filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
87K characters. Original on sec.gov · Markdown
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements,” including statements about our beliefs and expectations. There are many risks and uncertainties that could cause actual results to differ materially from those discussed in the forward-looking statements. Potential factors that could cause actual results to differ materially from those discussed in any forward-looking statements include, but are not limited to, those stated above in Item 1A. under the headings “Risk Factors - Cautionary Statement Concerning Forward-Looking Statements” and “ Risk Factors,” as well as those described from time to time in our filings with the Securities and Exchange Commission.
All forward-looking statements are based on information available to us on the date of this filing and we assume no obligation to update such statements, whether as a result of new information, future events or otherwise. The following discussion should be read in conjunction with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings with the Securities and Exchange Commission and the consolidated financial statements and related notes included in this Annual Report on Form 10-K.
Overview
CoStar Group, Inc. (the “Company” or “CoStar”) is the number one provider of information, analytics and online marketplaces to the commercial real estate industry in the United States (“U.S.”) and the United Kingdom (“U.K.”) based on the fact that we offer the most comprehensive commercial real estate database available; have the largest research department in the industry; own and operate leading online marketplaces for commercial real estate and apartment listings in the U.S. based on the numbers of unique visitors and site visits per month; provide more information, analytics and marketing services than any of our competitors and believe that we generate more revenues than any of our commercial real estate information and online marketplace competitors. We created and compiled our standardized platform of information, analytics and online marketplace services where industry professionals and consumers of commercial real estate, including apartments, and the related business communities, can continuously interact and facilitate transactions by efficiently accessing and exchanging accurate and standardized real estate-related information.
We have five flagship brands - CoStar®, LoopNet®, Apartments.comTM, BizBuySell® and LandsofAmericaTM. Our subscription-based services consist primarily of information, analytics and online marketplace services offered over the Internet to commercial real estate industry and related professionals. Our subscription-based information services consist primarily of CoStar Suite® services. CoStar Suite is sold as a platform of service offerings consisting of CoStar Property Professional®, CoStar COMPS Professional® and CoStar Tenant® and through our mobile application, CoStar Go®. Our integrated suite of online service offerings includes information about space available for lease, comparable sales information, information about properties for sale, tenant information, Internet marketing services, analytical capabilities, information for clients' websites, information about industry professionals and their business relationships, data integration and industry news. We provide market research, consulting and analysis for commercial real estate investors and lenders via our CoStar Portfolio Strategy and CoStar Suite service offerings; portfolio and debt analysis, management and reporting capabilities through our CoStar Investment Analysis and CoStar Risk Analytics service offerings; and, real estate and lease management solutions, including lease administration and abstraction services, through our CoStar Real Estate Manager service offerings.
Our LoopNet subscription-based online marketplace services enable commercial property owners, landlords and real estate agents working on their behalf to list properties for sale or for lease and to submit detailed information about property listings. Commercial real estate agents, buyers and tenants also use LoopNet's online marketplace services to search for available property listings that meet their criteria.
Apartments.com is part of our network of apartment marketing sites, which also includes ApartmentFinder.comTM, ForRent.com®, ApartmentHomeLiving.comTM, WestsideRentals.com®, AFTER55.com®, CorporateHousing.comTM, ForRentUniversity.com® and Apartamentos.comTM, our apartment-listing site offered exclusively in Spanish. Our apartment marketing network of subscription-based services offers renters a searchable database of over one million listings and provides professional property management companies and landlords with an advertising destination. Our apartment marketing network draws on and leverages CoStar’s multifamily database, which contains detailed information on apartment properties. We designed the Apartments.com, ApartmentFinder.com and Apartamentos.com websites to meet renter preferences and demands, creating qualified renter prospects for our advertisers. We acquired the ForRent.com, AFTER55.com, CorporateHousing.com and ForRentUniversity.com sites when we completed the acquisition of ForRent, a division of Dominion Enterprises, on February 21, 2018. Our network of apartment marketing sites provide a comprehensive selection of rentals, information on actual availabilities and rents, and in-depth data on neighborhoods, including restaurants, nightlife, history, schools and other facts important to renters. To help renters find the information that meets their needs, the sites also offer innovative search tools such as the PolygonTM Search tool, which allows renters to specifically define the area in which they want to find an apartment. The Screening ProsTM is an
online apartment leasing platform that includes tenant screening services, rental applications and payments processing and lease renewals. On February 21 2018, we completed the acquisition of ForRent, a division of Dominion Enterprises, for a purchase price of approximately $385 million, payable approximately $350 million in cash and approximately $35 million in shares of CoStar Group common stock, subject to a customary working capital adjustment and other post-closing adjustments. Approximately $11 million of the cash consideration was placed in escrow to be used for potential employee stay bonuses.
Similar to our other past acquisitions, we have been, and plan to continue, integrating, further developing and cross-selling the services offered by Apartments.com, ApartmentFinder.com and Westside Rentals and the other services we offer, including but not limited to CoStar Suite. Now that we have completed the ForRent acquisition, we plan to develop and cross-sell the services offered by ForRent. We have incurred and plan to continue to incur product development costs to improve the online Apartments.com and ApartmentFinder.com platforms and Apartamentos.com. We have incurred and plan to continue to incur sales and marketing expenses in order to support the Apartments.com network and to increase brand awareness. To generate brand awareness and site traffic for the Apartments.com network, we utilize a multi-channel marketing campaign featuring television and radio advertising, online/digital advertising, social media and out-of-home ads and reinforced that advertising with Search Engine Marketing. We plan to continue to utilize these marketing methods and will continue to work to determine the optimal level of marketing investment for our services for future periods.
Our BizBuySell services, which include BizQuest®, provide an online marketplace for businesses for sale. Our Land.com network of sites, which provide online marketplaces for rural lands for sale, includes LandsofAmerica, LandAndFarm and LandWatch®.
Our service offerings span all commercial property types, including office, retail, industrial, multifamily, commercial land, mixed-use and hospitality.
Subscription-Based Services
Our subscription-based services consist primarily of information, analytics and online marketplace services offered over the Internet to commercial real estate industry and related professionals. Our services are typically distributed to our clients under subscription-based license agreements that renew automatically, a majority of which have a term of one year. Upon renewal, many of the subscription contract rates may change in accordance with contract provisions or as a result of contract renegotiations. To encourage clients to use our services regularly, we generally charge a fixed monthly amount for our subscription-based services rather than charging fees based on actual system usage or number of paid clicks. Depending on the type of service, contract rates are generally based on the number of sites, number of users, organization size, the client's business focus, geography, the number and types of services to which a client subscribes, the number of properties a client advertises and the prominence and placement of a client's advertised properties in the search results. Our subscription clients generally pay contract fees in advance on a monthly basis, but in some cases may pay us in advance on a quarterly or annual basis.
As of December 31, 2017 and 2016, our annualized net bookings of subscription-based services on all contracts were approximately $43 million and $29 million, respectively, calculated based on the annualized amount of change in our sales resulting from all new subscription-based contracts or upsales on all existing subscription-based contracts, less write downs and cancellations, for the period reported. Our net bookings is a quantitative measurement that is typically closely correlated with our subscription revenue results. Net bookings is considered a key indicator of future subscription revenue growth and is also used as a metric of salesforce productivity by management and investors. We recognize subscription revenues on a straight-line basis over the life of the contract.
For each of the twelve months ended December 31, 2017 and 2016, our contract renewal rate for existing CoStar subscription-based services on annual contracts was approximately 91% and 90%, respectively, and therefore our cancellation rate for those services was approximately 9% and 10%, respectively, for the same time periods. Our contract renewal rate is a quantitative measurement that is typically closely correlated with our revenue results. As a result, management also believes that the rate may be a reliable indicator of short-term and long-term performance. Our trailing twelve-month contract renewal rate may decline if, among other reasons, negative economic conditions lead to greater business failures and/or consolidations among our clients, reductions in customer spending, or decreases in our customer base.
