Cars.com Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended September 30, 2018

OR

Commission File Number: 001-37869

Cars.com Inc.

(Exact Name of Registrant as Specified in its Charter)

300 S. Riverside Plaza, Suite 1000

Chicago, Illinois 60606

(Address of principal executive offices)

(312) 601-5000

Registrant’s telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed 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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of October 31, 2018, the registrant had 68,568,102 shares of common stock, $0.01 par value per share, outstanding.

Table of Contents

1

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

Cars.com Inc.

Consolidated and Combined Balance Sheets

(In thousands, except per share data)

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

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Cars.com Inc.

Consolidated and Combined Statements of Income

(In thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

3

Cars.com Inc.

Consolidated and Combined Statements of Stockholders’ Equity

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

4

Cars.com Inc.

Consolidated and Combined Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the Consolidated and Combined Financial Statements.

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements

(Unaudited)

NOTE 1. Description of Business, Company History and Summary of Significant Accounting Policies

Description of Business and Company History. Cars.com (“the Company”) is a leading two-sided digital automotive marketplace that creates meaningful connections between consumers (individuals researching cars or looking to purchase a car) and partners, dealer customers and automotive original equipment manufacturers (“OEMs”). While connecting advertising partners with in-market car shoppers and providing data-driven intelligence to increase inventory turn and gain market share, the Company empowers consumers with resources and information to assist them in making better informed buying decisions around The 4Ps of Automotive Marketing^TM: Product, Price, Place and Person. The Company has evolved into one of the largest digital automotive platforms, connecting tens of thousands of local dealers across the country with millions of consumers. Through trusted expert content, on-the-lot mobile features and intelligence, millions of new and used vehicle listings, a comprehensive set of pricing and research tools, and the largest database of consumer reviews in the industry, the Company believes Cars.com is transforming the car shopping experience.

In May 2017, the Company separated from its former parent company, TEGNA Inc. (“TEGNA”) by means of a spin-off of a newly formed company, Cars.com Inc., which now owns TEGNA’s former digital automotive marketplace business (the “Separation”). The Company filed a Registration Statement on Form 10 relating to the Separation with the U.S. Securities and Exchange Commission (the “SEC”), which was declared effective on May 15, 2017. On May 31, 2017, the Company made a $650.0 million cash transfer to TEGNA and TEGNA completed the Separation through a pro rata distribution to its stockholders of all of the outstanding shares of the Company’s common stock. Each holder of TEGNA common stock received one share of the Company’s common stock for every three shares of TEGNA common stock held on May 18, 2017, the record date for the distribution. TEGNA structured the distribution to be tax-free to its U.S. stockholders for U.S. federal income tax purposes. The Company’s common stock began trading “regular way” on the New York Stock Exchange on June 1, 2017.

In February 2018, the Company acquired all of the outstanding stock of Dealer Inspire Inc. (“DI”) and substantially all of the net assets of Launch Digital Marketing LLC (“LDM”). For additional information, see Note 3 (Business Combination and Goodwill).

Basis of Presentation. These accompanying unaudited interim Consolidated and Combined Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the rules and regulations of the SEC for interim financial statements. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. These Consolidated and Combined Financial Statements should be read in conjunction with the audited Consolidated and Combined Financial Statements and the notes thereto for the year ended December 31, 2017, which are included in the Company's Annual Report on Form 10-K dated March 6, 2018 (the “December 31, 2017 Consolidated and Combined Financial Statements”).

The significant accounting policies used in preparing these Consolidated and Combined Financial Statements were applied on a basis consistent with those reflected in the December 31, 2017 Consolidated and Combined Financial Statements. In the opinion of management, the Consolidated and Combined Financial Statements contain all adjustments (consisting of a normal, recurring nature) necessary to present fairly the Company's financial position, results of operations, cash flows and changes in stockholders' equity as of the dates and for the periods indicated. The unaudited results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of results that may be expected for the year ended December 31, 2018.

Use of Estimates. The preparation of the accompanying unaudited interim Consolidated and Combined Financial Statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the Consolidated and Combined Financial Statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may differ from those estimates.

Principles of Consolidation. The accompanying unaudited Consolidated and Combined Financial Statements include the accounts of Cars.com Inc. and its 100% owned subsidiaries. All intercompany transactions and accounts are eliminated in consolidation. The accompanying unaudited Consolidated and Combined Financial Statements for the period prior to the Separation are derived from the historical accounting records of TEGNA and present its financial position, results of operations and cash flows as if the Company were a separate entity for the period prior to the Separation and include allocations of certain TEGNA corporate expenses, such as insurance and other general corporate overhead expenses. All significant intercompany transactions between either (i) the Company and TEGNA or (ii) the Company and TEGNA affiliates have been included within the Consolidated and Combined Financial Statements and are considered to be effectively settled through equity contributions or distributions at the time the transactions were recorded. The total net effect of these intercompany transactions is reflected in “Transactions with TEGNA, net” in the Consolidated and Combined Statements of Cash Flows as financing activities.

