COSTAR GROUP, INC. - Quarter Report: 2008 September (Form 10-Q)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
[X] QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF
1934
For
the quarterly period ended September 30, 2008
OR
[ ] TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
the transition period from ______ to ______
Commission file number
0-24531
CoStar
Group, Inc.
(Exact name of registrant as
specified in its charter)
|
Delaware
|
52-2091509
|
|
|
(State
or other jurisdiction of incorporation
or organization)
|
(I.R.S.
Employer Identification
No.)
|
2 Bethesda Metro Center,
10th Floor
Bethesda, Maryland
20814
(Address
of principal executive offices) (zip code)
(301) 215-8300
(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past
90 days. Yes [X] No [ ]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Securities Exchange Act of 1934.
|
Large
accelerated filer x
|
Accelerated
filer o
|
|
Non-accelerated
filer o
|
Smaller
reporting company o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes [ ] No [X]
As
of October 31, 2008, there were 19,734,114 shares of the registrant’s
common stock outstanding.
COSTAR
GROUP, INC.
TABLE OF CONTENTS
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PART
I
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FINANCIAL
INFORMATION
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Item 1.
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3
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3
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4
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5
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6
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Item 2.
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17
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Item 3.
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28
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Item 4.
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29
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PART II
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OTHER
INFORMATION
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Item 1.
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30
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Item 1A.
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30
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Item 2.
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31
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Item 3.
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31
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Item 4.
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31
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Item 5.
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32
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Item 6.
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32
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33
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2
PART
I ¾ FINANCIAL
INFORMATION
|
Item
1.
|
COSTAR
GROUP, INC.
(in
thousands, except per share data)
(unaudited)
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30,
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September
30,
|
|||||||||||||||
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2008
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2007
|
2008
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2007
|
|||||||||||||
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Revenues
|
$ | 53,757 | $ | 49,340 | $ | 159,499 | $ | 141,965 | ||||||||
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Cost
of
revenues
|
17,613 | 19,551 | 55,675 | 56,695 | ||||||||||||
|
Gross
margin
|
36,144 | 29,789 | 103,824 | 85,270 | ||||||||||||
|
Operating
expenses:
|
||||||||||||||||
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Selling
and
marketing
|
10,336 | 11,924 | 33,330 | 39,752 | ||||||||||||
|
Software
development
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3,122 | 3,026 | 9,677 | 9,366 | ||||||||||||
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General
and
administrative
|
10,170 | 9,674 | 30,074 | 26,826 | ||||||||||||
|
Purchase
amortization
|
1,236 | 1,328 | 3,723 | 3,807 | ||||||||||||
| 24,864 | 25,952 | 76,804 | 79,751 | |||||||||||||
|
Income
from
operations
|
11,280 | 3,837 | 27,020 | 5,519 | ||||||||||||
|
Interest
and other income,
net
|
951 | 2,072 | 4,132 | 5,825 | ||||||||||||
|
Income
before income
taxes
|
12,231 | 5,909 | 31,152 | 11,344 | ||||||||||||
|
Income
tax expense,
net
|
5,586 | 2,659 | 14,030 | 5,105 | ||||||||||||
|
Net
income
|
$ | 6,645 | $ | 3,250 | $ | 17,122 | $ | 6,239 | ||||||||
|
Net
income per share ¾
basic
|
$ | 0.34 | $ | 0.17 | $ | 0.89 | $ | 0.33 | ||||||||
|
Net
income per share ¾
diluted
|
$ | 0.34 | $ | 0.17 | $ | 0.88 | $ | 0.32 | ||||||||
|
Weighted
average outstanding shares ¾
basic
|
19,393 | 19,045 | 19,330 | 18,997 | ||||||||||||
|
Weighted
average outstanding shares ¾
diluted
|
19,604 | 19,475 | 19,535 | 19,362 | ||||||||||||
See
accompanying notes.
3
COSTAR
GROUP, INC.
(in
thousands)
|
September
30,
|
December
31,
|
|||||||
|
2008
|
2007
|
|||||||
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ASSETS
|
(unaudited)
|
|||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$ | 139,150 | $ | 57,785 | ||||
|
Short-term
investments
|
43,805 | 129,641 | ||||||
|
Accounts
receivable, less allowance for doubtful accounts of
approximately $3,595 and $2,959 as
of September 30, 2008 and
December 31, 2007,
respectively
|
12,113 | 10,875 | ||||||
|
Deferred
income taxes, net
|
1,067 | 2,716 | ||||||
|
Prepaid
expenses and other current assets
|
4,152 | 4,661 | ||||||
|
Total
current assets
|
200,287 | 205,678 | ||||||
|
Long-term
investments
|
30,203 | ¾ | ||||||
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Deferred
income taxes, net
|
2,706 | 2,233 | ||||||
|
Property
and equipment, net
|
19,296 | 24,045 | ||||||
|
Goodwill
|
60,143 | 61,854 | ||||||
|
Intangibles
and other assets, net
|
20,639 | 25,711 | ||||||
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Deposits
and other assets
|
1,642 | 2,322 | ||||||
|
Total
assets
|
$ | 334,916 | $ | 321,843 | ||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
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Current
liabilities:
|
||||||||
|
Accounts
payable
|
$ | 1,384 | $ | 3,299 | ||||
|
Accrued
wages and commissions
|
7,006 | 7,489 | ||||||
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Accrued
expenses and deferred rent
|
11,438 | 16,884 | ||||||
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Deferred
revenue
|
10,180 | 10,374 | ||||||
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Income
taxes payable
|
3,905 | 191 | ||||||
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Total
current liabilities
|
33,913 | 38,237 | ||||||
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Deferred
income taxes, net
|
338 | 1,801 | ||||||
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Total
stockholders’ equity
|
300,665 | 281,805 | ||||||
|
Total
liabilities and stockholders’ equity
|
$ | 334,916 | $ | 321,843 | ||||
See
accompanying notes.
4
COSTAR
GROUP, INC.
(in
thousands)
(unaudited)
|
Nine
Months Ended
September
30,
|
||||||||
|
2008
|
2007
|
|||||||
|
Operating
activities:
|
||||||||
|
Net
income
|
$ | 17,122 | $ | 6,239 | ||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
|
Depreciation
|
6,409 | 5,699 | ||||||
|
Amortization
|
6,460 | 6,008 | ||||||
|
Stock-based
compensation expense
|
3,891 | 4,435 | ||||||
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Deferred
income tax expense, net
|
3,688 | 5,105 | ||||||
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Provision
for losses on accounts receivable
|
2,748 | 1,506 | ||||||
|
Changes
in operating assets and liabilities, net of acquisitions
|
(9,937 | ) | (1,034 | ) | ||||
|
Net
cash provided by operating activities
|
30,381 | 27,958 | ||||||
|
Investing
activities:
|
||||||||
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Purchases
of investments
|
(1,917 | ) | (86,780 | ) | ||||
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Sales
of investments
|
53,841 | 85,826 | ||||||
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Purchases
of property and equipment and other assets
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(3,232 | ) | (8,419 | ) | ||||
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Acquisition,
net of cash acquired
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(3,024 | ) | (16,737 | ) | ||||
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Net
cash provided by (used in) investing activities
|
45,668 | (26,110 | ) | |||||
|
Financing
activities:
|
||||||||
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Proceeds
from exercise of stock options
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6,227 | 2,946 | ||||||
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Net
cash provided by financing activities
|
6,227 | 2,946 | ||||||
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Effect
of foreign currency exchange rates on cash and cash
equivalents
|
(911 | ) | 309 | |||||
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Net
increase in cash and cash equivalents
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81,365 | 5,103 | ||||||
|
Cash
and cash equivalents at the beginning of period
|
57,785 | 38,159 | ||||||
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Cash
and cash equivalents at the end of period
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$ | 139,150 | $ | 43,262 | ||||
See
accompanying notes.
5
COSTAR
GROUP, INC.
|
1.
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ORGANIZATION
|
CoStar
Group, Inc. (the “Company”) has created a comprehensive, proprietary database of
commercial real estate information covering the United States, as well as parts
of the United Kingdom and France. Based on its unique database, the Company
provides information services to the commercial real estate and related business
community and operates within two segments, U.S. and International. The
Company’s information/marketing services are typically distributed to its
clients under subscription-based license agreements, which typically have a
minimum term of one year and renew automatically.
|
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
|
Basis
of Presentation
The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. Accounting policies are
consistent for each operating segment.
Interim
Financial Statements
The
accompanying unaudited condensed consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles (“GAAP”) in the United States of America for interim financial
information. In the opinion of the Company’s management, the financial
statements reflect all adjustments necessary to present fairly the Company’s
financial position at September 30, 2008, and the results of its operations and
its cash flows for the three and nine months ended September 30, 2008 and 2007.
These adjustments are of a normal recurring nature.
Certain
notes and other information have been condensed or omitted from the interim
financial statements presented in this Quarterly Report on Form 10-Q.
Therefore, these financial statements should be read in conjunction with the
Company’s Annual Report on Form 10-K for the year ended December 31,
2007.
The
results of operations for the three and nine months ended September 30, 2008 are
not necessarily indicative of future financial results.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
Reclassifications
Certain
previously reported amounts have been reclassified to conform to the Company’s
current presentation.
Foreign
Currency Translation
The
Company’s functional currency in its foreign locations is the local currency.
Assets and liabilities are translated into U.S. dollars as of the balance sheet
date. Revenues, expenses, gains and losses are translated at the average
exchange rates in effect during each period. Gains and losses resulting from
translation are included in accumulated other comprehensive income. Net gains or
losses resulting from foreign currency exchange transactions are included in the
consolidated statements of operations. There were no material gains or losses
from foreign currency exchange transactions for the three and nine months ended
September 30, 2008 and 2007.
