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RealPage (NASDAQ:RP)

Q2 2014 Earnings Call

August 04, 2014 5:00 pm ET

Executives

Rhett Butler -

Stephen T. Winn - Founder, Chairman, Chief Executive Officer and President

W. Bryan Hill - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

Patrick D. Walravens - JMP Securities LLC, Research Division

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Kyle Chen

Nandan Amladi - Deutsche Bank AG, Research Division

Brendan Barnicle - Pacific Crest Securities, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to your RealPage Q2 2014 Financial Results Conference. [Operator Instructions] And as a reminder, today's conference is being recorded. And now I would like to turn it over to your host, Rhett Butler, Director of Investor Relations.

Rhett Butler

Thank you, John. Good afternoon, and welcome to the RealPage financial results conference call for the second quarter ended June 30, 2014. With me on the call today is Steve Winn, our Chairman and Chief Executive Officer; and Bryan Hill, our Chief Financial Officer and Treasurer.

In our remarks today, we will include statements that are considered forward-looking within the meaning of securities laws. In addition, management may make additional forward-looking statements in response to your questions.

Forward-looking statements are based on managements' current knowledge and expectations as of today, August 4, 2014, and are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements and are described in today's press release.

A detailed discussion of such risks and uncertainties is contained in our Form 10-Q previously filed with SEC on May 12, 2014. RealPage undertakes no obligation to obligation to update any forward-looking statements except as required by law.

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures, in which we will exclude certain noncash or nonrecurring items depending on the measure, such as acquisition-related and other deferred revenue adjustments, depreciation and asset impairments, amortization of intangible assets, net interest expense, income tax expense or benefit, stock-based compensation expense, any impact related to Yardi litigation, including related insurance and settlement costs, stock registration costs and acquisition-related costs.

We believe that these non-GAAP measures of financial results provide useful information to investors regarding certain financial and business trends relating to our financial condition and results of operations. Please refer to today's press release announcing our financial results for the second quarter ended June 30, 2014, available on the Investor Relations portion of our website for a reconciliation of these non-GAAP performance measures to our GAAP financial results.

With that, I'll turn the call over to Steve.

Stephen T. Winn

Thanks, Rhett. Today, I'll review our performance for the second quarter and discuss expectations for the back half of 2014.

Non-GAAP on-demand revenue grew 1% and non-GAAP total revenue was flat both compared to the second quarter of last year. Adjusted EBITDA declined 41% compared to the same period last year as a direct result of the shortfall in revenue.

We ended the second quarter with 9.4 million on-demand units, representing 9% growth from the prior year period. Revenue per unit, or RPU, declined 7% over the same period as last year, as our gain in market share outpaced revenue growth. Annual customer value, or ACV, was $367 million, an increase of 1% compared to the prior year quarter.

Our financial performance was disappointing and well below our expectations. The business has historically been more predictable, and no one is more disappointed in these results and more motivated to address the root cause of the miss than myself and the rest of the RealPage management team.

Our senior management team was recently granted performance shares tied directly to stock performance, further aligning management incentives to what is most important to our shareholders. We are determined to bring to fruition our plan of building a $1 billion business. While it may take a little longer to get there, we still believe in the long-term opportunity, given our business model and market position.

So what happened? Two factors caused the bulk of the miss. We believe one is temporary and will not impact the rest of the year. We believe the second has longer-term implications that could be felt for several quarters or longer.

Today, we will discuss in detail major product family revenue and expected growth rates in order to help you better understand what is happening to the business, both good and bad.

I'll address the second and larger issue first. Revenue from products that help owners lease apartments declined in the second quarter, primarily due to aggressive pricing accommodations, which we determined were necessary to maintain and expand our market share.

In a separate press release issued last month, MPF Research, a wholly owned division of RealPage, reported that apartment occupancy for the second quarter of 2014 came in at 95.6%, up from 95% in the first quarter of 2014.

Annual revenue growth for the multifamily rental housing market, which includes shifts in both occupancy and effective rents, accelerated to 3.5% for the second quarter, up from 3.2% in the first quarter of 2014 and up from 2.9% in the fourth quarter of 2013. This indicates the rental housing market is tightening further.

