COSTAR GROUP, INC. The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains "forward-looking statements," including statements about our beliefs and expectations. There are many risks and uncertainties that could cause actual results to differ materially from those discussed in the forward-looking statements. Potential factors that could cause actual results to differ materially from those discussed in any forward-looking statements include, but are not limited to, those stated above in Item 1A. under the headings "Risk Factors - Cautionary Statement Concerning Forward-Looking Statements" and "Risk Factors," as well as those described from time to time in our filings with theSecurities and Exchange Commission . All forward-looking statements are based on information available to us on the date of this filing and we assume no obligation to update such statements, whether as a result of new information, future events or otherwise. The following discussion should be read in conjunction with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings with theSecurities and Exchange Commission and the consolidated financial statements and related notes included in this Annual Report on Form 10-K.
Overview
Our principal information, analytics and online marketplace services are described in the following paragraphs by type of service:
Information and Analytics
CoStar Suite®. Our subscription-based information services consist primarily of CoStar Suite services. CoStar Suite is sold as a platform of service offerings consisting of CoStar Property®, CoStar COMPS®, CoStar Market Analytics, CoStar Tenant®, CoStar Lease Comps and CoStar Public Record through our mobile applications. Our integrated suite of online service offerings includes information about space available for-lease, comparable sales information, information about properties for-sale, tenant information, Internet marketing services, analytical capabilities, information for clients' websites, information about industry professionals and their business relationships, and industry news. Our sales force is responsible for selling multiple product lines, including CoStar Suite andLoopNet . During 2020, we plan to shift the focus of our sales force to sales of LoopNet Signature Ads. As a result, we anticipate CoStar Suite revenue growth will moderate during the year. Information services. We provide real estate and lease management solutions, including lease administration and abstraction services, through our CoStar Real Estate Manager® service offerings, as well as portfolio and debt analysis, management and reporting capabilities through our CoStar Investment Analysis and CoStar Risk Analytics® service offerings. We provide information services internationally, through our Grecam,Belbex andThomas Daily businesses inFrance ,Spain andGermany , respectively. Sales ofCoStar Real Estate Manager represent a significant portion of our information services revenue.CoStar Real Estate Manager's revenue growth rates increased significantly in 2018 as new clients adopted, and existing clients expanded their use of,CoStar Real Estate Manager to manage compliance with new lease accounting and reporting requirements which became effective for public companies for financial reporting periods beginning afterDecember 15, 2018 . As a result, we expect the growth rate forCoStar Real Estate Manager to normalize as the initial surge of the demand has eased. OnOctober 22, 2019 , we acquired STR and we now also provide STR's complementary benchmarking and analytics services to the hospitality industry. We expect that the acquisition of STR and the combination of STR's and CoStar's offerings will allow us to create valuable new and improved tools for industry participants. See Note 4 to the accompanying Notes to the Consolidated Financial Statements included in Part IV of this Annual Report on Form 10-K for further discussion of the acquisition of STR.
Online Marketplaces
Multifamily. Apartments.comTM is part of our network of apartment marketing sites, which primarily includes ApartmentFinder®, ForRent.com®, ApartmentHomeLiving.comTM, Apartamentos.comTM,Westside Rentals and Off Campus Partners, LLC ("OCP"). Our apartment marketing network of subscription-based services offers renters a searchable database of apartment listings and provides professional property management companies and landlords with an advertising destination. OnFebruary 21, 2018 , we completed the acquisition of ForRent, a division ofDominion Enterprises , including the ForRent.com, AFTER55.com, CorporateHousing.com and ForRentUniversity.com apartment marketing sites. OnNovember 8, 2018 , we acquiredCozy Services, Ltd. ("Cozy"), a provider of online rental solutions that provides a broad spectrum of services to both landlords and tenants, including property listings, rent estimates, rental applications, tenant screening, online rent payments and expense tracking. OnJune 12, 2019 , we acquired OCP, a provider of student housing marketplace content and technology toU.S. universities. We expect the multifamily annual revenue growth rate to remain consistent with 2019 as we have fully integrated our ForRent and Cozy acquisitions into our service offerings. We continue to work on integrating the OCP acquisition and the 33 --------------------------------------------------------------------------------
services they offer into our
Commercial property and land. Our LoopNet.com network of commercial real estate websites offer subscription-based, online marketplace services that enable commercial property owners, landlords and real estate agents working on their behalf to list properties for-sale or for-lease and to submit detailed information about property listings. Commercial real estate agents, buyers and tenants use the LoopNet.com network of online marketplace services to search for available property listings that meet their criteria. As part of our rebuild and launch of the LoopNet Signature Ads product, we rolled out new packages in the fourth quarter of 2019. As a result, the growth rate increased in the fourth quarter of 2019, andLoopNet is expected to continue to grow in the subsequent periods. In addition, onOctober 12, 2018 , we acquired all of the issued share capital ofRealla Ltd. ("Realla"), the operator of a commercial property listings and data management platform in theU.K. , including a free-to-list search engine for commercial property listings. See Note 4 to the accompanying Notes to the Consolidated Financial Statements included in Part IV of this Annual Report on Form 10-K for further discussion of the