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

We are the number one provider of information, analytics and online marketplaces to the commercial real estate industry in the U.S. and the 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. 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.

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, 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. Our service offerings span all commercial property types, including office, retail, industrial, multifamily, commercial land, mixed-use and hospitality. 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, as applicable. 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.

We also provide market research, portfolio and debt analysis, management and reporting capabilities, and real estate and lease management solutions, including lease administration and abstraction services, to commercial customers, real estate investors and lenders via our other service offerings.

Our principal information, analytics and online marketplace services are described in the following paragraphs by type of service:

Information and Analytics

CoStar Suite®. 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 applications, CoStar Mobile App and 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 and industry news.

Information services. We provide real estate and lease management solutions, including lease administration and abstraction services, through our CoStar Real Estate Manager service offerings, as well as, portfolio and debt analysis, management and reporting capabilities through our CoStar Investment Analysis and CoStar Risk Analytics service offerings. We also provide information services internationally, through our Grecam, Belbex and Thomas Daily businesses in France, Spain and Germany, respectively.

Online Marketplaces

Multifamily. Apartments.comTM 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 apartment listings and provides professional property management companies and landlords with an advertising destination. On February 21, 2018, we completed the acquisition of ForRent, a division of Dominion Enterprises, including the ForRent.com, AFTER55.com, CorporateHousing.com and ForRentUniversity.com apartment marketing sites. We continue to integrate, develop and cross-sell the services offered by ForRent. On November 8, 2018, we acquired Cozy Services, Ltd. ("Cozy"), a leading provider of online rental solutions that provides a broad spectrum of services to both landlords and tenants, including property listings, rent estimates, rental applications, tenant screening, online rent payments and expense tracking. See Note 4 to the Notes to the Consolidated Financial Statements included in Part IV of this Annual Report on Form 10-K for further discussion of the acquisition of Cozy.

Commercial property and land. 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 use LoopNet's online marketplace services to search for available property listings that meet their criteria. On October 12, 2018, we acquired all of the issued share capital of Realla Ltd. ("Realla"), the operator of a commercial property listings and data management platform in the U.K., including a free-to-list search engine for commercial property listings. See Note 4 to the Notes to the Consolidated Financial Statements included in Part IV of this Annual Report on Form 10-K for further discussion of the acquisition of Realla. 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®

As of December 31, 2018, 2017 and 2016 our annualized net bookings of subscription-based services on all contracts were approximately $50 million, $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. We recognize subscription revenues on a straight-line basis over the life of the contract. 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.

For the years ended December 31, 2018, 2017 and 2016, our contract renewal rate for existing CoStar subscription-based services on annual contracts was approximately 90%, 91% and 90% respectively, and, therefore, our cancellation rate for those services was approximately 10%, 9%, and 10%, respectively. 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, improving and enhancing our information, news, analytics and online marketplace solutions, including expanding and improving our offerings for property managers and renters. 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. We have been, and plan to continue, integrating, further developing and cross-selling our services. To generate brand awareness and site traffic for our listing sites, we utilize a multi-channel marketing campaign, 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, consistent with historical levels, to promote our sites in 2019. 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 2019 include:

•

Continuing to develop new, and improve existing, online rental property service offerings for the apartments industry. We plan to utilize acquired platforms, including Cozy, along with our previously developed and newly developed technologies, to create a complete digital rental experience that enables renters to apply for leases, for landlords to run tenant credit and background checks and for landlords and tenants to generate and enter into leases and to make and process payments, all online through a single platform.

•

Continuing to develop and enhance CoStar Suite by making additional investments in analytical capabilities and developing products offerings with new capabilities focused on owners and lenders of commercial real estate. We also plan to invest in integrating the technology and infrastructure from other existing products into the CoStar Suite platform, including CoStar Real Estate Manager, in order to leverage data across our platforms and provide customers with additional functionality. We plan to invest further in our daily newsletter for U.S. subscribers, including providing curated content to our largest markets, and more personalized information.

•

Continuing to invest in the LoopNet marketplace by enhancing the content on the site, including high-quality imagery, seeking targeted advertisements and adding more content for premium listings, to better meet the needs of a broader cross section of the commercial real estate industry. Continuing to invest in our research operations to support continued growth of our information and analytics offerings. In furtherance of both of these priorities, we plan to continue to generate awareness and promote usage of Listing Manager, an online tool that allows customers with CoStar or LoopNet listings to update and manage their listings directly online. LoopNet users can also monitor listing performance, access lead and prospect reports, and upgrade exposure of their listings. We expect the use of this tool to result in more updates made directly by brokers and owners entering data directly into the self-service tool, which we believe will result in significant long-term cost savings and better quality data.