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

Reclassifications. Certain prior year balances have been reclassified to conform to the current year presentation. Cost of revenues and operations have been reclassified from the product support, technology and operations line item into a separate line item. Depreciation expense amounts have also been reclassified from the General and administrative line item into the amortization of intangible assets line item, which has been renamed Depreciation and amortization. There are no changes to total Operating expenses, Operating income or Net income.

NOTE 2. Recent Accounting Pronouncements 

Revenue Recognition. The Financial Accounting Standards Board (the “FASB”) amended the FASB Accounting Standards Codification (“ASC”) and created Topic 606, Revenue from Contracts with Customers (“ASC 606”). Under ASC 606, revenue recognition occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration which the Company expects to receive in exchange for those goods or services. In addition, ASC 606 requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company’s primary source of revenue is the sale of online subscription advertising products and services, which will continue to be recognized ratably over the contract term as the service is provided to the customer. Effective January 1, 2018, the Company adopted ASC 606 using the modified retrospective method. The adoption did not have a material impact on its Consolidated and Combined Financial Statements. For further information, see Note 10 (Revenues).

Financial Instruments – Equity Investments. In January 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-01, Financial Instruments—Overall, amending several elements surrounding the recognition and measurement of financial instruments and requiring equity investments (except those accounted for under the equity method of accounting or those that result in consolidation) to be measured at fair value with changes in fair value recognized in net income. Effective January 1, 2018, the Company adopted this ASU on a prospective basis. The adoption did not have a material impact on its Consolidated and Combined Financial Statements and related disclosures.

Financial Instruments – Credit Losses. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses changing the way credit losses on accounts receivable are estimated. Under current U.S. GAAP, credit losses on trade accounts receivable are recognized once it is probable that such losses will occur. Under this new guidance, the Company will be required to estimate credit losses based on the expected amount of future collections which may result in earlier recognition of allowance for doubtful accounts. The new guidance is effective for the Company on January 1, 2020 and will be adopted using a modified retrospective approach. The Company is currently evaluating this new guidance and does not expect it to have a material impact on its Consolidated and Combined Financial Statements and related disclosures.

Stock-Based Compensation. In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation, clarifying when changes to the terms or conditions of a stock-based payment award must be accounted for as modifications and allowing for certain changes to awards without accounting for them as modifications. Effective January 1, 2018, the Company adopted the ASU on a prospective basis. The adoption did not have a material impact on its Consolidated and Combined Financial Statements and related disclosures.

Definition of a Business. In January 2017, the FASB issued ASU 2017-01, Business Combinations, clarifying the definition of a business with the objective of adding guidance to assist companies with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. Effective January 1, 2018, the Company adopted this ASU on a prospective basis. The adoption did not have a material impact on its Consolidated and Combined Financial Statements and related disclosures.

Leases. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) requiring lessees to recognize assets and liabilities on the Consolidated and Combined Balance Sheets for leases with lease terms of more than 12 months and to disclose additional quantitative and qualitative information about leasing arrangements. The new guidance is effective for the Company on January 1, 2019. The Company plans to utilize the package of practical expedients and to initially apply Topic 842 as of January 1, 2019 and recognize a cumulative-effect adjustment to the opening balance of retained earnings. Although the Company is currently evaluating the provisions of the ASU to determine its full impact on the Company’s Consolidated and Combined Financial Statements, the primary impact will be to record assets and liabilities for current operating leases, which are principally related to real estate.

Cloud Computing Arrangements. In August 2018, the FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, aligning the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs for internal-use software. The new guidance is effective for the Company on January 1, 2020 and early adoption is permitted. The

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

Company is currently evaluating this new guidance and does not expect it to have a material impact on its Consolidated and Combined Financial Statements and related disclosures.

NOTE 3. Business Combination and Goodwill

On February 21, 2018, the Company acquired all of the outstanding stock of DI, an innovative technology leader providing progressive dealer websites, digital retailing and messaging platform products, and substantially all of the net assets of LDM, a provider of digital marketing services, including paid, organic, social and creative services (collectively, the “Acquisition”). The Acquisition consists of proprietary solutions that are complementary extensions of the Company’s online marketplace platform and current suite of dealer solutions.

The Company expensed as incurred total acquisition costs of $4.9 million, of which $4.3 million was recorded during the nine months ended September 30, 2018. These costs were recorded in General and administrative in the Consolidated and Combined Statements of Income. In connection with the Acquisition, DI’s unvested equity awards were cash settled for a total of $5.7 million. The fair value of these awards was based on the price paid per common share to the owners of the acquired businesses and recognized immediately after the Acquisition as compensation expense in the Company’s Consolidated and Combined Statements of Income.

Purchase Price Allocation. The fair values assigned to the tangible and intangible assets acquired and liabilities assumed were determined based on management’s estimates and assumptions, as well as other information compiled by management, including third party valuations that utilize customary valuation procedures and techniques, such as the income approach. These preliminary fair values are subject to change within the one-year measurement period. The Acquisition purchase price allocation is as follows (in thousands):

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

In addition to the total consideration of $160.8 million, the Company granted stock-based compensation awards, worth up to $25.5 million, to certain employees. These awards require continued employee service and are based on DI’s and LDM’s future performance related to certain revenue targets to be attained over a three-year performance period. For further information, see Note 9 (Stock-Based Compensation).

