CoStar Group, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Amounts below are in U.S. dollars; financial statement figures are unaudited. CoStar provides commercial real estate information, analytics and marketing services in the U.S., U.K. and France. Its subscription services generally renew automatically, with most contracts having one-year terms.
Financial performance
| Metric | Three months ended Sep. 30, 2012 | Three months ended Sep. 30, 2011 | Nine months ended Sep. 30, 2012 | Nine months ended Sep. 30, 2011 |
|---|---|---|---|---|
| Revenue | $96.0m | $63.8m | $249.9m | $185.6m |
| Gross margin | $65.1m (67.8%) | $42.7m (66.8%) | $166.5m (66.6%) | $119.4m (64.4%) |
| Operating income | $8.9m | $3.0m | $17.5m | $14.0m |
| Net income | $6.8m | $2.3m | $5.2m | $9.5m |
| Diluted EPS | $0.24 | $0.09 | $0.19 | $0.41 |
| Operating cash flow | $26.0m | $4.4m | $56.6m | $19.7m |
- Q3 revenue increased about 50%; nine-month revenue increased about 35%. Management attributed growth mainly to LoopNet, acquired April 30, 2012, and to subscription penetration, cross-selling and high renewal rates. LoopNet contributed $22.9m of Q3 revenue and $36.1m for the nine-month period.
- Q3 gross margin rose to 67.8% from 66.8%; nine-month gross margin rose to 66.6% from 64.4%. Higher revenue more than offset increased cost of revenue.
- Q3 net income improved year over year, but nine-month net income declined. The nine-month effective tax rate was approximately 65%, versus 35% in 2011, primarily because some LoopNet acquisition costs were not tax-deductible. Results also include LoopNet net losses of $1.7m in Q3 and $5.7m year to date.
- Q3 segment revenue was $91.2m in the U.S. and $4.8m in International. Segment EBITDA, a non-GAAP measure, was $22.7m for the U.S. and negative $3.0m for International; the latter included a $2.3m corporate allocation for international development and expansion.
Liquidity, cash flow and debt
- At September 30, cash and cash equivalents were $129.5m, short-term investments $0.8m, and long-term investments $21.6m. Current assets were $184.3m and current liabilities $93.0m.
- Cash, cash equivalents and short-term investments fell to $130.3m from $548.8m at year-end 2011, principally reflecting the LoopNet acquisition. Investing cash flow was negative $635.3m, including $640.9m net cash paid for acquisitions; financing cash flow was positive $162.9m, including the $175.0m term loan proceeds.
- Long-term debt was $170.6m, including $13.1m current maturities. The $50m revolving facility had no borrowings. Debt carries variable-rate interest; management estimated a 25-basis-point rate change would change annual interest expense by about $0.4m.
- The credit agreement imposes financial and other restrictive covenants; CoStar reported compliance at September 30. Management said available cash and expected operating cash flow should fund operations for at least 12 months.
Material changes, outlook and risks
- The $883.4m LoopNet acquisition materially expanded the business and drove higher revenue, goodwill, acquired intangible assets, amortization, debt and integration costs. Goodwill was $718.1m at September 30, including $625.2m recorded for LoopNet; purchase accounting remained preliminary.
- Management expected significant additional spending on LoopNet cross-selling campaigns in Q4 2012 and Q1 2013, and said the initiatives were intended to support revenue growth in 2013 and beyond. It also expected international development expenses to decrease in 2013 after planned platform upgrades. No specific revenue or earnings guidance was provided in the filing. Planned 2012 capital expenditures were approximately $10m–$15m.
- Management reported improving commercial real estate indicators but cautioned that the recovery remained uncertain and depended in part on employment growth. Customer cancellations, reduced spending, competition, integration difficulties, cost overruns, and failure to realize expected synergies could adversely affect results. Management also warned that investments may pressure near-term margins and could fail to deliver expected benefits.
- The FTC’s final consent order requires specified business practices, including separate product sales and nondiscriminatory licensing; noncompliance could lead to fines or injunctive relief. LoopNet’s minority interest in Xceligent was sold for $4.2m to satisfy the divestiture requirement.
- Failed auctions left $24.4m par value of auction-rate securities illiquid in the near term; fair value was $21.6m, with a $2.0m temporary unrealized loss. Further losses remain possible. CoStar also cited foreign-currency exposure and substantial intangible-asset impairment risk.
- Pending matters include a patent-infringement dispute with Civix; the company said it could not predict the outcome. A settlement of approximately $0.2m was anticipated in the LoopNet stockholder litigation, subject to court approval.
Investor verification priorities
- Separate organic growth from LoopNet’s contribution and assess whether cross-selling and integration produce the expected revenue and cost synergies.
- Reconcile stronger quarterly earnings and operating cash flow with lower nine-month net income, including acquisition-related amortization, costs and the elevated tax rate.
- Monitor cash and liquidity after the acquisition, debt amortization, variable-rate interest, covenant headroom and any excess-cash-flow prepayment.
- Review the FTC consent-order requirements, Civix litigation developments, and the valuation and liquidity assumptions for auction-rate securities.
- Track international investment spending, expected expense reductions in 2013, and progress on product launches and platform upgrades.