Development, Investments and Expansion
We are committed to supporting and improving our information, news, analytic and online marketplace solutions. We expect to continue our software development efforts to improve existing services, introduce new services, integrate and cross-sell services, and expand and develop supporting technologies for our research, sales and marketing organizations. To generate brand awareness and site traffic for our listing sites, we utilize a variety of marketing campaigns, including television and radio advertising, online/digital advertising, social media and out-of-home ads, and Search Engine Marketing. We expect to continue to invest in sales and marketing in 2018. As we continue to assess the success and effectiveness of our marketing campaign, we will continue to work to determine the optimal level of marketing investment for our services for future periods.
Our key priorities for 2018 and recent developments include:
-
We are migrating all of our commercial real estate information capabilities to our flagship CoStar Suite product and winding down the legacy LoopNet Information products. This process began in the fall of 2017 with the integration of the CoStar and Loopnet databases. In addition, we are transitioning the LoopNet marketplace to a pure pay-to-list marketing site for commercial real estate. We completed integrating the backend systems of the LoopNet and CoStar databases during the second half of 2017; the two services now share a unified database of information, creating operating efficiencies and improving the data available to our customers. We also introduced new enhancements on the CoStar homepage, including a Listing Manager feature that we believe will increase the quantity and quality of the listing information available by enabling brokers and other industry participants to load information directly into the integrated system. This in turn is expected to reduce the time and costs associated with researching and maintaining our comprehensive database of commercial real estate information.
-
On February 21, 2018, we completed the acquisition of ForRent, a division of Dominion Enterprises, ForRent’s primary service is digital advertising through a network of four multifamily websites - which includes ForRent.com, AFTER55.com, CorporateHousing.com and ForRentUniversity.com. We plan to integrate, develop and cross-sell the services offered by ForRent. ForRent.com is expected to remain a distinct, complementary brand to Apartments.com, giving property managers and owners more exposure for their listings.
-
We plan to continue developing new, and improve existing, product and service offerings to the apartments industry. In particular, we expect to implement the ability for renters to apply for leases online, for landlords to run tenant credit and background checks and, eventually, for landlords and tenants to generate leases and process payments online.
-
We continue to invest in our research operations to support continued growth of our information and analytics offerings. We established our research operations headquarters in Richmond, Virginia, in December 2016, which is developing into a technology innovation hub, powering the software development necessary to support the content within our information, analytics and marketing services. In connection with the opening of the Richmond research headquarters, we have expanded our research team to continue to meet the growing content needs of our clients. In addition, we expect to continue to invest in our International research operations in Madrid, Spain and the U.K.
In support of our continued expansion and development, in October 2017, we completed a public equity offering of 3,317,308 shares of common stock for $260.00 per share. Net proceeds from the public equity offering were approximately $834 million, after deducting approximately $29 million of underwriting discounts and fees. We expect to use the net proceeds from the public equity offering to fund all or a portion of the costs of any strategic acquisitions we determine to pursue in the future, to finance the growth of our business and for working capital and other general corporate purposes. General corporate purposes may include additions to working capital, capital expenditures, repayment of debt, investments in the Company’s subsidiaries, possible acquisitions and the repurchase, redemption or retirement of securities, including the Company’s common stock.
On October 19, 2017, the Company entered into an amended and restated credit agreement (the ‘‘2017 Credit Agreement’’), which amended and restated in its entirety the existing 2014 Credit Agreement. The 2017 Credit Agreement provides for a $750
million revolving credit facility with a term of five years from a syndicate of financial institutions as lenders and issuing banks. The Company also paid off the remaining balance of $310 million and interest on its existing $400 million term loan under the 2014 Credit Agreement on October 19, 2017 from existing cash balances. The 2017 revolving credit facility may be used for working capital and other general corporate purposes of the Company and its subsidiaries. The Company had no outstanding long-term debt at December 31, 2017 as it had not drawn any amounts under its 2017 Credit Agreement. The restructured credit facility, along with the proceeds from the October equity offering and cash generated by the Company’s business are expected to support the Company’s continued growth and give the Company flexibility to act on strategic acquisition opportunities that may arise.
We intend to continue to assess the need for additional investments in our business, in addition to the investments discussed above, in order to develop and distribute new services within our current platform or expand the reach of our current service offerings. Any future product development or expansion of services, combination and coordination of services or elimination of services or corporate expansion, development or restructuring efforts could reduce our profitability and increase our capital expenditures. Any new investments, changes to our service offerings or other unforeseen events could cause us to experience reduced revenues or generate losses and negative cash flow from operations in the future. Any development efforts must comply with our credit facility, which contains restrictive covenants that restrict our operations and use of our cash flow and may prevent us from taking certain actions that we believe could increase our profitability or otherwise enhance our business.
Property Developments
As we have done in the past, we expect to continue to identify new facilities and consolidate existing facilities to better accommodate the changing demands of our business operations and employees. As a result, we may incur additional lease restructuring charges for the abandonment of certain lease space and the impairment of leasehold improvements.
Non-GAAP Financial Measures
We prepare and publicly release quarterly unaudited financial statements prepared in accordance with generally accepted accounting principles ("GAAP"). We also disclose and discuss certain non-GAAP financial measures in our public releases, investor conference calls and filings with the Securities and Exchange Commission. The non-GAAP financial measures that we may disclose include net income before interest and other income (expense), income taxes, depreciation and amortization (“EBITDA”), adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share (also referred to as “non-GAAP EPS”). EBITDA is our net income before interest, loss on debt extinguishment, income taxes, depreciation and amortization. We typically disclose EBITDA on a consolidated and an operating segment basis in our earnings releases, investor conference calls and filings with the Securities and Exchange Commission. Adjusted EBITDA is different from EBITDA because we further adjust EBITDA for stock-based compensation expense, acquisition and integration related costs, restructuring costs and settlements and impairments incurred outside our ordinary course of business. Non-GAAP net income and non-GAAP net income per diluted share are similarly adjusted for stock-based compensation expense, acquisition and integration related costs, restructuring costs, settlement and impairment costs and loss on debt extinguishment incurred outside our ordinary course of business as well as amortization of acquired intangible assets and other related costs. We may disclose adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share on a consolidated basis in our earnings releases, investor conference calls and filings with the Securities and Exchange Commission. The non-GAAP financial measures that we use may not be comparable to similarly titled measures reported by other companies. Also, in the future, we may disclose different non-GAAP financial measures in order to help our investors meaningfully evaluate and compare our results of operations to our previously reported results of operations or to those of other companies in our industry.
We view EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share as operating performance measures and as such we believe that the most directly comparable GAAP financial measure is net income. In calculating EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share, we exclude from net income (loss) the financial items that we believe should be separately identified to provide additional analysis of the financial components of the day-to-day operation of our business. We have outlined below the type and scope of these exclusions and the material limitations on the use of these non-GAAP financial measures as a result of these exclusions. EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share are not measurements of financial performance under GAAP and should not be considered as a measure of liquidity, as an alternative to net income (loss) or as an indicator of any other measure of performance derived in accordance with GAAP. Investors and potential investors in our securities should not rely on EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share as a substitute for any GAAP financial measure, including net income. In addition, we urge investors and potential investors in our securities to carefully review the GAAP financial information included as part of our Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q that are filed with the Securities and Exchange Commission, as well as our quarterly earnings releases, and compare the GAAP financial information with our EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share.
EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share may be used by management to internally measure our operating and management performance and may be used by investors as supplemental financial measures to evaluate the performance of our business. We believe that these non-GAAP measures, when viewed with our GAAP results and the accompanying reconciliation, provide additional information that is useful to understand the factors and trends affecting our business. We have spent more than 30 years building our database of commercial real estate information and expanding our markets and services partially through acquisitions of complementary businesses. Due to the expansion of our information, analytics and online marketplace services, which has included acquisitions, our net income has included significant charges for amortization of acquired intangible assets, depreciation and other amortization, acquisition and integration related costs, restructuring costs, and loss on debt extinguishment. Adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share exclude these charges and provide meaningful information about the operating performance of our business, apart from charges for amortization of acquired intangible assets, depreciation and other amortization, acquisition and integration related costs, restructuring costs; settlement and impairment costs incurred outside our ordinary course of business. We believe the disclosure of non-GAAP measures can help investors meaningfully evaluate and compare our performance from quarter to quarter and from year to year. We also believe the non-GAAP measures we disclose are measures of our ongoing operating performance because the isolation of non-cash charges, such as amortization and depreciation, and other items, such as interest, income taxes, stock-based compensation expenses, acquisition and integration related costs, restructuring costs; loss on debt extinguishment and settlement and impairment costs incurred outside our ordinary course of business, provides additional information about our cost structure, and, over time, helps track our operating progress. In addition, investors, securities analysts and others have regularly relied on EBITDA and may rely on adjusted EBITDA, non-GAAP net income or non-GAAP net income per diluted share to provide a financial measure by which to compare our operating performance against that of other companies in our industry.
Set forth below are descriptions of financial items that have been excluded from net income to calculate EBITDA and the material limitations associated with using this non-GAAP financial measure as compared to net income :
| • | Amortization of acquired intangible assets in cost of revenues may be useful for investors to consider because it represents the diminishing value of any acquired trade names and other intangible assets and the use of our acquired database technology, which is one of the sources of information for our database of commercial real estate information. We do not believe these charges necessarily reflect the current and ongoing cash charges related to our operating cost structure. |
| • | Amortization of acquired intangible assets in operating expenses may be useful for investors to consider because it represents the estimated attrition of our acquired customer base. We do not believe these charges necessarily reflect the current and ongoing cash charges related to our operating cost structure. |
| • | Depreciation and other amortization may be useful for investors to consider because they generally represent the wear and tear on our property and equipment used in our operations. We do not believe these charges necessarily reflect the current and ongoing cash charges related to our operating cost structure. |
| • | The amount of interest and other income we generate may be useful for investors to consider and may result in current cash inflows. However, we do not consider the amount of interest and other income to be a representative component of the day-to-day operating performance of our business. |
| • | The amount of interest and other expense we incur may be useful for investors to consider and may result in current cash outflows. However, we do not consider the amount of interest and other expense to be a representative component of the day-to-day operating performance of our business. |
| • | The amount of loss on our debt extinguishment may be useful for investors to consider and may result in current cash outflows. However, we do not consider the amount of the loss on debt extinguishment to be a representative component of the day-to-day operating performance of our business. |
| • | Income tax expense may be useful for investors to consider because it generally represents the taxes which may be payable for the period and the change in deferred income taxes during the period and may reduce the amount of funds otherwise available for use in our business. However, we do not consider the amount of income tax expense to be a representative component of the day-to-day operating performance of our business. |
Set forth below are descriptions of additional financial items that have been excluded from EBITDA to calculate adjusted EBITDA and the material limitations associated with using this non-GAAP financial measure as compared to net income:
| • | Stock-based compensation expense may be useful for investors to consider because it represents a portion of the compensation of our employees and executives. Determining the fair value of the stock-based instruments involves a |
high degree of judgment and estimation and the expenses recorded may bear little resemblance to the actual value realized upon the future exercise or termination of the related stock-based awards. Therefore, we believe it is useful to exclude stock-based compensation in order to better understand the long-term performance of our core business.
| • | The amount of acquisition and integration related costs incurred may be useful for investors to consider because they generally represent professional service fees and direct expenses related to acquisitions. Because we do not acquire businesses on a predictable cycle we do not consider the amount of acquisition and integration related costs to be a representative component of the day-to-day operating performance of our business. |
| • | The amount of restructuring costs incurred may be useful for investors to consider because they generally represent costs incurred in connection with a change in a contract or a change in the makeup of our properties or personnel. We do not consider the amount of restructuring related costs to be a representative component of the day-to-day operating performance of our business. |
| • | The amount of settlement and impairment costs incurred outside of our ordinary course of business may be useful for investors to consider because they generally represent gains or losses from the settlement of litigation matters or impairments on acquired intangible assets. We do not believe these charges necessarily reflect the current and ongoing cash charges related to our operating cost structure. |
| • | The amount of loss on our debt extinguishment may be useful for investors to consider because they generally represent gains or losses from the early extinguishment of debt. However, we do not consider the amount of the loss on debt extinguishment to be a representative component of the day-to-day operating performance of our business. |
The financial items that have been excluded from our net income to calculate non-GAAP net income and non-GAAP net income per diluted share are amortization of acquired intangible assets and other related costs, stock-based compensation, acquisition and integration related costs, restructuring and related costs, settlement and impairment costs, and loss on debt extinguishment incurred outside our ordinary course of business. These items are discussed above with respect to the calculation of adjusted EBITDA together with the material limitations associated with using this non-GAAP financial measure as compared to net income (loss). We subtract an assumed provision for income taxes to calculate non-GAAP net income. In 2017, 2016, and 2015, we assumed a 38% tax rate, which approximates our historical long-term statutory corporate tax rate, excluding the impact of discrete items.
Non-GAAP net income per diluted share is a non-GAAP financial measure that represents non-GAAP net income divided by the number of diluted shares outstanding for the period used in the calculation of GAAP net income per diluted share.
Management compensates for the above-described limitations of using non-GAAP measures by using a non-GAAP measure only to supplement our GAAP results and to provide additional information that is useful to understand the factors and trends affecting our business.
