Tim Trainor - Communication Director
Andrew Florance - Founder, Director, President and CEO
Brian Radecki - CFO
Timo Connor - William Blair
Jonathan Maietta - Needham & Co.
Ian Corydon - B. Riley & Co.
Jim Wilson - JMP Securities
Vance Edelson - Morgan Stanley Research
Brett Huff - Stephens Inc.
CoStar Group Inc. CoStar Group, Inc (CSGP) Q1 2010 Earnings Call April 22, 2010 11:00 AM ET
Ladies and gentlemen thank you for standing by and welcome to the CoStar Group's First Quarter 2010 Conference Call. On the call today are CoStar Group’s CEO, Andrew Florance; CFO, Brian Radecki and Communications Director, Tim Trainor. During today’s conference all participants will be in a listen-only mode, later there will be a question-and-answer session; instructions will be given at that time (Operator Instructions). And as a reminder, today’s conference is being recorded.
I would now like to turn the conference over to CoStar's Group Communication Director, Mr. Tim Trainor, please go ahead.
Thank you, operator and good morning everyone. Welcome to CoStar Group’s first quarter 2010 conference call. Before I turn the call over to our CEO, Andrew Florance let me state that certain portions of this discussion contains forward-looking statements which involve many risks and uncertainties that can cause actual results to differ materially from such statements.
Important factors that can cause actual results to differ include but are not limited to, those stated in CoStar Group's first quarter press release and in CoStar's filings with the SEC, including its Form 10-K for the year ended December 31, 2009 under the heading Risk Factors. All forward-looking statements are based on information available to CoStar on the date of this call and CoStar assumes no obligation to update these statements.
As a reminder today’s conference call is also being broadcast live over the internet at www.costar.com. A replay will be available approximately one hour after this call concludes and remain available through May 6, 2010. To listen to the replay, call 800-475-6701 within the United States or Canada or 320-365-3844 outside the United States. The replay will also be available on CoStar’s website for a period of time following the call.
Thank you again for joining us. I will now turn the call over to Andy.
Thank you Tim, I appreciate it. Welcome everyone to CoStar Group’s first quarter 2010 conference call. I am very pleased to report the initial signs of economic improvement we reported last quarter had continued to strengthen throughout our business during this first quarter and this has all resulted in strong organic quarterly sales performance and a record $55.1 million in quarterly revenue. The $55.1 million in quarterly revenue for the first quarter of 2010 was an increase of approximately 500,000 over $54.6 million revenue during the fourth quarter of 2009. It was about a $5 million increase over the revenues a year ago same quarter. First quarter 2010 EBITDA was $8.8 million and the company’s net income was $2.9 million during the first quarter.
We are investing aggressively in our business in anticipation of economic recovery. We had invested by growing our sales force 32% year-over-year with the addition of nearly 50 net new sales professionals. We have also invested in the quality and depth of our research by adding 100 net new researchers year-over-year. We believe that this distressed real estate market has presented a unique opportunity for us to control long-term occupancy cost. So we’ve invested by purchasing a new headquarters building and made the decision to consolidate leases in both Boston and London.
We believe that advancing from what traditionally been a research focused business to one that includes analysis and applied research presents a tremendous growth opportunity for our company and so we've had a key personnel and have acquired and we are integrating Property And Portfolio Research and Resolve Technology in to CoStar Group.
With these investments, coupled with ongoing our organic sales momentum, we believe the company is well positioned to achieve accelerated high margin revenue growth as commercial state markets recover.
We are pursuing these opportunities with the benefit of a strong balance sheet. At the end of quarter, the company had a total of $218.5 million in cash, cash equivalents and investments, and we have no long-term debt obligations.
We had a very strong subscriber growth during the first quarter adding 1,265 new subscribers to take our total subscriber base to 86,590. This is the third quarter in a row in which we have turned in strong subscriber growth.
Our renewal rates remained very high in the first quarter 2010. The 12 month trailing renewal rates for subscription based services improved to approximately 86% in the first quarter of 2010 from approximately 85% in the forth quarter of 2009. This improvement in renewal rates is a direct result of our successful efforts to retain the business of newer customers. 18 months ago we identified the need to improve our renewal rate among firms that have been customers for less than five years. We noted that on average our newer customers use the service less than our more established customers and that the low usage rates were directly co-related with lower renewal probability.
We attack this problem by gradually changing our sales professionals commission plan such that they are paid for this sales, the salesmen would get their commission when a customer has used the service rather when they signed up to buy the service. The net result was a dramatic improvement in usage within new customers’ sites.
In 2008, an average 38% of the authorized user at first year client sites where actively using our service. So by 2009 that active user rate has climbed to 53% among first year client sites. Our revised commission plan appears to have translated directly in the higher new customer renewal rates and fewer failed sales. The new customer renewal rate were 70% in the first quarter of 2009. That renewal rate has climbed to 85% in first quarter of 2010.
The average new contract value increased to $9,365 in the first quarter of 2010 from $9,143 in fourth quarter of 2009. This increase was driven upward by the Property And Portfolio Research average new contracts value of $107,383. We’ve had tremendous success with CoStar accounting introduced in the PPR team to CoStar customers and vice-versa with the result being millions of dollars in annualized subscription value cross sold. The total number of subscription client sites remained approximately 16,000 company wide. All major business services CoStar U.S. PPR SHOWCASE in U.K had positive organic growth in revenue in their local currencies for the first quarter in 2010.
We posted a second consecutive quarter of positive net bookings. The total for the first quarter 2010 was approximately 1.6 million company wide reflecting the positive impact of an increase in our overall gross sales. The increase in first quarter organic revenue we enjoy this past quarter was our first quarterly increase in organic revenues since the economy went into a recession. As the same increased in former subscribers returning to the become subscribers again, contributed to our organic revenue growth here in the quarter.
