overloading and congestion. Additionally, the possible slow adoption of the Internet as a means of commerce by businesses may harm our prospects. Even if the Internet is widely adopted as a means of commerce, the adoption of our network for procurement, particularly by companies that have relied on traditional means of procurement, will require broad acceptance of e-commerce and online purchasing. In addition, companies that have already invested substantial resources in traditional methods of procurement, or in-house e-commerce solutions, may be reluctant to adopt our e-commerce solution, thus impairing the growth of our member base and revenue potential. THE SECURITY RISKS RELATED TO E-COMMERCE MAY CAUSE MEMBERS TO REDUCE THE USE OF OUR SERVICES, AND ATTEMPTING TO GUARD AGAINST THESE RISKS MAY CAUSE US TO INCUR SIGNIFICANT COSTS AND EXPENSES. A fundamental requirement to conduct business-to-business e-commerce is the secure transmission of information over public networks. If our members are not confident in the security of e-commerce, they may not effect transactions on our e-marketplace or renew their subscriptions, which would severely harm our business. There can be no guarantee that advances in computer capabilities, new discoveries in the field of cryptography, or other developments will not result in the compromise or breach of the algorithms that we use to protect content and transactions on our e-marketplace or proprietary information in our databases. We may be required to incur significant costs to protect against security breaches or to alleviate problems caused by breaches. Further, a well-publicized compromise of security could deter people from using the Internet to conduct transactions that involve transmitting confidential information. Our failure to prevent security breaches, or well-publicized security breaches affecting the Internet in general, could adversely affect the willingness of our members to use our services. IF OUR SELLERS FAIL TO PROVIDE TIMELY AND ACCURATE INFORMATION, OUR MEMBERSHIP BASE AND POTENTIAL REVENUE MAY DECLINE. Our members use our service in large part because of the comprehensive breadth and accuracy of our databases. It is our responsibility to load seller product information into our database and categorize the information for search purposes. However, we are dependent on our sellers to provide us in a timely manner with accurate, complete, and current information regarding inventory. If our timely loading of this information is impaired, this could result in member dissatisfaction and a loss of members. WE MAY NOT BE ABLE TO KEEP UP WITH TECHNOLOGICAL ADVANCEMENTS, WHICH COULD RESULT IN A LOSS OF MEMBERS AND HARM OUR ABILITY TO COMPETE. The market for Internet commerce is characterized by rapid change, evolving industry standards and the frequent introduction of new technological products and services. The introduction of new technology, products, services or standards may prove to be too difficult, costly or simply impossible to integrate into our existing systems. Moreover, innovations could render obsolete our existing or any future products and services. Our ability to remain competitive will also depend heavily upon our ability to maintain and upgrade our technology products and services. We must continue to add hardware and enhance software to accommodate any increased content and use of our Web site. If we are unable to increase the data storage and processing capacity of our systems at least in pace with the growth in demand, our Web site may fail to operate at an optimal level for unknown periods of time. As a relatively small company in the market for Internet commerce, we will be in a position of responding to technological changes rather than establishing them. Any difficulty keeping pace with technological advancements could hurt our ability to retain members and effectively compete. 4 A SYSTEM FAILURE COULD DELAY OR INTERRUPT OUR SERVICE WHICH COULD SEVERELY HARM OUR BUSINESS AND RESULT IN A LOSS OF MEMBERS. Our ability to successfully maintain an e-commerce marketplace and provide acceptable levels of customer service depends largely on the efficient and uninterrupted operation of our computer and communications hardware and network systems. Any interruptions could severely harm our business and result in a loss of members. Our computer and communications systems are located in Boca Raton, Florida. Although we back up our databases to tapes and store the backup tapes offsite, we do not maintain a redundant site. As a result, our systems and operations could be vulnerable to damage or interruption from human error, sabotage, fire, flood, hurricane, power loss, telecommunications or equipment failure, and similar events. We cannot assure you that we will not experience system failures in the future. Moreover, we have experienced delays and interruptions in our telephone and Internet access that have prevented members from accessing our e-marketplace and customer service department. Furthermore, we do not have a formal disaster recovery plan and do not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of any system failure, and therefore the occurrence of any system failure or similar event could