CoStar Group, Inc. — Q1 2014 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2014, compared with Q1 2013. CoStar provides commercial real estate information, analytics and marketing services, primarily through subscription agreements, in the U.S., U.K. and France. The company reports U.S. and International segments.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Revenue | $119.1 million | $104.0 million |
| Gross profit / margin | $85.4 million / 71.7% | $70.4 million / 67.7% |
| Operating income (loss) | $17.1 million | $(2.6) million |
| Net income (loss) | $9.7 million | $(2.4) million |
| Diluted EPS | $0.34 | $(0.09) |
| EBITDA, as reported by the company | $27.0 million | $7.6 million |
| Cash from operating activities | $(6.6) million | $10.7 million |
- Revenue rose about 14.5%, driven by further subscription-service penetration, cross-selling and continued high renewal rates. The trailing 12-month renewal rate was 93%, versus 94% a year earlier.
- Gross margin improved primarily with revenue growth. General and administrative expense fell to $24.9 million from $29.8 million, mainly reflecting $7.6 million less stock-based compensation, partly offset by acquisition costs and higher litigation contingencies.
- U.S. revenue was $113.3 million and segment EBITDA was $26.4 million, compared with $99.3 million and $9.3 million. International revenue was $5.8 million and EBITDA was $0.6 million, versus $4.7 million and a $1.7 million loss.
- Operating cash flow decreased by $17.3 million year over year, which management attributed primarily to the timing of receipts and payments and changes in operating assets and liabilities. Investing cash outflow was $4.1 million.
- Cash and cash equivalents were $223.4 million at March 31, down from $256.0 million at year-end. Long-term debt was $148.8 million, comprising $26.3 million current and $122.5 million non-current; no amounts were drawn on the existing revolving facility at quarter-end. The company reported compliance with its then-current debt covenants.
Material changes and unusual items
- CoStar recorded $1.1 million of impairment expense for trade names as part of a branding initiative, and approximately $1.1 million of acquisition-related costs associated with the planned Apartments.com purchase.
- Performance-based restricted stock awards vested after the company met the specified cumulative EBITDA condition. Stock-based compensation expense was $7.9 million, down from $17.3 million in Q1 2013.
- Financing cash flows included $42.6 million of restricted-stock repurchases to satisfy employee tax withholding obligations; these were not purchases under a public share-repurchase program.
- Available-for-sale auction rate securities had a $22.2 million fair value and $24.3 million par value. Auctions had failed; the securities were classified as long-term and were not readily liquid. The company treated the approximately $1.3 million decline in fair value as temporary and recorded it in other comprehensive loss, not earnings.
Outlook, acquisition, risks and contingencies
- No specific 2014 revenue or earnings guidance is provided. Management said current services were expected to remain profitable and generate substantial cash flow, while noting that investment or unforeseen events could result in losses or negative operating cash flow. It expected product-development and marketing investment to continue; estimated 2014 capital expenditures were $25–$30 million.
- On April 1, 2014, after quarter-end, CoStar completed its $585.0 million cash acquisition of Apartments.com for a closing payment of $587.1 million, subject to a final working-capital adjustment. Management said it could not yet estimate the acquisition’s financial impact and planned integration, product development and increased marketing.
- Also on April 1, the company refinanced its prior debt under a new five-year agreement providing a $400 million term loan and a $225 million revolving facility. It initially borrowed $150 million under the revolver; the facilities were used to refinance the old agreement and fund part of the acquisition. The new debt is secured and subject to financial and restrictive covenants. Integration, leverage, financing costs and covenant compliance are material considerations.
- In the Civix patent litigation, CoStar disputed the plaintiff’s damages analysis and said the matter could result in a loss of up to $2.5 million in excess of the amount accrued. CoStar offered $1.2 million to settle on April 9, 2014, but said the outcome remained uncertain. A separate LoopNet shareholder settlement could result in an approximately $0.2 million loss; court proceedings remained pending.
- Management cited slower-than-expected economic and commercial real estate recovery, customer cancellations or spending reductions, competition, foreign-exchange fluctuations, integration and execution risks, and reliance on website traffic and search-engine rankings. The filing states disclosure controls were effective and no material quarterly change in internal control over financial reporting occurred.
Important facts for investors to verify
- Whether subscription growth, cross-selling and renewal rates remain sufficient to sustain revenue and margin improvement.
- Post-acquisition Apartments.com contribution, integration costs and synergies, final working-capital adjustment, and the resulting debt balance and liquidity.
- Operating cash conversion and the effects of working-capital timing, employee tax-withholding share repurchases and acquisition-related spending.
- Debt interest expense, covenant headroom and refinancing terms, including the large final maturity disclosed under the new facility.
- Developments in Civix litigation and the shareholder case, plus liquidity and valuation of the failed-auction securities.