In addition to wining back these former clients, we are also seeing orders from existing customers to add additional users, services and expand market coverage at a rate that we have not seen since before the start of the recession.
Overall, I am very encouraged by the strengthening positive trends we have seen in our sales activity over the past three quarters. Although we are realistic that the past to a full recovery could be choppy during this transition year, we remain optimistic that we will likely see continuing positive sales performance through the rest of 2010. One major reason for optimism is the total potential size of the market that we see for our services. We firmly believe that we could earn hundreds of millions of dollars in potential additional annual subscription revenue by achieving higher penetration for our services throughout the U.S. We also believe that there are more than 10,000 plus brokerage firms in the U.S. that we could win as new clients.
In order to pursue this opportunity we have invested heavily in growing our sales force this year. As I mentioned earlier, we have grown our sales force headcount 32% year-over-year to take our sales force to a total of 203 personnel. This includes 127 U.S. subscription sales reps, 8 U.S. advertising sales reps, 43 in-house sales reps, 19 U.K. field sales reps and six sales reps for PPR and Resolve. This was only a 3% FTE increase quarter-over-quarter.
I think it’s worth noting that the quality and experience of the sales reps we have been able to onboard this downturn has been uniformly exceptional. Our sales are benefiting from the level of sales town available in the market and the effective training programs we have implement, a clear indicator of this is the average gross sales per sales rep in production. In the first quarter of 2010 the sales production measure was the highest it’s been since 2007.
Sales of our Showcase online marking service was strong this past quarter and continued to build on the growth that our internet marketing service generated in 2009. In fact, we are fast closing in on 10,000 subscribers just two years since its launch. At the end of the first quarter, there were approximately 9,750 total Showcase subscribers in the U.S. and the service is generating more than $6 million in annualized revenue. We believe that this service has been successful because of its low cost for value; it’s no hassle, no registration requirements before seeing the ads and the ease of maintaining listing inventories that are already in CoStar property.
We are very pleased to announce that with the launch of Showcase in United Kingdom this past quarter, CoStar has launched its first international service offering. We have already signed up dozens of British firms to our Showcase U.K. service. In fact I think the number is 48 or 50. As we did with our Showcase launch in the U.S. our early adopter clients in the U.K. are on trail contracts, some number mentioned now on the firm contracts but that’s basically got to do with the U.S. We assigned people initially on trial contract, and a very high of them went into permanent paying obligations and commitments to the service.
As part of the launch, we had to complete a successful integration effort of our U.S. and U.K. back-end data systems. We believe that this will pave the way for more integrated and uniform international service offerings in the future. We also expect these integrated services will give us more skill in our software offerings and I believe make our services more attractive to potential clients, thereby driving significant additional sales.
The last few quarters have provided convincing signs of economic rebound. Leasing throughout the U.S. in the quarter was up dramatically from one year ago and has increased in each of the past four consecutive quarters. Tenants that put off making long-term financial commitments in the down turn and postpone decisions in our expectation that rental rates would drop are now getting back in the market ahead of the expense recovery and are seeking to take advantage of the currently favorable leasing conditions.
This is driving record levels of leasing activity in the United States. And because leasing activity as a measure total leases signed an outer measure of growth in the net demand for office space. It’s a good proxy for leasing commission which is likely the single largest source of revenue for our core customers. Improving leasing activity creates the environment that was conducive to CoStar’s first quarter solid increase in net new subscribers, high customer renewal rates and our new record quarterly revenue.
Other positive economic indicators include high net absorption of vacant space, signs of vacancy stabilization, less job losses and job growth and office using employment segments. Also we saw continued positive GDP growth and an increase in consumer spending in March.
Most economists expect 2010 to be a transitional year for the economy. I want to take a minute to discuss the defining trends at work in the market right now and how we believe they will impact commercial real state for the foreseeable future and how we expect they will affect our business.
With the increase in leasing activity flat to positive absorption and little new construction, vacancy rates are beginning to stabilize across many markets. In fact, vacancy rates are beginning to drop in many markets. A decline in average rental rates have slowed and rents are even turning up in some markets.
One wild card however, is that there is a lot of phantom vacancy in the form of empty but leased office space or space behind a thousands and thousands of companies that laid off staff during the down turn. As demand retuned to the markets, this phantom vacancy will likely be absorbed first which could dampen leasing demand and ultimately the recovery itself. The investment sales debt in real estate capital markets continue to face serious challenges.
Sales volumes are down from recent inflated levels, credit markets remain in disarray and much uncertainty exists ahead of the 1.4 trillion in commercial estate mortgages expected to come due over the next three to four years.
The combination of cap rates reverting back to long-term means falling rents and decreasing occupancy levels has decimated commercial real estate values over the last two years. Last week, Dr. Pang [ph], Dr. Norm Miller, Dr. Ming Zong Hong [ph] and my self all at CoStar present a paper index in commercial real estate values we have repeat sales at the National Conference of the American Real Estate Society. We co-author this paper with Karl Case due its same with the Case-Shiller Residential real estate value index based on the repeat sales.
We believe that the index we have produced is one of the purest, most robust and authoritative indexes of commercial real estate values. Using 94,000 properties from CoStar’s database that are sold more than once since 1995, we determined that commercial real estate values peaked in the third quarter of 2007, after having increased 257% from the same period a decade prior. Commercial real estate value had since plunged 30% from that peak to year-end 2009. And while commercial real estate values have climbed 4% during first quarter of 2010, overall values are still down 27% from the third quarter of 2007 peak.
We published another paper last week at American Real Estate Society estimating the total value of the U.S. commercial real estate stock. We estimate the current value to be approximately $10 trillion. Based on our true analyses, the industry lost approximately $4 trillion in value from the peak of the market, keeping it in perspective we still see our position as the leasing information and analytics provider for a $10 trillion U.S. industry as a very exciting place to be with immense growth potential.
