CoStar Group, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; compared with Q1 2016. CoStar provides subscription-based commercial real estate information, analytics and online marketplaces across North America and international markets.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $226.6 million | $199.7 million | +13% |
| Gross profit / margin | $175.2 million / 77% | $156.8 million / 79% | Gross profit +12%; margin lower |
| Operating income / margin | $37.7 million / 16.6% | $30.3 million / 15.2% | +24% |
| Net income | $22.1 million | $16.7 million | +32% |
| Diluted EPS | $0.68 | $0.52 | +31% |
| Operating cash flow | $64.6 million | $48.4 million | +$16.2 million |
Revenue growth was led by CoStar Suite (+13% to $110.0 million) and Multifamily (+22% to $64.0 million). Commercial property and land revenue rose 12% to $34.2 million, while information services declined 6% to $18.3 million. North America revenue was $219.3 million and segment EBITDA was $54.4 million; International revenue was $7.2 million and EBITDA was $0.5 million.
Operating expenses increased 9% to $137.5 million. Software development rose 27% and general and administrative expense rose 24%, including higher personnel costs and approximately $3 million of legal costs. Gross margin percentage declined as research staffing, technology and occupancy costs increased. Advertising costs fell to approximately $23 million from $34 million.
Cash, debt and liquidity
- Cash and cash equivalents were $572.5 million at March 31, 2017, up from $567.2 million at year-end. Long-term investments were $10.0 million.
- Operating cash flow was $64.6 million; investing activities used $19.8 million, including $13.7 million for acquisitions and $6.1 million for property and equipment and other assets. Financing activities used $39.5 million, including $35.0 million of debt payments.
- Term-loan principal was $310 million; the balance-sheet carrying amount of total debt was $304.1 million after debt issuance costs. The $225 million revolving facility was undrawn. CoStar prepaid $30 million of scheduled term-loan payments in March.
- The company reported compliance with credit-agreement covenants and said cash and operating cash flow should fund operations for at least the next 12 months.
Outlook, developments and risks
- Management expected CoStar Suite and commercial property and land growth to remain consistent with historical rates. Information-services growth was expected to decline as LoopNet services are phased out and customers are encouraged to move to CoStar Suite. Multifamily revenue was expected to continue growing, but more slowly than in 2016.
- Management expected gross margin to decrease slightly in 2017 as it invests in research, and capital expenditures to increase for leased-office buildout, including the Richmond research headquarters, and technology. It planned continued product integration, research expansion and sales and marketing investment.
- Westside Rentals was acquired on January 31 for approximately $14 million in cash. The company expected integration losses while shifting its renter-paid subscription model toward advertising. On April 10, it signed an agreement to acquire certain LandWatch.com assets and liabilities, with closing anticipated in May 2017.
- Annual-contract renewal rates were approximately 90% for the trailing 12 months; management expected a slight moderation, partly because Multifamily services have lower renewal rates. Annualized net bookings were approximately $35 million versus $30 million a year earlier.
- Risks include execution and integration of acquisitions, LoopNet transition and customer conversion, customer retention, commercial real estate and economic conditions, competition, foreign-exchange movements, and increased costs or reduced revenue from product changes. CoStar does not hedge foreign-currency exposure.
- Approximately $11 million par value of auction-rate securities had failed to settle at auction; their recorded fair value was $10.0 million, including an $848,000 unrealized loss considered temporary. Further auction or credit deterioration could cause additional losses. A 25-basis-point interest-rate change was estimated to affect annual interest expense by approximately $800,000.
- Management said current litigation was not probable to result in a recorded loss and could not estimate a possible loss range, but expected legal costs related to a matter begun in 2016 to continue during 2017.
Material changes and unusual items
- Net income growth outpaced revenue growth; the effective tax rate declined to approximately 37% from 40%, primarily due to new share-based payment tax accounting. Adoption also resulted in a $2 million cumulative adjustment to deferred tax assets and retained earnings.
- Revenue grew despite lower information-services sales; Multifamily and CoStar Suite were the principal growth drivers. International EBITDA declined amid continued research investment.
- The company early adopted the revised goodwill impairment guidance; adoption had no material impact. It expected the new revenue standard, effective for it in 2018, to require capitalization of employee contract commissions and could materially affect its financial statements.
Important facts for investors to verify
- Whether CoStar Suite and Multifamily growth, bookings and renewal rates sustain the reported pace, particularly as Multifamily scales.
- Progress and economics of LoopNet customer conversion, Westside Rentals integration and the proposed LandWatch.com acquisition.
- Whether planned research, marketing and capital investments pressure gross margins or cash generation beyond management’s expectations.
- Developments in the ongoing legal matter, credit-facility covenant headroom, and the recoverability and liquidity of the auction-rate securities.
- The eventual accounting and earnings effects of capitalizing contract commissions under the new revenue-recognition standard.