6
COSTAR
GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES —
(CONTINUED)
|
Comprehensive
Income
The
components of comprehensive income were as follows (in thousands):
|
Nine
Months Ended
September
30,
|
||||||||
|
2008
|
2007
|
|||||||
|
(unaudited)
|
||||||||
|
Net
income
|
$ | 17,122 | $ | 6,239 | ||||
|
Foreign
currency translation adjustment
|
(4,659 | ) | 2,152 | |||||
|
Net
unrealized (loss) gain on investments, net of tax
|
(3,706 | ) | 38 | |||||
|
Comprehensive
income
|
$ | 8,757 | $ | 8,429 | ||||
The
components of accumulated other comprehensive income were as follows (in
thousands):
|
September
30,
2008
|
December 31,
2007
|
|||||||
|
(unaudited)
|
||||||||
|
Foreign
currency translation adjustment
|
$ | 881 | $ | 5,540 | ||||
|
Accumulated
net unrealized (loss) gain on investments, net of tax
|
(3,620 | ) | 86 | |||||
|
Total
accumulated other comprehensive income
|
$ | (2,739 | ) | $ | 5,626 | |||
Net
Income Per Share
Net
income per share is computed by dividing net income by the weighted average
number of common shares outstanding during the period on a basic and diluted
basis. The Company’s potentially dilutive securities include stock options and
restricted stock. Diluted net income per share considers the impact of
potentially dilutive securities except in periods in which there is a net loss,
as the inclusion of the potentially dilutive common shares would have an
anti-dilutive effect.
7
COSTAR
GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES —
(CONTINUED)
|
Net Income Per Share ¾ (Continued)
The
following table sets forth the calculation of basic and diluted net income per
share (in thousands, except per share data):
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
|||||||||||||||
|
Numerator:
|
2008
|
2007
|
2008
|
2007
|
||||||||||||
|
(unaudited)
|
||||||||||||||||
|
Net
income
|
$ | 6,645 | $ | 3,250 | $ | 17,122 | $ | 6,239 | ||||||||
|
Denominator:
|
||||||||||||||||
|
Denominator
for basic net income per share ¾ weighted-average
outstanding shares
|
19,393 | 19,045 | 19,330 | 18,997 | ||||||||||||
|
Effect
of dilutive securities:
|
||||||||||||||||
|
Stock
options and restricted stock
|
211 | 430 | 205 | 365 | ||||||||||||
|
Denominator
for diluted net income per share ¾ weighted-average
outstanding shares
|
19,604 | 19,475 | 19,535 | 19,362 | ||||||||||||
|
Net
income per share ¾
basic
|
$ | 0.34 | $ | 0.17 | $ | 0.89 | $ | 0.33 | ||||||||
|
Net
income per share ¾
diluted
|
$ | 0.34 | $ | 0.17 | $ | 0.88 | $ | 0.32 | ||||||||
Stock-Based
Compensation
The
Company accounts for stock-based compensation in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 123R “Share Based Payment” (“SFAS
123R”), which addresses the accounting for share based payment transactions in
which the Company receives employee services in exchange for equity instruments.
The statement generally requires that equity instruments issued in such
transactions be accounted for using a fair value based method and the fair value
of such equity instruments be recognized as expenses in the consolidated
statements of operations.
Stock-based
compensation expense for stock options and restricted stock included in the
Company’s results of operations for the three and nine months ended September
30, 2008 and 2007, was as follows (in thousands):
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30,
|
September
30,
|
|||||||||||||||
|
2008
|
2007
|
2008
|
2007
|
|||||||||||||
|
(unaudited)
|
||||||||||||||||
|
Cost
of revenues
|
$ | 135 | $ | 265 | $ | 418 | $ | 781 | ||||||||
|
Selling
and marketing
|
209 | 259 | 594 | 928 | ||||||||||||
|
Software
development
|
72 | 83 | 307 | 277 | ||||||||||||
|
General
and administrative
|
1,046 | 766 | 2,572 | 2,449 | ||||||||||||
|
Total
|
$ | 1,462 | $ | 1,373 | $ | 3,891 | $ | 4,435 | ||||||||
Options
to purchase 88,650 and 61,076 shares were exercised during the three months
ended September 30, 2008 and 2007, respectively. Options to purchase 198,434 and
128,477 shares were exercised during the nine months ended September 30, 2008
and 2007, respectively.
8
COSTAR
GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES —
(CONTINUED)
|
Recent
Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value
Measurements” (“SFAS 157”), which defines fair value, establishes a
framework for measuring fair value in accordance with GAAP and expands
disclosures about fair value measurements. SFAS 157 does not require any
new fair value measurements under GAAP and is effective for fiscal years
beginning after November 15, 2007. In February 2008, the FASB issued
FASB Staff Position (“FSP”) 157-2, “Partial Deferral of the Effective
Date of Statement 157” (“FSP 157-2”), which delays the effective date of
SFAS 157 to January 1, 2009 for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
consolidated financial statements on a recurring basis (at least
annually). Effective January 1, 2008, the Company adopted the portion
of SFAS 157 that was not deferred under FSP 157-2. The adoption of
SFAS 157 did not have a material impact on the Company’s results of operations
or financial position. In October 2008, the FASB issued
FSP 157-3, “Determining the
Fair Value of a Financial Asset in a Market That Is Not Active” (“FSP
157-3”), which clarifies the application of SFAS 157 to markets that are not
active and provides an example illustrating key considerations for determining
the fair value of financial assets when their markets are not active. FSP 157-3
was effective upon issuance, including prior periods for which financial
statements had not been issued. The adoption of this standard did not have an
impact on the Company’s results of operations or financial
position.
In
February 2007, the FASB issued SFAS No. 159, “Fair Value Option for Financial
Assets and Financial Liabilities — Including an amendment of FASB Statement
No. 115” (“SFAS 159”), which permits entities to choose to measure
many financial instruments and certain other items at fair value that are not
currently required to be measured at fair value. SFAS 159 is effective for
fiscal years beginning on or after December 31, 2007. The Company adopted SFAS
159 on January 1, 2008 and has elected not to apply the fair value option to any
of its financial instruments. The adoption of SFAS 159 did not have a
material impact on the Company’s results of operations or financial
position.
In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations”
(“SFAS 141R”), which will change the accounting for any business combination the
Company enters into with an acquisition date after December 31, 2008. Under SFAS
141R, an acquiring entity will be required to recognize all the assets acquired
and liabilities assumed in a transaction at the acquisition date fair value with
limited exceptions. SFAS 141R will change the accounting treatment and
disclosure for certain specific items in a business combination. SFAS 141R
will have an impact on accounting for business combinations once adopted, but
its effect will depend upon the specifics of any business combination with an
acquisition date subsequent to December 31, 2008.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—An Amendment of ARB No. 51” (“SFAS
160”), which establishes new accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for fiscal years beginning on or after
December 15, 2008. The adoption of SFAS 160 is not expected to have a
material impact on the Company’s results of operations or financial
position.
9
COSTAR
GROUP, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
2.
|
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES —
(CONTINUED)
|
Recent Accounting Pronouncements
¾ (Continued)
In April
2008, the FASB issued FSP SFAS 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP 142-3”), which is effective for all fiscal years
and interim periods beginning after December 15, 2008. Early adoption of FSP
142-3 is not permitted. FSP 142-3 requires additional footnote disclosures about
the impact of the Company’s ability or intent to renew or extend agreements
related to existing intangibles or expected future cash flows from those
intangibles, how the Company accounts for costs incurred to renew or extend such
agreements, the time until the next renewal or extension period by asset class,
and the amount of renewal or extension costs capitalized, if any. For any
intangibles acquired after December 31, 2008, FSP 142-3 requires that the
Company consider its experience regarding renewal and extensions of similar
arrangements in determining the useful life of such intangibles. If the Company
does not have experience with similar arrangements, FSP 142-3 requires that the
Company use the assumptions of a market participant putting the intangible to
its highest and best use in determining the useful life. The Company is
currently assessing the impact of FSP 142-3 on its results of operations and
financial position.
In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”), which identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements. SFAS 162 is effective as of November
17, 2008. The adoption of SFAS 162 is not expected to have a material impact on
the Company’s results of operations or financial position.
|
3.
|
ACQUISITIONS
|
On
February 16, 2007, CoStar Limited, a wholly owned U.K. subsidiary of the
Company, acquired all of the outstanding capital stock of Property Investment
Exchange Limited (“PropexTM”) for
approximately $22.0 million, consisting of cash, deferred consideration of
approximately $2.9 million, and 21,526 shares of CoStar common stock.
Propex provides web-based commercial property information and operates an
electronic platform that facilitates the exchange of investment property in the
U.K. Propex’s suite of electronic platforms and listing websites gives users
access to the U.K. commercial property investment and leasing
markets.
The
Propex acquisition was accounted for using the purchase method of accounting.
The purchase price for the acquisition was primarily allocated to customer base,
trade name, and goodwill. The acquired customer base, which consists of one
distinct intangible asset and is composed of acquired customer contracts and the
related customer relationships, is being amortized on a 125% declining balance
method over ten years. The Propex acquired trade name is being amortized on a
straight-line basis over three years. The Company recorded goodwill of
approximately $15.0 million related to the Propex acquisition. Goodwill is not
amortized, but is subject to annual impairment tests. The results of operations
of Propex have been consolidated with those of the Company since the date of the
acquisition and are not considered material to the consolidated financial
statements of the Company. Accordingly, pro forma financial information has not
been presented for the acquisition.
10
COSTAR
GROUP, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
3.
|
ACQUISITIONS
— (CONTINUED)
|
On April
1, 2008, the Company acquired certain assets of First CLS, Inc. (doing business
as the Dorey Companies and DoreyPRO), an Atlanta-based provider of local
commercial real estate information for $3.0 million in initial cash
consideration and deferred consideration payable within approximately six months
of the one-year anniversary of closing. The First CLS, Inc. acquisition was
accounted for using the purchase method of accounting. The purchase price for
the acquisition was primarily allocated to customer base. The acquired customer
base, which consists of one distinct intangible asset and is composed of
acquired customer contracts and the related customer relationships, is being
amortized on a 125% declining balance method over ten years. The results of
operations of First CLS, Inc. have been consolidated with those of the Company
since the date of the acquisition and are not considered material to the consolidated
financial statements of the Company. Accordingly, pro forma financial
information has not been presented for the acquisition.
|
4.
|
FAIR
VALUE
|
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”), which defines fair value, establishes a framework for measuring
fair value in accordance with GAAP and expands disclosures about fair value
measurements. The Company adopted the provisions of SFAS 157 as of January
1, 2008 for financial instruments. Although the adoption of SFAS 157
did not materially impact its financial position, results of operations, or cash
flow, the Company is now required to provide additional disclosures as part of
its financial statements.