As for market conditions affecting current property values, we believe that more than 20% of the leveraged commercial properties in the U.S. today have lower values than their mortgages because the majority of leases being signed today are at a significant discount to what they were four or five years ago, the increase in leasing activity is not excepted to increase the net operating incomes of properties over the next two years. Without increases in net operating incomes, we do not expect significant increases in value. It follows that we’ll likely see a large numbers of the falls in distressed sales over the next three years.
So the market going forward is likely a bit difficult for existing owners and lenders but good for brokers’ appraisers and future owners. The majority of CoStar’s revenue is derived from subscribers involved in leasing activity and property evaluation. We also hope to sell an increasing number of hedge funds, opportunity funds, REITs and other future owners. We see an opportunity to make information and market analysis CoStar offers available to the owners and lenders dealing with the new realities of the current environment.
More than ever, we believe investors, lenders, appraisers, government agencies and others involved in establishing the value of commercial property in a volatile sales market stand to benefit from CoStar’s information and applied research. For all these reasons I believe CoStar is extremely well poisoned to capture the significant opportunities we see resulting from the current market dynamics in commercial real estate.
We continue to see strong demand for PPR’s enhanced analytic and forecasting services from CoStar’s existing clients and for CoStar’s information and services among PPR’s existing client base. We signed 1.1 million in cross sales contracts during the first quarter of 2010 to continue the strong trend we had established in the third and fourth quarter of 2009. The integration of our two back end systems is proceeding smoothly and PPR is now using more CoStar information to support their analysis and forecasting capabilities. Vice versa CoStar is using a lot of the PPR analytics in our various presentation and webinars and alike.
In the first quarter of 2010, CoStar’s research team continue to expand our data base to unprecedented levels adding more than 42,000 listings, approximately 97,000 properties and 0.5 million digital images. We now have close to 3 million buildings in our U.S. database. We have doubled the U.S. database since the peak of the market adding more than 1.5 million buildings since 2007. I really think that’s if you’re starting to reflecting that’s an amazing number, adding 1.5 million buildings to our database in basically a three-year period.
Over the last 12 months, customers accessed information on 100% of these properties, so in other words, our customers actually accessed and looked at 100% of the 3 million buildings in our database. On average, the average property was viewed 385 times in the last 12 months, so 3 million properties viewed almost 400 times. We believe that our impressive database growth directly corresponds to the growth in long-term potential revenue and creates increasingly higher barriers to entry.
Let me close my remarks by saying that we couldn’t be happier with the clear signs of renewed strength in our business. We believe we continue to improve retaining sales; higher renewal rates and increasing subscriber counts are clear indications that we’ve entered initial recovery in growth base. We fully expect to achieve high margin revenues growth as the market recovery strengthens.
During the downturn last year, we took the opportunity to invest in and expand our business in a number of important areas and set the stage for increasing shareholder value in the recovery period. CoStar has experienced tremendous growth over the past 20 plus years and we believe that we’ve now have become an indispensable information utility for the commercial real estate industry. Achieving a leadership position and serving the information needs of a dynamic $10 trillion industry should not be confused with reaching a saturation point for our business. We believe CoStar Group is still in that early stages of realizing a total market potential for our Research and Services. Certainly the recent severe industry downturn has slowed our progress towards our goal of reaching over $1 billion in revenue. We’re also reconfirmed the value of our research based information and proven business model for the recovery emerging some of the headwinds appear to fading and before long we could potentially see something tailwinds for our business. We remain singularly focused on growing CoStar’s business towards a $1 billion in high margin revenue.
At this point, I am going to turn the call over to Brian Radecki, our CFO who will walk you through the first quarter numbers. Brian?
Thank you, Andy. As Andy mentioned we are pleased to report we’ve achieved solid financial results for the first quarter 2010 with record revenues as we continue to see positive momentum in many areas of our business. Today I’m going to principally focus on the sequential results for the first quarter of 2010 compared to the fourth quarter of 2009 and also our outlook for the second quarter and full year of 2010. We believe the sequential trends offer the most insights into the performance of our business as we continue to progress through the current economic and commercial real estate cycle.
As Andy mentioned, first quarter revenues came in stronger than anticipated at $55.1 million, an increase of approximately $0.5 million over the fourth quarter of 2009. A record revenue performance during the quarter was primarily driven by organic company wide net new sales as Andy mentioned.
Subscription revenues in the first quarter accounted for approximately 94.5% of all of our revenues. On a functional currency basis, international revenue was approximately £3.1 million which had positive organic subscription revenues in the first quarter and in line with our expectations. International revenues were approximately 8.7% of the company’s total revenues in the first quarter.
As of March 31, 2010 our 12 month trailing renewal rate which is a measure of renewing subscription revenue was approximately 86%. As I have publicly stated for about two years now we expect that our 12 month trailing renewal rates to decline from low to mid 80s in 2009 and then begin to recover in 2010. We ended 2009 at approximately 85% with our Q4 in quarter renewal rates turning out significantly. We are pleased to see our 12 months trailing renewal rate continue to increase and move back towards the historical average approximately 90%, customer retention efforts and company wide contract bookings continue to improve.
Turning now to gross margin, gross margin was approximately $33.9 million in the first quarter of 2010, and was flat compared to Q4 2009. Q1’s gross margin includes the full impact of PPR results of lower overall gross margin in the Investments and Research that was discussed on previous calls.
Moving down the income statement, total operating expenses for the first quarter of 2010 were $28.8 million compared to $27.8 million in the fourth quarter of 2009, in line with our outlook for the first quarter. The increase in operating expenses as we discussed on the last call was principally due to seasonally higher payroll taxes and benefits in the first quarter, our January annual company wide sales conference and some initial building caring cost related to the new corporate headquarters in Washington D.C.
