CoStar Group, Inc. — Q2 2018 Form 10-Q
Business context and period. Quarterly period ended June 30, 2018; comparisons are with Q2 and first half of 2017. CoStar provides commercial real estate information, analytics and online marketplaces, principally through subscription services. The statements are unaudited. CoStar acquired ForRent on February 21, 2018.
Key financial results
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $297.0 | $237.2 | $570.7 | $463.7 |
| Gross profit / margin | $229.9 / 77% | $181.9 / 77% | $441.1 / 77% | $357.1 / 77% |
| Operating income | $43.8 | $27.9 | $97.2 | $65.5 |
| Net income | $43.8 | $22.2 | $96.1 | $44.3 |
| Diluted EPS | $1.20 | $0.68 | $2.64 | $1.36 |
| Operating cash flow | Not separately stated | Not separately stated | $119.3 | $95.4 |
- Q2 revenue increased 25%; operating income increased 57%; net income increased 98%. First-half revenue rose 23%, operating income 48% and net income 117%.
- Q2 revenue growth was led by multifamily (+54% to $104.8 million) and CoStar Suite (+18% to $133.8 million). Commercial property and land revenue rose 16% to $42.7 million; information services fell 14% to $15.7 million as legacy LoopNet services were phased down.
- Cash and cash equivalents were $966.3 million at June 30, down from $1.211 billion at year-end 2017. Current assets were $1.076 billion and current liabilities $145.9 million.
- No long-term debt was outstanding. The company had a $750 million, five-year revolving facility and reported compliance with its covenants. First-half investing cash use was $355.9 million, primarily reflecting the ForRent acquisition; financing cash use was $8.2 million.
- Q2 and first-half operating margins were approximately 14.7% and 17.0%, versus 11.8% and 14.1%; net margins were approximately 14.8% and 16.8%, versus 9.4% and 9.6%, respectively.
Material changes and notable items
- ForRent was acquired for approximately $376 million: $340 million cash and $36 million in CoStar shares, subject to working-capital adjustment. The company recorded approximately $267 million of goodwill. ForRent contributed about $30 million of revenue from acquisition through June 30; its estimated $21 million net loss reflected personnel, severance and retention costs and acquired-intangible amortization. Purchase accounting remained preliminary.
- CoStar said revenue growth in 2018 was expected to be higher mainly because of ForRent, with organic growth expected to remain the same or be slightly higher than in 2017. Multifamily revenue was expected to continue increasing in the second half. CoStar Suite growth was expected to remain consistent with historical rates; information-services growth was expected to decline as LoopNet information services were wound down.
- Management planned continued investment in sales, marketing, research and product development; advertising and marketing spend for the rest of 2018 was expected to exceed 2017. Capital expenditures were also expected to increase in 2018 for office build-out and technology.
- ASC 606 was adopted January 1, 2018 using the modified-retrospective method, increasing opening retained earnings by $54.5 million. The new treatment defers and amortizes eligible contract commissions over three years. Management estimated that without adoption, first-half net income would have been about $4 million lower.
- The effective tax rate fell to 4% in Q2 and 5% for the first half, versus 14% and 28%, respectively, mainly due to the Tax Act, excess share-based tax benefits and state R&D credits. Tax accounting under the Tax Act was not yet complete; management expected to complete it within the one-year measurement period.
Outlook, risks and contingencies
- Management believed available cash and operating cash flow would fund operations for at least the next 12 months. Future capital needs depend in part on integration, expansion and acquisition activity; the company expected to continue considering acquisitions.
- Key execution risks include integrating ForRent and realizing expected synergies, customer retention and renewal rates, marketing returns, transitioning LoopNet to a pay-to-list marketplace, product development, competition, data quality, privacy and security, and economic and commercial real estate conditions. CoStar disclosed a 91% renewal rate for annual CoStar subscription contracts in the first half, unchanged year over year, and anticipated a slight future decline as multifamily services grow.
- Current litigation was not considered probable to result in a loss; management could not estimate a possible loss range and recorded no liability. ForRent purchase accounting includes estimated sales-tax and uncertain-tax-position liabilities, with seller indemnification subject to limitations.
- Approximately $11 million par value of auction-rate securities had failed to settle at auction. CoStar reported a $10.1 million fair value and considered the unrealized loss temporary, but noted it may not be able to liquidate the securities promptly or at par. Foreign-currency movements are unhedged.
- Adoption of the new lease accounting standard was expected to materially increase reported balance-sheet assets and liabilities. Disclosure controls were assessed as effective; implementation of a new financial system was expected to continue through 2019.
Investor verification priorities
- Separate ForRent’s acquired revenue and integration, retention, severance and amortization effects from organic growth and assess whether expected synergies materialize.
- Track multifamily growth and renewal rates, CoStar Suite performance, and the revenue and profitability effects of the LoopNet service transition.
- Reconcile cash generation with acquisition and capital spending, and monitor cash balances, acquisition plans and revolver availability.
- Review the final ForRent purchase-price allocation and tax-related estimates, as well as completion of the Tax Act accounting.
- Assess the liquidity and valuation risk in failed-auction securities and the potential balance-sheet effect of lease-standard adoption.