| COSTAR GROUP INC Item 1A Risk Factors 12 Item 1A Risk Factors 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 2006 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 and future economic performance; 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 “Business,” “Risk Factors,” “Properties,” “Legal Proceedings,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and the Financial Statements and related Notes |
| 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 necessarily estimates reflecting our judgment, 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 12 _________________________________________________________________ to those discussed in “Risk Factors,” 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; customer retention; competition; our ability to identify and integrate acquisitions; our ability to control costs; 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; litigation; changes or consolidations within the commercial real estate industry; 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; foreign currency fluctuations; legal and regulatory issues; changes in accounting policies or practices; 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 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 |
| Risk Factors Our planned expansion into the retail real estate sector may not be completed successfully or may not result in increased revenues, which may negatively impact our business, results of operations and financial condition |
| Expanding into the retail real estate sector imposes additional burdens on our research, systems development, sales, marketing and general managerial resources |
| During the next year, we expect to significantly expand the number of retail properties contained within our database |
| If we are unable to manage this expansion plan effectively, if this expansion effort takes longer than planned or if our costs for this effort exceed our expectations, our financial condition could be adversely affected |
| In addition, if we incur significant costs to expand into the retail sector and we are not successful in marketing and selling our expanded services, or customers fail to accept these new services, our expansion may have a material adverse effect on our financial condition by increasing our expenses without increasing our revenues, adversely affecting our profitability |
| Our recently completed 21-market expansion and any further geographic expansion or investment of resources to expand the depth of our coverage within existing markets may not result in increased revenues, which may negatively impact our business, results of operations and financial condition |
| Expanding into new markets and investing resources towards increasing the depth of our coverage within existing markets imposes additional burdens on our research, systems development, sales, marketing and general managerial resources |
| During 2006, we expect to continue to expand into a number of new US markets, expand geographic coverage in certain of our existing markets and increase the depth of our coverage in certain of our existing markets |
| If we are unable to manage these expansion efforts effectively, if the expansion efforts take longer than planned or if our costs for these efforts exceed our expectations, our financial condition could be adversely affected |
| In addition, if we incur significant costs to expand into these new markets or to improve data quality within existing markets, or are not successful in marketing and selling our services in these markets, our expansion may have a material adverse effect on our financial condition by increasing our expenses without increasing our revenues, adversely affecting our profitability |
| Technical problems that affect either our customers’ ability to access our services, or the software, internal applications and systems underlying our services, could lead to reduced demand for our information services, lower revenues and increased costs |
| Our business increasingly depends upon the satisfactory performance, reliability and availability of our web site, the Internet and our service providers |
| Problems with our web site, the Internet or the services provided by our local exchange carriers or Internet service providers could result in slower connections for our customers or interfere with our customers’ access to our information services |
| If we experience technical problems in distributing our services, we could experience reduced demand for our information services |
| In addition, the software, internal applications and systems underlying our services are complex and may not be efficient or error-free |
| Despite careful development and testing, we cannot be certain that we will not encounter technical problems when we attempt to enhance our software, internal applications and systems |
| For example, during the second quarter of 2005, we upgraded our internal research application used by our research staff to update our database of commercial real estate information |
| If this application does not continue to work properly, the ability of our clients to access our services may be affected, which could result in 13 _________________________________________________________________ reduced demand for our services, lower revenues and higher costs |
| Any inefficiencies, errors or technical problems with our software, internal applications and systems could reduce the quality of our services or interfere with our customers’ access to our information services, which could reduce the demand for our services, lower our revenues and increase our costs |
