Business context and reporting period
CoStar Group, Inc. provides commercial real estate information, analytics and online marketplaces, primarily through subscriptions. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015, compared with the corresponding 2014 periods.
Growth included the June 2015 acquisition of Apartment Finder, following the 2014 acquisition of Apartments.com. CoStar also acquired Madrid-based Belbex assets in July 2015.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $189.1m | $153.1m | $518.8m | $419.8m |
| Gross margin | $135.4m (71.6%) | $112.1m (73.3%) | $375.0m (72.3%) | $305.8m (72.8%) |
| Operating income (loss) | ($0.4m) | $23.5m | ($24.1m) | $57.5m |
| Net income (loss) | ($5.4m) | $13.0m | ($26.5m) | $30.9m |
| Diluted EPS | ($0.17) | $0.40 | ($0.83) | $1.03 |
| EBITDA (non-GAAP) | $22.1m | $43.7m | $34.9m | $108.3m |
Revenue rose about 23% in both comparison periods. Growth reflected Apartments.com and Apartment Finder, subscription penetration and cross-selling. Gross margin percentage declined, while substantial Apartments.com marketing spending weighed on profitability. North America EBITDA fell to $21.0m from $42.9m in Q3 and to $32.8m from $106.4m year to date; International EBITDA was $1.1m and $2.1m, respectively. EBITDA is a company-defined non-GAAP measure.
- Cash flow: Nine-month operating cash flow was $69.7m versus $96.0m. Investing cash outflow was $203.5m, including $177.5m for 2015 acquisitions; financing cash outflow was $17.5m. Cash declined to $375.5m from $527.0m at year-end 2014.
- Liquidity and debt: Cash and cash equivalents were $375.5m. Debt totaled $370.0m: $20.0m current and $350.0m long-term. No borrowings were outstanding on the $225m revolving facility. The company reported compliance with credit covenants and expects available cash and operating cash flow to fund operations for at least 12 months.
- Other metrics: Annualized net new sales on annual subscription contracts were $31.0m versus $15.4m. The trailing 12-month CoStar subscription renewal rate was approximately 90%, down from 92%.
Material changes and management commentary
- Selling and marketing expense increased to $80.5m in Q3 from $40.7m and to $242.4m year to date from $109.3m. The principal driver was the Apartments.com brand and traffic campaign. Management said the campaign began in Q1 and would continue through 2015, with an incremental investment of approximately $80m above Apartments.com’s 2014 annualized marketing spend.
- Software development expense increased, reflecting personnel costs for service improvements. Management expects technology enhancements and continued product integration to support revenue growth, but gave no quantified revenue or earnings guidance.
- CoStar is integrating the acquired apartment businesses, developing a redesigned ApartmentFinder.com website and shifting Apartment Finder from print to digital. It expects short-term revenue and cost reductions from eliminating certain services; results and timing of anticipated synergies are uncertain.
- 2015 capital expenditures were expected to total approximately $30m–$40m, mainly for technology and leased-office build-outs; approximately $28m had been incurred through September.
- The company recorded approximately $2.8m of impairment charges in 2015: about $1.4m related to Apartments.com database technology and about $1.4m related to Apartment Finder services and development work discontinued after acquisition.
Risks, contingencies and unusual items
- Management identified integration, customer retention, employee retention, acquisition costs and the ability to realize expected marketing returns and synergies as risks. The renewal rate decline was associated in part with LoopNet customers moving to annual contracts, whose renewal rate is typically lower.
- Litigation is described as incidental to the business. Management said an unfavorable outcome was reasonably possible but not probable, and it could not estimate a possible loss range; no liability was recorded.
- The company held $16.8m par value of auction-rate securities that had failed to settle at auction; these are not readily liquid in the short term. Fair value was $15.5m, including a $0.4m temporary unrealized loss. Further valuation losses or an impairment charge remain possible.
- Debt bears variable interest; management estimated a 25-basis-point rate change would alter annual interest expense by approximately $0.9m. Foreign-currency exposure is not hedged.
- Despite the Q3 pretax loss, the company recorded $2.6m of income tax expense, citing changes in its 2015 earnings forecast and an adjustment to the estimated full-year effective tax rate.
Important facts for investors to verify
- Whether the Apartments.com marketing investment increases traffic, advertiser demand, subscription sales and renewals enough to restore operating profitability.
- Progress integrating Apartment Finder, completing its digital transition, and realizing expected cross-selling benefits; also monitor purchase accounting, goodwill and intangible-asset impairment exposure.
- Future renewal rates, annualized net new sales and revenue growth excluding acquisition contributions.
- Cash generation, acquisition spending, capital expenditures, debt repayment and compliance with leverage covenants.
- Liquidity and valuation developments for failed auction-rate securities, and any material updates to litigation contingencies.