acquisition of Realla. Our BizBuySell.com network, which includes BizQuest® and FindaFranchise, provides online marketplaces for businesses for-sale. Our Land.com network of sites, which provides online marketplaces for rural lands for-sale, includes LandsofAmerica, LandAndFarm and LandWatch®. For the years endedDecember 31, 2019 , 2018 and 2017 our annualized net new bookings of subscription-based services on all contracts were approximately$210 million ,$169 million and$148 million , respectively, calculated based on the annualized amount of change in our sales resulting from all new subscription-based contracts or upsales on all existing subscription-based contracts, less write downs and cancellations, for the period reported. We recognize subscription revenues on a straight-line basis over the life of the contract. Net bookings is considered a key indicator of future subscription revenue growth and is also used as a metric of salesforce productivity by management and investors. For the years endedDecember 31, 2019 , 2018 and 2017, our contract renewal rate for existing CoStar subscription-based services on annual contracts was approximately 90%, 90% and 91% respectively, and, therefore, our cancellation rate for those services was approximately 10%, 10%, and 9%, respectively. Our contract renewal rate is a quantitative measurement that is typically closely correlated with our revenue results. As a result, management also believes that the rate may be a reliable indicator of short-term and long-term performance. Our trailing twelve-month contract renewal rate may decline if, among other reasons, negative economic conditions lead to greater business failures and/or consolidations among our clients, reductions in customer spending, or decreases in our customer base.
Development, Investments and Expansion
We are committed to supporting, improving and enhancing our information, analytics and online marketplace solutions, including expanding and improving our offerings for property owners, property managers and renters. We expect to continue our software development efforts to improve existing services, introduce new services, integrate and cross-sell services, and expand and develop supporting technologies for our research, sales and marketing organizations.
Our key priorities for 2020 include:
• Continue to develop, improve and market our recently launched
Apartments.com service offerings that focus on the digital rental
experience and enable renters to apply for-leases, and for landlords torun tenant credit and background checks and make rent payments, all online
through a single platform. We plan to aggressively market our multifamily
listing services in an effort to provide more value to advertisers and, in
turn, to attract advertisers. As such, we plan to increase our investment
in
may reduce our margins and profitability while we invest in future growth.
The increased investment is focused on search engine marketing and
enhanced brand awareness. We also plan to continue to invest in our
multifamily business by increasing the size of our sales force with afocus on increasing sales to midsize and smaller apartment communities.
• Obtaining necessary bankruptcy court and regulatory approvals to close the
pending acquisition of
subsidiary of the Company entered into an agreement to acquire for
million in cash all of the equity interests of
reorganized following an internal restructuring pursuant to and under the
joint chapter 11 plan of reorganization of
subsidiaries. Closing of the acquisition is subject to customary closing
conditions, including the expiration or termination of any applicable
waiting period under applicable antitrust laws and approval by the
bankruptcy court. See Note 19 to the accompanying Notes to the
Consolidated Financial Statements included in Part IV of this Annual
Report on Form 10-K for further discussion.
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• Continue to invest in the
the site (including high-quality imagery), seeking targeted
advertisements, providing premium listing services (such as
Signature Ads) that increase a property listing's exposure, and adding
more content for premium listings to better meet the needs of a broader
cross section of the commercial real estate industry. Additionally, we
initiated training and incentive programs for our sales team to increase
sales of LoopNet Signature Ads, with a focus on property owners.
• Integrating recently completed acquisitions, including STR, with CoStar's
business operations. We plan to consolidate STR data and services with
CoStar Suite to create an integrated platform. We plan to drive
international expansion, in part, through STR's global operations and to
apply STR's benchmarking expertise to other commercial real estate
segments served by CoStar.
• Continue to invest in CoStar Suite, including capabilities that allow us
to broaden the reach of CoStar Suite in
languages and currencies on the platform. We plan to enhance CoStar Suite
by making additional investments in analytical capabilities focused on
owners and lenders of commercial real estate. In addition, we plan to
invest in integrating the technology and infrastructure from other
existing service offerings into the CoStar Suite platform, including
CoStar Real Estate Manager, in order to leverage data and technologyacross our platforms and provide customers with additional functionality.
We intend to continue to assess the need for additional investments in our business, in addition to the investments discussed above, in order to develop and distribute new services and functionality within our current platform or expand the reach of, or otherwise improve, our current service offerings. Any future product development or expansion of services, combination and coordination of services or elimination of services or corporate expansion, development or restructuring efforts could reduce our profitability and increase our capital expenditures. Any new investments, changes to our service offerings or other unforeseen events could cause us to experience reduced revenues or generate losses and negative cash flow from operations in the future. Any development efforts must comply with our credit facility, which contains restrictive covenants that restrict our operations and use of our cash flow and may prevent us from taking certain actions that we believe could increase our profitability or otherwise enhance our business.
For further discussion of our Company, strategy and products, see our business overview set forth in "Item 1. Business" in this Annual Report on Form 10-K.