•

Continuing to invest in the growth of our international business. We plan to integrate Realla with our CoStar U.K. operations, including development of a single point of data entry to allow our clients to simultaneously arrange to display their commercial real estate listings through the CoStar Suite service offering and to also make them visible to prospective tenants and investors through Realla’s marketing portal.

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 and functionality 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.

For further discussion of our Company, strategy and products, see our business overview set forth in "Item 1. Business" in this Annual Report on Form 10-K.

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), loss on debt extinguishment, income taxes, depreciation and amortization (“EBITDA”), adjusted EBITDA, adjusted EBITDA margin, 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 and other income (expense), 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 incurred outside our ordinary course of business and loss on debt extinguishment as well as amortization of acquired intangible assets and other related costs. From this figure, we then subtract an assumed provision for income taxes to arrive at non-GAAP net income. We may disclose adjusted EBITDA, adjusted EBITDA margin, 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 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 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, adjusted EBITDA margin, 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 accompanying reconciliations, 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, adjusted EBITDA margin, 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 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 and expense 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 and 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 because it generally represents 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.

•

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 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 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 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 and settlement and impairment costs 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. We subtract an assumed provision for income taxes to calculate non-GAAP net income. In 2017 and 2016, we assumed a 38% tax rate, which approximated our historical long-term statutory corporate tax rate, excluding the impact of discrete items. In 2018 we assumed a 25% tax rate which reflects our full year 2018 statutory tax rate. The decrease in our tax rate in 2018 is mainly due to the Tax Act which reduced the U.S. federal corporate income tax rate from 35% to 21% effective January 1, 2018.

Adjusted EBITDA margin represents adjusted EBITDA divided by revenues for the period.

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,
	2018				2017				2016
Net income	$	238,334			$	122,695			$	85,071
Amortization of acquired intangible assets in cost of revenues	20,586				19,707				22,819
Amortization of acquired intangible assets in operating expenses	30,881				17,684				22,731
Depreciation and other amortization	26,276				26,252				24,615
Interest and other income	(13,281		)		(4,044		)		(1,773		)
Interest and other expense	2,830				9,014				10,016
Loss on debt extinguishment	—				3,788				—
Income tax expense	45,681				42,363				51,591
EBITDA	$	351,307			$	237,459			$	215,070
Net cash flows provided by (used in)
Operating activities	$	335,458			$	234,703			$	200,642
Investing activities	$	(448,001	)		$	(72,267	)		$	(23,259	)
Financing activities	$	2,744			$	480,430			$	(30,563	)

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,
	2018							2017							2016
Revenues	$	1,191,832			100	%		$	965,230			100	%		$	837,630			100	%
Cost of revenues	269,933				23			220,403				23			173,814				21
Gross profit	921,899				77			744,827				77			663,816				79
Operating expenses:
Selling and marketing (excluding customer base amortization)	359,858				30			318,362				33			296,483				35
Software development	100,937				8			88,850				9			76,400				9
General and administrative	156,659				13			146,128				15			123,297				15
Customer base amortization	30,881				3			17,671				2			22,731				3
Total operating expenses	648,335				54			571,011				59			518,911				62
Income from operations	273,564				23			173,816				18			144,905				17
Interest and other income	13,281				1			4,044				—			1,773				—
Interest and other expense	(2,830		)		—			(9,014		)		(1	)		(10,016		)		(1	)
Loss on debt extinguishment	—				—			(3,788		)		—			—				—
Income before income taxes	284,015				24			165,058				17			136,662				16
Income tax expense	45,681				4			42,363				4			51,591				6
Net income	$	238,334			20	%		$	122,695			13	%		$	85,071			10	%

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,
	2018							2017							2016
Information and analytics
CoStar Suite(1)	$	545,195			46	%		$	463,185			48	%		$	408,456			49	%
Information services(1)	67,624				6			72,618				8			77,178				9
Online marketplaces
Multifamily(1)	405,795				34			279,855				29			224,835				27
Commercial property and land(1)	173,218				14			149,572				15			127,161				15
Total revenues	$	1,191,832			100	%		$	965,230			100	%		$	837,630			100	%
__________________________

(1) For further discussion of our Company, strategy and products, see our business overview set forth in "Item 1. Business" in this Annual Report on Form 10-K.