Goodwill. In connection with the Acquisition, the Company recorded goodwill in the amount of $96.2 million, which is primarily attributable to sales growth from existing and future technology, product offerings and customers and the value of the acquired assembled workforce. Of the total goodwill recorded in connection with the Acquisition, approximately $15.0 million is deductible for income tax purposes. The Company’s goodwill activity for the nine months ended September 30, 2018 is as follows (in thousands):

Pro forma Financial Information (unaudited). The unaudited pro forma information presented below summarizes the combined revenues and net income of the Company and DI and LDM, as if the Acquisition had been completed on January 1, 2017 and gives effect to pro forma events that are factually supportable and directly attributable to the transaction. The unaudited pro forma results reflect adjustments for incremental intangible asset amortization based on the fair values of each identifiable intangible asset, interest expense on the borrowings under the revolving loan to fund the Acquisition, certain other compensation related costs including stock-based compensation and retention bonuses, and integration costs. Pro forma adjustments were tax-affected at the Company’s corporate blended statutory tax rate applicable during the respective periods presented.

This unaudited pro forma information is presented for informational purposes only and may not be indicative of the historical results of operations that would have been obtained if the Acquisition had taken place on January 1, 2017, nor the results that may be obtained in the future. The unaudited pro forma information does not reflect future synergies or other such costs or savings.

Selected unaudited pro forma information for the three months ended September 30, 2018 and 2017, respectively, is as follows (in thousands):

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

From the date of the Acquisition, the Company included DI’s and LDM’s financial results in its Consolidated and Combined Statements of Income for the three and nine months ended September 30, 2018. A summary of DI and LDM contributed revenues and net loss is as follows:  

NOTE 4. Unfavorable Contracts Liability

In connection with the October 2014 acquisition of Cars.com by TEGNA, the Company entered into affiliate agreements with the former owners of Cars.com. Under the affiliate agreements, affiliates have the exclusive right to sell and price Cars.com’s products and services in their local territories, paying Cars.com a wholesale rate for the Cars.com product. The Company charges the affiliates 60% of the corresponding Cars.com retail rate for products sold to affiliate dealers and recognizes revenue generated from these agreements as Wholesale revenues in the Consolidated and Combined Statements of Income. The unfavorable contracts liability was established as a result of these unfavorable affiliate agreements that the Company entered into as part of TEGNA’s acquisition of the Company in 2014.

Prior to the affiliate conversions discussed below, over the annual contract period, the Company recognized $25.2 million of Wholesale revenues with a corresponding reduction of the unfavorable contracts liability. As of September 30, 2018 and December 31, 2017, the unfavorable contracts liability on the Consolidated and Combined Balance Sheets was $25.2 million and $44.1 million, respectively. Of the total unfavorable contracts liability balances, $25.2 million was recorded in current liabilities on the Consolidated and Combined Balance Sheet as of September 30, 2018 and December 31, 2017.

In January 2018, the Company announced it amended its affiliate agreement with The McClatchy Company (“McClatchy”) to convert McClatchy’s 22 affiliate markets into the Company’s direct sales channel in phases, on or before October 2018, prior to the original October 2019 affiliate agreement expiration date. As of October 1, 2018, the Company has completed the McClatchy affiliate market conversions.

In January 2018, the Company amended its affiliate agreement with tronc, Inc. (“tronc”) to convert tronc’s eight affiliate markets into the Company’s direct sales channel, effective February 1, 2018.

In July 2018, the Company amended its affiliate agreement with the Washington Post and agreed to convert the Washington, DC market into the Company’s direct sales channel, effective August 1, 2018, which was prior to the October 2019 expiration of the original agreement.

The Company now has a direct relationship with the dealer customers and recognizes the revenue associated with converted markets as Retail revenues, rather than Wholesale revenues, in the Consolidated and Combined Statements of Income. In addition, as part of the recent changes in the structure of the affiliate agreements, the Company engaged McClatchy, tronc and the Washington Post to perform certain marketing support and transition services through December 31, 2019, March 31, 2020 and October 1, 2019, respectively. The fees associated with the amended affiliate agreements are recorded as Affiliate revenue share within Operating expenses in the Consolidated and Combined Statements of Income.

The Company no longer records the amortization of the unfavorable contracts liability associated with the converted markets to revenues as the Company is recognizing this direct revenue at retail rates. The amortization of the unfavorable contracts liability is now recorded as a reduction of Affiliate revenue share within Operating expenses in the Consolidated and Combined Statements of Income.

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

Therefore, during the three and nine months ended September 30, 2018, the Company recorded $5.4 million and $12.9 million, respectively, as a reduction to Affiliate revenue share, rather than Wholesale revenues, in the Consolidated and Combined Statements of Income. The reduction to Affiliate revenue share was partially offset by the fees associated with the marketing support and transition services.

The Company’s unfavorable contracts liability activity for the nine months ended September 30, 2018 is as follows (in thousands):

NOTE 5. Debt

As of September 30, 2018, the Company is in compliance with the covenants under its various credit agreements.

Term Loan. As of September 30, 2018, the outstanding principal amount under the term loan was $421.9 million and the interest rate in effect was 3.9%. During the nine months ended September 30, 2018, the Company made $16.9 million in quarterly term loan payments.