Non-GAAP Financial Measures
We prepare and publicly release quarterly unaudited financial statements
prepared in accordance with generally accepted accounting principles ("GAAP").
We also disclose and discuss certain non-GAAP financial measures in our public
releases, investor conference calls and filings with the Securities and Exchange
Commission . The non-GAAP financial measures that we may disclose include net
income before interest and other income (expense), loss on debt extinguishment,
income taxes, depreciation and amortization ("EBITDA"), adjusted EBITDA,
adjusted EBITDA margin, non-GAAP net income and non-GAAP net income per diluted
share. EBITDA is our net income before interest and other income (expense), loss
on debt extinguishment, income taxes, depreciation and amortization. We
typically disclose EBITDA on a consolidated and an operating segment basis in
our earnings releases, investor conference calls and filings with the Securities
and Exchange Commission . Adjusted EBITDA is different from EBITDA because we
further adjust EBITDA for stock-based compensation expense, acquisition- and
integration-related costs for pending and completed acquisitions, restructuring
costs and settlements and impairments incurred outside our ordinary course of
business. Non-GAAP net income is determined by adjusting our net income for
stock-based compensation expense, acquisition- and integration-related costs for
pending and completed acquisitions, restructuring costs, settlement and
impairment costs incurred outside our ordinary course of business and loss on
debt extinguishment, as well as amortization of acquired intangible assets and
other related costs, and then subtracting an assumed provision for income taxes.
We may disclose adjusted EBITDA, adjusted EBITDA margin, non-GAAP net income and
non-GAAP net income per diluted share on a consolidated basis in our earnings
releases, investor conference calls and filings with the Securities and Exchange
Commission . The non-GAAP financial measures that we use may not be comparable to
similarly titled measures reported by other companies. Also, in the future, we
may disclose different non-GAAP financial measures in order to help our
investors meaningfully evaluate and compare our results of operations to our
previously reported results of operations or to those of other companies in our
industry.
We view EBITDA, adjusted EBITDA, non-GAAP net income and non-GAAP net income per
diluted share as operating performance measures and as such we believe that the
most directly comparable GAAP financial measure to EBITDA, adjusted EBITDA and
non-GAAP net income is net income. We believe the most directly comparable GAAP
financial measures to non-GAAP net income per diluted share and adjusted EBITDA
margin are net income per diluted share and net income divided by revenue,
respectively. In calculating EBITDA, adjusted EBITDA, adjusted EBITDA margin,
non-GAAP net income and non-
35
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GAAP net income per diluted share, we exclude from net income the financial
items that we believe should be separately identified to provide additional
analysis of the financial components of the day-to-day operation of our
business. We have outlined below the type and scope of these exclusions and the
material limitations on the use of these non-GAAP financial measures as a result
of these exclusions. EBITDA, adjusted EBITDA, adjusted EBITDA margin, non-GAAP
net income and non-GAAP net income per diluted share are not measurements of
financial performance under GAAP and should not be considered as a measure of
liquidity, as an alternative to net income or as an indicator of any other
measure of performance derived in accordance with GAAP. Investors and potential
investors in our securities should not rely on EBITDA, adjusted EBITDA, adjusted
EBITDA margin, non-GAAP net income and non-GAAP net income per diluted share as
a substitute for any GAAP financial measure, including net income and net income
per diluted share. In addition, we urge investors and potential investors in our
securities to carefully review the GAAP financial information included as part
of our Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q that are
filed with the Securities and Exchange Commission , as well as our quarterly
earnings releases, and compare the GAAP financial information with our EBITDA,
adjusted EBITDA, adjusted EBITDA margin, non-GAAP net income and non-GAAP net
income per diluted share.
EBITDA, adjusted EBITDA, adjusted EBITDA margin, non-GAAP net income and
non-GAAP net income per diluted share may be used by management to internally
measure our operating and management performance and may be used by investors as
supplemental financial measures to evaluate the performance of our business. We
believe that these non-GAAP measures, when viewed with our GAAP results and
accompanying reconciliations, provide additional information to investors that
is useful to understand the factors and trends affecting our business. We have
spent more than 30 years building our database of commercial real estate
information and expanding our markets and services partially through
acquisitions of complementary businesses. Due to the expansion of our
information, analytics and online marketplace services, which has included
acquisitions, our net income has included significant charges for amortization
of acquired intangible assets, depreciation and other amortization, acquisition-
and integration-related costs for pending and completed acquisitions,
restructuring costs, and loss on debt extinguishment. Adjusted EBITDA, adjusted
EBITDA margin, non-GAAP net income and non-GAAP net income per diluted share
exclude these charges and provide meaningful information about the operating
performance of our business, apart from charges for amortization of acquired
intangible assets, depreciation and other amortization, acquisition- and
integration-related costs for pending and completed acquisitions, restructuring
costs; settlement and impairment costs incurred outside our ordinary course of
business. We believe the disclosure of non-GAAP measures can help investors
meaningfully evaluate and compare our performance from quarter to quarter and
from year to year. We also believe the non-GAAP measures we disclose are
measures of our ongoing operating performance because the isolation of non-cash
charges, such as amortization and depreciation, and other items, such as
interest, income taxes, stock-based compensation expenses, acquisition- and
integration-related costs for pending and completed acquisitions, restructuring
costs; loss on debt extinguishment and settlement and impairment costs incurred
outside our ordinary course of business, provides additional information about
our cost structure, and, over time, helps track our operating progress. In
addition, investors, securities analysts and others have regularly relied on
EBITDA and may rely on adjusted EBITDA, adjusted EBITDA margin, non-GAAP net
income or non-GAAP net income per diluted share to provide a financial measure
by which to compare our operating performance against that of other companies in
our industry.
