AppFolio, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Amounts below are in U.S. dollars; financial figures are rounded to millions unless noted.
Business context
AppFolio provides cloud-based software and related services, principally to real estate businesses; real estate customers account for more than 90% of revenue. It also serves small law firms. Growth priorities include expanding customers and units managed, increasing adoption of Value+ services, and developing new products. Property-manager customers increased 11% year over year to 14,034, and units under management rose 19% to 4.41 million. Law-firm customers increased to 10,781.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $67.9M | $50.1M | $188.7M | $139.7M |
| Operating income | $4.1M | $5.5M | $6.4M | $17.0M |
| Operating margin | 6.1% | 10.9% | 3.4% | 12.1% |
| Net income | $5.0M | $5.5M | $31.9M | $17.3M |
| Diluted EPS | $0.14 | $0.16 | $0.90 | $0.49 |
Q3 revenue grew 36%; core solutions rose 26%, Value+ services 35%, and other revenue 167%. For the first nine months, revenue grew 35%. Higher operating expenses—especially sales and marketing, product development, and depreciation and amortization—outpaced revenue growth and reduced operating margins. Cost of revenue excluding depreciation and amortization was 38.2% of revenue in Q3 and 39.9% year to date, versus 38.5% and 38.4%, respectively, in 2018.
Year-to-date net income includes a $26.9M income tax benefit, principally from reversing the valuation allowance on deferred tax assets after the company concluded those assets were more likely than not to be realized. This benefit was noncash and substantially explains why reported net income increased despite lower operating income. Q3 included a $1.3M tax benefit, primarily related to research and development credits.
Operating cash flow was $23.4M for the nine months, compared with $24.6M in 2018. Investing used $70.7M, including $54.0M net cash for the Dynasty acquisition, $15.7M of capitalized software development, and $4.1M of property and equipment purchases. Financing used $6.6M. Cash, cash equivalents and restricted cash declined $54.0M to $20.6M; cash and cash equivalents were $20.1M and investment securities were $25.1M at September 30. Working capital was $22.4M, down from $79.8M at year-end 2018.
Total assets were $233.8M and total liabilities $108.4M. Term-loan principal was $49.1M, with $1.2M classified as current; the $50M revolving facility had no borrowings. The company reported compliance with debt covenants. Operating lease liabilities totaled $23.4M, following adoption of the new lease standard. Management said available cash, investments, the undrawn revolver and operating cash flow should cover working capital and capital needs for at least 12 months.
Material changes and notable items
- On January 7, 2019, AppFolio acquired Dynasty Marketplace for preliminary consideration of $60.2M. The acquisition added AI leasing technology; Dynasty contributed $2.0M revenue and a $6.6M net loss from acquisition through September 30. Purchase accounting remains preliminary, and $6.0M was held back for adjustments and potential indemnification claims.
- Revenue growth reflected customer and unit growth as well as increased Value+ usage. Newer offerings included utility management, the AI Leasing Assistant Lisa, and AppFolio Investment Management.
- AppFolio adopted lease accounting effective January 1, 2019, recognizing right-of-use assets and lease liabilities; management said adoption materially affected the balance sheet but not the income statement or cash flows.
- The board authorized a $100M share repurchase program, inclusive of remaining authorization under the earlier program. No shares were repurchased under the program during the first nine months of 2019.
Outlook, risks and contingencies
Management emphasized long-term growth and expects continued investment in product development, sales and marketing, customer support, infrastructure and expansion. It expects operating margins to improve over the long term, while warning that investment timing may interrupt that trend. The company noted that leasing-related Value+ revenue is typically seasonally weaker in the fourth quarter. No specific financial guidance was provided in the supplied filing text.
Key risks include execution and integration of acquisitions, sustaining customer renewals and Value+ adoption, competition, cybersecurity and service availability, reliance on third-party payment and screening providers, and regulatory requirements affecting payments, insurance and tenant screening. The DOJ requested information in July 2019 concerning compliance with the Servicemembers Civil Relief Act and tenant screening; the FTC had issued a December 2018 information demand concerning Fair Credit Reporting Act compliance. AppFolio is cooperating and said it could not predict outcomes or potential costs or penalties. It also reported a $1.1M reserve for reported and incurred-but-not-reported landlord insurance claims. Management stated that no other disclosed legal proceeding was expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
Important facts for investors to verify
- How much of future reported earnings reflects operating performance rather than the deferred-tax-asset valuation-allowance reversal.
- Whether expense growth moderates and operating margins recover as growth investments generate revenue.
- Dynasty’s integration, operating losses, preliminary purchase-price allocation and the eventual release of its $6.0M holdback.
- Developments and potential financial or operational effects of the DOJ and FTC tenant-screening inquiries.
- Cash use, debt covenant headroom and any future share repurchases under the $100M authorization.