AppFolio, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparative periods are the corresponding 2018 periods. AppFolio provides cloud-based software and services primarily to real estate businesses; real estate customers account for more than 90% of annual revenue.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $63.6m | $47.2m | $120.7m | $89.6m |
| Operating income / margin | $2.3m / 3.6% | $7.3m / 15.5% | $2.2m / 1.8% | $11.5m / 12.8% |
| Net income / diluted EPS | $23.2m / $0.65 | $7.5m / $0.21 | $26.9m / $0.76 | $11.8m / $0.33 |
| Operating cash flow | Not presented for quarter | $11.8m | $15.1m |
Revenue increased 35% in both Q2 and the first half. Q2 core solutions revenue grew 27% to $21.6m and Value+ services revenue grew 36% to $39.1m. Management attributed growth mainly to customer and unit expansion and greater Value+ usage. Property manager customers rose 12% year over year to 13,737, and units under management increased 19% to 4.23m.
Q2 cost of revenue, excluding depreciation and amortization, was 39.5% of revenue versus 37.5% a year earlier. Total operating expenses were 96.4% of revenue versus 84.5%, with increased investment in personnel, sales and marketing, product development, and acquired businesses. The resulting compression in operating margin contrasts with the higher reported net margin: a $21.3m income tax benefit drove Q2 net income. The benefit followed release of the valuation allowance on deferred tax assets; it is not indicative of operating earnings.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $19.5m and investment securities were $23.0m, or $42.5m combined. Working capital was $22.2m, down from $79.8m at year-end 2018.
- Term-loan principal was $49.4m ($49.2m net carrying value); no revolving credit was drawn, with $50.0m available. The loan bears variable interest; the six-month average rate was 4.2%. The company reported covenant compliance.
- First-half operating cash flow was $11.8m, down from $15.1m. Investing used $60.8m, including $54.0m for the Dynasty acquisition and $9.4m of capitalized software development. Financing used $5.6m, mainly for employee tax withholding on vested shares and debt principal payments. Cash, cash equivalents and restricted cash fell $54.6m to $19.9m.
- Operating lease liabilities totaled $22.5m following adoption of the new lease standard, which also added a $15.4m right-of-use asset. This adoption materially affected the balance sheet but not reported operations or cash flows.
Changes, outlook and material items
- In January 2019, AppFolio acquired Dynasty for approximately $60.2m, including a $6.0m holdback. Dynasty contributed $1.2m revenue and a $4.1m net loss from acquisition through June 30. Goodwill rose to $58.5m, primarily from the acquisition. AppFolio also launched its Investment Management product in April and its AI Leasing Assistant, Lisa.
- Management intends to continue investing in growth and product development, and expects operating margins to improve over the long term, while cautioning that investment timing may interrupt that trend. No specific revenue or earnings guidance is provided. Management believes cash, investments, borrowing capacity and operating cash generation will cover requirements for at least the next 12 months.
- The board authorized a $100m share repurchase program; no shares were repurchased during the first half. The authorization has no expiration date and does not require the company to buy shares.
- AppFolio is cooperating with an FTC inquiry regarding tenant-screening compliance with the Fair Credit Reporting Act. In July 2019, it received a DOJ information request concerning Servicemembers Civil Relief Act compliance in the same service. A class-action settlement related to FCRA allegations received final court approval on July 18, 2019. The company says it cannot predict the inquiries’ outcomes or potential costs.
- Other relevant risks include dependence on real estate customers, competition, acquisition integration, cybersecurity and service availability, payment and insurance exposures, privacy and regulatory compliance, and the company’s dual-class voting structure. Management reported effective disclosure controls; lease-standard implementation changed related internal controls.
Investor verification priorities
- Separate recurring operating performance from the one-time $21.3m quarterly tax benefit; verify the deferred-tax-asset assumptions and sustainability of profitability.
- Assess whether revenue growth and customer/unit expansion can continue while operating expenses rise faster than revenue and operating margins contract.
- Review cash conversion, acquisition-related cash use, available liquidity, variable-rate debt and covenant headroom.
- Monitor the FTC and DOJ matters, the approved class settlement, and any resulting costs, penalties or operational changes.
- Track Dynasty integration and returns, acquisition-related goodwill and intangibles, and progress of new products and Value+ services.