Set forth below are descriptions of financial items that have been excluded from net income to calculate EBITDA and the material limitations associated with using this non-GAAP financial measure as compared to net income:
• Amortization of acquired intangible assets in cost of revenues may be
useful for investors to consider because it represents the diminishing
value of any acquired trade names and other intangible assets and the use
of our acquired technology, which is one of the sources of information for
our database of commercial real estate information. We do not believe
these charges necessarily reflect the current and ongoing cash charges
related to our operating cost structure.
• Amortization of acquired intangible assets in operating expenses may be
useful for investors to consider because it represents the estimated
attrition of our acquired customer base. We do not believe these charges
necessarily reflect the current and ongoing cash charges related to our
operating cost structure.
• Depreciation and other amortization may be useful for investors to
consider because they generally represent the wear and tear on our
property and equipment used in our operations. We do not believe thesecharges necessarily reflect the current and ongoing cash charges related
to our operating cost structure.
• The amount of interest and other income and expense we generate and incur
may be useful for investors to consider and may result in current cash
inflows and outflows. However, we do not consider the amount of interest
and other income and expense to be a representative component of the
day-to-day operating performance of our business.
36--------------------------------------------------------------------------------
• Income tax expense may be useful for investors to consider because it
generally represents the taxes which may be payable for the period and the
change in deferred income taxes during the period and may reduce the
amount of funds otherwise available for use in our business. However, we
do not consider the amount of income tax expense to be a representative
component of the day-to-day operating performance of our business.
• The amount of loss on our debt extinguishment may be useful for investors
to consider because it generally represents losses from the early
extinguishment of debt. However, we do not consider the amount of the loss
on debt extinguishment to be a representative component of the day-to-day
operating performance of our business.
Set forth below are descriptions of additional financial items that have been excluded from EBITDA to calculate adjusted EBITDA and the material limitations associated with using this non-GAAP financial measure as compared to net income:
• Stock-based compensation expense may be useful for investors to consider
because it represents a portion of the compensation of our employees and
executives. Determining the fair value of the stock-based instruments
involves a high degree of judgment and estimation and the expenses
recorded may bear little resemblance to the actual value realized upon the
future exercise or termination of the related stock-based awards.
Therefore, we believe it is useful to exclude stock-based compensation in
order to better understand the long-term performance of our core business.
• The amount of acquisition- and integration- related costs for pending and
completed acquisitions incurred may be useful for investors to consider
because such costs generally represent professional service fees and
direct expenses related to acquisitions. Because we do not acquire
businesses on a predictable cycle, we do not consider the amount of
acquisition- and integration- related costs for pending and completed
acquisitions to be a representative component of the day-to-day operating
performance of our business.
• The amount of settlement and impairment costs incurred outside of our
ordinary course of business may be useful for investors to consider
because they generally represent gains or losses from the settlement oflitigation matters or impairments on acquired intangible assets. We do not
believe these charges necessarily reflect the current and ongoing cash
charges related to our operating cost structure.
• The amount of restructuring costs incurred may be useful for investors to
consider because they generally represent costs incurred in connection
with a change in a contract or a change in the makeup of our properties or
personnel. We do not consider the amount of restructuring related costs to
be a representative component of the day-to-day operating performance of
our business.
The financial items that have been excluded from our net income to calculate
non-GAAP net income and non-GAAP net income per diluted share are amortization
of acquired intangible assets and other related costs, stock-based compensation,
acquisition- and integration- related costs for pending and completed
acquisitions, restructuring and related costs and settlement and impairment
costs incurred outside our ordinary course of business. These items are
discussed above with respect to the calculation of adjusted EBITDA together with
the material limitations associated with using this non-GAAP financial measure
as compared to net income. In addition to these exclusions from net income, we
subtract an assumed provision for income taxes to calculate non-GAAP net income.
In 2019 and 2018, we assumed a 25% tax rate which approximated our historical
long-term statutory corporate tax rate, excluding the impact of discrete items.
Adjusted EBITDA margin represents adjusted EBITDA divided by revenues for the period.
Non-GAAP net income per diluted share is a non-GAAP financial measure that represents non-GAAP net income divided by the number of diluted shares outstanding for the period used in the calculation of GAAP net income per diluted share.
Management compensates for the above-described limitations of using non-GAAP
measures by using a non-GAAP measure only to supplement our GAAP results and to
provide additional information that is useful to understand the factors and
trends affecting our business.