Turning to profitability, our first quarter 2010 income was $2.9 million or $0.14 per diluted share with non-GAAP net income per diluted share of approximately $0.25 and EBITDA our earnings before interest taxes, depreciation and amortization of approximately $8.8 million. A reconciliation of EBITDA, non-GAAP net income per share and all historical non-GAAP financial measures discussed today on this call are shown in detail in our press release issued yesterday which is available on our website at www.costar.com.
Looking at our balance sheet, we ended the first quarter with approximately $218.5 million in cash, cash equivalents and investments. Our balance sheet also reflects the acquisition of the office building in Washington D.C. for our corporate headquarters of approximately $41.25 million in cash which we announced in February. The company continues to have no long term debt.
I will now speak to our outlook for the second quarter and full year 2010, as its typical our guidance takes into account recent revenue growth rates and results maybe impacted by the economic conditions in the commercial real estate or overall economy. Our forward-looking guidance reflects our current expectations as of April 21, 2010. We expect revenue for the second quarter of 2010 in the range of $54.5 million to $55.5 million and we reiterate our full year guidance of approximately $218 million to $222 million of revenue.
After the first quarter of organic sales we are confident that we are tracking towards the middle to upper end of the annual guidance range and we continue to expect that new positive sale trends continue as Andy mentioned.
Our guidance on the impact for foreign currency exchange fluctuations on our top-line results remains consistent. We do not attempt to predict the foreign exchange fluctuations and our guidance assumes little or no volatility for the current rate. The average exchange rate for the first quarter of 2010 was £1.56 to U.S. dollars and our 2010 guidance which is unchanged continue to assume 1.6 for the majority of the year.
Not only layered in a full quarter of PPR result in investments in research, we expect CoStar revenues to be stabilized and to be in the $21 million range plus or minus with few 100,000. Moving down the P&L we expect selling and market expenses in the second quarter of approximately $12.5 million to $13.5 million which includes our difficult second quarter increase for the annual ICSC trade show in May.
We expect software development of approximately $4.2 million to $4.7 million in G&A expenses to remain relatively consistent in the $10.5 million to the $11.5 million dollar range. The mechanics of our effective tax rate continue to be affected by the modern income and loss in our U.K. entities. Tax expense and benefits in U.K. will not be equivalent to the U.S. rates and therefore our effective rates may be blended.
In addition any acquisition tax spending strategies or large one time gains or losses may affect the actual tax rates for 2010. With that in mind, we continue to currently expect the effective rate to be in the 40% to 44% range for the year, with individual quarters possibly being a little over or little under this range.
As we indicate in recent earnings calls beginning with the first quarter 2010 results, we began adding additional non-GAAP financial disclosures. We believe that both management and investors can benefit from referring to the non-GAAP financial measures in assessing performance and planning and forecasting future periods. For additional information please refer to the Non-GAAP Financial Measures section of our Press Release posted on our website.
In terms of earnings, we expect second quarter 2010 fully diluted net income per share of approximately $0.13 to $0.15 and non-GAAP net income per diluted share of approximately $0.22 to $0.24 per share.
Our second quarter outlook for GAAP net income includes approximately $300,000 to $500,000 of cost related to the transition of our corporate headquarters in D.C. as defined in our press release for non-GAAP net income per diluted share, which is excluded in the transition related equity compensation cost.
For 2010, we iterate our expectation from GAAP net income per share of approximately $0.60 to $0.65 per share, non-GAAP net income per diluted share of $1.06 to $1.22 per share. But we expect to grow our earnings in the second half of 2010 and achieve our outlook even with the short term dilution with net income resulting from our investments over the past 12 months that Andy mentioned with our largest sales force, extended research and recent acquisitions of PPR result.
For the full year 2010 we continue to expect approximately $0.04 to $0.06 per share of dilution due to investments in result services which we anticipate results and additional penetration among the commercial real estate owners and investors in the future.
In addition for fiscal year 2010, we continue to expect $3 million to $3.5 million in cost related to the acquisition and transition of our corporate headquarters in Washington D.C. and approximately $1.5 million to $1.8 million in restructuring and other cost related to the leases tends the consolidation of CoStar, PPR and Resolve officers into a single location in Boston which we expect to occur later this year.
The cost in 2010 related to the acquisition and transition of our corporate headquarter in Washington D.C. are expected to primarily include overlapping occupancy cost at end of our current lease terms and the carrying cost associated with the new building. Our current headquarter office lease expires on October 15th, 2010. We anticipate moving just slightly before that.
After this period, we expect to save approximately $2 million a year in occupancy cost for headquarters in 2011 compared to 2010. Once we get pass the transitionary cost this year, we believe we will accredit significant long-term value by reducing the company’s long-term cost structures for decades and decades to come.
In closing, we are thrilled with this record first quarter revenues results and the momentum we’re seeing in our business. Our business model remain strong facing the fact that we have a 95% subscription based business with high renewal rates, a unique proprietary data base, market leading position, strong balance sheet, no debt and continued high operating cash flow. We expect to return to more normalized organic growth rate and expanding margins that we have enjoyed over the past decade in the near future as we continue to see positive trends in our business and provide we continue to see positive trend in the overall economy. CoStar’s management team believes there is significant opportunity for high additional revenue margin growth following the investments we have made in research sales with strategic acquisitions like PPR and Resolve.
We continue to look forward to reporting our progress to you. And with that, I’ll open it up then call for questions.
Thanking you. (Operator Instructions). The first question comes from the line of Timo Connor with William Blair. Please go ahead.
Timo Connor - William Blair
Couple of questions around the renewal rates. Do you have any additional color around the in quarter renewal rates for the first quarter?
Yeah. The in quarter renewal rates was higher than the 12 months trailing and slightly lower than last quarter but it was higher than the 12 months trailing quarter. So we continue to see a lot of progress there. DSOs continue to get better, bad debt expense was down, write-off were down. So we continue to see progress there. We believe that the 12 month trailing renewal rate will continue to improve throughout the year, end up in the kind of high 80s.
Timo Connor - William Blair
Do you see quarter-over-quarter remaining on the high 80s?