SFAS 157
establishes a three-tier fair value hierarchy, which categorizes 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 in which
little or no market data exists, therefore requiring an entity to develop its
own assumptions.
11
COSTAR
GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
4.
|
FAIR
VALUE — (CONTINUED)
|
In
accordance with SFAS 157, the following table represents the Company's fair
value hierarchy for its financial assets (cash, cash equivalents and
investments) measured at fair value on a recurring basis as of September 30,
2008 (in thousands):
|
Level
1
|
Level
2
|
Level
3
|
Total
|
|||||||||||||
|
Cash
|
$ | 7,610 | $ | ¾ | $ | ¾ | $ | 7,610 | ||||||||
|
Money
market
funds
|
113,144 | ¾ | ¾ | 113,144 | ||||||||||||
|
Treasuries
|
18,396 | ¾ | ¾ | 18,396 | ||||||||||||
|
Auction
rate securities
|
¾ | ¾ | 30,203 | 30,203 | ||||||||||||
|
Government-sponsored
enterprise obligations
|
¾ | 178 | ¾ | 178 | ||||||||||||
|
Corporate
debt securities
|
¾ | 43,627 | ¾ | 43,627 | ||||||||||||
|
Total
|
$ | 139,150 | $ | 43,805 | $ | 30,203 | $ | 213,158 | ||||||||
The
Company’s Level 2 assets consist of corporate debt securities and
government-sponsored enterprise obligations, which do not have directly
observable quoted prices in active markets. The Company’s corporate
debt securities are valued using matrix pricing, which is an acceptable
practical expedient under SFAS 157 for inputs.
The
Company’s Level 3 assets consist of variable rate debt instruments with an
auction-reset feature (“auction rate securities” or “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.
The
following table presents the Company’s Level 3 assets measured at fair value on
a recurring basis using significant unobservable inputs as defined in SFAS 157,
as of September 30, 2008 (in thousands):
|
Auction
Rate
Securities
|
||||
|
Balance
at December 31, 2007
|
$ | 53,975 | ||
|
Unrealized
loss included in other comprehensive income
|
(2,900 | ) | ||
|
Net
settlements
|
(20,872 | ) | ||
|
Balance
at September 30, 2008 (unaudited)
|
$ | 30,203 | ||
ARS are
variable rate debt instruments whose interest rates are reset approximately
every 28 days. The underlying securities have contractual maturities
greater than twenty years. The ARS are recorded at fair
value. Typically, the carrying value of ARS approximates fair value
due to frequent resetting of the interest rates. As of September 30,
2008, the Company held ARS with $33.1 million par value, all of which
failed to settle at auctions. These investments are of high credit
quality with AAA credit ratings and are primarily student loan securities
supported by guarantees from the FFELP of the U.S. Department of
Education. The Company may not be able to liquidate and fully recover
the carrying value of the ARS in the near term. As a result, these
securities are classified as long-term investments in the Company’s condensed
consolidated balance sheet as of September 30,
2008.
12
COSTAR
GROUP, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
4.
|
FAIR
VALUE — (CONTINUED)
|
While the
Company continues to earn interest on its ARS investments at the maximum
contractual rate, these investments are not currently trading and therefore do
not currently have a readily determinable market value. Accordingly,
the estimated fair value of the ARS no longer approximates par
value. The Company has used a discounted cash flow model to determine
the estimated fair value of its investment in ARS as of September 30,
2008. The assumptions used in preparing the discounted cash flow
model include estimates for interest rates, timing and amount of cash flows and
expected holding periods of the ARS. Based on this assessment of fair
value, as of September 30, 2008, the Company determined there was a decline in
the fair value of its ARS investments of approximately $2.9
million. The decline was deemed to be a temporary impairment and
recorded as an unrealized loss in other comprehensive income in stockholders’
equity. In addition, while all of the ARS are currently rated AAA, if
the issuers are unable to successfully close future auctions and their credit
ratings deteriorate, the Company may be required to record additional unrealized
losses in other comprehensive income or an other-than-temporary impairment
charge to earnings on these investments.
|
5.
|
GOODWILL
|
The
changes in the carrying amount of goodwill by operating segment consist of the
following (in thousands):
|
United
States
|
International
|
Total
|
||||||||||
|
Goodwill,
December 31, 2006
|
$ | 30,428 | $ | 16,069 | $ | 46,497 | ||||||
|
Acquisitions
|
¾ | 14,806 | 14,806 | |||||||||
|
Effect
of foreign currency translation
|
¾ | 551 | 551 | |||||||||
|
Goodwill,
December 31, 2007
|
30,428 | 31,426 | 61,854 | |||||||||
|
Acquisitions
|
1,118 | ¾ | 1,118 | |||||||||
|
Effect
of foreign currency translation
|
¾ | (2,829 | ) | (2,829 | ) | |||||||
|
Goodwill,
September 30, 2008 (unaudited)
|
$ | 31,546 | $ | 28,597 | $ | 60,143 | ||||||
The
Company recorded goodwill of approximately $1.1 million in connection with First
CLS, Inc. acquisition in April 2008.
13
COSTAR
GROUP, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
6.
|
INTANGIBLES
AND OTHER ASSETS
|
Intangibles
and other assets consist of the following (in thousands, except amortization
period data):
|
September
30,
2008
|
December
31,
2007
|
Weighted-
Average Amortization Period (in years)
|
||||||||||
|
(unaudited)
|
||||||||||||
|
Building
photography
|
$ | 11,256 | $ | 10,799 |
5
|
|||||||
|
Accumulated
amortization
|
(7,588 | ) | (6,708 | ) | ||||||||
|
Building
photography, net
|
3,668 | 4,091 | ||||||||||
|
Acquired
database technology
|
21,168 | 21,390 |
4
|
|||||||||
|
Accumulated
amortization
|
(20,672 | ) | (20,573 | ) | ||||||||
|
Acquired
database technology, net
|
496 | 817 | ||||||||||
|
Acquired
customer base
|
51,355 | 50,891 |
10
|
|||||||||
|
Accumulated
amortization
|
(37,451 | ) | (34,374 | ) | ||||||||
|
Acquired
customer base, net
|
13,904 | 16,517 | ||||||||||
|
Acquired
trade names and other
|
8,649 | 9,089 |
6
|
|||||||||
|
Accumulated
amortization
|
(6,078 | ) | (4,803 | ) | ||||||||
|
Acquired
trade names and other, net
|
2,571 | 4,286 | ||||||||||
|
Intangibles
and other assets, net
|
$ | 20,639 | $ | 25,711 | ||||||||
|
7.
|
INCOME
TAXES
|
The
income tax provision for the nine months ended September 30, 2008 and 2007
reflects an effective tax rate of approximately 45%. The Company establishes a
valuation allowance with respect to deferred tax assets associated with future
tax benefits that the Company is not certain it will be able to realize. As of
September 30, 2008, the Company continues to maintain a valuation allowance of
approximately $63,000 for certain state net operating loss
carryforwards.
|
8.
|
COMMITMENTS
AND CONTINGENCIES
|
Currently,
and from time to time, the Company is involved in litigation incidental to the
conduct of its business. The Company is not a party to any lawsuit or
proceeding that, in the opinion of management, is likely to have a material
adverse effect on its financial position or results of operations.
14
COSTAR
GROUP, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
9.
|
SEGMENT
REPORTING
|
Due to
the increased size, complexity, and funding requirements associated with the
Company’s international expansion, in 2007 the Company began to manage the
business geographically in two operating segments, with the primary areas of
measurement and decision-making being the U.S. and International, which includes
the U.K. and France. The Company’s subscription-based information services,
consisting primarily of CoStar Property Professional®,
CoStar Tenant®,
CoStar COMPS Professional®,
and FOCUSTM
services, currently generate approximately 95% of the Company’s total revenues.
CoStar Property Professional, CoStar Tenant, and CoStar COMPS Professional are
generally sold as a suite of similar services and comprise the Company’s primary
service offering in the U.S. operating segment. FOCUS is the
Company’s primary service offering in the International operating segment. Management relies on an
internal management reporting process that provides revenue and segment EBITDA,
which is the Company’s net income before interest, income taxes, depreciation
and amortization. Management believes that segment EBITDA is an appropriate
measure for evaluating the operational performance of our
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.
Summarized
information by segment was as follows (in thousands):
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30,
|
September
30,
|
|||||||||||||||
|
2008
|
2007
|
2008
|
2007
|
|||||||||||||
|
Revenues
|
||||||||||||||||
|
United
States
|
$ | 48,026 | $ | 43,503 | $ | 141,888 | $ | 125,565 | ||||||||
|
International
|
5,731 | 5,837 | 17,611 | 16,400 | ||||||||||||
|
Total
revenues
|
$ | 53,757 | $ | 49,340 | $ | 159,499 | $ | 141,965 | ||||||||
|
EBITDA
|
||||||||||||||||
|
United
States
|
$ | 15,852 | $ | 9,407 | $ | 42,184 | $ | 21,011 | ||||||||
|
International
|
(319 | ) | (1,454 | ) | (2,295 | ) | (3,785 | ) | ||||||||
|
Total
EBITDA
|
$ | 15,533 | $ | 7,953 | $ | 39,889 | $ | 17,226 | ||||||||
|
Reconciliation
of EBITDA to net income
|
||||||||||||||||
|
EBITDA
|
$ | 15,533 | $ | 7,953 | $ | 39,889 | $ | 17,226 | ||||||||
|
Purchase
amortization in cost of revenues
|
(585 | ) | (439 | ) | (1,772 | ) | (1,387 | ) | ||||||||
|
Purchase
amortization in operating expenses
|
(1,236 | ) | (1,328 | ) | (3,723 | ) | (3,807 | ) | ||||||||
|
Depreciation
and other amortization
|
(2,432 | ) | (2,349 | ) | (7,374 | ) | (6,513 | ) | ||||||||
|
Interest
income, net
|
951 | 2,072 | 4,132 | 5,825 | ||||||||||||
|
Income
tax expense, net
|
(5,586 | ) | (2,659 | ) | (14,030 | ) | (5,105 | ) | ||||||||
|
Net
income
|
$ | 6,645 | $ | 3,250 | $ | 17,122 | $ | 6,239 | ||||||||
International
EBITDA includes a corporate allocation of approximately $277,000 and $450,000
for the three months ended September 30, 2008 and 2007, respectively, and
$887,000 and $2.2 million for the nine months ended September 30, 2008 and 2007,
respectively. The corporate allocation represents costs incurred for U.S.
employees involved in management and expansion activities of the Company’s
International operating segment.