Quarterly revenue growth reached a 14-year high of 1.9%, topping results not seen since late 2000.

Ongoing construction for the 100 largest markets in the U.S., which are expected to be completed within 18 to 24 months, was about 383,000 multifamily units at the end of the second quarter.

Construction starts have been roughly equal to completions during recent quarters, so ongoing construction has been holding between 350,000 and 400,000 units for 1.5 years. Strong leasing activity at new completions also is shaping the occupancy figures. Units at brand-new properties are being leased about as quickly as they can be delivered in most cases. Thus, new supply and lease-up isn't dampening overall occupancy to the degree that is typical.

We believe this supply-demand relationship has sharply driven up resident renewal rates, with leasing velocity continuing to decelerate as it becomes apparent that current renters are less mobile than previous generation in today's environment of tight rental markets and more stringent lending standards for new houses.

Supporting this are sample size of data from one site customers that's showing some of the highest renewal rates we have seen in our history. Ultimately, high occupancy and decreased renter mobility translate into a tailwind for our client base, which has led to record rent growth.

These are the best of times for apartment owners and managers. However, the current macroeconomic environment presents a headwind for our leasing solutions. There simply aren't as many new units to lease, so owners and managers have been questioning why they need to maintain advertising budgets and certain transaction volumes at such high levels when occupancy levels are at an all-time high.

With this macroeconomic backdrop, revenue per products related to leasing declined significantly in the second quarter, which implies that there is less perceived need for them. The lower demand -- or with lower demand comes aggressive competition, chasing a shrinking market for certain leasing products.

Approximately 30% of our second quarter on-demand revenue was derived from products that help owners and managers lease apartments, which is the primary driver of lower-than-expected revenue. This represents $29 million of in-quarter revenue, including the contact center, screening, organic lead generation tools, our Internet listing service and senior referral business. Revenue from this category is comprised of subscription and transactional components and was down 5% compared to the prior year, which equates to $7 million below our expectations.

Revenue for leasing solutions was primarily impacted by reduced pricing, not units. During the second quarter, we actually grew unit market share for our leasing products sequentially and compared to the same period last year. However, pricing accommodations, especially for clients who used our leasing products more than their allotted usage, increased significantly.

As competition stiffened, we could have held prices higher and ceded some market share. Instead, we elected to reduce price or offer accommodations intended to expand market share. We believe the strategy of overall price leadership is important, and our size and economy of scale enable us to more efficiently respond to market conditions in the long term than our point [ph] product competitors.

We believe that lower prices for leasing products are here to stay, at least until supply and demand come back into equilibrium, which could take several quarters or longer, and this expectation is reflected in our full year guidance.

The second factor that drove lower second quarter revenue compared to our expectations was contingent renter's insurance. We make money in 2 primary ways from renter's insurance: first, acting as master general license insurance agent, we get paid a commission from our underwriters for each policy that we originate. Upfront commissions are characterized as subscription revenue and performed as expected during the second quarter.

Second, we get paid additional commissions contingent upon our underwriting partners' profits. We consider contingent renter's insurance revenue to be transactional in nature, which was $4.3 million lower than our expectation in the second quarter. The lower revenue, which Bryan will speak about in more detail shortly, was driven by actual claim losses that were significantly higher than what we projected, driven in large part by the worst winter storm activity the country has seen in decades.

Ice and fire damage related to freezing weather in widespread parts of the United States caused an unprecedented spike in the number of claims, and the average cost of all claims rose unexpectedly during the quarter.

We believe higher claims loss, which translate into lower transactional or contingent revenue, is an anomaly that negatively impacted second quarter results. We plan to review strategies in the future that are intended to reduce volatility in our contingent commission revenue that can result from these exceptionally rare events.

So to summarize, we believe 2 primary factors hurt us: First was a significant increase in competitive pressure and leasing products, which represent 30% of our on-demand revenue. We responded to this threat by lowering certain prices to hold and increase market share, and the cost was about $7 million of the miss. Second, an unprecedented series of winter storms triggered some of the largest losses ever reported among property and casualty companies.

Our insurance solutions were impacted by the same weather patterns, resulting in an unexpected $4.3 million reduction in contingent renter's insurance revenue in the second quarter compared to our expectations. We do expect contingent renter's insurance revenue to return to normal levels in future quarters.