Yeah. We have a reasonable visibility looking for the quarter and we don’t have any reason at this point to believe that we’re seeing anything but improvement in renewal rates. That’s correct.
Timo Connor - William Blair
Thank you. Would you mind going over, I know you covered it earlier but again over the usage levels, especially customer segments.
Sure. So I think you’re refereeing to our efforts with new customers?
Timo Connor - William Blair
Okay. Right so. We end up putting a hundred authorized users into a decent size site like a major institutional investor site that we do not expect of all 100 IDs to be used. We typically see about 80% plus of the IDs that are consistently actively used. One other things we noticed was that we have low renewal rates among the brand new customers that’s because basically a manager or an officer that’s signed up to take on the CoStar service, once they made a decision that’s necessarily mean the staff will use the product.
And it can take up to five years before the staff has bigger location will really inaugurating CoStar into their day-to-day operations. Because of that we saw a lower renewal rate about 70% or 65% renewal rate among our newest customers. So we went at that by paying our sales people for actually getting new customers to use the services rather than to sign them up and has been extremely effective. The usage levels have gone from what, 37% to 50 some percent among the newest customers. And we’re now getting our new customer up to established customer usage levels within about two years or so. And that translated to us seeing almost the same renewal rate for new customers as for old customers. So we’re really quite happy with that. That said, accelerated our past few organic growth.
Timo Connor - William Blair
And did you see the customer renewal rate from five year plus customers staying within their mind with fourth quarter?
Timo Connor - William Blair
Thank you. CoStar progress with analytics, would you mind just covering that a little bit. I think mentioned 2 million in quarters three and four of PPR cross sold to CoStar subscription clients. Do you see that continue?
Yes. That was two million sum in the first, in the third and fourth quarter of ’09. And we saw 1.1 million in the first quarter of ’10. So I couldn’t be after that. That’s a phenomenal level. And we’ve got a very large composition there. PPR has a 180, 190, 180 some customers and CoStar has hundreds and hundreds of institutional customers that currently subscribe to PPR. So we’re basically introducing the PPR sales team to those folks and continue to get good cross sales. And really CoStar resolves any product issues that PPR had where they didn’t have a granularity of data and PPR resolves a lot product issues where CoStar didn’t have multi family or didn’t have forecasting or debt modeling. So we really got a new solution that is meeting a comprehensive need set for the institutional players. And we’re having a lot of competitive wins.
So as I understand it, I’m hearing that a very high percentage of these cross sells are wins from a direct competitor. So that should continue on through 2010 and we’ll also be looking to release a new product that is some where between the CoStar lower price point for institutional player and the PPR higher price point either late 2010 or early 2011. I think that will enable us to do even more cross selling. I'm very happy with that.
Now we haven’t yet begun in earnest but we’ve not yet begun the cross selling process between Resolve, CoStar and PPR. For that I think that like wise has an awful lot of potential. We’ll be able to sell PPR data into Resolve and CoStar data in the Resolve and Resolve back to CoStar PPR customers.
Timo Connor - William Blair
Great, thanks. And on the sale force you mention that new increase but what about on the retention side?
Well, we’ve seen a dramatic improvement in retention. So the, obviously in this economy we’ve seen our turnover rate drop in half, probably across the board and we also are really quite pleased with the quality of candidates we’re selecting from right now. So we have going to bring on board some real players that are out there on the sale side.
Timo Connor - William Blair
Okay. Average deal size increased slightly especially maybe driven by PPR. Could you provide a little more context about the increases especially on the subscription side?
Sure. This million dollars in cross selling activity in PPR was probably 10 accounts or nine accounts. So we are selling in the lot high value solutions into large institution on the PPR side. So that’s driving the averages price point where the headcount. And as we put financial sales people out there, we should see that continue to go up. In the CoStar traditional product lines, subscription product lines in the U.S. I think they’re basically stable, roughly the same price point. We do have some initiative in the rest of the year which will be targeting, actively targeting higher volume low price points on a particular, some particular customer segment. So it will probably drive the CoStar side down a little because of high volume in the low end and the PPR the pulling it back up. So we are at build up the high end and we’re doing well at low end pretty much with the competing forces.
Okay. And then finally just to a real quick question on trends and broker headcount, what do you think when your customer specially on the mid sized brokers?
Well, I think that many of those who were going to die in this downturn has died and I had a couple of lunches with industry leadership recently where they are extremely bullish. So, if you’re looking at commercial real estate brokerage firms out there, I think many of them that has had their best quarter ever and I wouldn’t be surprised if you did some earnings surprises. So this whole thing with leasing activity, hitting a new high it’s really real. We hit the highest leasing activity number in the fourth quarter of '09. It takes about a month or so after the end of the quarter really getting good sense of where it’s going to finally land. But the fourth quarter leasing number of '09 was blow away number. It would likely be higher than the leasing activity number we saw in 2000 which was you still in that .com zone. So it's well above anything we saw in '07 or '06 and that could translate into leasing commissions which is broker revenue.
So I don’t see brokerage firms today reducing headcount. The only folks to be reducing headcount would be boutique shops that really did investment sales only. But they would have reduced their headcount in the middle of '09 and their watching their brethren over on the leasing side of the equation make a lot of money right now and they are hoping that their turn is next. So, I think we’re sort passed the headcount reduction phase.
One more probably this is the last one. Any changes in non-customers are paying payment cycle that you seeing that move from one year to quarterly perhaps?
No, actually they’ve been pretty consistent. The majority of our customer base pays monthly and we do have some larger accounts that like to pay quarterly or annually. But the majority have always paid monthly even though they are under contract for a year or longer. Well I can say that the as I mentioned earlier the accounts receivable, the days that people are extending payment is reducing receivables are getting much better, bad debts write off also reducing. So you can definitely see in lot of different metrics in the business effect, the clients are starting to get healthier.
