CoStar Group, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited results are compared with the corresponding 2012 periods. CoStar provides commercial real estate information, analytics and marketing services, primarily through subscription agreements. Its U.S. and International segments include the LoopNet marketplace.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $112.3 million | $96.0 million | $325.3 million | $249.9 million |
| Gross margin | $80.6 million; 71.8% | $65.1 million; 67.8% | $227.9 million; 70.1% | $166.5 million; 66.6% |
| Operating income | $19.8 million | $8.9 million | $32.5 million | $17.5 million |
| Net income | $11.1 million | $6.8 million | $16.9 million | $5.2 million |
| Diluted earnings per share | $0.39 | $0.24 | $0.60 | $0.19 |
| Operating cash flow | Not separately presented for the quarter | Not separately presented for the quarter | $72.8 million | $56.6 million |
- Q3 revenue increased 17% year over year; nine-month revenue increased 30%. Management attributed growth to subscription penetration and cross-selling, with the nine-month comparison also including approximately $46.9 million of LoopNet revenue.
- Q3 net income rose approximately 63%; nine-month net income more than tripled. Nine-month effective tax rates were approximately 38% in 2013 and 65% in 2012; the earlier rate was elevated by nondeductible LoopNet acquisition costs.
- Q3 operating margin was approximately 17.6%, versus 9.3% a year earlier. Nine-month operating margin was approximately 10.0%, versus 7.0%. Q3 margin expansion reflected revenue growth and higher gross margin, partly offset by increased operating expenses.
- EBITDA, a non-GAAP measure, was $29.8 million for Q3 versus $19.6 million, and $62.7 million for nine months versus $39.7 million. The filing cautions that EBITDA is not a substitute for GAAP results or a liquidity measure.
Liquidity, debt and balance sheet
- At September 30, cash and cash equivalents were $222.9 million, compared with $156.0 million at December 31, 2012. Current assets were $277.6 million and current liabilities $107.4 million.
- Cash from operations was $72.8 million for nine months; investing activities used $15.2 million, including $15.3 million of capital expenditures; financing activities provided $9.2 million. Cash increased by $66.9 million during the period.
- Long-term debt totaled $157.5 million, including $21.9 million current and $135.6 million long term. The $50 million revolving facility was undrawn. CoStar reported compliance with its debt covenants. Cash exceeded reported debt by approximately $65.4 million.
- Management expected 2013 capital expenditures of $18–$22 million, primarily for leased office-space buildouts, and believed cash and operating cash flow would fund operations for at least the next 12 months.
Changes, outlook and material risks
- Subscription renewal rates were approximately 93% for the twelve months ended September 30, 2013, compared with 94% a year earlier. Annualized net new sales of annual subscription contracts were approximately $13.7 million versus $9.3 million.
- Operating expenses increased, including software development spending to enhance products and stock-based compensation. Nine-month stock-based compensation was $32.3 million, versus $8.7 million in 2012; this included $17.5 million related to performance-based awards. Approximately $6.2 million of additional expense was estimated for the remainder of 2013 and 2014.
- CoStar introduced major CoStar Suite enhancements and CoStarGo 2.0 in October 2013. Management expected the product enhancements to support revenue growth in 2014 and beyond, while sales and marketing costs were expected to rise late in Q4 2013, with most of that spending in Q1 2014. No specific revenue or earnings guidance was provided.
- Management planned to expand services internationally, including a Toronto launch in 2014, and continue integrating LoopNet, Virtual Premise, Resolve Technology and PPR. The filing notes that product development, integration and expansion costs could reduce profitability and that future investments could cause losses or negative operating cash flow.
- Risk factors include a slow commercial real estate recovery, weak job growth, customer cancellations or spending reductions, competition, foreign-exchange fluctuations, and execution and cost risks from product launches and acquisitions. The filing reported no material changes to previously disclosed risk factors.
- CoStar held $24.3 million par value of auction-rate securities that had failed auctions, carried at $21.7 million. These investments are illiquid in the short term; the $1.8 million fair-value decline was recorded as a temporary unrealized loss. Deteriorating credit or continued auction failures could cause further losses.
- Pending matters include a patent dispute with Civix seeking unspecified damages, which CoStar said it would vigorously defend, and a LoopNet merger shareholder case with a proposed settlement estimated at approximately $200,000; a court hearing was scheduled for February 2014. Management said it could not predict the Civix outcome and did not consider pending litigation likely to have a material adverse effect overall.
Important facts for investors to verify
- How much reported growth reflects recurring organic sales and cross-selling versus LoopNet’s inclusion and other acquisition effects.
- Whether renewal rates stabilize and recently introduced products produce the anticipated revenue growth relative to added sales, marketing and development costs.
- How stock-based compensation, including performance awards, affects GAAP earnings, dilution and future cash tax payments; the filing estimated approximately $30 million of cash tax withholding payments upon award vesting, subject to assumptions.
- Debt amortization, variable-rate exposure and covenant headroom; a 25-basis-point rate increase was estimated to add approximately $400,000 in annual interest expense.
- Recoverability and liquidity of the auction-rate securities, and developments in the Civix litigation and shareholder settlement proceedings.