Now while 30% of the business is experiencing a drag on growth, the rest of the business is benefiting from the same tailwinds that are driving multifamily industry performance to an all-time high. Our property management systems, which include OneSite; Propertyware; Kigo, which is our vacation rental platform; and OpsTechnology continue to experience solid growth and represent approximately 30% of on-demand revenue in the second quarter.

OneSite has been the mainstay of our property management systems since the inception of the business and consistently has been evaluated as the most user-friendly system in the industry. This can actually be measured in the number of support calls that RealPage receives from OneSite, a proxy for usability, which we believe runs substantially fewer than competitors.

OneSite has always required far fewer people to support it, which is a big deal, given field turnover rates in the industry. At our user conference, we spoke in depth about a new 3-tier database architecture that we deployed in 2013 and the next generation of OneSite, which is based on that architecture.

The next generation of OneSite incorporates reporting and management control from a central location, an even more streamlined and contemporary user interface, is browser-agnostic, device-independent and responsive in design and includes single sign-on [ph] capabilities. We expect the next generation of OneSite will completely replace the current generation over the next 18 months because customers can self-implement it on a site-by-site basis or even on a user-by-user basis.

The next generation of OneSite is not going to change pricing for existing customers. They will receive the upgrade for free. However, we expect that it will make us more competitive.

Propertyware also continued to grow rapidly, and we are especially pleased with our new maintenance smartphone app that facilitates inspections and work orders in multifamily and an even more powerful Virtual Maintenance Manager in single family that automates inspections, work orders in our vendor network, so that maintenance and purchasing are seamlessly coupled together.

Single-family property managers have reported that they can increase profits on maintenance and turnovers by as much as $120 per unit per year, with Virtual Maintenance Manager.

As you may recall, we also made 2 acquisitions in the vacation rental property management and syndication space: InstaManager in the U.S. and Kigo in Europe. We expect to combine the best features of both platforms over time and, at this time, plan to market the combined solution as Kigo, or get your key and go.

The vacation rental market is very appealing to us because it is not suffering from the same vacancy tightness, with leasing velocity as much as 16x higher than long-term rentals. Accordingly, we will continue to invest in this area to acquire market share, integrate platforms and expand functionality to include many of the ancillary services offered by RealPage in other markets.

We expect average revenue growth in the low- to mid-teens from our property management systems through the remainder of the year. Once our Kigo platform reaches sufficient size, growth in this area could accelerate, given the exceptional size of the vacation market which operates worldwide.

Next, resident management services, which includes our resident portals, payments, utility billing systems and renter's insurance, represented about 24% of our on-demand revenue in Q2. We have high hopes for this area of the business as it represents an untapped opportunity to generate revenue directly from residents. There are billions of annual transactions related to the living experience in rental housing. RealPage wants to tap into as many of these transaction streams with products and services that make home living easier.

Resident service revenue, excluding what we believe is a onetime impact of lower contingent renter insurance revenue, is expected to grow in the mid- to high-teens. We believe the vast pipeline of new products and services in this area will fuel growth in this product family for many years to come.

We introduced many new products at our user conference in Chicago in July, including new forms of electronic payments; the next generation of ActiveBuilding; move-in connections, whereby we generate revenue for connecting new residents to services that are important during the move-in process; and a new package delivery system called the EGG.

YieldStar continued to be a steady grower with a large pipeline of new products that we talked about in detail at our user conference. These products include 3DO, or 3-dimensional optimization of credit, price and demand in a much more powerful, statistically calibrated model that considers revenue optimization from 3 perspectives.

Performance Analytics and Revenue Forecaster, which when combined with 3DO, are expected to drive future revenue growth, as they help clients to refine pricing strategies to increase revenue and reduce resident credit exposure. We believe the broader market is still hesitant to adopt revenue management capabilities, but we intend to stay the course here and continue to educate the market on the significant ROI related to our solutions.

We also introduced a next generation of Business Intelligence, which relies on the 3-tier data architecture that we deployed last year. We believe that YieldStar, which represents about 11% of our on-demand revenue, will continue to grow in the high teens and perhaps accelerate in future years, as new product adoptions begin to scale up to significant numbers of our clients.