Comparison of Year Ended December 31, 2018 and Year Ended December 31, 2017

The following table provides a comparison of our selected consolidated results of operations for the year ended December 31, 2018 and 2017 (in thousands of dollars):

	2018				2017				Increase (Decrease) ($)				Increase (Decrease) (%)
Revenues
CoStar Suite	$	545,195			$	463,185			$	82,010			18	%
Information services	67,624				72,618				(4,994		)		(7	)
Multifamily	405,795				279,855				125,940				45
Commercial property and land	173,218				149,572				23,646				16
Total revenues	1,191,832				965,230				226,602				23
Cost of revenues	269,933				220,403				49,530				22
Gross profit	921,899				744,827				177,072				24
Operating expenses:
Selling and marketing (excluding customer base amortization)	359,858				318,362				41,496				13
Software development	100,937				88,850				12,087				14
General and administrative	156,659				146,128				10,531				7
Customer base amortization	30,881				17,671				13,210				75
Total operating expenses	648,335				571,011				77,324				14
Income from operations	273,564				173,816				99,748				57
Interest and other income	13,281				4,044				9,237				228
Interest and other expense	(2,830		)		(9,014		)		(6,184		)		(69	)
Loss on extinguishment	—				(3,788		)		(3,788		)		NM
Income before income taxes	284,015				165,058				118,957				72
Income tax expense	45,681				42,363				3,318				8
Net income	$	238,334			$	122,695			$	115,639			94	%
__________________________
NM - Not meaningful

Revenues. Revenues increased to $1,192 million in 2018, from $965 million in 2017. The $227 million increase was primarily attributable to increased revenues of approximately $82 million or 18% from continued organic growth of CoStar Suite, as well as, conversion of our LoopNet customers to our CoStar platform as a result of integration of the LoopNet and CoStar databases. Information services revenue decreased $5 million or 7% primarily due to the continued wind down of LoopNet information services, including Premium Searcher, resulting in a loss of $29 million of revenues, partially offset by a $22 million increase in revenues from the continued growth of our CoStar Real Estate Manager offering. Multifamily revenue increased $126 million or 45%, driven by incremental revenues related to the acquisition of ForRent. Commercial property and land revenue increased $24 million or 16%, due to growth in our LoopNet online marketplace services of $12 million, as well as, growth in our land and businesses for sale services of $12 million.

Gross Profit. Gross profit increased to $922 million in 2018, from $745 million in 2017. The gross margin percentage remained relatively consistent as a percentage of revenues at 77% for both 2018 and 2017. Investment in research to further support our products and services led to an increase in cost of revenues of $50 million. The increase was primarily due to additional research personnel costs of $32 million, an increase of $7 million in direct costs partially due to the ForRent and Cozy acquisitions and our Westside Rentals services, an increase in software licensing expense of $3 million and $2 million in occupancy related costs in connection with our research office in Richmond, Virginia.

Selling and Marketing Expenses. Selling and marketing expenses increased to $360 million in 2018, from $318 million in 2017, and decreased as a percentage of revenues to 30%, compared to 33% in 2017. The increase in the amount of selling and marketing expenses was due to a $14 million increase in sales personnel costs, partially related to the acquisition of ForRent, which included additional salaries and retention costs. In addition, marketing related expenses increased $21 million, primarily

due to increased search engine marketing costs due to the acquisition of ForRent. Sales conference and travel related costs also increased $4 million.

Software Development Expenses. Software development expenses increased to $101 million in 2018, from $89 million in 2017, and decreased as a percentage of revenues to 8% in 2018, compared to 9% in 2017. The increase in the amount of software development expense was primarily due to a $16 million increase in personnel costs, of which $6 million was due to the acquisition of ForRent. These increases were partially offset by a $4 million decrease in professional services and recruiting costs in 2018.

General and Administrative Expenses. General and administrative expenses increased to $157 million in 2018, from $146 million in 2017, and decreased as a percentage of revenues to 13% in 2018, compared to 15% 2017. The increase in the amount of general and administrative expenses was primarily due to an increase in administrative personnel costs of $9 million to support the ongoing growth of the business and a $6 million increase in software licensing costs, partially offset by a $6 million decrease in professional services, primarily due to a reduction in legal costs of $9 million.

Customer Base Amortization Expense. Customer base amortization expense increased to $31 million in 2018, from $18 million in 2017, and increased as a percentage of revenues to 3% in 2018, compared to 2% in 2017. The increase was primarily due to the ForRent acquisition, partially offset by lower amortization of existing customer base intangible assets acquired in prior years due to applying an accelerated amortization methodology for a majority of those assets.

