CoStar Group, Inc. — Q3 2011 Form 10-Q
Business context and period: The filing covers the quarter and nine months ended September 30, 2011. CoStar provides subscription-based commercial real estate information and analytics in the U.S., U.K. and France; subscriptions generated more than 93% of revenue. Results are unaudited. Dollar amounts below are in millions except per-share data.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $63.8 | $57.1 | $185.6 | $168.1 |
| Gross profit / margin | $42.7 / 66.8% | $36.4 / 63.7% | $119.4 / 64.4% | $105.8 / 62.9% |
| Operating income | $3.0 | $6.1 | $14.0 | $15.7 |
| Net income | $2.3 | $3.4 | $9.5 | $9.5 |
| Diluted EPS | $0.09 | $0.16 | $0.41 | $0.46 |
| EBITDA (non-GAAP) | $6.0 | $9.4 | $23.7 | $26.0 |
- Revenue grew about 12% in Q3 and 10% year to date. Management attributed growth mainly to deeper subscription penetration, cross-selling and strong renewals.
- Q3 net income fell about 32% and operating income about 51% year over year; nine-month net income was nearly flat while operating income declined about 11%. Cost growth—particularly acquisition, marketing, restructuring and personnel costs—outpaced revenue growth.
- Cash provided by operations was $19.7 for the first nine months, down from $27.1 a year earlier. Investing provided $72.2, mainly reflecting the headquarters building sale; financing provided $252.4, primarily from the June equity offering. Capital expenditures were $12.2.
Balance sheet, liquidity and capital
- At September 30, cash and cash equivalents were $550.7; short-term investments were $3.6. Cash, cash equivalents and short-term investments totaled $554.3, versus $210.1 at December 31, 2010.
- Total assets were $764.8; total liabilities were $115.1; stockholders’ equity was $649.7. The balance sheet lists no outstanding borrowings. Management said available cash and expected operating cash flow should fund operations for at least 12 months.
- The cash increase chiefly reflects $247.9 of net equity-offering proceeds and the $101.0 cash sale of the Washington, DC headquarters building. CoStar recorded a $36.0 deferred sale-leaseback gain, recognized as a reduction of rent expense over the lease term; approximately $0.6 was recognized in Q3 and $1.6 year to date.
- CoStar had $31.4 par value of failed-auction student-loan auction-rate securities (ARS), carried at $28.4 with a $3.0 unrealized loss in accumulated other comprehensive loss. These investments are long-term and may not be liquid in the near term.
Material changes and unusual items
- Q3 selling and marketing expense rose to $17.5 from $13.0, including about $3.4 of CoStarGo launch marketing. CoStarGo launched in the U.S. on August 15, with a 34-city tour.
- General and administrative expense increased to $16.6 from $12.4 in Q3. It included $5.8 of LoopNet acquisition costs and $1.5 of Maryland office restructuring charges, partly offset by a $1.2 reduction from settling Resolve Technology deferred consideration. Nine-month LoopNet costs were $11.1.
- Q3 U.S. segment revenue was $59.2 and EBITDA was $6.8, down from $9.5. International revenue was $4.6; its EBITDA loss widened to $0.8 from $0.1, primarily due to personnel costs. Nine-month international EBITDA loss narrowed to $2.8 from $3.1.
- CoStar issued 4.31 million shares at $60 per share in June, raising $247.9 net. Weighted-average diluted shares rose to 25.3 million in Q3 from 20.7 million.
Outlook, transactions and risks
- Management expected existing services to remain profitable and support overall 2011 earnings and substantial cash flow, but gave no specific numerical earnings or revenue guidance in the provided filing text. It cautioned that new investment could reduce profitability or produce losses and negative operating cash flow. Expected 2011 capital expenditures were $14–$16.
- The proposed LoopNet acquisition was valued at approximately $860 million equity value and $762 million enterprise value. FTC review, including a second request for information, remained outstanding; closing by year-end 2011 was possible but uncertain. CoStar had committed financing for a $415 million term loan and a $50 million revolving facility, of which $37.5 million was committed. The merger was not subject to a financing condition. Termination fees could be $51.6 million payable by CoStar or $25.8 million payable by LoopNet in specified circumstances.
- After quarter-end, CoStar acquired Virtual Premise on October 25 for approximately $17.2 million in cash.
- Other risks include commercial real estate and broader economic conditions, customer cancellations and payment failures, competition, currency fluctuations, integration and retention challenges if LoopNet closes, potential restrictive debt covenants, and uncertain ARS liquidity and valuation. Three shareholder suits challenging the LoopNet merger were proposed for settlement, potentially costing CoStar approximately $0.1 million, subject to merger completion and court approval. Management reported no other current litigation loss considered probable and estimable.
- The company recognized $1.3 of Boston office restructuring charges in Q3 2010; the current-year Maryland consolidation generated $1.5 in Q3 2011. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether and when FTC clearance and other conditions permitted the LoopNet transaction to close, and the final financing, debt and integration costs.
- Whether subscription growth and renewal performance continued to support revenue, and whether higher operating expenses and investment spending pressured margins.
- Operating cash flow trends, especially the timing of receivable collections, and the extent to which reported cash depended on equity proceeds and asset-sale proceeds.
- Liquidity and valuation developments in the failed-auction ARS, including any additional impairment or realized loss.
- Actual sale-leaseback rent expense and restructuring costs, plus the purchase accounting and subsequent cash payments related to Virtual Premise.