So in summary, we believe 70% of our on-demand business is healthy, with a growth profile averaging in the mid-teens, dependent on product mix and excluding the second quarter abnormality with contingent renter insurance revenue.

So the big question is how long will the present macroeconomic environment continue? We don't know for sure, but we are taking the following actions in response to these conditions: First, we intend to complete certain marketing products under development that will be delivered in the near term. These include one powerful search engine marketing add-on for websites that increases the number of leads that a client website can generate. Two, new contact center products that improve conversion rates; three, better demand optimization tools that allow us to deliver just the right number of leads to a property based on imbalances in supply and demand at any moment in time; and finally, a new merchant builder animated website that addresses the needs of the 1,600 new apartments that are under construction in the U.S. at the present time.

We are also restructuring our senior referral business to perform more services from a central location, which we believe will improve Care Advisor productivity and reduce cost.

Finally, we have decided to collaborate with Internet listing services, so we are introducing a new partnership with Zillow to share listings, Live Agent-enable Zillow listings and syndicate pricing and availability to Zillow. We hope that this relationship will be expanded to other Internet listing services over time.

While I've mentioned a few new products throughout my remarks, I think it is critical to consider the depth of development that has been underway at RealPage for the past couple of years. We released a new database architecture in 2013 that is forming the basis for the next generation of several mainstream products at RealPage.

More important, this platform has made it possible to accelerate new product development. At the beginning of 2014, we offered a total of 55 product centers. By the end of 2014, we expect to have approximately 65 product centers, the largest increase in new products in our history. There's been a significant investment in resource to take RealPage to the next level, and we expect to reap rewards from this investment for many years to come.

For the past few years since we acquired MyNewPlace, our acquisition programs have been active but small in terms of adding material revenue and profit growth to the business. Our acquisition pipeline is robust and as active as any other time in our history. We are optimistic that acquisition activity will lead to more incremental growth in the future.

Having said this, it is not our intent to loosen our acquisition criteria, so we expect to stay focused on product and market share extensions and acquisitions that can meet our growth and margin objectives.

One final point on revenue growth. We believe the easiest path to near-term incremental revenue growth is having more sales reps. We under-hired in this area in 2013 and have paid a price for this in lower-than-expected bookings. So we have aggressively added sales reps in 2014.

During the quarter, we added 40 sales reps, nearly 30 of which were from our vacation acquisitions. Compared to June 30 of last year, we are up almost 40%. While we may not see full results on these investments until the end of 2014, we are making progress. During the quarter, bookings grew significantly faster than revenue.

I've talked mostly about revenue initiatives but I also want to make a few comments about expenses. Most of the decline in revenue was due to pricing accommodations and lower contingent renter insurance revenue. Market share actually increased in the second quarter, so there was not much opportunity to reduce expenses because business activity generally increased during the quarter. This is why you saw adjusted EBITDA miss, in line with the revenue shortfall compared to our expectation.

We have begun a 3-point action plan to bring margins back up, but it will take a few quarters to fully deploy this plan. First, we continue to optimize labor allocation between locations around the globe. Areas that are particularly expensive to operate will be reduced in size over time, while preserving a presence in key centers of excellence. Areas that are less expensive, including Dallas and certain smaller cities in the U.S., as well as countries such as Spain, India and the Philippines, will continue to expand in a deliberate manner while carefully managing quality and productivity. We believe there are several hundred basis points of margin opportunity left in labor optimization.

Second, we are examining all areas of the business to assess opportunities for more efficiency. Examples of areas where we know we have opportunity to improve margins include partnering with Internet listing services; centralizing much of our senior referral business; fully integrating acquired companies into our systems and processes; adopting new development techniques that streamline quality assurance testing; adopting more effective high-velocity selling techniques in sales; and dramatically improving our implementation systems and processes, adopting self-provisioning tools that our clients can use wherever possible.

Finally, we believe the vast pipeline of new product development will slow down as the current backlog of development is delivered to our clients. While we will continue to aggressively fund product development because it creates the differentiation we need to support growth, we expect gradual reductions, excluding acquisitions, as a percentage of revenue as we move into 2015.