Interest and Other Income. Interest and other income increased to $13 million in 2018, from $4 million in 2017. The increase was primarily due to our higher average cash and cash equivalent balance and interest rates in 2018 than in 2017.

Interest and Other Expense. Interest and other expense decreased to $3 million in 2018, from $9 million in 2017. The decrease was primarily due to the repayment of outstanding debt in connection with entering into the amended and restated credit agreement (the ‘‘2017 Credit Agreement’’) in October 2017.

Loss on Extinguishment. The loss on extinguishment recognized in 2017 was due to entering into the 2017 Credit Agreement, which amended and restated in its entirety the existing credit agreement dated April 1, 2014, and resulted in a loss on debt extinguishment of approximately $4 million.

Income Tax Expense. Income tax expense increased to $46 million in 2018, from $42 million in 2017. The effective tax rate was 16% in 2018 compared to 26% in 2017. This decrease was primarily due to the Tax Act, which reduced the federal corporate income tax rate effective January 1, 2018, from 35% to 21% and excess tax benefits on share payments and state research and development tax credits.

Comparison of Business Segment Results for Year Ended December 31, 2018 and Year Ended December 31, 2017

We manage our business geographically in two operating segments, with the 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 revenue and operating segment net income before interest and other income (expense), loss on debt extinguishment, income taxes, depreciation and amortization (“EBITDA”). 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 operating and management performance and to evaluate the performance of the 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 $1,157 million for the year ended December 31, 2018, from $934 million for the year ended December 31, 2017. The increase in North America revenues was primarily due to a $126 million increase in Multifamily revenues driven by incremental revenues related to the acquisition of ForRent, continued organic growth in CoStar Suite revenues of $79 million and an increase of $24 million in Commercial property and land revenue due to growth in our LoopNet online marketplace services of $12 million, as well as, growth in our land and businesses for sale services of $12 million. International revenues increased to $35 million for the year ended December 31, 2018, from $31 million for the year ended December 31, 2017. The increase in International revenues was primarily due to an increase in revenues from the further penetration of our subscription-based services, and to a lesser extent, a positive impact from foreign currency fluctuations in 2018.

Segment EBITDA. North America EBITDA increased to $358 million for the year ended December 31, 2018, from $237 million for the year ended December 31, 2017. The increase in North America EBITDA was due primarily to an increase in revenues, partially offset by increases in personnel related costs due to the ForRent acquisition and ongoing support of the business.

International EBITDA decreased to a loss of $7 million for the year ended December 31, 2018, from $1 million profit for the year ended December 31, 2017. The decrease in International EBITDA was primarily due to the continued investment in our International research operations in the U.K., along with higher occupancy related costs, additional travel and professional services costs.

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				NM
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 $5 million or 6% primarily due to continued wind down of LoopNet Information products including Premium Searcher partially offset by increases in our CoStar 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.

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, partially 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 connection with the 2017 Credit Agreement, partially 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 the 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 revenue and operating segment EBITDA. 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 operating and management performance and to evaluate the performance of the 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.

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.

	2018																2017
	Mar. 31				Jun. 30				Sep. 30				Dec. 31				Mar. 31				Jun. 30				Sep. 30				Dec. 31
Revenues	$	273,718			$	297,018			$	305,525			$	315,571			$	226,553			$	237,153			$	247,533			$	253,991
Cost of revenues	62,477				67,136				72,072				68,248				51,346				55,273				55,483				58,301
Gross profit	211,241				229,882				233,453				247,323				175,207				181,880				192,050				195,690
Operating expenses	157,796				186,108				162,765				141,666				137,545				153,997				134,537				144,932
Income from operations	53,445				43,774				70,688				105,657				37,662				27,883				57,513				50,758
Interest and other income	2,987				2,652				3,035				4,607				429				605				555				2,455
Interest and other expense	(690		)		(728		)		(717		)		(695		)		(2,686		)		(2,693		)		(2,901		)		(734		)
Loss on debt extinguishment	—				—				—				—				—				—				—				(3,788		)
Income before income taxes	55,742				45,698				73,006				109,569				35,405				25,795				55,167				52,479
Income tax expense	3,511				1,863				14,247				26,060				13,275				3,611				20,990				4,487
Net income	$	52,231			$	43,835			$	58,759			$	83,509			$	22,130			$	22,184			$	34,177			$	47,992
Net income per share — basic	$	1.46			$	1.22			$	1.63			$	2.31			$	0.69			$	0.68			$	1.05			$	1.24
Net income per share — diluted	$	1.44			$	1.20			$	1.61			$	2.29			$	0.68			$	0.68			$	1.04			$	1.22