15
COSTAR
GROUP, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) —
(CONTINUED)
|
9.
|
SEGMENT
REPORTING — (CONTINUED)
|
Summarized
information by segment consist of the following (in thousands):
|
September
30,
|
December
31,
|
|||||||
|
2008
|
2007
|
|||||||
|
(unaudited)
|
|
|||||||
|
Property
and equipment, net
|
||||||||
|
United
States
|
$ | 14,994 | $ | 18,162 | ||||
|
International
|
4,302 | 5,883 | ||||||
|
Total
property and equipment, net
|
$ | 19,296 | $ | 24,045 | ||||
|
Goodwill
|
||||||||
|
United
States
|
$ | 31,546 | $ | 30,428 | ||||
|
International
|
28,597 | 31,426 | ||||||
|
Total
segment goodwill
|
$ | 60,143 | $ | 61,854 | ||||
|
Assets
|
||||||||
|
United
States
|
$ | 340,094 | $ | 308,373 | ||||
|
International
|
56,256 | 72,659 | ||||||
|
Total
segment assets
|
$ | 396,350 | $ | 381,032 | ||||
|
Reconciliation
of segment assets to total assets
|
||||||||
|
Total
segment assets
|
$ | 396,350 | $ | 381,032 | ||||
|
Investment
in subsidiaries
|
(18,343 | ) | (18,343 | ) | ||||
|
Intercompany
receivables
|
(43,091 | ) | (40,846 | ) | ||||
|
Total
assets
|
$ | 334,916 | $ | 321,843 | ||||
|
Liabilities
|
||||||||
|
United
States
|
$ | 24,443 | $ | 21,581 | ||||
|
International
|
50,667 | 61,025 | ||||||
|
Total
segment liabilities
|
$ | 75,110 | $ | 82,606 | ||||
|
Reconciliation
of segment liabilities to total liabilities
|
||||||||
|
Total
segment liabilities
|
$ | 75,110 | $ | 82,606 | ||||
|
Intercompany
payables
|
(40,859 | ) | (42,568 | ) | ||||
|
Total
liabilities
|
$ | 34,251 | $ | 40,038 | ||||
16
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. See “Cautionary Statement
Concerning Forward-Looking Statements” at the end of this Item 2. for additional
factors relating to such statements, and see “Risk Factors” in Item 1A. of Part
II of this Report for a discussion of certain risk factors applicable to our
business, financial condition and results of operations.
The
following discussion should be read in conjunction with our Annual Report on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other
filings with the Securities and Exchange Commission and the condensed
consolidated financial statements and related notes included in this Quarterly
Report on Form 10-Q.
Overview
CoStar
Group, Inc. (“CoStar”) is the leading provider of information/marketing services
to the commercial real estate industry in the U.S. and the U.K. based on the
fact that we offer access to the most comprehensive commercial real estate
information database available, have the largest research department in the
industry, provide more information and marketing services than any of our
competitors and believe we generate more revenues than any of our competitors.
We have created a standardized information platform where the members of the
commercial real estate and related business community can continuously interact
and facilitate transactions by efficiently exchanging accurate and standardized
commercial real estate information. Our integrated suite of online service
offerings includes information about space available for lease, comparable sales
information, tenant information, information about properties for sale, internet
marketing services, information for clients' websites, information about
industry professionals and their business relationships, analytic information,
data integration, property marketing and industry news. Our service offerings
span all commercial property types ¾ office, industrial,
retail, land, mixed-use, hospitality and multifamily.
Since
1994, we have expanded the geographical coverage of our existing information
services and developed new information services. In addition to internal growth,
this expansion included the acquisitions of Chicago ReSource, Inc. in Chicago in
1996 and New Market Systems, Inc. in San Francisco in 1997. In August 1998,
we expanded into the Houston region through the acquisition of Houston-based
real estate information provider C Data Services, Inc. In January 1999, we
expanded further into the Midwest and Florida by acquiring LeaseTrend, Inc. and
into Atlanta and Dallas/Fort Worth by acquiring Jamison Research, Inc. In
February 2000, we acquired COMPS.COM, Inc., a San Diego-based provider of
commercial real estate information. In November 2000, we acquired First Image
Technologies, Inc., a California-based provider of commercial real estate
software. In September 2002, we expanded further into Portland, Oregon through
the acquisition of certain assets of Napier Realty Advisors (doing business as
REAL-NET). In January 2003, we established a base in the U.K. with our
acquisition of London-based FOCUS Information Limited. In May 2004, we expanded
into Tennessee through the acquisition of Peer Market Research, Inc., and in
September 2004, we extended our coverage of the U.K. through the acquisition of
Scottish Property Network (SPNTM). In
September 2004, we strengthened our position in Denver, Colorado through the
acquisition of substantially all of the assets of RealComp, Inc., a local
comparable sales information provider.
In
January 2005, we acquired National Research Bureau, a Connecticut-based leading
provider of U.S. shopping center information. In December 2006, our U.K.
subsidiary, CoStar Limited, acquired Grecam S.A.S. (“GrecamTM”), a
provider of commercial property information and market-level surveys, studies
and consulting services located in Paris, France. In February 2007, CoStar
Limited also acquired Property Investment Exchange Limited (“Propex”), a
provider of web-based commercial property information and operator of an
electronic platform that facilitates the exchange of investment property located
in London, England. On April 1, 2008, we acquired the assets of First CLS, Inc.
(doing business as the Dorey Companies and DoreyPRO), an Atlanta-based provider
of local commercial real estate information. The most recent acquisitions are
discussed later in this section under the heading “Recent
Acquisitions.”
17
In 2004,
we began our expansion into 21 new metropolitan markets throughout the U.S., as
well as expanding the geographical coverage of many of our existing U.S. and
U.K. markets. We completed our expansion into the 21 new markets in the first
quarter of 2006.
In early
2005, we announced the launch of a major effort to expand our coverage of retail
real estate information. The new retail component of our flagship product,
CoStar Property Professional, was unveiled in May 2006 at the International
Council of Shopping Centers’ convention in Las Vegas.
During
the second half of 2006, we began actively researching commercial properties in
81 new Core Based Statistical Areas (“CBSAs”) in the U.S., increased our U.S.
field research fleet by adding 89 vehicles and hired researchers to staff these
vehicles. In March 2007, we signed a long-term lease for a new research facility
in White Marsh, Maryland, in support of our expanded research efforts and hired
and trained additional researchers and other personnel. We released our CoStar
Property Professional service in the 81 new CBSAs across the U.S. in
the fourth quarter of 2007 in an effort to further expand the geographical
coverage of our service offerings.
In
connection with our acquisitions of Propex and Grecam, we are continuing to
expand the coverage of our service offerings within the U.K., and integrate our
international operations more fully with those in the U.S. We intend to
eventually introduce a consistent international platform of service offerings.
Further, in 2007 we introduced the “CoStar Group” as the brand encompassing our
international operations.
To cost
effectively manage the growth of our international operations, we opened a
research operations center in Glasgow, Scotland in 2007, rather than expand our
operations in London. During the third quarter of 2007, we took steps to
consolidate and streamline our international operations. As a result of these
steps, certain management and staff positions in the U.K. were made redundant,
which reduced certain costs and the amount of office space required in London.
Effective December 19, 2007, CoStar UK Limited assigned its lease interest in
our Mayfair office to a third party in exchange for a one-time payment of $7.6
million, net of expenses. We consolidated our London offices in Mayfair and
Sheen into one facility in central London. We have gained operational
efficiencies as a result of consolidating a majority of our U.K. research
operations in one location in Glasgow and combining the majority of our
remaining U.K. operations in one central location in London.
We
believe that our recent U.S. and international expansion and integration efforts
have created a platform for earnings growth and will generate additional revenue
now that the related costs have stabilized. In fact, our results for the first
nine months of 2008 reflect growth in earnings as a result of these investments
in our business, and we expect revenues to continue to grow over what is now a
relatively fixed cost base for our research operations. Significant
foreign currency exchange rate fluctuations may negatively impact our
international revenue, which in turn could impact our revenue
results.
Although
we do not currently plan to initiate new significant investments for the
remainder of 2008 and through 2009, we expect to continue to develop and
distribute new services, expand existing services within our current platform,
consider strategic acquisitions and develop our sales and marketing
organization. For instance, in May 2008, we released CoStar Showcase®,
an internet marketing service that provides commercial real estate professionals
the opportunity to make their listings accessible to all visitors to our public
website, www.CoStar.com. In addition, in April 2008, as described above we
acquired the online commercial real estate information assets of First CLS, Inc.
(doing business as the Dorey Companies and DoreyPRO). Any future expansion could
reduce our profitability and increase our capital expenditures. Therefore, while
we expect current service offerings to remain profitable, driving overall
earnings growth for the remainder of 2008 and through 2009, and providing
substantial cash flow for our business, it is possible that any new investments
or acquisitions could cause us to generate losses and negative cash flow from
operations in the future.
We
believe we are well positioned to generate continued, sustained earnings growth
through the end of 2008. We expect 2008 revenue to grow over 2007
revenue as a result of further penetration of our services in our potential
customer base across our platform, successful cross selling of our services to
our existing customers, the release of new services, continued depth of coverage
and acquisitions. We expect that 2008 EBITDA, which is our net income before
interest, income taxes, depreciation and amortization, will increase over 2007
based on the growth in EBITDA from U.S. operations. We anticipate that our
EBITDA for our existing U.S. platform will continue to grow due to growth in
revenue, and sustained earnings leverage.