37
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The following table shows our net income reconciled to our EBITDA and our net
cash flows from operating, investing and financing activities for the indicated
periods (in thousands):
Year Ended December 31,
2019 2018 2017
Net income $ 314,963 $ 238,334 $ 122,695
Amortization of acquired intangible assets in
cost of revenues 21,357 20,586 19,707
Amortization of acquired intangible assets in operating expenses 33,995 30,881
17,684
Depreciation and other amortization 25,813 26,276 26,252 Interest and other income (30,017 ) (13,281 ) (4,044 ) Interest and other expense 2,615 2,830 9,014 Loss on debt extinguishment - - 3,788 Income tax expense 75,986 45,681 42,363 EBITDA$ 444,712 $ 351,307 $ 237,459 Net cash flows provided by (used in) Operating activities$ 457,780 $ 335,458 $ 234,703 Investing activities$ (483,753 ) $ (448,001 ) $ (72,267 ) Financing activities$ (4,154 ) $ 2,744 $ 480,430 38
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Consolidated Results of Operations
The following table provides our selected consolidated results of operations for
the indicated periods (in thousands of dollars and as a percentage of total
revenue):
Year Ended December 31,
2019 2018 2017
Revenues $ 1,399,719 100 % $ 1,191,832 100 % $ 965,230 100 %
Cost of revenues 289,239 21 269,933 23 220,403 23
Gross
profit 1,110,480 79 921,899 77 744,827 77
Operating expenses:
Selling and marketing (excluding customer
base amortization) 408,596 29 359,858 30 318,362 33
Software development 125,602 9 100,937 8 88,850 9
General and
administrative 178,740 13 156,659 13 146,128 15
Customer base
amortization 33,995 2 30,881 3 17,671 2
Total operating
expenses 746,933 53 648,335 54 571,011 59
Income from
operations 363,547 26 273,564 23 173,816 18
Interest and other income 30,017 2 13,281 1 4,044 -
Interest and other expense (2,615 ) - (2,830 ) - (9,014 ) (1 )
Loss on debt extinguishment - - - - (3,788 ) -
Income before income
taxes 390,949 28 284,015 24 165,058 17
Income tax expense 75,986 5 45,681 4 42,363 4
Net income $ 314,963 23 % $ 238,334 20 % $ 122,695 13 %
The following table provides our revenues by type of service (in thousands of dollars and as a percentage of total revenue):
Year Ended December 31,
2019 2018 2017
Information and analytics
CoStar Suite (1) $617,798 44 % $545,195 46 % $ 463,185 48 %
Information services (1) 88,446 6 % 67,624 6 % 72,618 8 %
Online marketplaces
Multifamily (1) 490,631 35 % 405,795 34 % 279,855 29 %
Commercial property and land (1) 202,844 15 % 173,218 14 % 149,572 15 %
Total revenues $ 1,399,719 100 % $ 1,191,832 100 % $ 965,230 100 %
__________________________
(1) For further discussion of our Company, strategy and products, see our business overview set forth in "Item 1. Business" in this Annual Report on Form 10-K.
39
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Comparison of Year Ended
The following table provides a comparison of our selected consolidated results of operations for the year endedDecember 31, 2019 and 2018 (in thousands of dollars): Increase Increase 2019 2018 (Decrease) ($) (Decrease) (%) Revenues CoStar Suite$ 617,798 $545,195 $ 72,603 13 % Information services 88,446 67,624 20,822 31 Multifamily 490,631 405,795 84,836 21 Commercial property and land 202,844 173,218 29,626 17 Total revenues 1,399,719 1,191,832 207,887 17 Cost of revenues 289,239 269,933 19,306 7 Gross profit 1,110,480 921,899 188,581 20 Operating expenses: Selling and marketing (excluding customer base amortization) 408,596 359,858 48,738 14 Software development 125,602 100,937 24,665 24 General and administrative 178,740 156,659 22,081 14 Customer base amortization 33,995 30,881 3,114 10 Total operating expenses 746,933 648,335 98,598 15 Income from operations 363,547 273,564 89,983 33 Interest and other income 30,017 13,281 16,736 NM Interest and other expense (2,615 ) (2,830 ) (215 ) (8 ) Income before income taxes 390,949 284,015 106,934 38 Income tax expense 75,986 45,681 30,305 66 Net income$ 314,963 $ 238,334 $ 76,629 32 % __________________________ NM - Not meaningful Revenues. Revenues increased to$1.4 billion in 2019, from$1.2 billion in 2018. The$208 million increase was primarily attributable to an$85 million , or 21%, increase in multifamily revenue. The multifamily increase was due to upgrades of existing customer packages to higher value advertising packages, higher volume as a result of recent investments in marketing, and to a lesser extent, growth from the acquisitions of Cozy and OCP. CoStar Suite revenues increased$73 million , or 13%, primarily due to further increases in pricing and, to a lesser extent, further market penetration and cross-selling of our services. Commercial property and land revenue increased$30 million , or 17%, primarily due to growth in ourLoopNet online marketplace services of$23 million , as well as, growth in our land and businesses for-sale services of$6 million . Information services revenue increased$21 million , or 31%, primarily due to increased revenue of$13 million from ourCoStar Real Estate Manager service offerings and$9 million due to the acquisition of STR. Gross Profit. Gross profit increased to$1.1 billion in 2019, from$922 million in 2018. The gross profit percentage was 79% for 2019 compared to 77% for 2018 as revenues increased at a higher rate than cost of revenues. The increase in cost of revenues of$19 million , or 7%, was primarily due to additional merchant fees and data and content costs of$9 million , primarily attributable to the acquisition of Cozy, additional personnel costs of$8 million and additional costs for research equipment of$3 million . The increase from the prior year was partially offset by nonrecurring research personnel restructuring costs incurred in the prior year of$3 million . Selling and Marketing Expenses. Selling and marketing expenses increased to$409 million in 2019, from$360 million in 2018. The increase was primarily attributable to$41 million in additional marketing spend, including$23 million in search engine marketing,$7 million in co-branding and$11 million in other forms of marketing, primarily forApartments.com . The increase was also due to a$5 million increase in personnel costs driven by increased headcount, partially offset by higher severance and retention costs incurred in 2018 related to the acquisition of ForRent. 40
