Cars.com Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results; dollar figures below are in millions unless stated otherwise. Cars.com operates a digital automotive marketplace connecting consumers, dealers and advertisers. Comparisons are year over year; the 2017 comparative period predates the February 2018 Dealer Inspire (DI) and Launch Digital Marketing (LDM) acquisition and includes pre-separation combined financial information.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $168.5 | $156.6 | $328.5 | $309.8 |
| Operating income | $24.6 | $28.9 | $31.7 | $56.1 |
| Operating margin | 14.6% | 18.4% | 9.7% | 18.1% |
| Net income | $12.7 | $24.8 | $13.7 | $51.7 |
| Net margin | 7.6% | 15.8% | 4.2% | 16.7% |
| Diluted EPS | $0.18 | $0.35 | $0.19 | $0.72 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $70.6 | $96.7 |
| Capital expenditures | Not stated for quarter | Not stated for quarter | $6.4 | $18.9 |
- At June 30, cash was $18.4; current assets were $147.9 and current liabilities $104.4, for working capital of $43.5. Cash was $20.6 at December 31, 2017.
- Debt comprised $427.5 of term-loan principal and $300.0 of revolver borrowings, or $727.5 total principal. Cash net of principal debt was approximately $709.1. Term and revolver rates were 3.9% and 3.6%, respectively. The company reported a 3.0-to-1.0 net leverage ratio, $150.0 of remaining revolver availability, and compliance with debt covenants.
- Six-month investing cash outflow was $163.4, including $157.0 net acquisition payments. Financing cash inflow was $90.6, including new debt proceeds; cash declined $2.2 during the period. Cash interest paid was $12.5.
Material changes versus the prior comparable period
- Q2 revenue rose 8% and six-month revenue rose 6%, while Q2 net income fell 49% and six-month net income fell 74%. Operating income declined 15% in Q2 and 43% for the six-month period.
- Q2 retail revenue increased 27% to $146.9; wholesale revenue decreased 47% to $21.7. The company attributed much of this mix shift to converting affiliate markets to direct sales. Conversions added $21.2 of Q2 direct revenue and reduced wholesale revenue by $18.9; six-month effects were +$35.7 and −$31.9, respectively. These channel changes affect comparability and do not represent equivalent growth in total revenue.
- DI and LDM contributed $14.5 of Q2 revenue and $20.2 for the post-acquisition period through June 30. Their reported net loss was $2.5 for Q2 and $8.1 for the six-month period, including acquisition-related costs and incremental acquired-intangible amortization.
- Higher operating expenses, depreciation and amortization, and interest expense pressured earnings. Q2 net interest expense was $7.3 versus $1.8; six-month net interest expense was $13.3 versus $1.7. The company cited acquisition and public-company costs, a stockholder activist campaign, marketing and sales investments, and acquisition-related amortization among the expense drivers.
- Traffic increased 8% in both Q2 and the first half. Dealer customers declined 3% year over year to 20,720, and average vehicle listings declined 4% in Q2, attributed mainly to fewer new-car listings.
Outlook, commentary, risks and unusual items
- The filing provides no numerical full-year revenue, earnings, margin or cash-flow guidance. Management said it expects to manage higher public-company and transition costs through operating efficiency and business growth, with a focus on margins and free cash flow.
- In February, Cars.com acquired DI and substantially all net assets of LDM for stated total consideration of $160.8, including $2.2 of estimated contingent consideration. Up to an additional $15.0 may be payable based on performance. The purchase-price allocation, including $96.4 of goodwill, was preliminary. Certain employee awards associated with the acquisition may provide up to $25.5 of performance-based stock compensation.
- The board authorized a $200.0 share-repurchase program in March. During the first half, the company repurchased and retired approximately 2.0 million shares for $50.0, funded in part with $25.0 of revolver borrowing. The program has a two-year duration and may be changed or discontinued.
- Affiliate conversions continued: nearly 2,400 dealer customers moved to direct sales in the first half; about 80% of dealer customers were directly served at June 30. A July amendment provided for conversion of the Washington, D.C. market effective August 1, 2018.
- Key disclosed risks include competition, dealer and advertiser retention, automotive-market conditions, dependence on third-party data and search traffic, technology and cybersecurity risks, acquisition integration and leverage, variable interest rates, intangible-asset impairment, legal matters, and the company’s limited history as an independent public company. The filing reported no material changes to the risk factors in its 2017 Form 10-K. Legal proceedings may result in material liabilities, but the filing text does not provide a clear quantified exposure.
- ASC 606 was adopted January 1, 2018 with no material financial-statement impact. The company was evaluating the new lease standard, effective for it January 1, 2019, and expected recognition of assets and liabilities for operating leases, principally real estate. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How much reported revenue growth reflects acquired DI/LDM operations and affiliate-to-direct reclassification versus underlying organic growth, pricing and customer trends.
- Whether dealer-customer and vehicle-listing declines stabilize, and whether traffic growth converts into durable dealer revenue and improved margins.
- Acquisition integration performance, preliminary purchase accounting, contingent consideration, performance awards, and the acquired businesses’ contribution to profit and cash flow.
- Debt repayment capacity and covenant headroom given $727.5 of debt principal, variable-rate exposure and the company’s share-repurchase commitments.
- Whether higher marketing, public-company, activist-campaign and acquisition-related costs recede, and whether cash generation can support investment and repurchases.