	2018												2017
	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			24			22			23			23			22			23
Gross profit	77			77			76			78			77			77			78			77
Operating expenses	57			63			54			46			60			65			55			58
Income from operations	20			14			22			32			17			12			23			19
Interest and other income	1			1			1			1			—			—			—			1
Interest and other expense	—			—			—			—			(1	)		(1	)		(1	)		—
Loss on debt extinguishment	—			—			—			—			—			—			—			(1	)
Income before income taxes	21			15			23			33			16			11			22			19
Income tax expense	1			1			5			8			6			2			8			2
Net income	20	%		14	%		18	%		25	%		10	%		9	%		14	%		17	%

Liquidity and Capital Resources

Our principal sources of liquidity are cash and cash equivalents, cash from operations and the availability of funds from our revolving credit facility. Total cash and cash equivalents decreased to $1.1 billion at December 31, 2018 compared to cash and cash equivalents of $1.2 billion at December 31, 2017. The decrease in cash and cash equivalents for the year ended December 31, 2018 was primarily due to the cash paid, net of cash acquired in connection with the acquisitions of ForRent, Cozy and Realla of an aggregate of $418 million, as well as cash paid for purchases of property and equipment of $30 million and repurchases of restricted stock to satisfy employee tax withholding obligations upon vesting of restricted stock awards valued at approximately $24 million. These decreases were partially offset by proceeds from the exercise of employee stock options of approximately $27 million and cash generated from operations of $335 million.

Net cash provided by operating activities for the year ended December 31, 2018 was $335 million compared to $235 million for the year ended December 31, 2017 and $201 million for the year ended December 31, 2016. The $100 million and $34 million

increases from December 31, 2017 to December 31, 2018 and from December 31, 2016 to December 31, 2017, respectively, are primarily due to higher income from operations in both periods. Income from operations was partially offset by fluctuations in working capital.

Net cash used in investing activities for the year ended December 31, 2018 was $448 million compared to $72 million for the year ended December 31, 2017. The $376 million increase in investing activities in 2018 compared to 2017 was primarily due to approximately $418 million cash paid, net of cash acquired, to acquire ForRent, Cozy and Realla during 2018, compared to $48 million cash paid to acquire Westside Rentals, LandWatch and The Screening Pros during 2017. During 2018, we incurred capital expenditures of approximately $30 million compared to approximately $24 million during 2017.

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. The $49 million increase in investing activities in 2017 compared to 2016 was primarily due to $48 million cash paid to acquire Westside Rentals, LandWatch and The Screening Pros during 2017. 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.

Net cash provided by financing activities for the year ended December 31, 2018 was $3 million compared to net cash provided by financing activities of $480 million for the year ended December 31, 2017 and $31 million in December 31, 2016. This $477 million decrease in financing activities in 2018 compared to 2017 and $449 million increase in financing activities in 2017 compared to 2016 was primarily due to $834 million in net proceeds from our equity offering, partially offset by an increase in debt repayments of $325 million in 2017.

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. Any 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 any future acquisitions.

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, 2018 and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

	Total				2019				2020-2021				2022-2023				Thereafter
Operating leases	$	169,078			$	30,485			$	56,676			$	50,149			$	31,768
Purchase obligations(1)	12,690				7,178				5,477				35				—
Total contractual principal cash obligations	$	181,768			$	37,663			$	62,153			$	50,184			$	31,768
__________________________

(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 income taxes payable of $17 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. We consider policies relating to the following matters to be critical accounting policies:

•	Long-lived assets, intangible assets and goodwill

•	Revenue recognition

•	Income taxes

•	Business combinations

With respect to our accounting policy for long-lived assets, intangible assets and goodwill, we further supplement in Note 2 of the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K with the following:

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 as a result of our qualitative impairment analysis on October 1, 2018, that would indicate that the carrying value of each reporting unit may not be recoverable.

For an in depth discussion of each of our significant accounting policies, including our critical accounting policies and further information regarding estimates and assumptions involved in their application, see Note 2 to the accompanying consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

Recent Accounting Pronouncements

See Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for information on recent accounting pronouncements, including the expected dates of adoption.