-------------------------------------------------------------------------------- Software Development Expenses. Software development expenses increased to$126 million in 2019, from$101 million in 2018, and increased as a percentage of revenues to 9% in 2019, compared to 8% in 2018. The increase in the amount of software development expense was primarily due to a$22 million increase in personnel costs as a result of increased headcount to enhance our product offerings, including$2 million due to the acquisition of STR. General and Administrative Expenses. General and administrative expenses increased to$179 million in 2019, from$157 million in 2018, and remained consistent as a percentage of revenues at 13% in 2019 and 2018. The increase in general and administrative expenses was primarily due to personnel costs of$12 million due to increased headcount,$4 million as a result of the acquisition of STR, bad debt expense of$4 million , additional software and equipment of$4 million , depreciation expense of$2 million and travel and conference expenses of$1 million each, partially offset by a$5 million decrease in professional services. Customer Base Amortization Expense. Customer base amortization expense increased to$34 million in 2019, from$31 million in 2018, and decreased as a percentage of revenues to 2% in 2019, compared to 3% in 2018. The increase in customer base amortization expense was primarily due to the STR acquisition. Interest and Other Income. Interest and other income increased to$30 million in 2019, from$13 million in 2018. The increase was primarily due to$11 million in legal settlement proceeds received during 2019, as well as, higher rates of return and average cash and cash equivalent balances during 2019 compared to 2018. Interest and Other Expense. Interest and other expense remained consistent for 2019 and 2018, and primarily consists of commitment fees and amortization of debt issuance costs. Income Tax Expense. Income tax expense increased to$76 million in 2019, from$46 million in 2018. The increase was primarily due to higher income before income taxes for 2019, and to a lesser extent, discrete items for higher state research and development tax credits recognized for 2018. The effective tax rate for 2019 was 19%, compared to 16% in 2018 and lower than the statutory rates due to discrete items including research and development credits as well as excess tax benefits.
For a comparison of the Company's results of operations for the fiscal year
ended
Comparison of Business Segment Results for Year Ended
We manage our business geographically in two operating segments, with the primary areas of measurement and decision-making beingNorth America , which includes theU.S. andCanada , and International, which primarily includesEurope ,Asia-Pacific andLatin America . Management relies on an internal management reporting process that provides revenue and operating segment net income before interest and other income (expense), loss on debt extinguishment, income taxes, depreciation and amortization ("EBITDA"). Management believes that operating segment EBITDA is an appropriate measure for evaluating the operational performance of our operating segments. EBITDA is used by management to internally measure operating and management performance and to evaluate the performance of the business. However, this measure should be considered in addition to, not as a substitute for or superior to, income from operations or other measures of financial performance prepared in accordance with GAAP. Segment Revenues.North America revenues increased to$1.4 billion for the year endedDecember 31, 2019 , from$1.2 billion for the year endedDecember 31, 2018 . The increase inNorth America revenues was primarily due to a$85 million increase in multifamily revenues driven by the sale of higher value advertising packages and volume, and to a lesser extent, the acquisition of Cozy, and continued organic growth in CoStar Suite revenues of$71 million . There were also increases of$29 million and$18 million in commercial property and land and information services, respectively, primarily due to growth in ourLoopNet andCoStar Real Estate Manager service offerings, and to a lesser extent, the acquisition of STR. International revenues increased to$40 million for the year endedDecember 31, 2019 , from$35 million for the year endedDecember 31, 2018 . The increase in International revenues was primarily due the acquisition of STR and further growth of our subscription-based services. Segment EBITDA. North America EBITDA increased to$452 million for the year endedDecember 31, 2019 , from$358 million for the year endedDecember 31, 2018 . The increase in North America EBITDA was due primarily to an increase in revenues, partially offset by increases in personnel and marketing costs. International EBITDA remained consistent at a loss of$7 million for the years endedDecember 31, 2019 andDecember 31, 2018 .