Revolving Loan. As of September 30, 2018, the outstanding borrowings under the revolving loan was $285.0 million and the interest rate in effect was 3.8%. During the nine months ended September 30, 2018, the Company borrowed $165.0 million to fund the Acquisition and $30.0 million to fund share repurchases. The Company also made $55.0 million in voluntary revolving loan payments. As of September 30, 2018, the Company was permitted to borrow an additional $165.0 million under the revolving loan. The Company’s borrowings are limited by its net leverage ratio, which was 2.9 to 1.0 as of September 30, 2018.

Fair Value. The Company’s debt is classified as Level 2 in the fair value hierarchy and the fair value is measured based on comparable trading prices, ratings, sectors, coupons and maturities of similar instruments. The carrying amount of the Company’s debt approximated the fair value as of September 30, 2018.

NOTE 6. Income Taxes

Prior to the Separation, Cars.com LLC was a multi-member LLC that was considered a partnership for U.S. income tax purposes. Multi-member LLCs are generally considered flow-through entities and therefore are not subject to federal, state or local income taxes. Effective with the Separation, the Company established a corporate legal entity structure that is subject to U.S. corporate income tax on a stand-alone basis post-Separation.

On December 22, 2017, the Tax Cuts and Jobs Act was enacted into law. The new legislation contains several key tax provisions that impact the Company, including the reduction of the corporate income tax rate to 21% effective January 1, 2018. The Company continues to evaluate the impacts of the Tax Cuts and Jobs Act and will consider additional guidance from the U.S. Treasury Department, Internal Revenue Service or other standard-setting bodies. Further adjustments, if any, will be recorded by the Company during the measurement period in 2018 as permitted by SEC Staff Accounting Bulletin 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act.

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

A summary of income tax expense (dollars in thousands) and the effective tax rate for the three and nine months ended September 30, 2018 and 2017, respectively, is as follows:

Income tax expense was $5.6 million and $10.4 million for the three and nine months ended September 30, 2018, respectively, compared to $13.0 million and $15.8 million for the three and nine months ended September 30, 2017, respectively. The current period income tax expense reflects the financial activity for Cars.com and DMR Holdings, Inc. (“DealerRater”), the Company’s only subsidiary prior to the Acquisition, and the financial results of DI and LDM for the post-acquisition period of February 21, 2018 through September 30, 2018. The prior period income tax expense represents the financial activity of DealerRater and corporate income tax for the Company upon its Separation from TEGNA on June 1, 2017. The effective income tax rate, expressed by calculating the income tax expense as a percentage of income before income taxes, was 26.2% and 26.0% for the three and nine months ended September 30, 2018, respectively, and differed from the U.S. federal statutory rate primarily due to state income taxes, nondeductible transaction costs and the impact of the Tax Cuts and Jobs Act, partially offset by certain tax credits and excess tax benefits from stock-based compensation.    

NOTE 7. Commitments and Contingencies

The Company and its subsidiaries are parties from time to time in legal and administrative proceedings involving matters incidental to its business. These matters, whether pending, threatened or unasserted, if decided adversely to the Company or settled, may result in liabilities material to its financial position, results of operations or cash flows. The Company records a liability when it believes that it is both probable that a loss will be incurred and the amount of loss can be reasonably estimated. The Company evaluates, at least quarterly, developments in its legal matters that could affect the amount of liability that has been previously accrued and makes adjustments as appropriate. Significant judgment is required to determine both the probability and the estimated amount.

NOTE 8. Stockholders’ Equity

In March 2018, the Company’s Board of Directors authorized a share repurchase program to acquire up to $200 million of the Company’s common stock. The Company may repurchase shares from time to time in open market transactions or through privately negotiated transactions in accordance with applicable federal securities laws. The timing and amounts of any purchases under the share repurchase program will be based on market conditions and other factors including price. The repurchase program has a two-year duration, does not require the purchase of any minimum number of shares and may be suspended, modified or discontinued at any time without prior notice. The Company intends to fund the share repurchase program principally with cash from operations. During the nine months ended September 30, 2018, the Company repurchased and subsequently retired 3.0 million shares for $77.2 million.

NOTE 9. Stock-Based Compensation

Performance Share Units (“PSUs”). PSUs represent the right to receive unrestricted shares of the Company’s common stock at the time of vesting. The fair value of the PSUs is equal to the Company’s common stock price on the date of grant. During the nine months ended September 30, 2018, the Company granted 780,000 PSUs at a weighted average grant date fair value of $27.41 per unit. Of the total PSUs granted, 632,000 PSUs were granted to certain employees in connection with the Acquisition and require continued employee service. The percentage of PSUs that shall vest will range from 0% to 150% of the number of PSUs granted based on DI’s and LDM’s future performance related to certain revenue targets over a three-year performance period. These PSUs are subject to graded vesting over three years. The remaining PSUs granted during the nine months ended September 30, 2018 require continued employee service. The percentage of these PSUs that shall vest will range from 0% to 200% of the number of PSUs granted based on the Company’s future performance related to certain revenue and adjusted earnings before interest, income taxes, depreciation and amortization targets over a two-year performance period. These PSUs are subject to graded vesting over three years.