| Temporary or permanent outages of our computers, software or telecommunications equipment could lead to reduced demand for our information services, lower revenues and increased costs |
| Our operations depend on our ability to protect our database, computers and software, telecommunications equipment and facilities against damage from potential dangers such as fire, power loss, security breaches, computer viruses and telecommunications failures |
| Any temporary or permanent loss of one or more of these systems or facilities from an accident, equipment malfunction or some other cause could harm our business |
| If we experience a failure that prevents us from delivering our information services to clients, we could experience reduced demand for our information services, lower revenues and increased costs |
| Changes in accounting and reporting policies or practices may affect our financial results or presentation of results, which may affect our stock price |
| Changes in accounting and reporting policies or practices could reduce our net income, which reductions may be independent of changes in our operations |
| These reductions in reported net income could cause our stock price to decline |
| For example, beginning in the first quarter of 2006, the Company expects to adopt the provisions of SFAS 123R, which will require us to expense the value of granted stock options |
| The Company is continuing to assess the impact of the adoption of SFAS 123R, but currently expects to incur dlra3dtta0 to dlra4dtta0 million in charges for stock options granted in 2006 |
| In addition, in the fourth quarter of 2004, we recorded a one-time income tax credit of dlra16dtta7 million primarily related to the release of our previously recorded valuation allowance against our net operating loss carryforwards, and as a result our net income for the fourth quarter and year ended December 31, 2004 was significantly higher than in previous periods |
| As a result of the release of our previously recorded valuation allowance, we expect to record income tax expense for subsequent periods at an effective tax rate that approximates the statutory tax rate, which will decrease our net income |
| Our revenues and financial condition will be adversely affected if we are not able to attract and retain clients |
| Our success and revenues depend on attracting and retaining subscribers to our information services |
| Our subscription-based information services generate the largest portion of our revenues |
| However, we may be unable to attract new clients in planned expansion markets and our clients in existing markets may decide not to add, not to renew or to cancel subscription services |
| In addition, in order to increase our revenue growth rate, we must continue to attract new customers, continue to keep our cancellation rate low and continue to sell new services to our existing customers |
| We may not be able to continue to grow our customer base as a result of several factors, including without limitation: a decision that customers have no need for our services; a decision to use alternative services; customers’ and potential customers’ pricing and budgetary constraints; consolidation in the real estate and/or financial services industries; data quality; technical problems; or economic or competitive pressures |
| If clients decide to cancel or not to renew their agreements, and we do not attract new clients or sell new services to our existing clients, then our revenues or our revenue growth rate may decline |
| If our operating costs are higher than we expect, our profitability may be reduced |
| Many of our expenses, particularly personnel costs and occupancy costs, are relatively fixed |
| Additionally, we may experience higher than expected operating costs, including increased personnel costs, occupancy costs, selling and marketing costs, investments in geographic expansion, acquisition costs, communications costs, travel costs, software development costs, professional fees and other costs |
| If operating costs exceed our expectations or cannot be adjusted accordingly, our profitability may be reduced and our results of operations and financial condition will be adversely affected |
| General economic conditions could increase our expenses and reduce our revenues |
| Our business and the commercial real estate industry are particularly affected by negative trends in the general economy |
| The success of our business depends on a number of factors relating to general global, national, regional and local economic conditions, including inflation, interest rates, perceived and actual economic conditions, taxation policies, availability of credit, employment levels, and wage and salary levels |
| Negative general economic conditions could adversely affect our business by reducing our revenues and profitability |
| Any significant terrorist attack is likely to have a dampening effect on the economy in general which could negatively affect our financial performance and our stock price |
| In addition, a significant increase in inflation could increase our expenses more 14 _________________________________________________________________ rapidly than expected, the effect of which may not be offset by corresponding increases in revenue |
| If clients choose to cancel our information services as a result of economic conditions, and we do not acquire new clients, our revenues may decline and our financial position would be adversely affected |
| A downturn or consolidation in the commercial real estate industry may decrease customer demand for our services |
