Cars.com Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our business, financial condition, results of operations and quantitative and qualitative disclosures should be read in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion and analysis also contains forward-looking statements and should be read in conjunction with the disclosures and information contained in “Note About Forward-Looking Statements” in this Quarterly Report on Form 10-Q. The financial information discussed below and included elsewhere in this Quarterly Report on Form 10-Q may not necessarily reflect what our financial condition, results of operations and cash flows may be in the future. References in this discussion and analysis to “we,” “us,” “our” and similar terms refer to Cars.com Inc. and its subsidiaries, collectively, unless the context indicates otherwise. Business Overview We are a leading digital marketplace and solutions provider for the automotive industry, connecting car shoppers with sellers. Through our marketplace, dealer websites and other digital products, we showcase dealer inventory, elevate and amplify dealers’ and automotive manufacturers’ (“OEMs”) brands, connect sellers with our ready-to-buy audience and empower shoppers with the resources and information needed to make confident car buying decisions. Our digital solutions strategy builds on the rich data and audience of our digital marketplace to offer media and solutions that drive growth and efficiency for the automotive industry. Our portfolio of brands now includes Cars.com, Dealer Inspire, FUEL, DealerRater, Auto.com, PickupTrucks.com and NewCars.com. Overview of Results Three Months Ended March 31, (in thousands) 2021 2020 Revenue $ 153,295 $ 148,094 Net income (loss) (1) 5,278 (787,434 ) (1) The net loss for the three months ended March 31, 2020 was primarily attributed to the goodwill and intangible asset impairment of $905.9 million. 2021 Highlights and Trends Dealer Customers. In the first quarter of 2021, Dealer Customers increased by 451, or 2%, to 18,823 as of March 31, 2021, as compared with 18,372 as of December 31, 2020. This increase was a result of continued strong retention rates and new sales to marketplace and digital solutions dealer customers. FUEL. Launched in early 2020, FUEL is a unique, high ROI, targeted video advertising solution that generates higher returns than high-cost broadcast television, on which the auto industry spends approximately $10 billion per year, as well as spend on other expensive advertising mediums. FUEL enables dealerships and OEMs to target and reach purely in-market car shoppers by leveraging the power of Cars.com's exclusive first-party audience data. FordDirect Agreement. In April 2021, we announced that we were selected by FordDirect as a preferred website and technology platform provider for its approximately 3,000 local U.S. dealerships. Technology Transformation. In 2019, our product and technology teams prioritized shifting our technology spend towards innovation to improve our speed of product delivery, to enable integration across current and future systems, and to migrate our systems to the cloud (the “Technology Transformation”). As part of this process, we continue to modernize our technology platform and invest in a more efficient cloud-based infrastructure focused on machine learning, product innovation and growth. Although the impact of the COVID-19 pandemic has elongated our timeline for the completion of the Technology Transformation, we have achieved cost efficiencies and expect to achieve further cost efficiencies upon completion of the Technology Transformation. Impact of COVID-19 on our business. In March 2020, the World Health Organization categorized COVID-19 as a pandemic, and it has since spread throughout the United States and the rest of the world with different geographical locations impacted more than others. The pandemic resulted in governmental authorities around the country implementing numerous measures to contain the virus, such as quarantines, shelter-in-place orders and business shutdowns (the “related restrictions”). During the year ended December 31, 2020 and to a lesser extent during the three months ended March 31, 2021, our business, financial condition, liquidity and operating results were adversely affected by the COVID-19 pandemic and related restrictions, which caused a widespread increase in unemployment and resulted in reduced consumer spending and an economic recession. 15 The future effects of the COVID-19 pandemic and related restrictions still remain relatively unknown and depend on factors outside of our control. However, we believe our marketplace, advertising and digital solutions were critical in helping our customers navigate the challenges of the pandemic and related restrictions through March 31, 2021. We also believe our solutions will continue to be important tools to our customers in the future and, in particular, help mitigate any potential future impacts of the pandemic and related restrictions. We believe our core strategic strengths, including our powerful family of brands, growing high-quality audience and suite of digital solutions for advertisers will assist us as we navigate a rapidly changing marketplace. Additionally, we are focused on equipping our dealer customers with digital solutions to enable them to compete in an environment in which an increasing number of car-buying consumers are shopping from home and consider their car an extension of their home. These solutions