The following table shows our net income reconciled to our EBITDA and our net cash flows from operating, investing and financing activities for the indicated periods (in thousands):
| Year Ended December 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| Net income (loss) | $ | 122,695 | $ | 85,071 | $ | (3,465 | ) | ||||
| Amortization of acquired intangible assets in cost of revenues | 19,707 | 22,819 | 30,077 | ||||||||
| Amortization of acquired intangible assets in operating expenses | 17,684 | 22,731 | 27,931 | ||||||||
| Depreciation and other amortization | 26,252 | 24,615 | 20,524 | ||||||||
| Interest and other income | (4,044 | ) | (1,773 | ) | (537 | ) | |||||
| Interest and other expense | 9,014 | 10,016 | 9,411 | ||||||||
| Loss on debt extinguishment | 3,788 | — | — | ||||||||
| Income tax expense | 42,363 | 51,591 | 6,046 | ||||||||
| EBITDA | $ | 237,459 | $ | 215,070 | $ | 89,987 | |||||
| Net cash flows provided by (used in) | |||||||||||
| Operating activities | $ | 234,703 | $ | 200,642 | $ | 139,773 | |||||
| Investing activities | $ | (72,267 | ) | $ | (23,259 | ) | $ | (215,502 | ) | ||
| Financing activities | $ | 480,430 | $ | (30,563 | ) | $ | (29,032 | ) |
Consolidated Results of Operations
The following table provides our selected consolidated results of operations for the indicated periods (in thousands of dollars and as a percentage of total revenue):
| Year Ended December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2015 | ||||||||||||||||||
| Revenues | $ | 965,230 | 100 | % | $ | 837,630 | 100 | % | $ | 711,764 | 100 | % | ||||||||
| Cost of revenues | 220,403 | 23 | 173,814 | 21 | 188,885 | 27 | ||||||||||||||
| Gross profit | 744,827 | 77 | 663,816 | 79 | 522,879 | 73 | ||||||||||||||
| Operating expenses: | ||||||||||||||||||||
| Selling and marketing (excluding customer base amortization) | 318,362 | 33 | 296,483 | 35 | 302,226 | 42 | ||||||||||||||
| Software development | 88,850 | 9 | 76,400 | 9 | 65,760 | 9 | ||||||||||||||
| General and administrative | 146,128 | 15 | 123,297 | 15 | 115,507 | 16 | ||||||||||||||
| Customer base amortization | 17,671 | 2 | 22,731 | 3 | 27,931 | 4 | ||||||||||||||
| Total operating expenses | 571,011 | 59 | 518,911 | 62 | 511,424 | 72 | ||||||||||||||
| Income from operations | 173,816 | 18 | 144,905 | 17 | 11,455 | 1 | ||||||||||||||
| Interest and other income | 4,044 | — | 1,773 | — | 537 | — | ||||||||||||||
| Interest and other expense | (9,014 | ) | (1 | ) | (10,016 | ) | (1 | ) | (9,411 | ) | (1 | ) | ||||||||
| Loss on debt extinguishment | (3,788 | ) | (2 | ) | — | — | — | — | ||||||||||||
| Income before income taxes | 165,058 | 16 | 136,662 | 16 | 2,581 | — | ||||||||||||||
| Income tax expense | 42,363 | 4 | 51,591 | 6 | 6,046 | 1 | ||||||||||||||
| Net income (loss) | $ | 122,695 | 12 | % | $ | 85,071 | 10 | % | $ | (3,465 | ) | (1 | )% |
The following table provides our revenues by type of service (in thousands of dollars and as a percentage of total revenue):
| Year Ended December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2015 | ||||||||||||||||||
| Information and analytics | ||||||||||||||||||||
| CoStar Suite(1) | $ | 463,185 | 48 | % | $ | 408,456 | 49 | % | $ | 360,440 | 50 | % | ||||||||
| Information services(2) | 72,618 | 8 | 77,178 | 9 | 75,790 | 11 | ||||||||||||||
| Online marketplaces | ||||||||||||||||||||
| Multifamily(3) | 279,855 | 29 | 224,835 | 27 | 160,630 | 23 | ||||||||||||||
| Commercial property and land(4) | 149,572 | 15 | 127,161 | 15 | 114,904 | 16 | ||||||||||||||
| Total revenues | $ | 965,230 | 100 | % | $ | 837,630 | 100 | % | $ | 711,764 | 100 | % |
(1) CoStar Suite is comprised of CoStar Property Professional, CoStar COMPS Professional, CoStar Tenant; and CoStar Portfolio Strategy.
(2) Information services is comprised of LoopNet Premium Searcher; CoStar Real Estate Manager; CoStar Risk Analytics COMPASS; CoStar Investment Analysis Portfolio Maximizer; CoStar Investment Analysis Request; CoStar Brokerage Applications; PROPEX; Grecam; Belbex and Thomas Daily.
(3) Multifamily is comprised of Apartments.com, ApartmentFinder.com, ApartmentHomeLiving.com, WestsideRentals.com; Apartamentos.com; and The Screening Pros.
(4) Commercial property and land is comprised of LoopNet Premium Lister; LoopLink; CoStar Advertising; BizBuySell and BizQuest; LandsofAmerica, LandAndFarm and LandWatch; and CoStar Private Sale Network.
Comparison of Year Ended December 31, 2017 and Year Ended December 31, 2016
The following table provides a comparison of our selected consolidated results of operations for the year ended December 31, 2017 and 2016 (in thousands of dollars):
| 2017 | 2016 | Increase (Decrease) ($) | Increase (Decrease) (%) | |||||||||||
| Revenues | ||||||||||||||
| CoStar Suite | $ | 463,185 | $ | 408,456 | $ | 54,729 | 13 | % | ||||||
| Information services | 72,618 | 77,178 | (4,560 | ) | (6 | ) | ||||||||
| Multifamily | 279,855 | 224,835 | 55,020 | 24 | ||||||||||
| Commercial property and land | 149,572 | 127,161 | 22,411 | 18 | ||||||||||
| Total revenues | 965,230 | 837,630 | 127,600 | 15 | ||||||||||
| Cost of revenues | 220,403 | 173,814 | 46,589 | 27 | ||||||||||
| Gross profit | 744,827 | 663,816 | 81,011 | 12 | ||||||||||
| Operating expenses: | ||||||||||||||
| Selling and marketing (excluding customer base amortization) | 318,362 | 296,483 | 21,879 | 7 | ||||||||||
| Software development | 88,850 | 76,400 | 12,450 | 16 | ||||||||||
| General and administrative | 146,128 | 123,297 | 22,831 | 19 | ||||||||||
| Customer base amortization | 17,671 | 22,731 | (5,060 | ) | (22 | ) | ||||||||
| Total operating expenses | 571,011 | 518,911 | 52,100 | 10 | ||||||||||
| Income from operations | 173,816 | 144,905 | 28,911 | 20 | ||||||||||
| Interest and other income | 4,044 | 1,773 | 2,271 | 128 | ||||||||||
| Interest and other expense | (9,014 | ) | (10,016 | ) | (1,002 | ) | (10 | ) | ||||||
| Loss on extinguishment | (3,788 | ) | — | 3,788 | NM | |||||||||
| Income before income taxes | 165,058 | 136,662 | 28,396 | 21 | ||||||||||
| Income tax expense | 42,363 | 51,591 | (9,228 | ) | (18 | ) | ||||||||
| Net income | $ | 122,695 | $ | 85,071 | $ | 37,624 | 44 | % | ||||||
| __________________________ | ||||||||||||||
| NM - Not meaningful |
Revenues. Revenues increased to $965 million in 2017, from $838 million in 2016. The $127 million increase was primarily attributable to increased revenues of approximately $55 million or 13% from continued organic growth in CoStar Suite as well as a movement of our Loopnet customers onto our CoStar platform as a result of the Loopnet integration. Information Services decreased $5M or 6% primarily due to continued wind down of Loopnet Information products including Premium Searcher partially offset by increases in our Real Estate Manager offering. Multifamily year over year increases of $55 million or 24% was primarily attributable to organic growth as well as some smaller increases for several acquisitions. Commercial Property and Land revenue increased $22 million or 18% over 2016 primarily due to organic growth as well as an increase due to the Landwatch acquisition. Overall, revenue growth rates are expected to be in line or slightly higher than 2017.
Gross Profit. Gross profit increased to $745 million in 2017, from $664 million in 2016. The gross margin percentage decreased to 77% in 2017, from 79% in 2016. Revenue growth led to an increase in costs of revenues of $38 million for additional research personnel costs, $5 million in occupancy related costs from our new research office in Richmond offset by a decrease in the amortization of intangible assets of$4 million. Gross margins are impacted by the amortization of certain intangible assets acquired through acquisitions.
Selling and Marketing Expenses. Selling and marketing expenses increased to $318 million in 2017, from $296 million in 2016, and decreased as a percentage of revenues to 33% from 35%. The increase in the amount of selling and marketing expenses was primarily due to a $25 million increase in sales personnel costs related to increased commission expense from higher sales in 2017 partially offset by a $2 million decrease in digital marketing costs.
Software Development Expenses. Software development expenses increased to $89 million in 2017, from $76 million in 2016, and remained relatively consistent as a percentage of revenues at 9% for both 2017 and 2016. The increase in the amount of software development expense was primarily due to a $14 million increase in personnel costs to support enhancements and upgrades to our services and integration of the backend systems of the LoopNet and CoStar databases.
General and Administrative Expenses. General and administrative expenses increased 19% to $146 million in 2017, from $123 million in 2016, and remained relatively consistent as a percentage of revenues at 15% in 2017 and 2016. The increase in the amount of general and administrative expenses was primarily due to legal costs related to litigation of approximately $13 million, an increase in administrative personnel costs of $5 million to support the ongoing growth of the business, and a $3 million increase in charitable donations.