| A reversal of recent improvements in the commercial real estate industry’s leasing activity, rental rates and absorption rates, or renewed downturn in the commercial real estate market may affect our ability to generate revenues and may lead to more cancellations by our current or future customers, both of which could cause our revenues or our revenue growth rate to decline and reduce our profitability |
| A depressed commercial real estate market has a negative impact on our core customer base, which could decrease demand for our information services |
| Also, companies in this industry are consolidating, often in order to reduce expenses |
| Consolidation may lead to more cancellations of our information services by our customers, reduce the number of our existing clients, reduce the size of our target market or increase our clients’ bargaining power, all of which could cause our revenues or our revenue growth rate to decline and reduce our profitability |
| Competition could render our services uncompetitive |
| The market for information systems and services in general is highly competitive and rapidly changing |
| Our existing competitors, or future competitors, may have greater name recognition, larger customer bases, better technology or data, lower prices, easier access to data, greater user traffic or greater financial, technical or marketing resources than we have |
| Our competitors may be able to undertake more effective marketing campaigns, obtain more data, adopt more aggressive pricing policies, make more attractive offers to potential employees, subscribers, distribution partners and content providers or may be able to respond more quickly to new or emerging technologies or changes in user requirements |
| Increased competition could result in lower revenues and higher expenses, which would reduce our profitability |
| If we are not able to obtain and maintain accurate, comprehensive or reliable data, we could experience reduced demand for our information services |
| Our success depends on our clients’ confidence in the comprehensiveness, accuracy and reliability of the data we provide |
| The task of establishing and maintaining accurate and reliable data is challenging |
| If our data, including the data we obtain from third parties, is not current, accurate, comprehensive or reliable, we could experience reduced demand for our services or legal claims by our customers, which could result in lower revenues and higher expenses |
| In April 2005, we deployed a new company-wide internal research application for our US researchers to use to update our database |
| Any inefficiencies, errors, or technical problems with this new application could reduce the quality of our data, which could result in reduced demand for our services, lower revenues and higher costs |
| In addition, in July 2005, we closed our Mason, Ohio research center in an effort to reduce costs and improve the quality of our research operations |
| If the consolidation of our research operations within our remaining research centers is unsuccessful, our data quality may be affected, which could result in reduced demand for our services |
| We have experienced operating losses and our future profitability is uncertain |
| Until the third quarter of 2003, we had not recorded an overall operating profit because the investment required for geographic expansion and new information services had caused our expenses to exceed our revenues |
| Our ability to continue to earn a profit will largely depend on our ability to manage our growth, including our expansion plans, and to generate revenues that exceed our expenses |
| We generated net income for the years ended December 31, 2003 2004, and 2005, and our decision to release the valuation allowance on our deferred tax assets was based on our expectation of future taxable income from operations; however, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future |
| We will continue to evaluate our expectation of future taxable income during each quarter, and if we are unable to conclude that it is more likely than not that we will continue to be profitable, then the realization of our deferred tax assets could become uncertain |
| In such a case, we may be required to establish a valuation allowance against some or all of our deferred tax assets, which could result in a significant charge to our earnings that could adversely affect our net income in the period in which the charge is incurred |
| In addition, our ability to continue to earn a profit, to increase revenues or to control costs could be affected by the factors set forth in this section |
| We may not be able to generate revenues or control expenses to a degree sufficient to earn a profit, to increase profits on a quarterly or annual basis, or to sustain or increase our future revenue growth and, as a result, the market price of our common stock may decline |
| Litigation or government investigations in which we become involved may significantly increase our expenses and adversely affect our stock price |
| Currently and from time to time, we are a party to various lawsuits |
| Any lawsuits, threatened lawsuits or government investigations in which we are involved could cost us a significant amount of time and money to defend, could result in negative publicity, and could adversely affect 15 _________________________________________________________________ our stock price |
| In addition, if any claims are determined against us or if a settlement requires us to pay a large monetary amount, our profitability could be significantly reduced and our financial position could be adversely affected |
| We cannot assure you that we will have any or sufficient insurance to cover any litigation claims |
| If we are unable to hire qualified persons for, or retain and continue to develop, our sales force, or if our sales force is unproductive, our revenues could be adversely affected |