18
Our
subscription-based information services, consisting primarily of CoStar Property
Professional, CoStar Tenant, CoStar COMPS Professional, and FOCUS services,
currently generate approximately 95% of our total revenues. CoStar Property
Professional, CoStar Tenant, and CoStar COMPS Professional are generally sold as
a suite of similar services and comprise our primary service offering in our
U.S. operating segment. FOCUS is our primary service offering in our
International operating segment. Our contracts for our
subscription-based information services typically have a minimum term of one
year and renew automatically, unless the customer submits written notice of its
intent not to renew 60 days prior to the contract’s expiration date. Upon
renewal, many of the subscription contract rates may increase 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 fees based on actual
system usage. Contract rates are typically based on the number of sites, number
of users, organization size, the client’s business focus, geography and the
number of services to which a client subscribes. Our subscription clients
generally pay contract fees on a monthly basis, but in some cases may pay us on
a quarterly or annual basis. We recognize this revenue on a straight-line basis
over the life of the contract. Annual and quarterly advance payments result in
deferred revenue, substantially reducing the working capital requirements
generated by accounts receivable.
For the
twelve months ended September 30, 2008 and 2007, our contract renewal rates were
approximately 90% and 92%, respectively.
Application
of Critical Accounting Policies and Estimates
The
preparation of financial statements and related disclosures in conformity with
generally accepted accounting principles (“GAAP”) in the United States of
America 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 estimates reasonably could have been used in the current
period. Changes in the accounting estimates we use 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 realize any undiscounted cash
flows of the carrying amounts of such assets and are affected by 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 measure any impairment based on a projected discounted cash flow
method using a discount rate determined by our management to be commensurate
with the risk inherent in our current business model.
Goodwill
and identifiable intangible assets not subject to amortization are tested
annually by reporting unit on October 1st of each
year for impairment and are tested for impairment more frequently based upon the
existence of one or more of the above indicators. We measure any impairment loss
to the extent that the carrying amount of the asset exceeds its fair
value. We consider our operating segments, U.S. and International, as
our reporting units under Statement of Financial Accounting Standards (“SFAS”)
No. 142 for consideration of potential impairment of goodwill.
19
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 actual current tax exposure
and assess the temporary differences resulting from differing treatment of
items, such as deferred revenue or 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 statements of operations.
As of
December 31, 2007, we had net operating loss carryforwards for federal income
tax purposes of approximately $14.9 million, which we expect to use during
2008. We expect to make cash payments for taxes during 2008 of
approximately $13.0 to $14.0 million because our U.S. taxable income will no
longer be fully absorbed by carryforward losses.
Our U.K.
operations are expected to generate net operating losses for the full year
2008. Losses in the U.K. will generate a lower tax benefit than if
the costs were incurred in the U.S., thereby creating a higher effective tax
rate in 2008.
In
determining the quarterly provision for income taxes, we use an estimated annual
effective tax rate based on expected annual income by jurisdiction, statutory
tax rates, permanent timing differences, and tax planning opportunities
available in the various jurisdictions in which we operate.
Non-GAAP
Financial Measure
We
prepare and publicly release quarterly unaudited financial statements prepared
in accordance with GAAP. We also disclose and discuss certain non-GAAP financial
measures in our public releases. Currently, the non-GAAP financial measure that
we disclose is EBITDA, which is our net income (loss) before interest, income
taxes, depreciation and amortization. We 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. 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 more meaningfully evaluate and
compare our future results of operations to our previously reported results of
operations.
We view
EBITDA as an operating performance measure and as such we believe that the GAAP
financial measure most directly comparable to it is net income (loss). In
calculating EBITDA, 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 the non-GAAP financial measures as a result of these
exclusions. EBITDA is not a measurement 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 as a substitute for any GAAP financial measure, including net
income (loss). In addition, we urge investors and potential investors in our
securities to carefully review the reconciliation of EBITDA to net income (loss)
set forth below, in our earnings releases and in other filings with the
Securities and Exchange Commission and to carefully review the GAAP financial
information included as part of our Quarterly Reports on Form 10-Q and our
Annual Reports on Form 10-K 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.
20
EBITDA is
used by management to internally measure our operating and management
performance and by investors as a supplemental financial measure to evaluate the
performance of our business that, when viewed with our GAAP results and the
accompanying reconciliation, we believe provides additional information that is
useful to gain an understanding of the factors and trends affecting our
business. We have spent more than 20 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 and marketing services, which included acquisitions, our net
income (loss) has included significant charges for purchase amortization,
depreciation and other amortization. EBITDA excludes these charges and provides
meaningful information about the operating performance of our business, apart
from charges for purchase amortization, depreciation and other amortization. We
believe the disclosure of EBITDA helps investors meaningfully evaluate and
compare our performance from quarter to quarter and from year to year. We also
believe EBITDA is a measure of our ongoing operating performance because the
isolation of non-cash charges, such as amortization and depreciation, and
non-operating items, such as interest and income taxes, 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 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 the financial items that have been excluded from our
net income (loss) to calculate EBITDA and the material limitations associated
with using this non-GAAP financial measure as compared to net income
(loss):
|
|
·
|
Purchase
amortization in cost of revenues may be useful for investors to consider
because it represents 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.
|
|
|
·
|
Purchase
amortization in operating expenses may be useful for investors to consider
because it represents the estimated attrition of our acquired customer
base and the diminishing value of any acquired trade names. 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 net interest income we generate may be useful for investors to
consider and may result in current cash inflows or outflows. However, we
do not consider the amount of net interest income to be a representative
component of the day-to-day operating performance of our
business.
|
|
|
·
|
Income
tax expense (benefit) 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 (benefit) to be a representative component of the day-to-day
operating performance of our
business.
|
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 gain an understanding of the factors
and trends affecting our business.
21
The
following table shows our EBITDA reconciled to our net income and our cash flows
from operating, investing and financing activities for the indicated periods (in
thousands):
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
|||||||||||||||
|
2008
|
2007
|
2008
|
2007
|
|||||||||||||
|
Net
income
|
$ | 6,645 | $ | 3,250 | $ | 17,122 | $ | 6,239 | ||||||||
|
Purchase
amortization in cost of revenues
|
585 | 439 | 1,772 | 1,387 | ||||||||||||
|
Purchase
amortization in operating expenses
|
1,236 | 1,328 | 3,723 | 3,807 | ||||||||||||
|
Depreciation
and other amortization
|
2,432 | 2,349 | 7,374 | 6,513 | ||||||||||||
|
Interest
income, net
|
(951 | ) | (2,072 | ) | (4,132 | ) | (5,825 | ) | ||||||||
|
Income
tax expense, net
|
5,586 | 2,659 | 14,030 | 5,105 | ||||||||||||
|
EBITDA
|
$ | 15,533 | $ | 7,953 | $ | 39,889 | $ | 17,226 | ||||||||
|
Cash
flows provided by (used in)
|
||||||||||||||||
|
Operating
activities
|
$ | 14,545 | $ | 11,174 | $ | 30,381 | $ | 27,958 | ||||||||
|
Investing
activities
|
19,461 | (6,294 | ) | 45,668 | (26,110 | ) | ||||||||||
|
Financing
activities
|
3,456 | 1,734 | 6,227 | 2,946 | ||||||||||||
Comparison
of Three Months Ended September 30, 2008 and Three Months Ended September 30,
2007
Revenues. Revenues increased
to $53.8 million in the third quarter of 2008 from $49.3 million in the third
quarter of 2007. This increase in revenue is due to further penetration of our
subscription-based information services, and successful cross-selling of our
services to our customers in existing markets, combined with continued high
renewal rates. Our subscription-based information services, consisting primarily
of CoStar Property Professional, CoStar Tenant, CoStar COMPS Professional and
FOCUS, currently generate approximately 95% of our total revenues.
Gross Margin. Gross margin
increased to $36.1 million in the third quarter of 2008 from $29.8 million in
the third quarter of 2007. The gross margin percentage increased to 67.2% in the
third quarter of 2008 from 60.4% in the third quarter of 2007. The increase in
gross margin amount and percentage was principally due to an increase in
revenues coupled with a decrease in the cost of revenues. Cost of
revenues decreased to $17.6 million for the third quarter of 2008 from $19.6
million for the third quarter of 2007. The decrease in cost of revenues was
principally due to our reduction of approximately $500,000 in research
department personnel cost, a decrease of approximately $300,000 in hiring and
training costs, and a decrease of approximately $400,000 in outsourcing costs
incurred in connection with our expansion in 2007 that were not incurred in
2008. Additionally, cost of revenues decreased approximately $400,000
due to more favorable data agreements in 2008 compared to 2007.
Selling and Marketing
Expenses. Selling and marketing expenses decreased to $10.3 million in
the third quarter of 2008 from $11.9 million in the third quarter of 2007, and
decreased as a percentage of revenues to 19.2% in the third quarter of 2008 from
24.2% in the third quarter of 2007. The decrease in the amount of selling and
marketing expenses was primarily due to decreases in marketing initiatives of
approximately $700,000 and personnel expense of approximately $600,000. The
decrease in marketing initiatives was primarily due to expenses incurred for our
listing sweepstakes campaign in the third quarter of 2007, which were not
incurred in 2008. The decrease in personnel expense was primarily due to the
fact that the sales force sold services with a smaller average price point in
the third quarter of 2008, which resulted in lower average contract values
compared to the third quarter of 2007.
Software Development
Expenses. Software development expenses remained relatively consistent at
$3.1 million in the third quarter of 2008 compared to $3.0 million in the third
quarter of 2007, and remained relatively consistent as a percentage of revenues
at 5.8% in the third quarter of 2008 compared to 6.1% in the third quarter of
2007. The decrease in the percentage was due to increased revenues in
2008.