Our next question comes from the line of Jon Maietta with Needham and Company. Please go ahead.
Jonathan Maietta - Needham & Co.
Good morning. First question I had was around just to piggyback around that question around cross sell opportunities. To what extent is the CoStar's install base familiar with PPR, Resolve? I am just trying to get a sense of what level of education has to be put forth when you are trying to up sell those two platforms?
I would actually think that the awareness would fairly low at this point for Resolve. Realistically I think Resolve has one sales person to cover the United States of America, PPR had four or five sales people to cover the United States. Neither firm engaged in aggressive marketing activities. So these firms are historically targeting the very top of institutional stock and what we’re doing is bringing a much broader sales and marketing approach to the organization. So with an average price points north of a hundred thousand annually where you’re expecting to have multiyear contracts, these are reasonably high end sales and they are done with direct field sales force and typically two meetings. So it's something with education process that occurs face to face and is fairly straight forward.
But when you bring a 100 sales people to bear on something we had one or four, you can expect a lot of cross selling potential and these are great products, the PPR products have the forecast, the analysis with economist are doing there. It’s very high quality stuff. We believe it's industry leading. Their result product that we have a ton of potential. So once you get that meeting the education process is very fairly straight forward. And I think this whole cross selling has a lot of legs to it.
Jonathan Maietta - Needham & Co.
Got it. Okay. That is helpful. And a question for you around property owners, that is certainly the segment in the economy that is suffering the most. Do you have a sense as to when do you think the owners face sort of the toughest time period? Is it 2010? Is it 2011? Is it 2012? When does print tenant extend and sort of come up and hit these guys in the face?
Right. So I will also give you some specific numbers and we used to do a survey in the UK and 72% of the respondent were familiar with CoStar and I believe that single digit were familiar with PPR unaided very worthy. When the owners confront, extend and pretend. Well and as the owner of our building it's not turning up every other light in the stairwell and the lobby. So I am guessing that's an aggressive cost cutting move or an effort to try to get Energy Star. So I am thinking that you got a high percentage of the loans that were issued in 2007 at the peak of the market were five year bubble loans, non amortizing loan. So they are going roll the peak of the worst loan were roll in 2012 but there was still lot of very bubble like activity in 2006 which will roll in 2011. You look at the volume of activities that are occurred in '06, '07 and as phenomenal may so that will be '11 and '12 should be fairy hairy year and they are going to be hoping that the lack of supply will bring up rents in time to make a possible refinances loans. But I think you will be seeing a study stream of folks coming to reality, the mid part of '10 all they way through to 2017 because you got 10 years the CMBS loans from '06 and, 07 rolling 10 years off back. So I think you are going to have small percentage single digit percentage owners owner facing the music each year for the next five or six years.
Jonathan Maietta - Needham & Co.
Okay. And then just the last question from me is where does the UK sit, in terms of what they are seeing with regard to absorption trends, vacancy rates, so on and so forth?
Identical. For example they would argued that their I think they probably a bit euphoric about the pace of recovery. To me it feels about the same. As an example thought rents in the city are up 12% quarter -over-quarter and I think that not really looking free rent so they are probably out in a probably 7% 8% but that's actually happening in a couple of US markets right now. So I think it's similar. One of the difference is they have got more supply than we do, so I think their vacancy recovery bill the slower pretty much atmosphere is identical in both markets, is an optimism of thing are actually improving dramatically
The next question comes from the line of the Ian Corydon from B. Riley and Company. Please go ahead.
Ian Corydon - B. Riley & Co.
Thanks. On the SHOWCASE side, what is the renewal rate like for that product, and will you continue to give us subs on a quarterly basis just for modeling purposes?
Yes, that's on quarterly base for modeling. The price is being as I guess there is two answer there. One is the firm level subscription where the renewal rate would probably closer to our traditional 80% plus renewal rates. We also have the individual subscription, which are going to be sold on a month-to-month basis, and often they are sold to people who have one or two listings, so when those listing actually release up they don’t renew so you have much lower renewal rate on the individual showcase. It is better, as I understand that, we have a higher renewal rate on the individual subs than do some of our industry competitors but it’s not as high as our firm level subscriptions and sort of stabilizing out, if it’s process finding a balance point.
Ian Corydon - B. Riley & Co
And on PPR, you mentioned you’ve got a couple of competitive wins. On what basis are you getting those, and then are there any other milestones we should be looking at for integration of that business, besides the late 2010, early 2011 release?
We’ve got a incredibly compelling value proposition to an institutional player right now. Many of our competitors, if you look at the evolution at this business of providing analysis and forecasting for commercial real-estate, back in ten years ago, nobody had a database for commercial real-estates in the United States. So people are out there reading, economists would read the (tea leaves) of what was happening in employment and GDP and try to guess as to what was occurring in vacancy rates, leasing activity, rental rates and the likes. So, there was a lot of sampling and estimation occurring in producing a key industry indicator.
CoStar Group if you look at our budget for research over the last 15 years its been approaching 10,000 people a year, are mainly are effort with nearly a $1 billion expended in collecting this information, and millions and millions of interviews. So we actually have the first census level representation of what’s happening in the market within CoStar Group. And that so we are sampling the majority of the active buildings on a 30 days cycle.
Our second closest competitor is sampling a subset of that on an annual cycle. So, imagine that you were trying to buy equity’s information service from someone and you need to know what the NASDAQ closed at yesterday and one company was sampling all the stocks of the NASDAQ everyday, to come up with what the NASDAQ closed at. And the other company was sampling 150 second of the NASDAQ each week for the prior year, and they were the stocks they had a sample in 30 weeks. They were estimating what they will be here today based on what they had sampled yesterday. That’s what our competitor does they do a lot of sampling and estimation, where we are actually presenting actual numbers or 30 days cycle numbers, they take that level of advantage and granular data and then you bring on the PPR analytics team where we have more PhDs and masters, economist and some of our competitors have total staff including their receptionist, and so we have got incredibly robust.