Restricted Share Units (“RSUs”). RSUs represent the right to receive unrestricted shares of the Company’s common stock at the time of vesting, subject to any restrictions as specified in the individual holder’s award agreement. RSU’s are subject to graded vesting, generally ranging between one and four years and the fair value of the RSUs is equal to the Company’s common stock price on the

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Cars.com Inc.

Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

date of grant. During the nine months ended September 30, 2018, the Company granted 519,000 RSUs at a weighted-average grant-date fair value of $26.74 per unit.

Employee Stock Purchase Plan (“ESPP”). During the nine months ended September 30, 2018, the Company issued  21,000 shares of the Company’s common stock in connection with the first ESPP offering period. In September 2018, the Company completed its second ESPP offering period and will issue 36,000 shares of the Company’s common stock during the fourth quarter of 2018.

NOTE 10. Revenues

The Company accounts for a customer arrangement when the Company and the customer have an approved contract that specifies the rights and obligations of each party and the payment terms, and the Company believes it is probable it will collect substantially all of the consideration to which it will be entitled in exchange for the services that will be provided to the customer. The Company allocates the contractual transaction price to each distinct performance obligation and recognizes revenue when it satisfies a performance obligation by providing a service to a customer. Revenue is generated through the Company’s direct sales force (Retail revenues) and affiliate sales channels (Wholesale revenues).

Online Subscription Advertising Products and Services Revenue. The Company’s primary source of Retail and Wholesale revenues is through the sale of online subscription advertising products to dealer customers through varying levels of subscription packages. The Company’s subscription packages provide the dealer customer’s available new and used vehicle inventory to in-market shoppers on the Cars.com website. The subscription packages are generally a fixed price arrangement with a one-year contract term that is automatically renewed, typically on a month-to-month basis. The Company recognizes subscription package revenues ratably as the service is provided over the contract term. Online subscription advertising products and services revenue is recorded in Retail revenues and Wholesale revenues in the Consolidated and Combined Statements of Income.

The Company also offers its customers several add-on products to the subscription packages. Add-on products include premium advertising products that can be uniquely tailored to an individual dealer customer’s current needs. The Company does not sell add-on products separately from the subscription packages as the customer cannot benefit from add-on products on their own. Therefore, the subscription packages and add-on products are combined as a single performance obligation and the Company recognizes the related revenue ratably as the services are provided over the contract term.

As part of the acquisition of DI, the Company also provides services related to flexible, custom designed website platforms supporting highly personalized digital marketing campaigns, digital retailing and messaging platform products. The Company recognizes revenue related to these services ratably as the services are provided over the contract term. The related revenue is recorded in Retail revenues in the Consolidated and Combined Statements of Income.

The Company’s affiliates also sell online subscription advertising products to dealer customers and the Company earns Wholesale revenues through its affiliate agreements. Affiliates are assigned certain sales territories in which they sell the Company’s products. Under these agreements, the Company charges the affiliates 60% of the corresponding Cars.com retail rate for products sold to affiliate dealers. The Company recognizes Wholesale revenues ratably as the service is provided over the contract term. In situations where the Company’s direct sales force sells the Company’s products within an affiliate’s assigned territory, the Company pays the affiliate a revenue share which is classified as “Affiliate revenue share” in the Consolidated and Combined Statements of Income. Wholesale revenues also includes a portion of the amortization of the unfavorable contracts liability. For information related to the unfavorable contracts liability, see Note 4 (Unfavorable Contracts Liability).

Display Advertising Products and Services Revenue. The Company also earns revenue through the sale of display advertising on the Company’s website to national advertisers, pursuant to transaction-based contracts, which are billed for impressions delivered or click-throughs on their advertisements. An impression is the display of an advertisement to an end-user on the website and is a measure of volume. A click-through occurs when an end-user clicks on an impression. The Company recognizes revenue as the impressions or click-throughs are delivered. If the impressions or click-throughs delivered are less than the amount invoiced to the customer, the difference is recorded as deferred revenue and recognized as revenue when earned. Display advertising products revenue is recorded in Retail revenues in the Consolidated and Combined Statements of Income.

As part of the acquisition of LDM, the Company also provides services related to customized digital marketing and customer acquisition services, including paid, organic, social and creative services. The Company recognizes revenue related to these services

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Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

primarily at the point in time the service is provided. The related revenue is recorded in Retail revenues in the Consolidated and Combined Statements of Income.

Pay Per Lead Revenue. The Company also sells certain leads, which are connections from consumers to dealer customers in the form of phone calls, emails and text messages, to dealer customers, OEMs and third-party resellers. The Company recognizes pay per lead revenue primarily on a per-lead basis at the point in time in which the lead has been delivered. Revenue related to pay per leads is recorded in Retail revenues and Wholesale revenues in the Consolidated and Combined Statements of Income.

Other Revenue.  Other revenue primarily includes revenues related to vehicle listing data sold to third-parties and peer-to-peer vehicle advertising. The Company recognizes Other revenue either ratably as the services are provided or at the point in time the services have been performed. Other revenue is recorded in Retail revenues in the Consolidated and Combined Statements of Income.