For a comparison of the Company's business segment results of operations for the
fiscal year ended
41
--------------------------------------------------------------------------------
Operations in the Company's Annual Report on Form 10-K for the year
ended
42
--------------------------------------------------------------------------------Consolidated Quarterly Results of Operations
The following tables present our unaudited consolidated results of operations on
a quarterly basis for the indicated periods (in thousands, except per share
amounts, and as a percentage of total revenues). These tables should be read in
conjunction with the consolidated financial statements and related notes
included in this Annual Report on Form 10-K. The quarterly results of historical
periods are not necessarily indicative of quarterly results for any future
period.
2019 2018
Mar. 31 Jun. 30 Sep. 30 Dec. 31 Mar. 31 Jun. 30 Sep. 30 Dec. 31
Revenues $ 328,425 $ 343,760 $ 352,808 $ 374,726 $ 273,718 $ 297,018 $ 305,525 $ 315,571
Cost of revenues 71,153 71,918 71,172 74,996 62,477 67,136 72,072 68,248
Gross
profit 257,272 271,842 281,636 299,730 211,241 229,882 233,453 247,323
Operating expenses 163,780 197,042 187,367 198,744 157,796 186,108 162,765 141,666
Income from operations 93,492 74,800 94,269 100,986 53,445 43,774 70,688 105,657 Interest and other income
4,945 5,913 5,358 13,801 2,987 2,652 3,035 4,607 Interest and other expense
(732 ) (697 ) (704 ) (482 ) (690 ) (728 ) (717 ) (695 ) Income before income taxes
97,705 80,016 98,923 114,305 55,742 45,698 73,006 109,569
Income tax expense 12,536 16,768 20,304 26,378 3,511 1,863 14,247 26,060
Net income $ 85,169 $ 63,248 $
78,619
$ 2.35 $ 1.74 $
2.16
$ 2.33 $ 1.73 $ 2.15 $ 2.39 $ 1.44 $ 1.20 $ 1.61 $ 2.29 2019 2018 Mar. 31 Jun. 30 Sep. 30 Dec. 31 Mar. 31 Jun. 30 Sep. 30 Dec. 31 Revenues 100 % 100 % 100 % 100 % 100 % 100 % 100 % 100 % Cost of revenues 22 21 20 20 23 23 24 22 Gross 78 80 78 profit 79 80 77 77 76 Operating expenses 50 57 53 53 58 63 54 45 Income from operations 28 22 27
27 20 14 22 32 Interest and other income
2 2 2 4 1 1 1 1 Income before income taxes
30 24 29 31 21 15 23 33
Income tax expense 4 5 6 7 1 1 5 8
Net income 26 % 19 % 23 % 24 % 20 % 14 % 18 % 25 %
Liquidity and Capital Resources
Our principal sources of liquidity are cash and cash equivalents and cash from operations. We also have access to$750 million from our revolving credit facility. In total, cash and cash equivalents decreased by$30 million atDecember 31, 2019 compared toDecember 31, 2018 , primarily due to the cash paid in connection with the acquisitions of STR and OCP for an aggregate amount of$438 million , cash paid for purchases of property and equipment of$46 million and repurchases of restricted stock to satisfy employee tax withholding obligations upon vesting of restricted stock awards valued at approximately$28 million . These decreases were partially offset by net cash generated from operations of$458 million and proceeds from the exercise of employee stock options of approximately$25 million . Net cash provided by operating activities for the year endedDecember 31, 2019 was$458 million compared to$335 million for the year endedDecember 31, 2018 . The approximately$123 million increase fromDecember 31, 2018 toDecember 31, 2019 was primarily due to an increase in net income of$77 million including an increase in other non-cash expenses such as stock-based compensation expense and the timing of collections for accounts receivable, partially offset by$15 million placed into an escrow account for deferred compensation for certain STR employees. 43
-------------------------------------------------------------------------------- Net cash used in investing activities for the year endedDecember 31, 2019 was$484 million compared to$448 million for the year endedDecember 31, 2018 . The$36 million increase in cash used in investing activities was primarily due to approximately$418 million of net cash paid to acquire ForRent, Cozy and Realla during 2018, compared to$438 million net cash paid during 2019 for the STR and OCP acquisitions. During 2019, we made capital expenditures of approximately$46 million compared to approximately$30 million during 2018. The increase in capital expenditures during the year endedDecember 31, 2019 was partially driven by the purchase of a corporate aircraft, which is principally used for business travel by our executives. Net cash used in financing activities for the year endedDecember 31, 2019 was$4 million compared to net cash provided by financing activities of$3 million for the year endedDecember 31, 2018 . This$7 million increase in cash used in financing activities in 2019 compared to 2018 was primarily due to higher repurchases of restricted stock to satisfy employee tax withholding obligations upon vesting of restricted stock awards of$3 million , as well as a decrease in proceeds from the exercise of employee stock options of$2 million . Our future capital requirements will depend on many factors, including, among others, our operating results, expansion and integration efforts, and our level of acquisition activity or other strategic transactions. To date, we have grown in part by acquiring other companies, and we expect to continue to make acquisitions. OnFebruary 11, 2020 , our wholly owned subsidiary entered into a purchase agreement to acquire all of the equity interests of reorganizedRentPath , following an internal restructuring pursuant to a chapter 11 plan of reorganization, for$588 million in cash. The purchase agreement requires us to pay a$59 million fee in the event the purchase agreement is terminated prior to closing under specified circumstances. The acquisition will be funded using cash on hand. See Note 19 to the accompanying Notes to the Consolidated Financial Statements included in Part IV of this Annual Report on Form 10-K for further discussion. Based on current plans, we believe that our available cash combined with positive cash flow provided by operating activities should be sufficient to fund our operations for at least the next twelve months. Contractual Obligations. The following table summarizes our principal contractual obligations atDecember 31, 2019 and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands): Total 2020 2021-2022 2023-2024 Thereafter Operating leases$ 165,542 $ 34,976 $ 64,698 $ 53,635 $ 12,233 Purchase obligations (1) 41,284 20,798 18,762 1,152 572 Total contractual principal cash obligations$ 206,826 $ 55,774 $ 83,460 $ 54,787 $ 12,805 __________________________ (1) Amounts do not include (i) contracts with terms of twelve months or less, (ii) multi-year contracts that may be terminated by a third-party or us, or (iii) employment agreements. Amounts do not include income taxes payable due to uncertainty regarding the timing of future cash payments. 44 --------------------------------------------------------------------------------