| In order to support revenue growth, we need to continue to develop, train and retain our sales force |
| Our ability to build and develop a strong sales force may be affected by a number of factors, including: our ability to attract, integrate and motivate sales personnel; our ability to effectively train our sales force; the ability of our sales force to sell an increased number of services; our ability to grow and manage effectively an outbound telesales group; the length of time it takes new sales personnel to become productive; the competition we face from other companies in hiring and retaining sales personnel; and our ability to effectively manage a multi-location sales organization |
| If we are unable to hire qualified sales personnel and develop and retain the members of our sales force, including sales force management, or if our sales force is unproductive, our revenues could decline or cease to grow and our expenses could increase |
| Our stock price may be negatively affected by fluctuations in our financial results |
| Our operating results, revenues and expenses may fluctuate with general economic conditions and also for many other reasons, many of which are outside of our control, such as: cancellations or non-renewals of our services; competition; our ability to control expenses; loss of clients or revenues; technical problems with our services; changes or consolidation in the real estate industry; our investments in geographic expansion and to increase coverage in existing markets; interest rate fluctuations; the timing and success of new service introductions and enhancements; successful execution of our expansion plans; data quality; the development of our sales force; managerial execution; employee retention; foreign currency fluctuations; inflation; successful adoption of and training on our services; litigation; acquisitions of other companies or assets; sales, brand enhancement and marketing promotional activities; client support activities; changes in client budgets; or our investments in other corporate resources |
| In addition, changes in accounting policies or practices may affect our level of net income, including without limitation, changes requiring us to expense stock options |
| Fluctuations in our financial results, revenues and expenses may cause the market price of our common stock to decline |
| We may not be able to successfully introduce new or upgraded information services, which could decrease our revenues and our profitability |
| Our future business and financial success will depend on our ability to continue to introduce new and upgraded services into the marketplace |
| To be successful, we must adapt to rapid technological changes by continually enhancing our information services |
| Developing new services and upgrades to services imposes heavy burdens on our systems department, management and researchers |
| This process is costly, and we cannot assure you that we will be able to successfully develop and enhance our services |
| In addition, successfully launching and selling a new service puts pressure on our sales and marketing resources |
| If we are unable to develop new or upgraded services, then our customers may choose a competitive service over ours and our revenues may decline and our profitability may be reduced |
| In addition, if we incur significant costs in developing new or upgraded services, are not successful in marketing and selling these new services or upgrades, or our customers fail to accept these new services, it could have a material adverse effect on our results of operations by decreasing our revenues or our revenue growth rate and by reducing our profitability |
| Fluctuating foreign currencies may negatively impact our business, results of operations and financial condition |
| Due to our acquisition of FOCUS Information and Scottish Property Network (“SPN”), a portion of our business is denominated in the British Pound and as a result, fluctuations in foreign currencies may have an impact on our business, results of operations and financial condition |
| Currencies may be affected by internal factors, and external developments in other countries, all of which can have an adverse impact on a country’s currency |
| Currently, we do not have any hedging transactions 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 may decrease the value of our foreign assets, as well as decrease our revenues and earnings from our foreign subsidiaries |
| If we are unable to enforce or defend our ownership and use of intellectual property, our business, competitive position and operating results could be harmed |
| The success of our business depends in large part on the intellectual property involved in our methodologies, database, services and software |
| We rely on a 16 _________________________________________________________________ combination of trade secret, patent, copyright and other laws, nondisclosure and noncompetition provisions, license agreements and other contractual provisions and technical measures to protect our intellectual property rights |
| However, current law may not provide for adequate protection of our databases and the actual data |
| In addition, legal standards relating to the validity, enforceability and scope of protection of proprietary rights in Internet-related businesses are uncertain and evolving, and we cannot assure you of the future viability or value of any of our proprietary rights |
| Our business could be significantly harmed if we are not able to protect our content and our other intellectual property |
| The same would be true if a court found that our services infringe other persons’ intellectual property rights |
