COSTAR GROUP, INC. quarterly report, Q1 FY2015

Business context and reporting period

CoStar Group, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2015. The company provides commercial real estate information, analytics and online marketplaces, with North America and International operating segments. Most subscription services are sold under automatically renewing agreements, typically with one-year terms.

Financial performance and key metrics

• Revenue increased 33.5%, primarily reflecting approximately $26.1 million from Apartments.com, acquired April 1, 2014, alongside subscription growth and cross-selling. North America revenue was $153.0 million; International revenue was $6.0 million.
• Cash and cash equivalents were $541.8 million at quarter-end, up from $527.0 million at December 31, 2014. Investing activities used $11.1 million and financing activities used $4.1 million in the quarter.
• Long-term debt totaled $380.0 million: $20.0 million current and $360.0 million long-term. No revolving credit borrowings were outstanding; the facility provides up to $225.0 million. The company reported compliance with credit agreement covenants.
• Current assets were $627.7 million and current liabilities were $135.9 million. Long-term investments included $16.7 million of auction rate securities (ARS).

Material changes versus the prior comparable period

• The company moved from net income to a net loss as selling and marketing expense rose to $69.5 million from $27.7 million. The increase was primarily driven by the Apartments.com marketing campaign; advertising costs were $34.6 million versus $2.6 million.
• Management said the Apartments.com campaign began in Q1 and would continue through 2015, with an incremental investment of $75.0 million above Apartments.com’s 2014 annualized marketing spend since the acquisition.
• North America EBITDA declined to $13.7 million from $26.4 million, primarily due to the campaign. International EBITDA was relatively stable at $0.6 million.
• Gross margin percentage edged down to 71.5% from 71.7%. Purchase amortization rose to $7.1 million from $3.3 million, principally due to the Apartments.com acquisition.
• CoStar impaired $1.4 million of acquired Apartments.com database technology after replacing it for the February 2015 website launch.
• Trailing twelve-month CoStar subscription renewal rates were 91%, compared with 93% a year earlier; annualized net new sales on annual subscription contracts were $16.2 million versus $14.7 million.

Outlook, commentary, risks and unusual items

• Management expects 2015 capital expenditures of approximately $30 million to $40 million, primarily for leased office build-outs. It stated available cash and expected operating cash flows should fund operations for at least the next 12 months.
• Management expects existing services to remain profitable and generate cash flow, while cautioning that investments, service changes or other events could produce future losses or negative operating cash flow. It said technology enhancements are expected to support revenue growth in 2015 and beyond.
• After quarter-end, CoStar agreed to acquire Apartment Finder for $170 million in cash, subject to adjustments and customary closing conditions. The deal was signed April 27, 2015, with closing expected within 90 days; the company could not yet estimate its financial impact.
• ARS had $18.0 million par value and had failed to settle at auction; the company may not be able to liquidate them promptly at par. Their $16.7 million fair value included a $0.5 million temporary unrealized loss in accumulated other comprehensive loss. Further fair-value losses or an earnings impairment remain possible.
• Debt bears variable interest. The filing estimates that a 25-basis-point rate change would alter annual interest expense by approximately $1.0 million. The company did not hedge foreign-currency exposure; translation losses in accumulated other comprehensive loss were approximately $7.0 million.
• Management said current litigation was not probable to result in a loss and that it could not estimate a possible loss range; no liability was recorded. The filing also cited acquisition-integration, customer retention, marketing returns, competition, economic conditions and service-transition execution as risks.
• The effective tax rate was approximately negative 10% in Q1 2015 versus 38% in Q1 2014, primarily due to a local tax-law change. The filing reported $0.6 million of tax expense despite the pretax loss.

Important facts for investors to verify

• Whether Apartments.com marketing spend drives sufficient traffic, advertiser demand, subscription sales and renewal rates to offset its substantial near-term cost.
• Apartment Finder transaction completion, final purchase price, financing and integration costs, and expected synergies.
• Underlying subscription growth and renewal trends, including the decline in the reported renewal rate to 91%.
• Debt repayment schedule, variable-rate exposure, covenant headroom and liquidity after planned acquisition and capital spending.
• Recoverability of acquisition-related goodwill and intangible assets, including any further effects from product or service changes.
• Liquidity and valuation of the failed-auction ARS, and developments in litigation or other contingencies.