For years, we've delivered 3 or 4 new products each year. 2014 was the exception, with 10 new products and several major enhancements as we migrated to the new database architecture deployed in 2013. We would expect 2015 and forward to drop back down in terms of the number of new products that we deliver to more historical levels; and thereby, enable us to slow down the growth and product development, especially as a percentage of overall revenue.

In summary, we're excited about our business prospects. While we have experienced a downdraft in revenue from products relating to leasing activity, 70% of our on-demand revenue is not tied to leasing activity and is benefiting from the same tailwind that the overall rental housing market has experienced.

Also, we've now brought our sales staffing levels up to full force and believe it should be only a matter of time before they become productive and drive incremental bookings.

I'd now like to turn the discussion over to Bryan Hill, our Chief Financial Officer.

W. Bryan Hill

Thanks, Steve. As Steve mentioned, total revenue for the second quarter was $94.8 million, flat compared to the second quarter of last year. The details on the components of revenue are as follows: on-demand revenue for the second quarter was $91.4 million, an increase of 1% compared to last year. ACV grew to $367 million or 1% compared to the prior year.

Our top 100 ACV clients possess an average RPU of $57 and have averaged 28% annual ACV growth since our IPO in August 2010. We ended the quarter with 9.4 million units, representing an increase of 9% compared to the same period last year. Based on average units of 9.3 million, RPU is $39.19, a decrease of 7% compared to the prior year quarter.

Our top 50 RPU clients possess an RPU range of $109 to $209, with an average RPU of $136. Since our IPO, we have averaged 19% annual RPU growth for this client group.

On-premise revenue for the second quarter was $800,000, a decrease of 18% from the same period last year. Professional and other revenue for the second quarter was $2.6 million, flat when compared to the same period last year.

I will now provide some additional detail behind our second quarter revenue shortfall. Compared to the midpoint of our guidance, revenue of $94.8 million represents a shortfall of approximately $12 million. The miss is primarily contained within the transactional components of our leasing and renter's insurance solutions.

Steve provided the percentage of revenue contributed by major product groups to help you better understand our business. This breakdown includes both transactional and subscription revenue for each product category.

In the past, we have discussed total transactional subscription revenue. Let me provide some additional detail with respect to the breakdown. Transactional revenue has typically represented 18% of on-demand revenue but represented only 11% for the second quarter, contributing significantly to our revenue shortfall.

The major components of transactional revenue were within our renter's insurance and leasing solutions, including contingent renter's insurance, the multifamily Internet listing services, our senior referral offering and certain portions of our contact center and screening solutions. In addition, a smaller component of transactional revenue relates to vendor network spend and invoice processing services within our property management solutions category.

Transactional revenue represented $8.7 million of the revenue shortfall compared to our expectations. Diving deeper into the transactional revenue miss, our leasing solutions contributed $4.4 million, while our contingent renter's insurance revenue contributed the balance or $4.3 million.

Our renter's insurance revenue possesses a transactional component, contingent on our underwriting partners' profits. This is where we experienced a shortfall compared to our expectations. When recognizing revenue for this component, we project expected losses based on historical trends and our understanding of how claims settle.

During 2014, the severe winter resulted in paid claims activity that departed from our prior experience in terms of frequency, severity and time to remediate. We believe these factors are temporary. However, we are evaluating risk management practices in order to restore visibility and reduce volatility of this revenue stream going forward. These practices include potential reinsurance relationships and evaluation of and potential action related to the appropriateness of premium levels and our methods for estimating future losses.

The balance of our revenue shortfall or $2.8 million was primarily driven by subscription revenue within our leasing solutions. Steve described the macroeconomic and competitive environment impacting our leasing solutions. This environment resulted in lower-than-expected subscription revenue from our organic lead generation, screening and contact center solutions.

It's important to emphasize our on-demand revenue, excluding leasing solutions, represents approximately 70% of on-demand revenue in Q2 2014 and excluding contingent renter's insurance, revenue grew approximately 14% compared to the prior year.

I will now turn the discussion to gross profit, operating expense and profitability. Our gross profit for the second quarter was $58 million, representing a gross margin of 61.2%. This compares to gross profit and gross margin for the second quarter last year of $61.3 million and 64.9%, respectively.