General and Administrative
Expenses. General and administrative expenses increased to $10.2 million
in the third quarter of 2008 from $9.7 million in the third quarter of
2007, and decreased as a percentage of revenues to 18.9% in the third quarter of
2008 compared to 19.6% in the third quarter of 2007. The increase in the amount
of general and administrative expenses was primarily due to additional legal
fees of approximately $800,000.
22
Purchase Amortization.
Purchase amortization remained relatively consistent at $1.2 million in the
third quarter of 2008 compared to $1.3 million in the third quarter of 2007, and
remained relatively consistent as a percentage of revenues at 2.3% in the third
quarter of 2008 compared to 2.7% in the third quarter of 2007.
Interest and Other Income,
Net. Interest and other income, net decreased to $951,000 in the third
quarter of 2008 from $2.1 million in the third quarter of
2007. Although, cash and cash equivalents, short-term and long-term
investments were higher in the third quarter of 2008 than in the third quarter
of 2007, our interest and other income decreased due to lower average interest
rates in the third quarter of 2008 compared to the third quarter of
2007.
Income Tax Expense,
Net. Income tax expense, net increased to $5.6 million in the
third quarter of 2008 from $2.7 million in the third quarter of 2007. This
increase was due to higher income before income taxes as a result of our growth
in profitability.
Comparison
of Business Segment Results for Three Months Ended September 30, 2008 and Three
Months Ended September 30, 2007
Due to
the increased size, complexity, and funding requirements associated with our
international expansion, in 2007 we began to manage our business geographically
in two operating segments, with our primary areas of measurement and
decision-making being the U.S. and International, which includes the U.K. and
France. Management relies on an internal management reporting process
that provides revenue and segment EBITDA, which is our net income before
interest, income taxes, depreciation and amortization. Management
believes that segment EBITDA is an appropriate measure for evaluating the
operational performance of our 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. CoStar Property
Professional, CoStar Tenant, and CoStar COMPS Professional are generally sold as
a suite of similar services and comprise our primary service offering in our
U.S. operating segment. U.S. revenues increased to $48.0 million in
the third quarter of 2008 from $43.5 million in the third quarter of
2007. This increase in U.S. revenue was due to further penetration of
our U.S. subscription-based information services and the successful
cross-selling of our services to our customers in existing markets, combined
with continued high renewal rates. FOCUS is our primary service offering in our
International operating segment. International revenues decreased slightly to
$5.7 million in the third quarter of 2008 from $5.8 million in the third quarter
of 2007 due to foreign currency fluctuations.
Segment EBITDA. U.S. EBITDA
increased to $15.9 million in the third quarter of 2008 from $9.4 million in the
third quarter of 2007. The increase in U.S. EBITDA was due to increased revenue
and lower personnel costs, partially offset by an increase in legal fees.
International EBITDA increased to a loss of $319,000 in the third quarter of
2008 from a loss of $1.5 million in the third quarter of 2007. This decreased
loss was primarily due to lower personnel and hiring costs for the third quarter
of 2008 compared to the third quarter of 2007. Additionally, the
third quarter of 2008 had a lower corporate allocation than the third quarter of
2007. International EBITDA includes a corporate allocation of approximately
$277,000 and $450,000 for the three months ended September 30, 2008 and 2007,
respectively. The corporate allocation represents costs incurred for U.S.
employees involved in international management and expansion
activities.
Comparison
of Nine Months Ended September 30, 2008 and Nine Months Ended September 30,
2007
Revenues. Revenues increased
to $159.5 million for the nine months ended September 30, 2008, from $142.0
million for the nine months ended September 30, 2007. This increase in revenue
was due to further penetration of our subscription-based information services,
and successful cross-selling of our services to our customers in existing
markets, combined with continued high renewal rates.
23
Gross Margin. Gross margin
increased to $103.8 million for the nine months ended in September 30, 2008,
from $85.3 million for the nine months ended September 30, 2007. Gross margin
percentage increased to 65.1% for the nine months ended September 30, 2008, from
60.1% for the nine months ended September 30, 2007. The increase in the gross
margin amount and percentage resulted principally from revenue growth from our
subscription-based information services, and a decrease in cost of revenues. The
decrease in cost of revenues to $55.7 million for the nine months ended
September 30, 2008, from $56.7 million for the nine months ended September 30,
2007, principally resulted from a decrease in research department hiring and
training costs and a reduction of outsourcing costs of approximately $1.0
million each, both of which were incurred in connection with our expansion in
2007. The decreases were partially offset by an increase in research
personnel costs of approximately $1.0 million, which was primarily related to
international expansion.
Selling and Marketing
Expenses. Selling and marketing expenses decreased to $33.3 million for
the nine months ended September 30, 2008, from $39.8 million for the nine months
ended September 30, 2007, and decreased as a percentage of revenues to 20.9% for
the nine months ended September 30, 2008, from 28.0% for the nine months ended
September 30, 2007. The decrease was mostly due to a decrease in personnel costs
primarily due to the fact that the sales force sold services with a smaller
average price point in 2008, which resulted in lower average contract values
compared to 2007.
Software Development
Expenses. Software development expenses remained relatively consistent at
$9.7 million for the nine months ended September 30, 2008, compared to $9.4
million for the nine months ended September 30, 2007, and decreased as a
percentage of revenues to 6.1% for the nine months ended September 30, 2008,
from 6.6% for the nine months ended September 30, 2007. The
decrease in the percentage was due to increased revenues in 2008.
General and Administrative
Expenses. General and administrative expenses increased to $30.1 million
for the nine months ended September 30, 2008, from $26.8 million for the nine
months ended September 30, 2007, and remained consistent as a percentage of
revenues at 18.9% for each of the nine months ended September 30, 2008, and
September 30, 2007, respectively. The increase in the amount of general and
administrative expenses was principally a result of an increase of approximately
$1.9 million in legal fees and an increase of approximately $1.3 million in bad
debt expense.
Purchase Amortization.
Purchase amortization remained relatively consistent at $3.7 million for the
nine months ended September 30, 2008 compared to $3.8 million for the nine
months ended September 30, 2007, and remained relatively consistent as a
percentage of revenues at 2.3% for the nine months ended September 30, 2008,
compared to 2.7% for the nine months ended September 30, 2007.
Interest and Other Income, Net.
Interest and other income, net decreased to $4.1 million for the nine
months ended September 30, 2008, from $5.8 million for the nine months ended
September 30, 2007. Although, cash and cash equivalents, short-term and
long-term investments were higher for the nine months ended September 30, 2008
compared to the nine months ended September 30, 2007, our interest and other
income decreased due to lower average interest rates compared to the nine months
ended September 30, 2007.
Income Tax Expense,
Net. Income tax expense, net increased to $14.0 million for
the nine months ended September 30, 2008, from $5.1 million for the nine months
ended September 30, 2007. This increase was due to higher income before income
taxes as a result of our growth in profitability.
Comparison
of Business Segment Results for Nine Months Ended September 30, 2008 and Nine
Months Ended September 30, 2007
Segment Revenues. U.S. revenues
increased to $141.9 million from $125.6 million for the nine months ended
September 30, 2008 and 2007, respectively. This increase in U.S. revenue was due
to further penetration of our U.S. subscription-based information services and
successful cross-selling of our services to our customers in existing markets,
combined with continued high renewal rates. International revenues increased to
$17.6 million from $16.4 million for the nine months ended September 30, 2008
and 2007, respectively. This increase in International revenue was principally a
result of further penetration of our subscription-based information
services.
24
Segment EBITDA. U.S. EBITDA
increased to $42.2 million from $21.0 million for the nine months ended
September 30, 2008 and 2007, respectively. The increase in U.S. EBITDA was due
to increased revenue and lower selling and marketing personnel costs, partially
offset by an increase in legal fees and bad debt
expense. International EBITDA increased to a loss of $2.3 million
from a loss of $3.8 million for the nine months ended September 30, 2008 and
2007, respectively. This decreased loss was primarily due to increased revenues
and a lower corporate allocation, partially offset by higher research personnel
costs. International EBITDA includes a corporate allocation of approximately
$887,000 and $2.2 million for the nine months ended September 30, 2008 and 2007,
respectively. The corporate allocation represents costs incurred for U.S.
employees involved in international management and expansion
activities.
Recent
Acquisitions
On
February 16, 2007, CoStar Limited, a wholly owned U.K. subsidiary of CoStar,
acquired Property Investment Exchange Limited (“Propex”), a provider of
web-based commercial property information and operator of an electronic platform
that facilitates the exchange of investment property in the U.K. Propex’s suite
of electronic platforms and listing websites give users access to the U.K.
commercial property investment and leasing markets. CoStar Limited acquired all
outstanding capital stock of Propex for approximately $22.0 million, consisting
of cash, deferred consideration, and 21,526 shares of CoStar common
stock.
This
acquisition was accounted for using the purchase method of accounting. The
purchase price for the acquisition was primarily allocated to customer base,
trade name, and goodwill. The acquired customer base, which consists of one
distinct intangible asset for the acquisition and is composed of acquired
customer contracts and the related customer relationships, is being amortized on
a 125% declining balance method over ten years. The Propex acquired trade name
is amortized on a straight-line basis over three years. We recorded goodwill of
approximately $15.0 million for the Propex acquisition. Goodwill is
not amortized, but is subject to annual impairment tests. The results of
operations of Propex have been consolidated with those of the Company since the
date of the acquisition and are not considered material to our consolidated
financial statements. Accordingly, pro forma financial information has not been
presented for the acquisition.
On April
1, 2008, we acquired certain assets of First CLS, Inc. (doing business as the
Dorey Companies and DoreyPRO), an Atlanta-based provider of local commercial
real estate information for $3.0 million in initial cash consideration and
deferred consideration payable within approximately six months of the one-year
anniversary of closing. The First CLS, Inc. acquisition was accounted for using
the purchase method of accounting. The purchase price for the acquisition was
primarily allocated to customer base. The acquired customer base, which consists
of one distinct intangible asset and is composed of acquired customer contracts
and the related customer relationships, is being amortized on a 125% declining
balance method over ten years. The results of operations of First CLS, Inc. have
been consolidated with those of the Company since the date of the acquisition
and are not considered material to our consolidated financial statements.