include virtual showrooms, home delivery badging, online chat and our FUEL product that allows dealers to target in-market buyers on streaming platforms. Key Operating Metrics We regularly review a number of key metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make operating and strategic decisions. Information regarding Traffic and Average Monthly Unique Visitors is as follows: Three Months Ended March 31, 2021 2020 % Change Traffic 156,604,000 158,921,000 (1 )% Average Monthly Unique Visitors 25,957,000 24,929,000 4 % Information regarding Dealer Customers and Monthly Average Revenue Per Dealer is as follows: March 31, 2021 March 31, 2020 % Change December 31, 2020 % Change Dealer Customers 18,823 18,938 (1 )% 18,372 2 % Monthly Average Revenue Per Dealer $ 2,268 $ 2,092 8 % $ 2,264 0 % Traffic. Traffic is fundamental to our business. Traffic to the CARS network of websites and mobile apps provides value to our advertisers in terms of audience, awareness, consideration and conversion. In addition to tracking traffic volume and sources, we monitor activity on our properties, allowing us to innovate and refine our consumer-facing offerings. Traffic is defined as the number of visits to CARS desktop and mobile properties (responsive sites and mobile apps), measured using Adobe Analytics. Traffic does not include traffic to Dealer Inspire websites. Traffic provides an indication of our consumer reach. Although our consumer reach does not directly result in revenue, we believe our ability to reach in-market car shoppers is attractive to our dealer customers and national advertisers. Traffic was down slightly year-over-year. For the three months ended March 31, 2021 and 2020, mobile traffic accounted for 75% and 76% of total Traffic, respectively. Average Monthly Unique Visitors (“UVs”). Growth in unique visitors and consumer traffic to our network of websites and mobile apps increases the number of impressions, clicks, leads and other events we can monetize to generate revenue. We define UVs in a given month as the number of distinct visitors that engage with our platform during that month. Visitors are identified when a user first visits an individual CARS property on an individual device/browser combination or installs one of our mobile apps on an individual device. If a visitor accesses more than one of our web properties or apps or uses more than one device or browser, each of those unique property/browser/app/device combinations counts toward the number of UVs. UVs do not include Dealer Inspire UVs. We measure UVs using Adobe Analytics. The growth in UVs was driven by heightened consumer demand resulting from an increase in consumer confidence due to the recently passed economic stimulus and the further opening of the economy. Average Revenue Per Dealer (“ARPD”). We believe that our ability to grow ARPD is an indicator of the value proposition of our products. We define ARPD as Dealer revenue, excluding digital advertising services, during the period divided by the monthly average number of Dealer Customers during the same period. ARPD was flat compared to the three months ended December 31, 2020. 16 ARPD increased 8% from March 31, 2020, primarily driven by growth in FUEL revenue, which was launched in early 2020. Dealer Customers . Dealer Customers represent dealerships using our products as of the end of each reporting period. Each physical or virtual dealership location is counted separately, whether it is a single-location proprietorship or part of a large, consolidated dealer group. Multi-franchise dealerships at a single location are counted as one dealer. Total Dealer Customers increased 2% from December 31, 2020. This increase was a result of continued strong retention rates and new sales to dealer customers. Total Dealer Customers declined 1% from March 31, 2020. This decrease was primarily driven by lower new dealer customer sales and higher cancellations of marketplace customers in the second quarter of 2020, principally due to the COVID-19 pandemic and related restrictions . This decrease was partially offset by growth in digital solutions customers. Factors Affecting Our Performance. Our business is impacted by the changes in the larger automotive environment, including inventory supply, which is currently under pressure due to semiconductor shortages, as well as, other macroeconomic factors, and changes related to automotive advertising. Changes in vehicle sales volumes in the United States also influence OEMs’ and dealerships’ willingness to increase investments with technology solutions and automotive marketplaces like Cars.com and could impact our pricing strategies and/or revenue mix. Our long-term success will depend in part on our ability to continue to transform our business toward a multi-faceted suite of digital solutions that complement our online marketplace offerings. We believe our core strategic strengths, including our powerful family of brands, growing high-quality audience and suite of digital solutions for advertisers will assist us as we navigate a rapidly changing marketplace. Additionally, we are focused on equipping our customers with digital solutions to enable them to compete in an environment in which an increasing number of car-buying customers are shopping online. These solutions include virtual showrooms, home delivery, online chat and our FUEL pro duct that allows dealers to target in-market buyers on streaming platforms . The foundation of our continued success is the value we deliver to customers, and