Customer Base Amortization Expense. Customer base amortization expense decreased to approximately $18 million in 2017, from $23 million in 2016, and decreased as a percentage of revenues to 2% in 2017, compared to 3% in 2016. The decrease in the amount and percentage of customer base amortization expense was primarily due to the accelerated amortization of acquired customer bases in 2016 as compared to 2017.
Interest and Other Income. Interest and other income increased to approximately $4 million in 2017 compared to approximately $2 million in 2016. The increase was primarily due to increased short term investments on a larger cash balance in 2017 than in 2016 mainly due to net proceeds of $834 million from the equity offering in October 2017.
Interest and Other Expense. Interest and other expense remained relatively consistent at $9 million in 2017 compared to $10 million in 2016. The decrease was primarily due to the repayment of outstanding debt in October 2017 in conjunction with the 2017 Credit Agreement offset by higher interest rates on outstanding debt in 2017 compared to 2016.
Loss on Extinguishment. The loss on extinguishment was due to the restatement and amendment of the 2014 Credit Agreement as the 2017 Credit Agreement, which resulted in a loss on debt extinguishment of approximately $4 million.
Income Tax Expense. Income tax expense decreased to $42 million in 2017 compared to $52 million in 2016. Without the effect of discrete items, income tax expense would have increased by approximately $12 million. Discrete items resulted in a reduction in tax expense of approximately $22 million including the revaluation of the deferred tax liability at the lower federal statutory tax rate resulting in a $7 million benefit. We also recognized approximately $8 million benefit in net research and development tax benefits related to the periods 2013-2017. Finally, we recognized $7 million benefit from the impact of the accounting rule change in ASU 2016-09 that provided for recognizing excess tax benefits in income tax expense as compared to additional paid in capital, which was the treatment prior to 2017.
Comparison of Business Segment Results for Year Ended December 31, 2017 and Year Ended December 31, 2016
We manage our business geographically in two operating segments, with our primary areas of measurement and decision-making being North America, which includes the U.S. and Canada, and International, which includes the U.K., Spain, Germany and France. Management relies on an internal management reporting process that provides revenues and operating segment EBITDA, which is our net income (loss) before interest, income taxes, depreciation and amortization. Management believes that operating segment EBITDA is an appropriate measure for evaluating the operational performance of our operating segments. EBITDA is used by management to internally measure our operating and management performance and to evaluate the performance of our business. However, this measure should be considered in addition to, not as a substitute for or superior to, income from operations or other measures of financial performance prepared in accordance with GAAP.
Segment Revenues. North America revenues increased to $934 million for the year ended December 31, 2017, compared to $809 million for the year ended December 31, 2016. This increase in North America revenues was primarily due to increased revenues of approximately $55 million from our Multifamily products, and an increase of $55 million in CoStar Suite from the continued growth of our subscription-based services due to successful cross-selling of our services to our customers in existing markets, combined with continued high renewal rates. International revenues increased to $31 million for the year ended December 31, 2017, compared to $28 million for the year ended December 31, 2016. This increase was primarily due to continued growth of our subscription-based information services resulting from sales of CoStar Suite.
Segment EBITDA. North America EBITDA increased to $237 million for the year ended December 31, 2017, compared to $211 million for the year ended December 31, 2016. The increase in North America EBITDA was due primarily to an increase in revenues of $125 million primarily offset by increased personnel costs from additional investments in our research operations and the opening of our Richmond research headquarters as well as increased legal costs. International EBITDA decreased to $1 million
for the year ended December 31, 2017, compared to $4 million for the year ended December 31, 2016. This decrease in International EBITDA was primarily due to an increase in personnel costs from the relocation of our European research headquarters from Glasgow, Scotland to London, England and as a result of increased headcount from investments in our International research operations in Madrid, Spain and the U.K.
Comparison of Year Ended December 31, 2016 and Year Ended December 31, 2015
The following table provides a comparison of our selected consolidated results of operations for the year ended December 31, 2016 and 2015 (in thousands of dollars):
| 2016 | 2015 | Increase (Decrease) ($) | Increase (Decrease) (%) | |||||||||||
| Revenues | ||||||||||||||
| CoStar Suite | $ | 408,456 | $ | 360,440 | $ | 48,016 | 13 | % | ||||||
| Information services | 77,178 | 75,790 | 1,388 | 2 | ||||||||||
| Multifamily | 224,835 | 160,630 | 64,205 | 40 | ||||||||||
| Commercial property and land | 127,161 | 114,904 | 12,257 | 11 | ||||||||||
| Total revenues | 837,630 | 711,764 | 125,866 | 18 | ||||||||||
| Cost of revenues | 173,814 | 188,885 | (15,071 | ) | (8 | ) | ||||||||
| Gross profit | 663,816 | 522,879 | 140,937 | 27 | ||||||||||
| Operating expenses: | ||||||||||||||
| Selling and marketing (excluding customer base amortization) | 296,483 | 302,226 | (5,743 | ) | (2 | ) | ||||||||
| Software development | 76,400 | 65,760 | 10,640 | 16 | ||||||||||
| General and administrative | 123,297 | 115,507 | 7,790 | 7 | ||||||||||
| Customer base amortization | 22,731 | 27,931 | (5,200 | ) | (19 | ) | ||||||||
| Total operating expenses | 518,911 | 511,424 | 7,487 | 1 | ||||||||||
| Income from operations | 144,905 | 11,455 | 133,450 | NM | ||||||||||
| Interest and other income | 1,773 | 537 | 1,236 | NM | ||||||||||
| Interest and other expense | (10,016 | ) | (9,411 | ) | 605 | 6 | ||||||||
| Income before income taxes | 136,662 | 2,581 | 134,081 | NM | ||||||||||
| Income tax expense | 51,591 | 6,046 | 45,545 | NM | ||||||||||
| Net income (loss) | $ | 85,071 | $ | (3,465 | ) | $ | 88,536 | NM |
Revenues. Revenues increased to $838 million in 2016, from $712 million in 2015. The $126 million increase was primarily attributable to increased revenues of approximately $64 million from our Apartments Network primarily related to the acquisition of Apartment Finder on June 1, 2015 as well as continued organic growth in CoStar Suite and Multifamily revenues.
Gross Profit. Gross profit increased to $664 million in 2016, from $523 million in 2015. The gross margin percentage increased to 79% in 2016, from 73% in 2015. The increase in the gross profit amount and percentage was principally due to an increase in revenues as well as a decrease in cost of revenues of $15 million. The decrease in costs of revenues is primarily due to a $7 million decrease in the amortization of intangible assets and a $6 million decrease in research personnel costs.
Selling and Marketing Expenses. Selling and marketing expenses decreased to $296 million in 2016, from $302 million in 2015, and decreased as a percentage of revenues to 35% in 2016, from 42% in 2015. The decrease in the amount and percentage of selling and marketing expenses was primarily due to a $19 million decrease in marketing expense for the wide-scale marketing campaign to generate brand awareness and site traffic for Apartments.com, partially offset by a $14 million increase in sales personnel costs.
Software Development Expenses. Software development expenses increased to $76 million in 2016, from $66 million in 2015, and remained relatively consistent as a percentage of revenues at 9% in 2016 and 2015. The increase in the amount of software development expense was primarily due to an increase in personnel costs to support enhancements and upgrades to our services and continued work to integrate the backend systems of the LoopNet and CoStar databases.
General and Administrative Expenses. General and administrative expenses increased to $123 million in 2016, from $116 million in 2015, and decreased as a percentage of revenues to 15% in 2016 from 16% in 2015. The increase in the amount of general and administrative expenses was primarily due to legal costs related to litigation of approximately $6 million incurred during 2016 that did not occur during 2015, as well as an increase in lease restructuring charges of $2 million for the abandonment of certain lease space and the impairment of leasehold improvements in 2016 compared to 2015.