So watching Dr. (Liu) Pang present the mathematics on our repeat sales index to a room of 40 or 50 real-estate professors at American Real-Estate Society and watching their eyes glaze over at the map she was presenting in alternative methods and what not has to do with index. We are at the cutting edge on the forecasting and analytic side, while we have this advantage in granular data and this is fairly easy for our sales people to present on the strengths that it is, its combination.
So we are doing very well in a competitive front and our competitor in this area, primary competitors in this area only competing on price at this point. So they are going down market on price, and we were managing $100 billion real-estate portfolio, I would question how often are people going to go for $20,000 annual cost savings for information when they are managing a $100 billion portfolio or larger. So that’s why they were doing really well, and going forward, we are very excited and this has really captured the imagination of the traditional CoStar staff and the traditional PPR staff because the kinds of products and tools, we can produce in combination are phenomenal. We are actually having a retreat next week we are going over some of these products and tools. I think we are going to be able to make a quantum leap over the state-of-the-art, and their wont be any one release or any one integration point, but integrations are already occurring. We have already all the comparable sale data that PPR is using, is now coming in directly in from CoStar.
Within a year we will be all their vacancy and that sort of information will be coming in from CoStar, But the product evolution that will be created through integration that will be ongoing and you’ll be seeing product releases, bi-annually for years, of this combination and the Resolve’s product integration releases will probably be even more impactful beginning in 2011, most likely. So this has got a lot of legs to it and it’s pretty exciting.
Ian Corydon - B. Riley & Co.
Okay. And last question is just on the market size. What do you think the size of the market for that kind of product is today, and how big can it be, five or ten years from now?
I think it’s multi-hundreds of million of dollars. CoStar is doing 10s of millions of revenues selling the institutional customer’s; PPR is doing roughly in the 20 million plus range. We see competitors in other foreign cities dealing more than $10 million in individual cities in revenues. You can interpolate that out pretty correctly to that being a (north) of $200 million or quarter of billion dollar revenue market in the United States, if one competitor can do, those are kinds of numbers in one city. So we think it’s a very significant market place. Then when you start building in the ability to do what Resolve does which is warehouse all the different data streams on a portfolios of properties for an institutional player and apply continuous valuation and risk information of that portfolio. I think that’s a whole new market which I think is —I wouldn’t be ready to hazard a guess, but I think that’s pretty significant marketplace as well.
Our next question comes from the line of Brett Huff with Stephens.
Brett Huff - Stephens Inc.
Somebody asked I think the beginning question and I was distracted what the in quarter retention rate was?
Yeah, the in quarter retention rate is above obviously the twelve month trailing and that’s one of the reason why we believe that number will continue to go up. It was slightly below what it was last quarter but it was above the twelve month trailing.
Brett Huff - Stephens Inc.
Did you give Resolve and PPR revenues? I know they are being integrated but just trying to get to an organic growth calc, any estimates there?
No, I think last year when we talked about earnings for this year we said that you know PPR was in the $18 million range but still we got them. And Resolve was in the $3million -$4 million range so you’ll be able to kind of back into the organic growth rate this year based on those numbers.
Brett Huff - Stephens Inc.
Okay. And then Andy, you had talked about organic sales strength; I guess both you and Brian did. When you say organic sales are you using sales and revenue interchangeably, or should we take that as both revenue organic growth was pretty good, but the sales and the bookings were also good and we should see that roll forward? Can you just distinguish those, if you can?
Sure, I think they are both strong, so that would be -- you are right, so retrospectively and forward looking things were looking good. And the other thing is that its looking good across the board, so there is no one region in the United States that appear to be or United Kingdom that was still lagging all regions. All sectors appear to be doing well and moving upward so it was across the board good news.
And Brat, Andy does do that interchangeably, what I’ll say to that is that, it’s not like we have big installation lag like some companies you might buy a product, you have to install it so you can kind of take a bookings number and say, well it's a really strong bookings number. It’s going to roll through the next quarter or two quarters. Ours is -- everything is obviously fairly instantaneous. So that you could have a little bit from, you know, March sales going into April but essentially us, believing that we are going to be organic, again for the second quarter is more about our confidence in the pipeline and what we actually think we're going to sell in the second quarter. So just to kind of keep a little clarity.
Brett Huff - Stephens
Helpful. Can you just update us on what you think sort of the margin profile does? I know that you are optimistic that this is sort of a transition year and you have got some dilutive things going on that will help in the medium term. You have talked specifically about the $2 million year-over-year that should go away presumably out of G&A, because of the building costs. Can you point to any other things specifically where, the 2011, say expenses should be flat or down, versus what we presume will be sort of a rising revenue environment?
Yeah, I think in my guidance I kind of always walk through the sections that we talked about cost of revenues. I believe that this quarter is kind of our first full quarter. You got PPR and Resolve. You have the investments and research. So it will fluctuate a little bit, a couple of $100,000 here and there, depending on the headcount we move down to DC that might fluctuate that number a little bit, but I think you can view that as a fairly stabilized rate.
At some point here, we will go back to having, right now there is no CPI increases in revenue, there is also no CPI increases for the staff but at some point, you know, between here and the end of the year or next year, I'm sure we will get to that. So eventually you will get back to a normalized environment where all your cost structure will go up by some CPI escalation number. Of course, that will be mainly offset by revenue. So I think you can look at that line which is the $21 million dollars, it is the majority of our cost structure is relatively stable now. So as you start dropping revenue from the top line, it will obviously drop right through the cost of sales and into the gross margin line.
But as far as the other operating expenses go, again I gave pretty specific guidance on each one of those.
I think the sales force, as Andy talked about, is relatively stable; it increased a lot over last year. So when you look at year-over-year and those numbers are going to look significant but when you look quarter-over-quarter, they only went up three. So that cost structure is going to be relatively stable, also again taking into account just some of the seasonality of things that we do like our annual sales conference or ICSC, those types of things.