we believe that our large audience of in-market, undecided car shoppers and innovative solutions deliver significant value to our customers. Results of Operations Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020 Three Months Ended March 31, (In thousands, except percentages) 2021 2020 $ Change % Change Revenue: Dealer $ 132,958 $ 125,361 $ 7,597 6 % OEM and National 18,069 19,393 (1,324 ) (7 )% Other 2,268 3,340 (1,072 ) (32 )% Total revenue 153,295 148,094 5,201 4 % Operating expenses: Cost of revenue and operations 27,831 26,030 1,801 7 % Product and technology 16,760 14,873 1,887 13 % Marketing and sales 53,211 54,922 (1,711 ) (3 )% General and administrative 13,266 14,117 (851 ) (6 )% Affiliate revenue share — 6,369 (6,369 ) ***% Depreciation and amortization 25,680 30,961 (5,281 ) (17 )% Goodwill and intangible asset impairment — 905,885 (905,885 ) ***% Total operating expenses 136,748 1,053,157 (916,409 ) (87 )% Operating income (loss) 16,547 (905,063 ) 921,610 ***% Nonoperating expense: Interest expense, net (10,001 ) (7,526 ) (2,475 ) (33 )% Other income (expense), net 38 (9,501 ) 9,539 ***% Total nonoperating expense, net (9,963 ) (17,027 ) 7,064 41 % Income (loss) before income taxes 6,584 (922,090 ) 928,674 ***% Income tax expense (benefit) 1,306 (134,656 ) 135,962 ***% Net income (loss) $ 5,278 $ (787,434 ) $ 792,712 ***% 17 *** Not meaningful Dealer revenue. Dealer revenue consists of marketplace and digital solutions sold to dealer customers. Dealer revenue is our largest revenue stream, representing 86.7% and 84.6% of total revenue for the three months ended March 31, 2021 and 2020, respectively. The overall increase was $7.6 million or 6% compared to the three months ended March 31, 2020, driven by an increase in ARPD as a result of growth in digital solutions and FUEL revenue, partially offset by a decline in dealer customers. OEM and National revenue. OEM and National revenue consists of display advertising and other solutions sold to OEMs, advertising agencies, automotive dealer associations and auto adjacent businesses. OEM and National revenue represents 11.8% and 13.1% of total revenue for the three months ended March 31, 2021 and 2020, respectively. OEM and National revenue declined 7%, primarily due to less spending by the OEMs due to the COVID-19 pandemic and related restrictions. Cost of revenue and operations . Cost of revenue and operations expense primarily consists of expenses related to our pay-per-lead products, third-party costs for processing dealer vehicle inventory, product fulfillment and compensation costs for the product fulfillment and customer service teams. Cost of revenue and operations expense represents 18.2% and 17.6% of total revenue for the three months ended March 31, 2021 and 2020, respectively. Cost of revenue and operations expense increased primarily due to growth in digital solutions, which have an inherently higher cost of revenue. Product and technology. The product team creates and manages consumer and dealer-facing innovation, manages consumer user experience and includes the costs associated with our editorial, data strategy and search engine optimization teams. The technology team develops and supports our products and websites. Product and technology expense includes compensation costs, hardware/software maintenance, software licenses, data center and other infrastructure costs. Product and technology expense represents 10.9% and 10.0% of total revenue for the three months ended March 31, 2021 and 2020, respectively. Product and technology expense increased, primarily due to higher compensation costs, including share-based compensation. Marketing and sales . Marketing and sales expense primarily consists of traffic and lead acquisition costs (including search engine and other online marketing), TV and digital display/video advertising and creative production, market research, trade events and compensation costs for the marketing, sales and sales support teams, as well as bad debt expense related to the allowance for doubtful accounts. Marketing and sales expense represents 34.7% and 37.1% of total revenue for the three months ended March 31, 2021 and 2020, respectively. Marketing and sales expense decreased, primarily due to a $1.5 million reduction of our provision for doubtful accounts, which had increased in 2020 due to the uncertain impact of the COVID-19 pandemic and related restrictions. General and administrative . General and administrative expense primarily consists of compensation costs for certain of the executive, finance, legal, human resources, facilities and other administrative employees. In addition, general and administrative expense includes office space rent, legal, accounting and other professional services, transaction-related costs, severance, transformation and other exit costs and costs related to the write-off and loss on assets, excluding the goodwill and intangible asset impairment discussed below. General and administrative expense represents 8.7% and 9.5% of total revenue for the three months ended March 31, 2021 and 2020, respectively. General and administrative expense decreased, primarily due to lower severance costs compared to the three months ended March 31, 2020. Affiliate revenue share. Affiliate revenue share expense represented payments made to affiliates pursuant to our affiliate agreements. Affiliate revenue share expense ended in June 2020. For information related to affiliates, see Note 7 (Unfavorable Contracts Liability) in Part II, Item 