CoStar Group, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. CoStar provides commercial real estate information, analytics and online marketplaces, primarily through automatically renewing subscriptions. Results are unaudited.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $247.5 million | $212.7 million | $711.2 million | $619.3 million |
| Gross margin | $192.1 million; 78% | $170.5 million; 80% | $549.1 million; 77% | $491.5 million; 79% |
| Operating income | $57.5 million | $39.6 million | $123.1 million | $98.0 million |
| Net income | $34.2 million | $23.2 million | $78.5 million | $55.5 million |
| Diluted EPS | $1.04 | $0.72 | $2.40 | $1.71 |
| EBITDA (non-GAAP measure as defined by CoStar) | $72.6 million | $57.7 million | $171.3 million | $151.1 million |
- Q3 revenue rose 16%; net income rose 47%. For the first nine months, revenue rose 15% and net income rose 41%.
- Q3 revenue by service: CoStar Suite $117.3 million (+14%); information services $18.7 million (-4%); multifamily $72.3 million (+25%); commercial property and land $39.2 million (+21%).
- Nine-month operating cash flow was $163.3 million, compared with $148.5 million. Investing used $67.5 million, including $47.8 million for acquisitions; financing used $40.9 million, including $35 million of debt payments. Cash increased $55.8 million to $623.0 million.
- At September 30, cash and cash equivalents were $623.0 million; current assets were $700.1 million and current liabilities $176.6 million. Gross term-loan debt was $310 million; the revolving facility was undrawn. Total debt net of issuance costs was $305.5 million. The company reported compliance with debt covenants.
Changes versus prior period
- Growth was led by CoStar Suite and multifamily. North America generated $239.5 million of Q3 revenue and $72.3 million of segment EBITDA; International generated $8.0 million and $0.4 million, respectively. International EBITDA declined, which management attributed to continued research investment.
- Q3 gross margin percentage declined to 78% from 80%, primarily as revenue-related costs increased, including personnel and occupancy costs associated in part with expanded research operations. Nine-month gross margin percentage was 77%, versus 79%.
- For the first nine months, general and administrative expense rose 18%, primarily reflecting approximately $9 million in legal costs related mainly to litigation and acquisitions and approximately $4 million in personnel costs. Software development expense rose 19% with research-team expansion.
Outlook, material events and risks
- Management expected CoStar Suite revenue growth to remain consistent with historical rates. It expected information-services growth to decline for the rest of 2017 as LoopNet information services were phased out and customers were targeted for conversion to CoStar Suite. Multifamily growth was expected to continue, at a lower rate than in 2016; commercial property and land growth was expected to benefit from LandWatch. Management expected gross margin percentage to remain relatively consistent for the rest of 2017 and capital expenditures to increase.
- Annualized net bookings were approximately $34 million at September 30, versus $26 million a year earlier. The trailing-twelve-month renewal rate for annual CoStar subscriptions was approximately 91%; management expected a slight decline as multifamily services, which had lower renewal rates, grew in scale.
- After quarter-end, CoStar raised approximately $833.2 million net from an October 3 public offering of 3,317,308 shares. On October 19 it repaid the remaining $310 million term loan using cash and replaced the prior credit agreement with a five-year, $750 million revolving facility. Management said cash, operating cash flow and available financing should fund operations for at least 12 months.
- The pending ForRent acquisition was agreed at $385 million—$350 million cash and $35 million in stock—subject to customary conditions and antitrust clearance. CoStar expected closing in Q4 2017. Under specified termination circumstances involving failure to obtain antitrust approvals, a $40 million termination fee may apply.
- Current litigation was not considered probable to result in a loss by management, which said it could not estimate a possible loss range. CoStar expected continued legal costs related to a matter it initiated in 2016. The filing says no lawsuit was then considered likely to have a material adverse effect.
- Other risks include acquisition execution and integration, ForRent clearance and timing, customer retention, competition, the LoopNet transition, foreign exchange exposure without hedging, and possible impairment of goodwill or intangible assets. Auction-rate securities of $9.95 million were illiquid and carried a $0.85 million unrealized loss; additional losses could arise if auctions or issuer credit deteriorate.
- Accounting changes are also relevant: adoption of the share-based payment standard produced an $8 million nine-month income tax benefit and a $2 million opening retained-earnings adjustment. The company expected to adopt the new revenue standard in 2018; it anticipated capitalizing employee commissions, potentially materially affecting the financial statements, while not expecting a material change to revenue-recognition policies. Lease-accounting adoption may materially increase reported assets and liabilities.
Important facts for investors to verify
- Whether organic growth, bookings and renewal trends support reported revenue growth, particularly as multifamily expands and LoopNet information services are phased out.
- ForRent antitrust clearance, closing timing, final purchase accounting and any financing or termination-fee implications.
- Post-offering cash, repayment of the term loan, terms and use of the new revolving facility, and covenant compliance.
- Whether research, marketing, acquisition and legal costs affect margins and cash generation as management’s stated plans proceed.
- The potential effects of commission capitalization and lease-accounting adoption, and the recoverability and liquidity of auction-rate securities and acquired intangible assets.