Development line, again that's actually pretty small number, it’s always in $4.5 million range plus or minus $300,000. That might increase slightly this year and we are doing some investments and development in Resolve and some other areas, but again it is not significant. And then in G&A, of course, that's the big number that you talked about obviously, you will definitely see a $2 million dollar saving as we go into next year as we eliminate some of these duplicative costs on headquarters.
So I mean, all in all, I think as you get through this year, it’s a transition year, and you get to dropping revenues from the top line and the bottom line is going to start looking a lot more like it did back in 2007 and you’ve got to remember what business the model can do when you are in a normalized environment and I think we're pretty excited about that.
Brett Huff - Stephens
Okay. And then Andy, did you give new customer sites? I think you gave total new customer subs, but did you give sites?
I thought it was about, off the top of my head about…
It was the same as usual.
About the same, I think it was 16,000 or so. So I can give you that exact number, it's about 16,000. It was pretty flat. New subscribing firms in quarter went from 423 in the fourth quarter of 2009 to 494 in the first quarter of 2010.
Our next question comes from the line of Jim Wilson with JMP Securities. Please go ahead.
Jim Wilson - JMP Securities
Again, thanks for all that demo I guess, two or three weeks ago. That was very helpful. I was wondering kind of out of, we talked a lot about cross selling and the distinct products of the three, and how powerful they are, which I agree from what I have seen. How about integration of them, and the process of it in the sense of being able to integrate the tools right inside a CoStar desktop of what PPR and Resolve offer, how long that will take, and how you see customer interest in that, or that some might be waiting for a kind of fully integrated desktop before they take the next step of paying you more money? How would you characterize that or outline it?
We have a big conference on the institutional side up in Cape Cod each year in the fall and our goal is to demonstrate some prototype product for that conference. We will not actually release that likely until beginning of 2011. And then for the Resolve integration what you are really trying to do there is take key variables used in valuing or reporting on the assets inside the portfolio and automate the flow of those variables from CoStar and PPR into Resolve. I think that will likely happen in 2011 and that is in the process, one of the things we are doing which we mentioned when we consolidated all these leases in Boston or we consolidated various leases, we are putting the people from Resolve in the same physical office space of the people from PPR and the people from CoStar, we are moving technical and analytic personnel up to Boston. So everyone is in one zone, so they can work as productively as possible on this integration effort which is fairly quantitative and hardcore.
I don’t think we have a big issue where customers are waiting to see this happen. I think they get it, they understand why when you put these things together they will be pretty powerful, the integration is already occurring.
They are already seeing the number of comparable sales that go in for the analysis of valuation trends increase ten fold. So they are already seeing a benefit from it right now. I think there will be some things we look forward to getting past like when we change the forecast models, use a different data set and have to align the different index as you know, that will be something that happens within the next 12 months. But I think we’re already well on path and right now the IT organizations for CoStar and PPR are already integrated.
So we’re already basically one group is already controlling the code for both organizations. It’s definitely easier than integrating a European and a US information set for instance.
The next question comes from the line of Vance Edelson from Morgan Stanley. Please go ahead
Vance Edelson - Morgan Stanley Research
Hi, thanks a lot. First just a housekeeping question. With net new customers of 1,265, any idea what the gross add number was? In other words, how many actual customers came online before you back out those who left?
Yeah, I don’t think we are reporting that, we have just been reporting the net number, so we’d probably continue to report the net number moving forward but it would be probably be similar to our renewal rates so you could back into it if you wanted to.
Vance Edelson - Morgan Stanley Research
Okay. Got it.
I am not sure what the number is.
Vance Edelson - Morgan Stanley Research
Just trying to find out how many customers were added. Given that net adds declined sequentially, what would you say the reason for that was? It sounds like things are looking up a bit for the targeted customer base, with leasing activity picking up dramatically as you mentioned, so just trying to get a feel for why the net adds would decline? Is there some seasonality there?
It’s actually the mix is the issue. So again our organization is selling product that is $600 a year to subscribe to and simultaneously selling product that’s $1 million a year to subscribe to. So what happened between Q4 and Q1 was the mix changed. And so you had fewer of the low end sales and more of the high-end sales occurring. And that’s why it went from 17 something, 1700 net new adds to 1200 but got more organic growth.
I think that you are going to continue to see that flip around all year long because of some of the things that Andy mentioned before. We are kind of selling barbells at the high end, and cross selling with PPR, but like as Andy mentioned, we are also introducing some new lower end service products in certain geographies this year. So just depending on when we release those, that mix could keep flipping all year. And it will change based on for example, we had 20 sales people being repositioned and retrained for a new product area and so if those folks go online are being transitioned to the new product initiative, you got a brief pause in low end sales on another product area. So it will be a little bumpy that way but the overall revenue result will be fairly predictable.
Yeah I think that’s right and Vance is that that could flip back and forth based on the initiative that we have going at lower end product or higher end product, but ultimately as we produce organic revenue growth, that’s really the end result.
Vance Edelson - Morgan Stanley
Got it and that also covers what would have been my next question on the customer profile. Maybe one last one for you. The acquisition pipeline, anything you can comment on? Are you looking for more M&A out there?
We definitely are. We think that there are still opportunities out there we are interested in. We are actively and continuously out there talking to people and looking for things, so I would not say that shut down are over. It’s just a question of timing and when something we like comes up and we are probably walking away from 4 out of 5 deals because we don’t like the valuation So Vance and anyone listening out there, we are still very interested. It’s firstname.lastname@example.org or email@example.com. We would love to chat if you are reasonable on valuation.
We have no more further questions, please continue.
Okay at this point I would like to thank everyone for joining us for the Q1 earnings call update and I hope you appreciate that I kept my comments down to nine pages. I look forward to talk to you again in the second quarter. Bye, bye
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