Accordingly, pro forma financial information has not been presented for the
acquisition.
Liquidity
and Capital Resources
Our
principal sources of liquidity are cash, cash equivalents and short-term
investments. Total cash, cash equivalents and short-term investments decreased
to $183.0 million at September 30, 2008 from $187.4 million at December 31,
2007. The decrease in cash, cash equivalents and short-term
investments during the nine months ended September 30, 2008 was primarily due to
reclassification of approximately $33.1 million par value auction rate
securities (“ARS”) from short-term investments to long-term investments in the
first quarter of 2008, partially offset by an increase in net cash from
operating activities of approximately $30.4 million. 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.
Net cash
provided by operating activities for the nine months ended September 30, 2008
was $30.4 million compared to $28.0 million for the nine months ended September
30, 2007. This increase was primarily due to increased
net income plus non-cash operating items of $40.3 million for the nine months
ended September 30, 2008 compared to $29.0 million for the nine months ended
September 30, 2007, partially offset by a decrease in changes in operating
assets and liabilities of approximately $8.9 million. The
decrease in changes in operating assets and liabilities was principally due to a
decrease of approximately $2.4 million related to timing
differences of accounts receivable, a decrease of approximately $6.5
million due to timing differences in accounts payable and accrued expenses, and
a decrease of approximately $2.9 million due to the payment of deferred
consideration for the Propex acquisition, partially offset by other changes in
working capital of approximately $2.9 million.
25
Net cash
provided by investing activities was $45.7 million for the nine months ended
September 30, 2008, compared to net cash used in investing activities of $26.1
million for the nine months ended September 30, 2007. This $71.8 million
increase in net cash provided by investing activities was primarily due to the
decision to invest in money market funds and U.S. treasuries instead of
short-term investment instruments, which resulted in a net sale of investments
of approximately $51.9 million in the nine months ended September 30, 2008
compared to a net purchase of investments of approximately $1.0 million in the
nine months ended September 30, 2007. In addition, we used $3.0
million in cash as initial consideration for the purchase of First CLS, Inc. in
the nine months ended September 30, 2008, as compared to the use of $16.7
million in cash consideration used for the acquisition of Propex in the nine
months ended September 30, 2007. We also purchased approximately $5.2 million
less in property, equipment and other assets during the nine months ended
September 30, 2008 compared to the nine months ended September 30,
2007.
Net cash
provided by financing activities increased to $6.2 million for the nine months
ended September 30, 2008, compared to $2.9 million for the nine months ended
September 30, 2007, due to increased proceeds from exercise of stock
options.
During
the nine months ended September 30, 2008, we incurred capital expenditures of
approximately $3.2 million. Additionally, we expect to incur
approximately $1.0 to $3.0 million of capital expenditures in the fourth quarter
of 2008.
To date,
we have grown in part by acquiring other companies and we may continue to make
acquisitions. Our acquisitions may vary in size and could be material
to our current operations. We expect to use cash, stock, debt or other means of
funding to make these acquisitions. In April 2008, we paid $3.0
million in initial cash consideration and made a commitment for deferred
consideration payable within approximately six months of the one-year
anniversary of closing for the online commercial real estate information assets
of First CLS, Inc., an Atlanta-based provider of local commercial real estate
information.
We have
net operating loss carryforwards for federal income tax purposes of
approximately $14.9 million, which we expect to use during 2008. We expect our
cash payments for taxes to be approximately $13.0 to $14.0 million during
2008 because our U.S. taxable income will no longer be fully absorbed by
carryforward losses. We expect our cash payments for estimated taxes
to be approximately $3.0 to $4.0 million in the fourth quarter of
2008.
As of
September 30, 2008, we had $33.1 million par value of long-term investments in
student loan ARS, which failed to settle at auctions. These investments
are of high credit quality with AAA credit ratings and are primarily
securities supported by guarantees from the Federal Family Education Loan
Program (“FFELP”) of the U.S. Department of Education. While we
continue to earn interest on these investments, the investments are not liquid
in the short term. In the event we need to immediately access these
funds, we may have to sell these securities at an amount below par
value. Based on our ability to access our cash, cash equivalents and
other short-term investments and our expected operating cash flows, we
do not anticipate having to sell these investments below par value in order to
operate our business in the foreseeable future.
Recent
Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value
Measurements” (“SFAS 157”), which defines fair value, establishes a
framework for measuring fair value in accordance with GAAP and expands
disclosures about fair value measurements. SFAS 157 does not require any
new fair value measurements under GAAP and is effective for fiscal years
beginning after November 15, 2007. In February 2008, the FASB
issued FASB Staff Position (“FSP”) 157-2, “Partial Deferral of the Effective
Date of Statement 157” (“FSP 157-2”), which delays the effective date of
SFAS 157 to January 1, 2009 for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in our
consolidated financial statements on a recurring basis (at least
annually). Effective
January 1, 2008, we adopted the portion of SFAS 157 that was not deferred under
FSP 157-2. The adoption of SFAS 157 did not have a material impact on
our results of operations or financial position. In October 2008, the
FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset in a Market That Is Not Active” (“FSP 157-3”), which
clarifies the application of SFAS 157 to markets that are not active and
provides an example illustrating key considerations for determining the fair
value of financial assets when their markets are not active. FSP 157-3 was
effective upon issuance, including prior periods for which financial statements
had not been issued. The adoption of this standard did not have an impact on our
results of operations or financial position.
26
In
February 2007, the FASB issued SFAS No. 159, “Fair Value Option for Financial
Assets and Financial Liabilities — Including an amendment of FASB Statement
No. 115” (“SFAS 159”), which permits entities to choose to measure
many financial instruments and certain other items at fair value that are not
currently required to be measured at fair value. SFAS 159 is effective for
fiscal years beginning on or after December 31, 2007. We adopted SFAS 159 on
January 1, 2008 and have elected not to apply the fair value option to any of
our financial instruments. The adoption of SFAS 159 did not have a
material impact on our results of operations or financial
position.
In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations”
(“SFAS 141R”), which will change the accounting for any business combination we
enter into with an acquisition date after December 31, 2008. Under SFAS 141R, an
acquiring entity will be required to recognize all the assets acquired and
liabilities assumed in a transaction at the acquisition date fair value with
limited exceptions. SFAS 141R will change the accounting treatment and
disclosure for certain specific items in a business combination. SFAS 141R
will have an impact on accounting for business combinations once adopted, but
its effect will depend upon the specifics of any business combination with an
acquisition date subsequent to December 31, 2008.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—An Amendment of ARB No. 51” (“SFAS
160”), which establishes new accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for fiscal years beginning on or after
December 15, 2008. The adoption of SFAS 160 is not expected to have a
material impact on our results of operations or financial
position.
In April
2008, the FASB issued FSP SFAS 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP 142-3”), which is effective for all fiscal years
and interim periods beginning after December 15, 2008. Early adoption of FSP
142-3 is not permitted. FSP 142-3 requires additional footnote disclosures about
the impact of our ability or intent to renew or extend agreements related to
existing intangibles or expected future cash flows from those intangibles, how
we account for costs incurred to renew or extend such agreements, the time until
the next renewal or extension period by asset class, and the amount of renewal
or extension costs capitalized, if any. For any intangibles acquired after
December 31, 2008, FSP 142-3 requires that we consider our experience regarding
renewal and extensions of similar arrangements in determining the useful life of
such intangibles. If we do not have experience with similar arrangements, FSP
142-3 requires that we use the assumptions of a market participant putting the
intangible to its highest and best use in determining its useful life. We are
currently assessing the impact the adoption of FSP 142-3 will have on our
results of operations and financial position.
In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”), which identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements. SFAS 162 is effective as of November
17, 2008. The adoption of SFAS 162 is not expected to have a material impact on
our results of operations or financial position.
Cautionary
Statement Concerning Forward-Looking Statements
We have
made forward-looking statements in this Report and make forward-looking
statements in our press releases and conference calls that are subject to risks
and uncertainties. Forward-looking statements include information that is not
purely historic fact and include, without limitation, statements concerning our
financial outlook for 2008 and beyond, our possible or assumed future results of
operations generally, and other statements and information regarding assumptions
about our revenues, EBITDA, fully diluted net income, taxable income, cash flow
from operating activities, available cash, operating costs, amortization
expense, intangible asset recovery, net income per share, diluted net income per
share, weighted-average outstanding shares, capital and other expenditures,
effective tax rate, equity compensation charges, future taxable income, purchase
amortization, financing plans, geographic expansion, capital structure,
contractual obligations, legal proceedings and claims, our database, database
growth, services and facilities, employee relations, future economic
performance, our ability to liquidate or realize our long-term investments,
management’s plans, goals and objectives for future operations and growth and
markets for our stock. The sections of this Report which contain forward-looking
statements include the Financial Statements and Related Notes, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”,
“Quantitative and Qualitative Disclosures About Market Risk”, “Legal
Proceedings” and “Risk Factors”.
27
Our
forward-looking statements are also identified by words such as “believes,”
“expects,” “thinks,” “anticipates,” “intends,” “estimates” or similar
expressions. You should understand that these forward-looking statements are
estimates reflecting our judgment, beliefs and expectations, not guarantees of
future performance. They are subject to a number of assumptions, risks and
uncertainties that could cause actual results to differ materially from those
expressed or implied in the forward-looking statements. The following important
factors, in addition to those discussed or referred to under the heading “Risk
Factors” in Item 1A. of Part II of this report, and other unforeseen events or
circumstances, could affect our future results and could cause those results or
other outcomes to differ materially from those expressed or implied in our
forward-looking statements: general economic conditions; commercial real estate
market conditions; changes or consolidations within the commercial real estate
industry; customer retention; competition; foreign currency fluctuations; our
ability to identify, acquire and integrate acquisition candidates; our ability
to obtain any required financing on favorable terms; global credit market
conditions affecting investments; our ability to integrate our U.S. and
international product offerings; our ability to continue to expand successfully;
our ability to effectively penetrate the market for retail real estate
information and gain acceptance in that market; our ability to control costs;
litigation; changes in accounting policies or practices; release of new and
upgraded services by us or our competitors; data quality; development of our
sales force; employee retention; technical problems with our services;
managerial execution; changes in relationships with real estate brokers and
other strategic partners; legal and regulatory issues; and successful adoption
of and training on our services.