Revenue Summary. In the table below (in thousands), revenue is disaggregated by sales channel and major products and services. The Company only has one reportable segment; therefore, further disaggregation is not applicable at this time.

Practical Expedient and Exemption. The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.

NOTE 11. Earnings per share

Basic earnings per share is calculated by dividing Net income by the weighted-average number of shares of common stock outstanding. Diluted earnings per share is similarly calculated, except that the calculation includes the dilutive effect of the assumed issuance of shares under stock-based compensation plans, unless the inclusion of such shares would have an anti-dilutive impact.

NOTE 12. Related Party Transactions

As a result of the Separation, certain stock-based awards previously granted by TEGNA to its employees were converted into stock of both TEGNA and Cars.com. The Company is responsible for any employee payroll taxes related to awards settled in Cars.com common stock for which stock was withheld for payroll tax purposes. During the nine months ended September 30, 2018, the

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Notes to the Consolidated and Combined Financial Statements (continued)

(Unaudited)

Company withheld $3.6 million, which is recorded as a reduction of Additional paid-in capital on the Consolidated and Combined Balance Sheets.

The Company is party to a commercial agreement with TEGNA, who was considered a related party through the Separation date of May 31, 2017. During the three and nine months ended September 30, 2017, related party revenue generated with this agreement was zero and $3.4 million, respectively. Although TEGNA is no longer a related party, the commercial agreement with TEGNA is still effective after the Separation.  

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Note About Forward-Looking Information

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the federal securities laws. All statements other than statements of historical facts are forward-looking statements. Forward-looking statements include information concerning our business strategies, plans and objectives, market potential, future financial performance, planned operational and product improvements, liquidity and other matters. These statements often include words such as “believe,” “expect,” “project,” “anticipate,” “intend,” “plan,” “estimate,” “target,” “seek,” “will,” “may,” “would,” “should,” “could,” “forecasts,” “mission,” “strive,” “more,” “goal” or similar expressions. Forward-looking statements are based on our current expectations, beliefs, estimates, projections and assumptions, based on our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments and other factors we think are appropriate. These statements are expressed in good faith and we believe these judgments are reasonable. However, you should understand that these statements are not guarantees of performance or results. Our actual results could differ materially from those expressed in the forward-looking statements. Given these uncertainties, forward-looking statements should not be relied on in making investment decisions.  Comparisons of results between current and prior periods are not intended to express any future trends, or indications of future performance, unless expressed as such, and should only be viewed as historical data. Whether or not any such forward-looking statement is in fact achieved will depend on future events, some of which are beyond our control.

Important factors that could cause actual results or events to differ materially from those anticipated include, among others: 

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For a detailed discussion of these risks and uncertainties, see Part I, Item 1A— “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission (“SEC”) on March 6, 2018. All forward-looking statements made in this this Quarterly Report on Form 10-Q are qualified by these cautionary statements. The forward-looking statements contained herein are based only on information currently available to us and speak only as of the date of this this Quarterly Report on Form 10-Q. We undertake no obligation, other than as may be required by law, to update or revise any forward-looking or cautionary statements to reflect changes in assumptions, the occurrence of events, unanticipated or otherwise, or

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changes in future operating results over time or otherwise.  The forward-looking statements in this Quarterly Report on Form 10-Q are intended to be subject to the safe harbor protection provided by the Federal securities laws.

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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 and Combined 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 also be read in conjunction with the disclosures and information contained in “Note About Forward-Looking Information” 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 would have been had we been a stand-alone company during the applicable periods presented or what our financial condition, results of operations and cash flows may be in the future.

References in this discussion and analysis to “Cars.com,” “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 two-sided digital automotive marketplace that creates meaningful connections between consumers (individuals researching cars or looking to purchase a car) and partners, dealer customers and automotive original equipment manufacturers (“OEMs”). While connecting advertising partners with in-market car shoppers and providing data-driven intelligence to increase inventory turn and gain market share, we empower consumers with resources and information to assist them in making better- informed buying decisions around The 4Ps of Automotive Marketing^TM: Product, Price, Place and Person. We have evolved into one of the largest digital automotive platforms, connecting tens of thousands of local dealers across the country with millions of consumers. Through trusted expert content, on-the-lot mobile features and intelligence, millions of new and used vehicle listings, a comprehensive set of pricing and research tools, and the largest database of consumer reviews in the industry, we believe Cars.com is transforming the car shopping experience.

In May 2017, we separated from our former parent company, TEGNA Inc. (“TEGNA”) by means of a spin-off of a newly formed company, Cars.com Inc., which now owns TEGNA’s former digital automotive marketplace business (the “Separation”). We filed a Registration Statement on Form 10 relating to the Separation with the U.S. Securities and Exchange Commission (the “SEC”), which was declared effective on May 15, 2017. On May 31, 2017, we made a $650.0 million cash transfer to TEGNA and TEGNA completed the Separation through a pro rata distribution to its stockholders of all of the outstanding shares of our common stock. Each holder of TEGNA common stock received one share of our common stock for every three shares of TEGNA common stock held on May 18, 2017, the record date for the distribution. TEGNA structured the distribution to be tax-free to its U.S. stockholders for U.S. federal income tax purposes. Our common stock began trading “regular way” on the New York Stock Exchange on June 1, 2017.