| Any intellectual property lawsuits or threatened lawsuits in which we are involved, either as a plaintiff or as a defendant, could cost us a significant amount of time and money and distract management’s attention from operating our business |
| In addition, if we do not prevail on any intellectual property claims, this could result in a change to our methodology or information services and could reduce our profitability |
| If we are not able to successfully identify and integrate acquisitions, our business operations and financial condition could be adversely affected |
| We have expanded our markets and services in part through acquisitions of complementary businesses, services, databases and technologies, and expect to continue to do so in the future |
| Our strategy to acquire complementary companies or assets depends on our ability to identify, and the availability of, suitable acquisition candidates |
| In addition, acquisitions involve numerous risks, including managing the integration of personnel and products; managing geographically remote operations, such as SPN in Scotland; the diversion of management’s attention from other business concerns; the inherent risks in entering markets and sectors in which we have either limited or no direct experience; and the potential loss of key employees or clients of the acquired companies |
| We may not successfully integrate any acquired businesses or assets and may not achieve anticipated benefits of any acquisition |
| Future acquisitions that we may pursue could result in dilutive issuances of equity securities, the incurrence of debt, one-time write-offs of goodwill and substantial amortization expenses of other intangible assets |
| Our business depends on retaining and attracting highly capable management and operating personnel |
| Our success depends in large part on our ability to retain and attract management and operating personnel, including our President and Chief Executive Officer, Andrew Florance, and our other officers and key employees |
| Our business requires highly skilled technical, sales, management, web-development, marketing and research personnel, who are in high demand and are often subject to competing offers |
| To retain and attract key personnel, we use various measures, including employment agreements, awards under a stock incentive plan and incentive bonuses for key executive officers |
| These measures may not be enough to retain and attract the personnel we need or to offset the impact on our business of the loss of the services of Mr |
| Florance or other key officers or employees |
| International expansion may result in new business risks which may reduce our profitability |
| Our international expansion could subject us to new business risks, including: adapting to the differing business practices and laws in foreign countries; difficulties in managing foreign operations; limited protection for intellectual property rights in some countries; difficulty in collecting accounts receivable and longer collection periods; costs of enforcing contractual obligations; impact of recessions in economies outside the United States; currency exchange rate fluctuations; and potentially adverse tax consequences |
| In addition, international expansion imposes additional burdens on our executive and administrative personnel, systems development, research and sales departments, and general managerial resources |
| If we are not able to manage our growth successfully, we may incur higher expenses and our profitability may be reduced |
| Finally, the investment required for international expansion could exceed the profit generated from such expansion, which would reduce our profitability and adversely affect our financial condition |
| We may be subject to legal liability for displaying or distributing information |
| Because the content in our database is distributed to others, we may be subject to claims for defamation, negligence or copyright or trademark infringement or claims based on other theories |
| We could also be subject to claims based upon the content that is accessible from our web site through links to other web sites or information on our web site supplied by third parties |
| Even if these claims do not result in liability to us, we could incur significant costs in investigating and defending against any claims |
| Our potential liability for information distributed by us to others could require us to implement measures to reduce our exposure to such liability, which may require us to expend substantial resources and limit the attractiveness of our information services to users |
| 17 _________________________________________________________________ Market volatility may have an adverse effect on our stock price |
| The trading price of our common stock has fluctuated widely in the past, and we expect that it will continue to fluctuate in the future |
| The price could fluctuate widely based on numerous factors, including: quarter-to-quarter variations in our operating results; changes in analysts’ estimates of our earnings; announcements by us or our competitors of technological innovations or new services; general conditions in the commercial real estate industry; developments or disputes concerning copyrights or proprietary rights; regulatory developments; and economic or other factors |
| In addition, in recent years, the stock market in general, and the shares of Internet-related and other technology companies in particular, have experienced extreme price fluctuations |
| This volatility has had a substantial effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of the specific companies |