8., “Financial Statements and Supplementary Data”, of the Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the SEC on February 25, 2021. Depreciation and amortization . Depreciation and amortization expense decreased primarily due to certain assets being fully depreciated and amortized as compared to the prior year period, partially offset by depreciation and amortization on additional assets acquired. Goodwill and intangible asset impairment . As of March 31, 2020, we determined there was a triggering event, caused by the economic impacts of the COVID-19 pandemic and related restrictions. We performed interim quantitative impairment tests as of March 31, 2020. The results of the goodwill and indefinite-lived intangible asset impairment tests indicated that the carrying values exceeded the estimated fair values and thus, we recorded an impairment of $505.9 million and $400.0 million, respectively. Interest expense, net . Interest expense, net increased by $2.5 million compared to the prior year period, due to a higher overall interest rate on our outstanding debt, partially offset by lower debt outstanding. For information related to our debt, see Note 4 (Debt) and Note 5 (Interest Rate Swap) to the accompanying Consolidated Financial Statements included in Part I, Item 1., “Financial Statements” of this Quarterly Report on Form 10-Q. 18 Other income (expense), net . Other income (expense), net decreased, primarily due to the $9.4 million impairment of a non-marketable investment, triggered by the COVID-19 pandemic during the first quarter of 2020. For information related to the impairment, see Note 9 (Other Income (Expense), net) to the accompanying Consolidated Financial Statements included in Part I, Item 1., “Financial Statements” of this Quarterly Report on Form 10-Q. Income tax expense (benefit) . The effective income tax rate, expressed by calculating the income tax expense (benefit) as a percentage of Income (loss) before income taxes, was 19.8% for the three months ended March 31, 2021, lower than the statutory federal income tax rate of 21%, primarily due to the tax benefit realized on stock-based compensation, offset in part by the full valuation allowance on our net deferred tax asset position recorded during the three months ended March 31, 2021. 19 Liquidity and Capital Resources Overview. Our primary sources of liquidity are cash flows from operations, available cash reserves and debt capacity available under our credit facilities. Our positive operating cash flow, along with the Term Loan, Revolving Loan and the Senior Unsecured Notes described below, provide adequate liquidity to meet our business needs, including those for investments and strategic acquisitions. However, our ability to maintain adequate liquidity for our operations in the future is dependent upon a number of factors, including our revenue, macroeconomic conditions, the duration and severity of the economic and operational impacts caused by the COVID-19 pandemic and related restrictions, our ability to contain costs, including capital expenditures, and to collect accounts receivable, and various other factors, many of which are beyond our direct control. As discussed below, we are subject to certain financial and other covenants contained in our debt agreements, as amended, including by the Third Amendment to the Credit Agreement. For information related to the Credit Amendment, as amended, see Note 8 (Debt) in Part II, Item 8., “Financial Statements and Supplementary Data”, of the Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the SEC on February 25, 2021. We may also seek to raise funds through debt or equity financing in the future to fund operations, significant investments or acquisitions that are consistent with our strategy. If we need to access the capital markets, there can be no assurance that financing may be available on attractive terms, if at all. As of March 31, 2021, Cash and cash equivalents were $53.7 million and including the undrawn Revolving Loan our total liquidity was $283.7 million. Term Loan, Revolving Loan and Senior Unsecured Notes. As of March 31, 2021, the outstanding aggregate principal amount of our debt was $545.0 million, at an effective interest rate of 5.4%, not including the impact of the interest rate swap, including $145.0 million of outstanding principal under the Term Loan, with an effective interest rate of 2.8% and outstanding senior unsecured notes of $400.0 million, at an effective interest rate of 6.375%. During the three months ended March 31, 2021, we made $52.5 million in Term Loan payments, of which $50.0 million were voluntary. As of March 31, 2021, we had $230.0 million available to borrow under the Revolving Loan. Our borrowings are limited by our senior secured leverage ratio and consolidated interest coverage ratio, which are calculated in accordance with our Credit Agreement, and were 0.86x and 5.86x as of March 31, 2021, respectively. Interest Rate Swap. The interest rate on borrowings under our Term Loan and Revolving Loan is floating and, therefore, subject to fluctuations. In order to manage the risk associated with changes in interest rates on our borrowing under the Term Loan, we entered into an interest rate swap (the “Swap”) effective December 31, 2018. Under the terms of the Swap, we are locked into a fixed rate of interest of 2.96% plus an applicable margin, on a notional amount of $300 million. The Swap was initially designated as a cash flow hedge of interest rate risk. During the second