In February 2018, we acquired all of the outstanding stock of Dealer Inspire Inc. (“DI”) and substantially all of the net assets of Launch Digital Marketing LLC (“LDM”) (collectively, “the Acquisition”). For additional information, see Note 3 (Business Combination and Goodwill) to the accompanying Consolidated and Combined Financial Statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q.  

Overview of Results

2018 Highlights

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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. We also review other key metrics including: unique visitors, average revenue per dealer and dealer customer and consumer satisfaction statistics.

Information regarding Traffic and Average Vehicle Listings is as follows:  

Information regarding our Dealer Customers is as follows:

Traffic (Visits). Traffic and our ability to generate traffic are key to our business. Tracking our traffic performance is a critical measure. Traffic to the Cars.com 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 an internal metric representing the number of visits to Cars.com desktop and mobile properties (web browser and apps). Visits refers to the number of times visitors accessed Cars.com properties during the period, no matter how many visitors make up those visits. We measure traffic using Adobe Analytics. Traffic provides an indication of our consumer reach. Although our consumer reach does not directly result in revenue, we believe our ability to reach diverse demographic audiences is attractive to our dealers and national advertisers.

Traffic increases were primarily driven by an increase in search engine optimization and planned strategic marketing investments aimed at consumer acquisition, engagement and brand awareness amongst auto shopping audiences. Mobile traffic accounted for 68% and 66% of total Traffic for the three and nine months ended September 30, 2018, respectively. Average monthly unique visitors increased 10% and 9% for the three and nine months ended September 30, 2018, respectively.

Dealer Customers. Our value to consumers tracks to our ability to showcase the inventory of our dealer and OEM customers. The larger the advertiser base, the more inventory and options that are available for consumers to review. Dealer Customers represents the car dealerships using our products as of the end of each reporting period. Each 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. Beginning June 30, 2018, this key operating metric includes DI and LDM customers.

Total Dealer Customers declined 2% from June 30, 2018. Direct dealer customers increased 419, resulting from dealer customers converted from affiliate markets, partially offset by higher cancellations in previously converted affiliate markets and lower overall sales.

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Total Dealer Customers declined 4% from September 30, 2017. Direct dealer customers increased 3,048, resulting from dealer customers converted from affiliate markets and the addition of incremental customers from the Acquisition, partially offset by higher cancellations in previously converted affiliate markets and due to the sunsetting of a lower priced, legacy DealerRater baseline product.

Average Vehicle Listings. Our value to consumers tracks to our ability to showcase the inventory of our dealer and OEM customers. The more vehicle listings that are available for consumers to review, the more traffic we attract and the higher the consumer engagement. Average Vehicle Listings represents the daily average of vehicles listed for sale on Cars.com properties. The daily average is calculated on a monthly basis and averaged for the reporting period.

Declines in Average Vehicle Listings for the three and nine months ended September 30, 2018 were due to fewer new car listings, primarily related to fewer dealer customers. For the three and nine months ended September 30, 2018, used car listings were flat and increased 3%, respectively.

Factors Affecting Our Performance

Our continued success will depend in part on our ability to address and successfully manage challenges, both specific to our business and in the digital advertising marketplace generally. In the near term, we may experience compressed margins as a result of our transition from a wholly-owned subsidiary of TEGNA to an independent publicly traded company. Due to the transition, we have further developed our internal infrastructure and support functions through the recruiting and hiring of managers and employees required to strengthen our legal, treasury, finance, tax, investor relations and other similar functions. Similarly, we will incur ongoing public company costs, including those related to an independent board of directors, compliance with regulatory and stock exchange requirements and increased auditing and insurance fees. Further, the indebtedness we incurred in connection with the Separation from TEGNA in May 2017 and the Acquisition in February 2018, has reduced our free cash flow, which may limit our ability to make strategic acquisitions or other transactions that we believe to be in the best interests of our stockholders or that might increase the value of our business. We expect to manage these incremental costs and the associated increased risk by focusing on improving our operating efficiency and continued growth in our business to drive operating margins and generate free cash flow. In addition, our business is subject to risks related to the larger automotive ecosystem, including consumer demand and other macroeconomic factors. We have recently observed the beginning of a cyclical downturn in the United States auto market, which has impacted new car sales and thus OEMs’ and dealers’ spending. While our customers may weigh lower-priced and other options in the market, we believe that the value we deliver will provide continuity as they evaluate their spend.

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Results of Operations

Three Months Ended September 30, 2018 Compared to Three Months Ended September 30, 2017

Retail Revenues—Direct.  Direct revenues primarily represent online subscription products sold to dealer customers who purchase advertising packages to market their vehicle inventory and other aspects of their dealership. Direct revenues is our largest revenue stream, representing 70.6% of total revenues for the three months ended September 30, 2018. The addition of DI’s and LDM’s business contributed $15.8 million to the direct revenue increase. The affiliate market conversions contributed $25.6 million to direct revenue, while reducing wholesale revenues $22.6 million ($5.4 million relates to the unfavorable contracts liability amortization). Excluding the impact of the Acquisition and affiliate market conversions, direct revenues declined $4.4 million, primarily due to a 7% decline in dealer customers. Direct dealer customers decreased 2% from June 30, 2018. For information related to the affiliate market conversions, see Note 4 (Unfavorable Contracts Liability) to the accompanying Consolidated and Combined Financial Statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q.