Accordingly,
you should not place undue reliance on forward-looking statements, which speak
only as of, and are based on information available to us on, the date of this
Report. All subsequent written and oral forward-looking statements attributable
to us or any person acting on our behalf are expressly qualified in their
entirety by the cautionary statements contained or referred to in this section.
We do not undertake any obligation to update any such statements or release
publicly any revisions to these forward-looking statements to reflect events or
circumstances after the date of this Report or to reflect the occurrence of
unanticipated events.
We
provide information services to the commercial real estate and related business
community in the U.S., U.K. and France. Our functional currency for our
operations in the U.K. and France is the local currency. As such, fluctuations
in the British Pound and Euro may have an impact on our business, results of
operations and financial position. We currently do not use financial instruments
to hedge our exposure to exchange rate fluctuations with respect to our foreign
subsidiaries. We may seek to enter hedging transactions in the future to reduce
our exposure to exchange rate fluctuations, but we may be unable to enter into
hedging transactions successfully, on acceptable terms or at all. As
of September 30, 2008, accumulated other comprehensive income included a gain
from foreign currency translation adjustments of approximately
$900,000.
We do not
have material exposure to market risks associated with changes in interest rates
related to cash, cash equivalents and short-term investments held as of
September 30, 2008. As of September 30, 2008, we had $183.0 million
of cash, cash equivalents and short-term investments. If there
is an increase or decrease in interest rates, there will be a corresponding
increase or decrease in the amount of interest earned on our cash, cash
equivalents and short-term investments. Based on our ability to
access our cash, cash equivalents and short-term investments, and our
expected operating cash flows, we do not believe that increases or decreases in
interest rates will impact our ability to operate our business in the
foreseeable future.
28
Included
within our long-term investments are investments in AAA-rated student loan
ARS. These securities are primarily securities supported by
guarantees from the FFELP of the U.S. Department of Education. As of
September 30, 2008, auctions for $33.1 million par value of our investments in
ARS failed. As a result, we may not be able to sell these investments
at par value until a future auction on these investments is successful. In the
event we need to immediately liquidate these investments, we may have to locate
a buyer outside the auction process, who may be unwilling to purchase the
investments at par, resulting in a loss. Based on the company’s
assessment of fair value of its investments in ARS as of September 30, 2008, we
determined that there was a decline in the fair value of our ARS investments of
approximately $2.9 million, which was deemed to be a temporary impairment and
recorded as an unrealized loss in other comprehensive income in stockholders’
equity. If the issuers are unable to successfully close future
auctions and the ARS credit ratings deteriorate, we may be required to further
adjust the carrying value of these investments as a temporary impairment and
recognize a greater unrealized loss in other comprehensive income or as an
other-than-temporary impairment charge to earnings. Based on our
ability to access our cash, cash equivalents and other short-term investments,
and our expected operating cash flows, we do not anticipate having to sell these
securities below par value in order to operate our business in the foreseeable
future.
We have a
substantial amount of intangible assets. As of September 30, 2008, we believe
our intangible assets will be recoverable. Changes in the economy,
the business in which we operate and our own relative performance could change
the assumptions used to evaluate intangible asset recoverability. In the event
that we determine that an asset has been impaired, we would recognize an
impairment charge equal to the amount by which the carrying amount of the assets
exceeds the fair value of the asset. We continue to monitor these assumptions
and their effect on the estimated recoverability of our intangible
assets.
|
Item
4.
|
We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission’s rules and forms,
and that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
As of
September 30, 2008, we carried out an evaluation, under the supervision and with
the participation of our management, including our Chief Executive Officer and
our Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures. Based on the foregoing, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective and were operating at the reasonable
assurance level.
There
have been no changes in our internal control over financial reporting during our
most recent fiscal quarter that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
29
PART
II ¾ OTHER
INFORMATION
|
Item
1.
|
Currently,
and from time to time, we are involved in litigation incidental to the conduct
of our business. We are not a party to any lawsuits or proceedings that, in the
opinion of our management based on consultations with legal counsel, are likely
to have a material adverse effect on our results of operations or financial
position.
|
Item
1A.
|
In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition or future results. The risks described
in our Annual Report on Form 10-K are not the only risks facing our
Company. Additional risks and uncertainties not currently known to us
or that we currently deem to be immaterial also may materially adversely affect
our business, financial condition and/or results of operations. Other
than discussed below, there have been no material changes to the Risk Factors as
previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on
Form 10-K for the year ended December 31, 2007.
Fluctuating foreign currencies may
negatively impact our business, results of operations and financial
position. Due to our acquisitions of CoStar UK Limited
(formerly FOCUS Information Limited), Scottish Property Network, Property
Investment Exchange Limited (Propex) and Grecam S.A.S., a portion of our
business is denominated in the British Pound and Euro and as a result,
fluctuations in foreign currencies may have an impact on our business, results
of operations and financial position. In the current global economic
environment, foreign currency exchange rates have fluctuated greatly and may
continue to fluctuate. Significant foreign currency exchange rate
fluctuations may negatively impact our international revenue, which in turn
affects the Company’s revenue results. Currencies may be affected by
internal factors, general economic conditions and external developments in other
countries, all of which can have an adverse impact on a country’s
currency. Currently, we are not party to any hedging transactions
intended to reduce our exposure to exchange rate fluctuations. We may
seek to enter into hedging transactions in the future, but we may be unable to
enter into these transactions successfully, on acceptable terms or at
all. We cannot predict whether we will incur foreign exchange losses
in the future. Further, significant foreign exchange fluctuations
resulting in a decline in the British Pound or Euro may decrease the value of
our foreign assets, as well as decrease our revenues and earnings from our
foreign subsidiaries.
Negative conditions in the global
credit markets may affect the liquidity of a portion of our long-term
investments. Currently our long-term investments include
AAA-rated auction rate securities (“ARS”), which are primarily securities
supported by guarantees from the Federal Family Education Loan Program of the
U.S. Department of Education. Recent negative conditions in the global credit
markets have prevented some investors from liquidating their holdings of auction
rate securities because the amount of securities submitted for sale has exceeded
the amount of purchase orders for such securities. As of September 30, 2008, we
held $33.1 million par value of auction rate securities all of which failed to
settle at auctions. When an auction fails for securities in which we
have invested, we may be unable to liquidate some or all of our auction rate
securities at par, should we need or desire to access the funds invested in
those securities immediately. In the event we need or desire to immediately
access these funds, we will not be able to do so until a future auction on these
investments is successful, a buyer is found outside the auction process or an
alternative action is determined. If a buyer is found but is unwilling to
purchase the investments at par, we may incur a loss.
Our ARS
investments are not currently trading and therefore do not currently have a
readily determinable market value. Accordingly, 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 September 30, 2008. The assumptions used in
preparing the discounted cash flow model include estimates for interest rates,
timing and amount of cash flows and expected holding periods of the
ARS. Based on this assessment of fair value, as of September 30,
2008, we determined there was a decline in the fair value of our ARS investments
of approximately $2.9 million. The decline was deemed to be a
temporary impairment and recorded as an unrealized loss in other comprehensive
income in stockholders’ equity. If the issuers of these ARS are
unable to successfully close future auctions and their credit ratings
deteriorate, we may be required to record additional unrealized losses in other
comprehensive income or an other-than-temporary impairment charge to earnings on
these investments.
30
The
following table is a summary of our repurchases of common stock during each of
the three months in the quarter ended September 30, 2008:
ISSUER
PURCHASES OF EQUITY SECURITIES
|
Month
|
Total
Number of Shares Purchased
|
Average
Price Paid per Share
|
Total
Number of Shares Purchased as Part of Publicly Announced Plans or
Programs
|
Maximum
Number of Shares that May Yet Be Purchased Under the Plans or
Programs
|
|||||||||||||
|
July
1 through 31, 2008
|
¾
|
(1) |
¾
|
¾ | ¾ | ||||||||||||
|
August
1 through 31, 2008
|
¾
|
(1) |
¾
|
¾ | ¾ | ||||||||||||
|
September 1
through 30, 2008
|
4,121 |
(1)
|
52.93 | ¾ | ¾ | ||||||||||||
|
Total
|
4,121 | (1) | 52.93 | ¾ | ¾ | ||||||||||||
(1) The
number of shares purchased consists of shares of common stock tendered by
employees to the Company to satisfy the employees’ tax withholding obligations
arising as a result of vesting of restricted stock grants under the Company’s
1998 Stock Incentive Plan, as amended, which shares were purchased by the
Company based on their fair market value on the vesting date. None of
these share purchases were part of a publicly announced program to purchase
common stock of the Company.
|
Item
3.
|
None
None
31
|
Item
5.
|
None
|
Item
6.
|
|
3.1
|
Restated
Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 to
the Registration Statement on Form S-1 of the Registrant (Reg. No.
333-47953) filed with the Commission on March 13, 1998 (the
“1998 Form S-1”))
|
|
3.2
|
Certificate
of Amendment of Restated Certificate of Incorporation (Incorporated by
reference to Exhibit 3.1 to the Registrant’s Report on Form 10-Q for the
period ending June 30, 1999)
|
|
3.3
|
Amended
and Restated By-Laws (Incorporated by reference to Exhibit 3.2 to the 1998
Form S-1)
|
|
31.1
|
Certification
of Principal Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (filed
herewith)
|
|
31.2
|
Certification
of Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (filed
herewith)
|
|
32.1
|
Certification
of Principal Executive Officer pursuant to 18 U.S.C. Sec. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
|
|
32.2
|
Certification
of Principal Financial Officer pursuant to 18 U.S.C. Sec. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
|
32
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
COSTAR
GROUP, INC.
|
||||
|
Date: November
6, 2008
|
By:
|
/S/
Brian J. Radecki
|
||
|
Brian
J. Radecki
Chief
Financial Officer
(Principal
Financial and Accounting Officer and Duly Authorized
Officer)
|
||||
33