Customer Base Amortization Expense. Customer base amortization expense decreased to approximately $23 million in 2016, from $28 million in 2015, and decreased as a percentage of revenues to 3% in 2016, compared to 4% in 2015. The decrease in the amount and percentage of customer base amortization expense was primarily due to the accelerated amortization of acquired customer bases in 2015 as compared to 2016.
Interest and Other Income. Interest and other income increased to approximately $2 million in 2016 compared to approximately $537,000 in 2015. The increase was primarily due to a realized gain of approximately $808,000 on investments in auction rate securities (“ARS”) in 2016 that did not occur in 2015.
Interest and Other Expense. Interest and other expense remained relatively consistent at $10 million in 2016 compared to $9 million in 2015.
Income Tax Expense. Income tax expense increased to $52 million in 2016 compared to $6 million in 2015. This increase was primarily due to higher income before income taxes in 2016 as compared to 2015 as a result of our increased revenues.
Comparison of Business Segment Results for Year Ended December 31, 2016 and Year Ended December 31, 2015
We manage our business geographically in two operating segments, with our primary areas of measurement and decision-making being North America, which includes the U.S. and Canada, and International, which includes the U.K., Spain, Germany and France. Management relies on an internal management reporting process that provides revenues and operating segment EBITDA, which is our net income (loss) before interest, income taxes, depreciation and amortization. Management believes that operating segment EBITDA is an appropriate measure for evaluating the operational performance of our operating segments. EBITDA is used by management to internally measure our operating and management performance and to evaluate the performance of our business. However, this measure should be considered in addition to, not as a substitute for or superior to, income from operations or other measures of financial performance prepared in accordance with GAAP.
Segment Revenues. North America revenues increased to $809 million for the year ended December 31, 2016, compared to $687 million for the year ended December 31, 2015. This increase in North America revenues was primarily due to increased revenues of approximately $64 million from our Apartments Network, as well as the further penetration of our subscription-based services and successful cross-selling of our services to our customers in existing markets, combined with continued high renewal rates. International revenues increased to $28 million for the year ended December 31, 2016, compared to $25 million for the year ended December 31, 2015. This increase was primarily due to further penetration of our subscription-based information services resulting from sales of CoStar Suite.
Segment EBITDA. North America EBITDA increased to $211 million for the year ended December 31, 2016, compared to $87 million for the year ended December 31, 2015. The increase in North America EBITDA was due primarily to an increase in revenues. International EBITDA increased to $4 million for the year ended December 31, 2016, compared to $3 million for the year ended December 31, 2015. This increase in International EBITDA was primarily due to an increase in revenues.
Consolidated Quarterly Results of Operations
The following tables present our unaudited consolidated results of operations on a quarterly basis for the indicated periods (in thousands, except per share amounts, and as a percentage of total revenues). These tables should be read in conjunction with the consolidated financial statements and related notes included in this Annual Report on Form 10-K. The quarterly results of historical periods are not necessarily indicative of quarterly results for any future period.
| 2017 | 2016 | ||||||||||||||||||||||||||||||
| Mar. 31 | Jun. 30 | Sep. 30 | Dec. 31 | Mar. 31 | Jun. 30 | Sep. 30 | Dec. 31 | ||||||||||||||||||||||||
| Revenues | $ | 226,553 | $ | 237,153 | $ | 247,533 | $ | 253,991 | $ | 199,739 | $ | 206,869 | $ | 212,711 | $ | 218,311 | |||||||||||||||
| Cost of revenues | 51,346 | 55,273 | 55,483 | 58,301 | 42,900 | 42,679 | 42,222 | 46,013 | |||||||||||||||||||||||
| Gross profit | 175,207 | 181,880 | 192,050 | 195,690 | 156,839 | 164,190 | 170,489 | 172,298 | |||||||||||||||||||||||
| Operating expenses | 137,545 | 153,997 | 134,537 | 144,932 | 126,538 | 136,071 | 130,893 | 125,409 | |||||||||||||||||||||||
| Income from operations | 37,662 | 27,883 | 57,513 | 50,758 | 30,301 | 28,119 | 39,596 | 46,889 | |||||||||||||||||||||||
| Interest and other income | 429 | 605 | 555 | 2,455 | 84 | 159 | 344 | 1,186 | |||||||||||||||||||||||
| Interest and other expense | (2,686 | ) | (2,693 | ) | (2,901 | ) | (734 | ) | (2,509 | ) | (2,455 | ) | (2,498 | ) | (2,554 | ) | |||||||||||||||
| Loss on debt extinguishment | — | — | — | (3,788 | ) | — | — | — | — | ||||||||||||||||||||||
| Income (loss) before income taxes | 35,405 | 25,795 | 55,167 | 48,691 | 27,876 | 25,823 | 37,442 | 45,521 | |||||||||||||||||||||||
| Income tax expense | 13,275 | 3,611 | 20,990 | 4,487 | 11,155 | 10,247 | 14,241 | 15,948 | |||||||||||||||||||||||
| Net income | $ | 22,130 | $ | 22,184 | $ | 34,177 | $ | 44,204 | $ | 16,721 | $ | 15,576 | $ | 23,201 | $ | 29,573 | |||||||||||||||
| Net income per share — basic | $ | 0.69 | $ | 0.68 | $ | 1.05 | $ | 1.24 | $ | 0.52 | $ | 0.48 | $ | 0.72 | $ | 0.92 | |||||||||||||||
| Net income per share — diluted | $ | 0.68 | $ | 0.68 | $ | 1.04 | $ | 1.22 | $ | 0.52 | $ | 0.48 | $ | 0.72 | $ | 0.91 |
| 2017 | 2016 | ||||||||||||||||||||||
| Mar. 31 | Jun. 30 | Sep. 30 | Dec. 31 | Mar. 31 | Jun. 30 | Sep. 30 | Dec. 31 | ||||||||||||||||
| Revenues | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % | |||||||
| Cost of revenues | 23 | 23 | 22 | 23 | 21 | 21 | 20 | 21 | |||||||||||||||
| Gross profit | 77 | 77 | 78 | 77 | 79 | 79 | 80 | 79 | |||||||||||||||
| Operating expenses | 60 | 65 | 55 | 58 | 64 | 65 | 61 | 58 | |||||||||||||||
| Income from operations | 17 | 12 | 23 | 19 | 15 | 14 | 19 | 21 | |||||||||||||||
| Interest and other income | — | — | — | 1 | — | — | — | 1 | |||||||||||||||
| Interest and other expense | (1 | ) | (1 | ) | (1 | ) | — | (1 | ) | (1 | ) | (1 | ) | (1 | ) | ||||||||
| Loss on debt extinguishment | — | — | — | (1 | ) | — | — | — | — | ||||||||||||||
| Income before income taxes | 16 | 11 | 22 | 19 | 14 | 13 | 18 | 21 | |||||||||||||||
| Income tax expense | 6 | 2 | 8 | 2 | 6 | 5 | 7 | 7 | |||||||||||||||
| Net income | 10 | % | 9 | % | 14 | % | 17 | % | 8 | % | 8 | % | 11 | % | 14 | % |
Liquidity and Capital Resources
Our principal sources of liquidity are cash and cash equivalents, and cash from operations. Total cash and cash equivalents increased to $1 billion at December 31, 2017 compared to cash and cash equivalents of $567 million at December 31, 2016. The increase in cash and cash equivalents for the year ended December 31, 2017 was primarily due to $834 million in net proceeds from our public equity offering in October 2017 of 3,317,308 shares of common stock for $260.00 per share after deducting underwriting discounts and fees of $29 million. In addition, the Company generated net cash provided by operating activities of approximately $235 million, partially offset by debt payments of $345 million, purchase of property, equipment and other assets of approximately $24 million, and payments made for acquisitions including LandWatch, Westside Rentals and The Screening Pros totaling approximately $48 million.