Retail Revenues—National Advertising.  National advertising revenues consists of display advertising sold to advertising agencies and OEMs, as well as leads sold to OEMs. Display ads are placed throughout the Cars.com website and apps. National advertising revenues represented 16.6% of total revenues for the three months ended September 30, 2018. National advertising revenue declined 12%, as OEMs reduced their spending on display ads mostly due to the cyclical nature of the auto industry.

Wholesale Revenues.  Wholesale revenues represent the fees we charge for online subscription products sold to dealers by affiliates. Wholesale revenues represented 10.4% of total revenues for the three months ended September 30, 2018. Wholesale revenues decreased primarily due to the affiliate market conversions from wholesale revenues ($22.6 million, which includes $5.4 million of unfavorable contracts liability amortization) to direct revenues ($25.6 million). In addition, excluding the affiliate market conversions, wholesale revenues was impacted by a 7% decline in dealer customers. For information related to the affiliate market conversions, see Note 4 (Unfavorable Contracts Liability) to the accompanying Consolidated and Combined Financial Statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q.

Cost of revenues and operations.  Cost of revenues and operations primarily consist of expenses related to our pay-per-lead products, third-party costs for processing dealer vehicle inventory, product fulfillment, customer service and related compensation costs. Cost of revenues and operations represents 14.2% and 11.4% of total revenues for the three months ended September 30, 2018 and 2017,

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respectively. The addition of DI’s and LDM’s business contributed $6.5 million to the overall increase. Excluding the impact of the Acquisition, cost of revenues and operations decreased $0.7 million and 4%, primarily due to reduced compensation.

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 and data strategy teams. The technology team develops and supports the Cars.com products and website. Product and technology expenses include compensation costs, as well as license fees for vehicle specifications, search engine optimization, hardware/software maintenance, software licenses, data center and other infrastructure costs. Product and technology expenses represent 9.4% and 11.5% of total revenues for the three months ended September 30, 2018 and 2017, respectively. Product and technology expenses decreased 14%, primarily due to reduced compensation costs associated with lower headcount, partially offset by the addition of DI’s and LDM’s business.

Marketing and sales.  Marketing and sales expenses primarily consist of traffic and lead acquisition costs (including search engine management and other online marketing), TV and online advertising and production of ad creative, market research, trade events and compensation costs for the marketing, sales support and sales teams. Marketing and sales expenses represent 33.1% and 31.7% of total revenues for the three months ended September 30, 2018 and 2017, respectively. The addition of DI’s and LDM’s business contributed $4.2 million to the overall increase, as we expanded the salesforce to support our new product offerings. Excluding the impact of the Acquisition, marketing and sales expenses increased $1.2 million and 2%, primarily due to planned strategic marketing investments aimed at consumer engagement, brand awareness amongst auto shopping audiences and search engine optimization, partially offset by cost efficiencies related to investments aimed at consumer acquisition.

General and administrative. General and administrative expenses primarily consist of compensation costs for the finance, legal, human resources, facilities and other administrative employees. In addition, general and administrative expenses include office space rent, legal and accounting services, other professional services, transaction-related costs and costs related to the write-off and loss on assets. General and administrative expenses represent 8.5% and 5.7% of total revenues for the three months ended September 30, 2018 and 2017, respectively. General and administrative expenses increased $5.2 million and 56%, primarily due to $2.9 million in costs related to consulting services incurred as part of our settlement agreement with our stockholder activist, $0.8 million in incremental stock-based compensation and the addition of DI’s and LDM’s business.

Affiliate revenue share. Affiliate revenue share expenses primarily represent payments made to affiliates pursuant to our affiliate agreements. Affiliate revenue share expenses increased 93%, primarily due to increase in costs associated with the early conversions of the McClatchy, tronc and Washington Post markets, partially offset by amortization of the unfavorable contracts liability which was previously recorded in wholesale revenues. For information related to the unfavorable contracts liability, see Note 4 (Unfavorable Contracts Liability) to the accompanying Consolidated and Combined Financial Statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q.

Depreciation and amortization. Depreciation and amortization expense increased 21%, primarily due to the incremental amortization expense related to the Acquisition.

Interest expense, net. Interest expense increased due to interest associated with the Credit Agreement principally utilized to fund the Separation and the Acquisition. For information related to our term and revolving loans, see Note 5 (Debt) to the accompanying Consolidated and Combined Financial Statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q.  

Income tax expense. The effective income tax rate, expressed by calculating the income tax expense as a percentage of Income before income taxes, was 26.2% for the three months ended September 30, 2018 and differed from the U.S. federal statutory rate of 21%, primarily due to state income taxes, nondeductible transaction costs and the impact of the Tax Cuts and Jobs Act, partially offset by certain tax credits and excess tax benefits from stock-based compensation. For information related to income taxes, see Note 6 (Income Taxes) to the Consolidated and Combined Financial Statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q.    

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Nine Months Ended September 30, 2018 Compared to Nine Months Ended September 30, 2017