harm our business dramatically. DEFECTS IN THE COMPLEX SOFTWARE ON WHICH OUR SERVICES DEPEND COULD CAUSE SERVICE INTERRUPTIONS THAT COULD DAMAGE OUR REPUTATION AND HARM OUR BUSINESS. Unlike many traditional suppliers and distributors of aviation parts, we are wholly dependent on the error-free functioning of our Web site and its associated software. Our e-marketplace depends on complex software developed internally and by third parties. Moreover, we are relying on third-party software to implement our transaction-based model, which software has not yet been integrated into our system. Software often contains defects, particularly when first introduced or when new versions are released. Our testing procedures may not discover software defects that affect our new or current services or enhancements until after they are deployed. These defects could cause service interruptions, which could damage our reputation or increase our service costs, cause us to lose revenue, delay market acceptance, or divert our development resources, any of which could severely harm our business, financial condition, and results of operations. WE COULD FACE LIABILITY FOR INFORMATION RETRIEVED FROM OR TRANSMITTED OVER THE INTERNET AND LIABILITY FOR AIRCRAFT PRODUCTS SOLD OVER THE INTERNET. We could be exposed to liability with respect to third-party information that may be accessible through our Web site. If any third-party content information provided on our Web site contains errors, consumers potentially could make claims against us for losses incurred in reliance on that information. In addition, because defective aviation products can result in substantial losses of property or life, we have a relatively greater risk of being exposed to product liability claims arising out of or relating to aviation parts and products sold through our Web site, which could result in us incurring substantial defense costs and, if successful, liability, either of which could severely harm our business. We currently carry no policies which would insure us against product liability claims. RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR INVESTMENTS. We may acquire or make investments in complementary or other businesses, products, services or technologies. From time to time we may have discussions with companies regarding our acquiring, or investing in, their businesses, products, services or technologies. We cannot assure you that we will be able to identify suitable acquisition or investment candidates. Even if we do identify suitable candidates, we cannot assure you that we will be able to make such acquisitions or investments on commercially acceptable terms. If we buy a company, we could have difficulty in assimilating that company's personnel and operations. In addition, the key personnel of the acquired company may decide not to work for us. If we make other types of acquisitions, we could have difficulty in assimilating the acquired products, services or technologies into our operations. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations due to accounting requirements such as goodwill. Furthermore, we may incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities could be dilutive to our existing stockholders. 5 FUTURE GROWTH OF OUR OPERATIONS MAY MAKE ADDITIONAL CAPITAL OR FINANCING NECESSARY. We anticipate that we have sufficient working capital to meet our working capital needs for at least the next 12 months. However, we may need to raise additional funds in the future in order to: finance unanticipated working capital requirements; develop or enhance existing services or products; respond to competitive pressures; and acquire complementary businesses, technologies, content or products. We cannot be certain that we will be able to obtain needed funds on favorable terms, if at all. If we decide to raise funds by issuing additional equity securities, investors in our common stock may experience additional dilution. WE MAY BE UNABLE TO OBTAIN SUFFICIENT FUNDS TO EFFECTIVELY OPERATE OUR BUSINESS THAT COULD DAMAGE OUR COMPETITIVE POSITION. In the rapidly evolving and highly competitive e-commerce industry, our future prospects will depend heavily on our ability to take advantage of new business opportunities and respond to technological developments. There can be no assurances that we will have sufficient capital resources to respond to business opportunities, technological advancements and competitive pressures. A lack of capital resources could seriously damage our competitive position and prospects. YOU MAY EXPERIENCE SIGNIFICANT VOLATILITY IN THE MARKET VALUE OF YOUR SHARES AND MAY BE UNABLE TO SELL OUR STOCK ON TERMS FAVORABLE TO YOU. Because we have no history of profitability, it will be difficult for investors in the public market to determine the intrinsic value of our shares. In addition, our initial market capitalization and public float is small relative to other public companies in the business-to-business e-commerce or other sectors. As a result, the price at which our common stock trades may be more volatile than those of other public companies and, as a result, it may be more difficult for you to sell our stock on terms favorable to you. 6

PARTSBASE COM INC 10-Q