The lower margin is primarily driven by lower revenue in buyer implementation and IT investments to support product center growth, increases in units managed by our solutions and improving response time for our solutions.

Total operating expense for the second quarter was $48.1 million compared to $42.1 million last year. As a percentage of revenue, operating expenses were 50.9%, which increased 630 basis points compared to the prior year. The details on expense components are as follows: product development expense for the second quarter was $13.8 million, up 25% compared to the prior year period; higher development, which is driven by our 2013 and 2014 acquisitions; and increased headcount costs to develop and launch our new product center Steve previously discussed.

Sales and marketing expense for the second quarter was $22.1 million, an increase of 12% compared to last year. Compared to the prior year quarter, we added 79 sales FTEs, aggregating to a total of 292 sales reps. Our 2014 vacation rental acquisitions contributed 33 FTEs to the increase.

The increase in sales headcount has outpaced the increase in expense, as our focus has been in corporate, SMB and vacation sales reps, which carry a lower overall cost than enterprise and institutional reps. Investments in the sales force should be delivering returns in fourth quarter of 2014, as it generally takes 6-plus months for a new sales rep to become productive.

General and administrative expense for the second quarter was $12.2 million, an increase of 6% compared to the prior year period. The increase in expense is driven by continued investments to drive offshore efficiency and support growth efforts of the company. Operating income for the second quarter decreased to $7.9 million or 8.4% of revenue compared to the second quarter last year at $17.7 million or 18.7% of revenue.

Net income for the second quarter was $4.6 million or $0.06 per share compared to $10.4 million or $0.14 per share last year. Adjusted EBITDA for the second quarter was $12.5 million or 13.2% of revenue. Based on our market opportunity and product pipeline, we stayed the course with our sales and product development investments. However, longer term, we believe that we can improve efficiency by focusing on continued offshoring, evaluating certain workforce functions and locations and optimizing business models, such as the strategy to centralize our senior referral Care Advisor network.

Now turning to the balance sheet and cash flow metrics. Cash and cash equivalents were $39.2 million at June 30, 2014, compared to $34.5 million at December 31, 2013. Cash flow from operations for the second quarter was $19.1 million, up 10% compared to the prior year.

We ended the quarter with accounts receivable of $60 million. DSO for the second quarter was 55 days, a reduction of 5 days from year-end 2013. And finally, capital expenditures were $11.9 million for the quarter. The drivers were IT-related, primarily attributed to improving our back-end technology platform, our disaster recovery initiatives and improving developer productivity. A secondary factor was leasehold improvements to support our headcount growth domestically and offshore.

Now I would like to provide our outlook for the second half of 2014. We are lowering our third and fourth quarter revenue and earnings expectation, primarily due to the macroeconomic trend affecting our leasing products. The reduction in revenue guidance, combined with a mix shift towards a larger percentage of subscription revenue, allows us to reestablish greater revenue visibility.

In addition, it is my intent to provide guidance that appropriately balances the opportunities and risks based on the improved visibility. Adjusted EBITDA should also follow sequential revenue growth from our second quarter results. We view the revised EBITDA range as an opportunity for us to continue investment in our sales force, optimize our cost structure and provide us with additional long-term flexibility in managing our internal growth initiatives.

For the third quarter of 2014, we expect the following: non-GAAP total revenue in the range of $101 million to $103 million, adjusted EBITDA in the range of $16 million to $17 million and non-GAAP EPS of $0.08 to $0.09 per share.

For 2014 full year, we expect the following: non-GAAP total revenue in the range of $400 million to $405 million, adjusted EBITDA in the range of $70 million to $73 million and non-GAAP EPS of $0.37 to $0.40.

I will now turn the call over to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] It looks like our first question that's coming from Jeff Houston from Barrington Research.

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

Regarding the guidance for the back half of the year, does that guidance assume that the contingent insurance fully recovers? And that the other industry headwinds remain? And then lastly, that the rest of the business continues to grow in the low- to mid-teens? Just want to make sure I heard that correctly.

W. Bryan Hill

It does, Jeff. The way to think about our guidance in the back half of the year is our non-leasing on-demand products will continue to grow in the low- to mid-teens level. That does include the contingent renter's insurance revenue returning back to normal levels. When you think about the leasing products, during the quarter, the leasing products actually declined 5% year-over-year. We are not building improvement in the back half of the year to that trend.

