CoStar Group, Inc. — Q2 2012 Form 10-Q
Business context and period. This unaudited quarterly filing covers the three and six months ended June 30, 2012. CoStar provides subscription-based commercial real estate information, analytics and marketing services in the U.S., U.K. and France. On April 30, 2012, it completed its acquisition of LoopNet, a U.S. commercial real estate online marketplace.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $85.2m | $62.1m | $153.9m | $121.7m |
| Gross margin | $57.1m; 66.9% | $39.7m; 63.9% | $101.3m; 65.9% | $76.8m; 63.1% |
| Operating income (loss) | $(0.01)m | $3.9m | $8.6m | $11.0m |
| Net income (loss) | $(6.7)m | $2.6m | $(1.6)m | $7.2m |
| Diluted earnings (loss) per share | $(0.25) | $0.12 | $(0.06) | $0.33 |
| Operating cash flow | Not separately stated | Not separately stated | $30.6m | $15.3m |
Revenue increased 37% in Q2 and 26% for the first half. Q2 revenue included $13.2m from LoopNet. The filing attributes growth primarily to the acquisition, subscription-service penetration, cross-selling and high renewal rates. Trailing 12-month renewal rates for existing CoStar subscription services were 94%, versus 92% a year earlier.
Q2 net loss included a $4.0m net loss from the LoopNet contributed business. The six-month effective tax rate was approximately 120%, versus 37% in 2011; management attributed the increase largely to LoopNet-related costs that were not tax-deductible. CoStar reported EBITDA, a non-GAAP measure, of $8.2m for Q2 versus $7.1m, and $20.1m for the first half versus $17.6m.
At June 30, cash and cash equivalents were $103.3m and short-term investments were $0.8m, totaling $104.2m, down from $548.8m at year-end, mainly due to the LoopNet acquisition. Current assets were $159.6m and current liabilities $85.3m. Total debt was $172.8m; the $50m revolving facility was undrawn. Six-month investing cash outflow was $636.6m, including $640.9m net cash used for acquisitions. Goodwill increased to $717.2m from $91.8m, and net intangibles and other assets rose to $186.0m from $20.5m, principally reflecting LoopNet.
Material changes versus prior period
- LoopNet added $13.2m of reported Q2 revenue, but acquisition and integration costs, purchase amortization, interest expense and a high tax burden contributed to a quarterly net loss.
- Gross margin percentage improved, while selling, development and general and administrative expenses increased. Q2 general and administrative expense rose to $25.5m from $15.8m.
- The acquisition was funded with cash and equity consideration totaling $883.4m and a $175m term loan. Debt covenants become effective in Q3 2012; the agreement includes leverage and debt-service tests and restrictions on certain business actions.
- Six-month operating cash flow rose year over year, while cash and investments fell substantially following the acquisition. The prior-year investing cash inflow included proceeds from the headquarters building sale, which did not recur.
Outlook, commentary and risks
- Management expects current services to remain profitable and generate substantial cash flow, and believes product expansion and acquisition integration can support revenue growth in 2013 and beyond. It gave no specific revenue or earnings forecast in the provided filing text.
- CoStar expects $15m–$20m of capital expenditures in 2012 and significant additional sales and marketing campaign costs in Q3 and Q4 as it cross-sells CoStar and LoopNet services. Management cautions that investment and integration costs may reduce profitability and could result in losses or negative operating cash flow.
- The company cited improving commercial real estate indicators but warned that economic, employment and industry conditions remain uncertain and could affect customer spending, renewals and collections. Other execution risks include integrating LoopNet, achieving anticipated synergies, retaining customers and employees, competition, data security and foreign exchange movements.
- The FTC consent order required divestiture of LoopNet’s minority interest in Xceligent, completed May 3, and imposes business-practice conditions. Final FTC acceptance remained pending at the filing date.
- LoopNet faced a patent-infringement suit by Civix seeking unspecified damages; a November 2012 trial was scheduled. CoStar said it could not predict the outcome and intended to defend the claims. A proposed settlement of former LoopNet stockholder litigation could cost approximately $0.2m, subject to court approval.
- Failed auctions left $28.5m par value of auction-rate securities illiquid; their reported fair value was $25.0m, with a $2.7m temporary unrealized loss. CoStar warned that further valuation losses could arise if credit quality or auction conditions deteriorate.
Important facts for investors to verify
- How much of subsequent growth and profitability reflects LoopNet versus organic subscription growth, and whether integration synergies materialize.
- Compliance with debt covenants beginning in Q3, variable-rate interest exposure, scheduled principal payments and any required excess-cash-flow prepayment.
- The timing and magnitude of integration, severance and cross-selling campaign costs, and their effect on margins and cash flow.
- Final FTC acceptance and ongoing compliance with the consent order, plus developments in the Civix litigation and proposed stockholder settlement.
- Recoverability of acquisition-related goodwill and intangibles, and liquidity and fair-value assumptions for the failed-auction securities.