Changes in cash and cash equivalents are dependent upon changes in, among other things, working capital items such as accounts receivable, accounts payable, accrued expenses and deferred revenues, as well as proceeds from the exercise of stock options offset by issuance of shares to cover taxes.
Net cash provided by operating activities for the year ended December 31, 2017 was $235 million compared to $201 million for the year ended December 31, 2016 and $140 million for the year ended December 31, 2015. The $34 million and $61 million increase from December 31, 2016 to December 31, 2017 and from December 31, 2015 to December 31, 2016, respectively, is primarily due to higher income from operations in both periods. Income from operations was partially offset fluctuations in working capital.
Net cash used in investing activities for the year ended December 31, 2017 was $72 million compared to $23 million for the year ended December 31, 2016 and $216 million for the year ended December 31, 2015. The $49 million increase in investing activities in 2017 compared to 2016 was primarily due to the increase in cash used for acquisitions from 2016 to 2017. 2017 included cash payments for the acquisitions of Westside Rentals for $14 million, a $31 million payment for LandWatch and a $3 million payment for the acquisition of The Screening Pros. During 2017, we incurred capital expenditures of approximately $24 million primarily related to computer equipment and leasehold improvements for build out of sales office space. We expect capital expenditures to increase in 2018 related to the build out of leased office space, including the Richmond research headquarters, as well as investments in technology.
The $192 million decrease in investing activities in 2016 compared to 2015 was primarily due to the decrease in cash used for acquisitions from 2015 to 2016. The $182 million of net cash used for acquisitions in 2015 included $179 million for the acquisition of Apartment Finder and certain assets related to the business operations of Apartment Finder's independent distributors as well as $3 million for the acquisition of the assets of Belbex Corporate, S.L. In 2016, we spent $10 million for the acquisitions of Thomas Daily and certain assets related to the business operations of Apartment Finder's independent distributors. During 2016, we incurred capital expenditures of approximately $19 million primarily related to computer equipment and leasehold improvements for build out of sales office space.
Net cash provided by financing activities for the year ended December 31, 2017 was $480 million compared to net cash used in financing activities of $31 million for the year ended December 31, 2016 and $29 million in December 31, 2015. This $511 million increase from 2016 to 2017 was primarily due to $834 million in net proceeds from our equity offering offset by an increase in debt repayments in 2017 of $325 million.
Our future capital requirements will depend on many factors, including, among others, our operating results, expansion and integration efforts, and our level of acquisition activity or other strategic transactions. To date, we have grown in part by acquiring other companies, and we expect to continue to make acquisitions. On January 31, 2017, we acquired Westside Rentals; on May 10, 2017, we acquired LandWatch; and on July 18, 2017, we acquired The Screening Pros. On February 21, 2018, we completed the acquisition of ForRent, a division of Dominion Enterprises, for approximately $350 million in cash and approximately $35 million in CoStar Group stock, subject to customary working capital and other post-closing adjustments. Our future acquisitions may vary in size and could be material to our current operations. We may use cash, stock, debt or other means of funding to make these acquisitions.
On October 19, 2017, the Company entered into the ‘‘2017 Credit Agreement’’, which amended and restated in its entirety the existing 2014 Credit Agreement. The 2017 Credit Agreement provides for a $750 million revolving credit facility with a term of five years from a syndicate of financial institutions as lenders and issuing banks. The Company had not drawn on the 2017 Credit Agreement as of December 31, 2017.
Based on current plans, we believe that our available cash combined with positive cash flow provided by operating activities should be sufficient to fund our operations for at least the next 12 months.
Contractual Obligations. The following table summarizes our principal contractual obligations at December 31, 2017 and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):
| Total | 2018 | 2019-2020 | 2021-2022 | Thereafter | |||||||||||||||
| Operating leases | $ | 178,402 | $ | 30,853 | $ | 54,061 | $ | 47,427 | $ | 46,061 | |||||||||
| Purchase obligations(1) | 11,953 | 4,408 | 4,615 | 2,284 | 646 | ||||||||||||||
| Total contractual principal cash obligations | $ | 190,355 | $ | 35,261 | $ | 58,676 | $ | 49,711 | $ | 46,707 |
(1)Amounts do not include (i) contracts with terms of twelve months or less, (ii) multi-year contracts that may be terminated by a third-party or us, or (iii) employment agreements. Amounts do not include unrecognized tax benefits of $13.4 million due to uncertainty regarding the timing of future cash payments.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. The following accounting policies involve a “critical accounting estimate” because they are particularly dependent on estimates and assumptions made by management about matters that are highly uncertain at the time the accounting estimates are made. In addition, while we have used our best estimates based on facts and circumstances available to us at the time, different acceptable assumptions would yield different results. Changes in the accounting estimates are reasonably likely to occur from period to period, which may have a material impact on the presentation of our financial condition and results of operations. We review these estimates and assumptions periodically and reflect the effects of revisions in the period that they are determined to be necessary.
Valuation of Long-Lived and Intangible Assets and Goodwill
We assess the impairment of long-lived assets, identifiable intangibles and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Judgments made by management relate to the expected useful lives of long-lived assets and our ability to recover the carrying value of such assets. The accuracy of these judgments may be adversely affected by several factors, including the factors listed below:
| • | Significant underperformance relative to historical or projected future operating results; |
| • | Significant changes in the manner of our use of the acquired assets or the strategy for our overall business; |
| • | Significant negative industry or economic trends; or |
| • | Significant decline in our market capitalization relative to net book value for a sustained period. |
When we determine that the carrying value of long-lived and identifiable intangible assets may not be recovered based upon the existence of one or more of the above indicators, we test for impairment.
Goodwill and identifiable intangible assets that are not subject to amortization are tested annually for impairment by each reporting unit on October 1 of each year and are also tested for impairment more frequently based upon the existence of one or more of the above indicators.
Goodwill represents the excess of costs over the fair value of assets of acquired businesses. Goodwill is not amortized, but instead tested for impairment at least annually by each reporting unit. The Company may first assess qualitative factors to evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount or elect to bypass such assessment. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value, or the Company elects to bypass such assessment, the Company then determines the fair value of each reporting unit. We estimate the fair value of each reporting unit based on a projected discounted cash flow model that includes significant assumptions and estimates including our discount rate, growth rate and future financial performance. Assumptions about the discount rate are based on a weighted average cost of capital for comparable companies. Assumptions about the growth rate and future financial performance of a reporting unit are based on our forecasts, business plans, economic projections and anticipated future cash flows. These assumptions are subject to change from period to period and could be adversely impacted by the uncertainty surrounding global market conditions, commercial real estate conditions and the competitive environment in which we operate. Changes in these or other factors could negatively affect our reporting units' fair value and potentially result in impairment charges. Such impairment charges could have an adverse effect on our results of operations.
The fair value of each reporting unit is compared to the carrying amount of the reporting unit. If the carrying value of the reporting unit exceeds the fair value, then an impairment loss is recognized for the difference. We estimate the fair value of our reporting units based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk in our current business model. As of October 1, 2017, the date of our most recent impairment analysis, the estimated fair value of each of our reporting units substantially exceeded the carrying value of our reporting units. There have been no events or changes in circumstances since the date of our impairment analysis on October 1, 2017, that would indicate that the carrying value of each reporting unit may not be recoverable.