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity withU.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. The following accounting policies involve a "critical accounting estimate" because they are particularly dependent on estimates and assumptions made by management about matters that are highly uncertain at the time the accounting estimates are made. In addition, while we have used our best estimates based on facts and circumstances available to us at the time, different acceptable assumptions would yield different results. Changes in the accounting estimates are reasonably likely to occur from period to period, which may have a material impact on the presentation of our financial condition and results of operations. We review these estimates and assumptions periodically and reflect the effects of revisions in the period that they are determined to be necessary. We consider policies relating to the following matters to be critical accounting policies:
• Long-lived assets, intangible assets and goodwill
• Revenue recognition • Income taxes • Business combinations With respect to our accounting policy for long-lived assets, intangible assets and goodwill, we further supplement in Note 2 of the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K with the following: We assess the impairment of long-lived assets, identifiable intangibles and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Judgments made by management relate to the expected useful lives of long-lived assets and our ability to recover the carrying value of such assets. The accuracy of these judgments may be adversely affected by several factors, including the factors listed below:
• Significant underperformance relative to historical or projected future
operating results;
• Significant changes in the manner of our use of the acquired assets or the
strategy for our overall business;
• Significant negative industry or economic trends; or
• Significant decline in our market capitalization relative to net book value
for a sustained period.
When we determine that the carrying value of long-lived and identifiable intangible assets may not be recovered based upon the existence of one or more of the above indicators, we test for impairment.
Goodwill and identifiable intangible assets that are not subject to amortization are tested annually for impairment by each reporting unit onOctober 1 of each year and are also tested for impairment more frequently based upon the existence of one or more of the above indicators.Goodwill represents the excess of costs over the fair value of assets of acquired businesses.Goodwill is not amortized, but instead tested for impairment at least annually by each reporting unit. We may first assess qualitative factors to evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount or elect to bypass such assessment. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value, or we elect to bypass such assessment, we then determine the fair value of each reporting unit. We estimate the fair value of each reporting unit based on a projected discounted cash flow model that includes significant assumptions and estimates including our discount rate, growth rate and future financial performance. Assumptions about the discount rate are based on a weighted average cost of capital for comparable companies. Assumptions about the growth rate and future financial performance of a reporting unit are based on our forecasts, business plans, economic projections and anticipated future cash flows. These assumptions are subject to change from period to period and could be adversely impacted by the uncertainty surrounding global market conditions, commercial real estate conditions and the competitive environment in which we operate. Changes in these or other factors could negatively affect our reporting units' fair value and potentially result in impairment charges. Such impairment charges could have an adverse effect on our results of operations. The fair value of each reporting unit is compared to the carrying amount of the reporting unit. If the carrying value of the reporting unit exceeds the fair value, then an impairment loss is recognized for the difference. We estimate the fair value of our reporting units based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk in our current business model. As ofOctober 1, 2019 , we assessed the relevant qualitative factors and concluded that it was not more likely than not that the fair value of our reporting units was less than their respective carrying amounts. There have been no events or changes in circumstances as a result of our qualitative impairment analysis onOctober 1, 2019 , that would indicate that the carrying value of each reporting unit may not be recoverable. 45 -------------------------------------------------------------------------------- For an in-depth discussion of each of our significant accounting policies, including our critical accounting policies and further information regarding estimates and assumptions involved in their application, see Note 2 to the accompanying consolidated financial statements included in this Annual Report on Form 10-K.
Recent Accounting Pronouncements
See Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for information on recent accounting pronouncements, including the expected dates of adoption.
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