quarter of 2020, we entered into the second amendment to the Credit Agreement, which triggered a quantitative hedge effectiveness test that resulted in the loss of hedge accounting. As a result, as of the date of the second amendment, the unrealized loss included within Accumulated other comprehensive loss was frozen and is now being ratably reclassified into Net income (loss) over the remaining life of the Swap through Interest expense, net and Income tax expense (benefit) within the Consolidated Statements of Income (Loss). Subsequent to the second amendment, any changes in the fair value of the Swap is recorded within Other income (expense), net on the Consolidated Statements of Income (Loss). During the fourth quarter of 2020, we entered into the third amendment to the Credit Agreement, which triggered a partial debt extinguishment, including a partial extinguishment of the underlying Term Loan. Due to the reduction in the Term Loan as compared to the notional amount of the Swap, we wrote-off a proportional amount of the frozen Accumulated other comprehensive loss balance as of the date of the partial extinguishment proportional to the reduction in the underlying notional amount of Term Loan. We will continue to amortize the remaining Accumulated other comprehensive loss to Interest expense, net and Income tax expense (benefit) within the Consolidated Statements of Income (Loss) through the remainder of the term of the Swap. Any changes in the fair value of the Swap will continue to be recorded within Other income (expense), net on the Consolidated Statements of Income (Loss). As of March 31, 2021, the fair value of the Swap was an unrealized loss of $10.0 million, of which $8.6 million and $1.4 million is recorded in Other accrued liabilities and Other noncurrent liabilities, respectively, on the Consolidated Balance Sheets. As of December 31, 2020, the fair value of the Swap was an unrealized loss of $12.1 million, of which $8.5 million and $3.6 million is recorded in Other accrued liabilities and Other noncurrent liabilities, respectively, on the Consolidated Balance Sheets. During the three months ended March 31, 2021 and 2020, $1.4 million and $1.0 million was reclassified from Accumulated other comprehensive loss and recorded in Interest expense, net, respectively. During the three months ended March 31, 2021, we made payments of $2.1 million related to the Swap as the result of London Interbank Offered Rate (“LIBOR”) rates falling below the swap rate of 2.96%. During the three months ended March 31, 2021, $0.2 20 million was reclassified as a tax benefit from Accumulated other comprehensive loss into Income tax expense (benefit) on the Consolidated Statements of Income (Loss ) . Cash Flows. Details of our cash flows are as follows (in thousands): Three Months Ended March 31, 2021 2020 Change Net cash provided by (used in): Operating activities $ 50,362 $ 28,892 $ 21,470 Investing activities (6,219 ) (5,755 ) (464 ) Financing activities (58,138 ) 150,658 (208,796 ) Net change in cash and cash equivalents $ (13,995 ) $ 173,795 $ (187,790 ) Operating Activities. The increase in cash provided by operating activities was primarily related to the increase of net income (loss), excluding the impact of non-cash items, as well as changes in operating assets and liabilities, primarily due to a decrease in taxes receivable related to the receipt of a $9.1 million tax refund from the carryback of federal and state income tax net operating loss as a result of the CARES Act and an increase in accrued interest related to the Senior Unsecured Notes. Investing Activities. The increase in cash used in investing activities is due to an increase in purchases of property and equipment. Financing Activities. During the three months ended March 31, 2021, cash used in financing activities is primarily related to $52.5 million of debt repayments, of which $50.0 million were voluntary. During the three months ended March 31, 2020, cash used in financing activities is primarily related to $165.0 million in proceeds related to the draw on our Revolving Loan, partially offset by $13.4 million in debt repayments, of which $5.0 million was voluntarily paid. For information related to our debt, see Note 4 (Debt) to the accompanying Consolidated Financial Statements included in Part I, Item 1., “Financial Statements” of this Quarterly Report on Form 10-Q. Commitments and Contingencies. For information related to commitments and contingencies, see Note 6 (Commitments and Contingencies) to the accompanying Consolidated Financial Statements included in Part I, Item 1., “Financial Statements” of this Quarterly Report on Form 10-Q. Off-Balance Sheet Arrangements. We do not have any material off-balance sheet arrangements. Critical Accounting Policies. For information related to critical accounting policies, see “Critical Accounting Policies and Estimates” in Part II, Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of the Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the SEC on February 25, 2021 and see Note 1 (Description of Business, Company History and Summary of Significant Accounting Policies) to the accompanying Consolidated Financial Statements included in Part I, Item 1., “Financial Statements” of this Quarterly Report on Form 10-Q. During the three months ended March 31, 2021, there have been no changes to our critical accounting policies. Recent Accounting Pronouncements. There were no significant new accounting pronouncements applicable to us in the period. 21