Revenue Recognition
We recognize revenues when (1) there is persuasive evidence of an arrangement, (2) the fee is fixed or determinable, (3) services have been rendered and payment has been contractually earned and (4) collectability is reasonably assured. Revenues from subscription-based services are recognized on a straight-line basis over the term of the agreement. We evaluate our allowance for doubtful accounts and estimate collectability of accounts receivable based on our analysis of historical collection experience, changes in customer payment profiles and the aging of receivable balances, as well as current economic conditions, all of which may affect a customer’s ability to pay. A credit reserve has also been established based on historical experience of credits issued to customers to ensure that revenue is recognized appropriately in the current period. Deferred revenue results from advance cash receipts from customers or amounts billed in advance to customers from the sale of subscription services and is recognized over the term of the service agreement.
We derive revenues by providing access to our proprietary database of commercial real estate information. We generally charge a fixed monthly amount for our subscription-based services. Our subscription-based services consist primarily of information, analytics and online marketplace services offered over the internet to commercial real estate industry and related professionals. Subscription contract rates are based on the number of sites, number of users, organization size, the client’s business focus, geography, the number and types of services to which a client subscribes, the number of properties a client advertises and the prominence and placement of a client's advertised properties in the search results, as applicable. A majority of the subscription-based service agreements have a term of one year and renew automatically.
We analyze contracts with multiple elements under the accounting guidance for multiple-element arrangements. Our multiple-element arrangements include information, analytics and/or online marketplace services that are generally provided to the customer over the same term. When identifying multiple-element arrangements, we consider multiple purchases made by the same customer within a short time frame and assess whether the purchases were negotiated together as one overall arrangement. If a multiple-element arrangement is identified, then the arrangement consideration is allocated among the separate units of accounting based on their relative selling prices, which is estimated considering factors such as historical pricing, pricing strategy, market conditions and other factors. We account for each deliverable in the transaction separately. If the deliverables cannot be separated into multiple units of accounting, then the arrangement consideration is combined and recognition of revenues is determined for the combined unit of accounting. Multiple-element transactions require judgment to determine the selling price or fair value of the different elements. The judgments impact the amount of revenues recognized over the term of the contract, as well as the period in which they are recognized.
Accounting for Income Taxes
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process requires us to estimate our current tax exposure and assess the temporary differences resulting from differing treatment of items, such as deductibility of certain intangible assets, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We must then also assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that it is more-likely-than not that some portion or all of our deferred tax assets will not be realized, we must establish a valuation allowance. To the extent we establish a valuation allowance or change the allowance in a period, we must reflect the corresponding increase or decrease within the tax provision in the consolidated statements of operations.
We generally recognize the effect of the tax law changes in the period of enactment. Changes in existing tax laws and rates, their related interpretations, and the uncertainty generated by the current economic environment may affect the amounts of our deferred tax liabilities or the valuations of our deferred tax assets over time. Our accounting for deferred tax consequences represents management’s best estimate of future events that can be appropriately reflected in the accounting estimates. In accordance with SEC Staff Accounting Bulletin 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, we report provisional amounts if we are able to determine a reasonable estimate but do not have the necessary information available, prepared, and analyzed in reasonable detail to complete the accounting for Tax Reform. We may revise our estimates as we finalize our accounting during a measurement period of up to one year from the enactment of Tax Reform.
Stock-Based Compensation
We account for equity instruments issued in exchange for employee services using a fair-value based method and we recognize the fair value of such equity instruments as an expense in the consolidated statements of operations. We estimate the fair value of each option granted on the date of grant using the Black-Scholes option-pricing model, which requires us to estimate the dividend yield, expected volatility, risk-free interest rate and expected life of the stock option. For equity instruments that vest based on a market condition, we estimate the fair value of each equity instrument granted on the date of grant using a Monte-Carlo simulation model, which also requires us to estimate the dividend yield, expected volatility, risk-free interest rate and expected life of the equity instruments. These assumptions and the estimation of expected forfeitures are based on multiple factors, including historical employee behavior patterns of exercising options and post-employment termination behavior, expected future employee option exercise patterns, and the historical volatility of our stock price. For equity instruments that vest based on performance, we assess the probability of the achievement of the performance conditions at the end of each reporting period, or more frequently based upon the occurrence of events that may change the probability of whether the performance conditions would be met. If our initial estimates of the achievement of the performance conditions change, the related stock-based compensation expense and timing of recognition may fluctuate from period to period based on those estimates. If the performance conditions are not met, no stock-based compensation expense will be recognized, and any previously recognized stock-based compensation expense will be reversed.
We do not expect any material changes in the near term to the underlying assumptions used to calculate stock-based compensation expense for the year ended December 31, 2017. However, if changes in these assumptions occur, and, should those changes be significant, they could have a material impact on our stock-based compensation expense.
Business Combinations
We allocate the purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customer bases, acquired database technology, and acquired trade names from a market participant's perspective, useful lives and discount rates. During the measurement period, we may record adjustments to the assets acquired and liabilities assumed. Any adjustments to provisional amounts that are identified during the measurement period are recorded in the reporting period in which the adjustment amounts are determined. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.
Fair Value of Auction Rate Securities
Fair value is defined as the price that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. There is a three-tier fair value hierarchy, which categorizes assets and liabilities by the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions. Our Level 3 assets consist of auction rate securities ("ARS"), whose underlying assets are primarily student loan securities supported by guarantees from the Federal Family Education Loan Program (“FFELP”) of the U.S. Department of Education.
Our ARS investments are not currently actively trading and therefore do not currently have a readily determinable market value. The estimated fair value of the ARS no longer approximates par value. We have used a discounted cash flow model to determine the estimated fair value of our investment in ARS as of December 31, 2017. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, credit spreads, timing and amount of contractual cash flows, liquidity risk premiums, expected holding periods and default risk of the ARS. We update the discounted cash flow model on a quarterly basis to reflect any changes in the assumptions used in the model and settlements of ARS investments that occurred during the period.
The only significant unobservable input in the discounted cash flow model is the discount rate. The discount rate used represents our estimate of the yield expected by a market participant from the ARS investments. The weighted average discount rate used in the discounted cash flow model as of December 31, 2017 and 2016 was approximately 6% and 5%, respectively. Selecting another discount rate within the range used in the discounted cash flow model would not result in a significant change to the fair value of the ARS.
Based on this assessment of fair value, as of December 31, 2017, we determined there was a net decline in the fair value of our ARS investments of approximately $730,000. The decline was deemed to be a temporary impairment and recorded as an unrealized loss in accumulated other comprehensive loss in stockholders’ equity. If the issuers of these ARS are unable to successfully close future auctions and/or their credit ratings deteriorate, we may be required to record additional unrealized losses in accumulated other comprehensive loss or an other-than-temporary impairment charge to earnings on these investments, which would reduce our profitability and adversely affect our financial position.
We have not made any material changes in the accounting methodology used to determine the fair value of the ARS. We do not expect any material changes in the near term to the underlying assumptions used to determine the unobservable inputs used to calculate the fair value of the ARS as of December 31, 2017. However, if changes in these assumptions occur, and, should those changes be significant, we may be exposed to additional unrealized losses in accumulated other comprehensive loss or an other-than-temporary impairment charge to earnings on these investments.
Recent Accounting Pronouncements
In March 2016, the FASB issued authoritative guidance to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification of share-based payment transactions on the statement of cash flows. Effective the first quarter of 2017, the Company adopted the standard, which impacted our 2017 net income because excess tax benefits, which were previously reflected in additional paid in capital, are now reflected in income tax expense. The significance of the impact will depend on the intrinsic value at the time of vesting or exercise of equity instruments.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350: Simplifying the Test for Goodwill Impairment, which is designed to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The guidance indicates that an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This guidance is effective on a prospective basis for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period. Early application is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company early adopted this guidance during the first quarter of 2017 and the early adoption did not have a material impact on the Company's consolidated financial statements and related disclosures.
See Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information on recent accounting pronouncements, including the expected dates of adoption.
Previous: Item 6. Selected Consolidated Financial and Operating Data · Next: Item 7A. Quantitative and Qualitative Disclosures About Market Risk