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

Great. Then separately, shifting to adjusted EBITDA margin. I think it was about 24% in the first quarter, close to 13% in the second quarter. And you mentioned the several margin initiatives to get it back up to where it was, closer to the 24% range. Trying to get a sense of when you think those initiatives should come to fruition. Is that more of a later 2015 or into 2016? Just a little bit of timeframe there is -- would be great.

W. Bryan Hill

Well, you'll see the EBITDA margins improving sequentially by virtue of some of the revenue improvement that we have built into the back half of the year. The majority of the reason why our margins dropped in Q2 were pricing-related and the sharp decline in revenue. However, related specifically to the initiatives that Steve and I mentioned, we would expect those to start coming into play more in the back half and on into 2015 -- the back half, so Q4, that is.

Operator

And our next question is from Pat Walravens from JMP.

Patrick D. Walravens - JMP Securities LLC, Research Division

Steve, I was thinking it might be helpful if you could walk us through how your understanding of the challenges facing the leasing products has changed. What did you think before and what do you think now? And when did you realize that the original way of thinking about it wasn't right?

Stephen T. Winn

Well, we've always said that the marketing area was the most competitive category of products that we offer. We've always said that we felt that organic lead generation was a more cost-effective way to generate leads than traditional Internet listing services, and we still believe that to be true. The market has tightened, and I think owners and managers have become, candidly, more aware that they simply don't need to spend as much money generating leads as they did in prior quarters and years because they don't have as many vacant units. And so our choice was to potentially have owners switch to alternatives or to issue pricing accommodations, and we elected to do the latter. Which, while I don't like the idea of lowering price, I do think that the strategy was effective because we expanded usage of all of our marketing solutions by doing that. I don't see this environment changing going forward. It looks to us like the market's going to stay tight for some time. And I think owners are simply going to spend less money on advertising. So our challenge and our opportunity is to convince them that spending money on organic lead generation is the most efficient way to spend a shrinking dollar on advertising.

Patrick D. Walravens - JMP Securities LLC, Research Division

Could you do something similar -- when you talked about Zillow, you mentioned that now you're thinking about partnering with Internet listing services. Were you against doing that before? And again sort of what's the thinking behind the change?

Stephen T. Winn

I think owning our own Internet listing service precluded us from partnering at the level we'd like to partner at with the ILSs, and MyNewPlace has gotten smaller over time. And I think at this juncture, it makes a lot of sense for us to expand the relationship we have with Internet listing services to Live Agent-enable their listings. If you put a contact center on a listing, it can almost double the conversion rates. So it's a very productive expenditure for the clients to add contact centers. And we think working through the ILS is going to make it easier to sell contact center services. We also think we can syndicate more content to the ILSs. The pricing availability is one example but there are many others. RealPage has a vast repository of very current and valuable information that the ILSs can use to improve their search engine optimization results. And so I think a partnership, which was not possible when MyNewPlace was larger, is very possible now. And Zillow has certainly demonstrated that at least they're willing to work with us, and I think you'll see others.

Operator

So we'll take our next question coming from Brandon Dobell from William Blair.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Maybe you can -- if you could bridge us from Q2 to Q3. I'm assuming the majority of the sequential increase in revenues is tied just to normalization of some of the insurance products. But I want to make sure I'm not missing anything else that was either exaggerated or enhanced seasonality or something in the surface that gives you a little more confidence in, I guess, the non-leasing part of the business that's going to make up that Q2 to Q3 bridge.

W. Bryan Hill

That's correct. Brandon, there is a lift that comes from the normalization of the renter's insurance. But in addition to that, the 70% of the business, which is predominantly subscription and non-leasing-related, we're expecting a sequential lift from that.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay, fair enough. Given the, let's call it, pricing changes or pricing strategy changes on the leasing-focused products, I guess, what's to say that, that might not be a broader opportunity or alternative, take a different pricing approach with some of the other products or their customers? Or is it a risk that the pricing changes on the leasing side will lead to your existing customers looking for different pricing on their existing products outside of leasing-focused ones?

Stephen T. Winn

Well, I guess, that risk always exists. But the other product centers are substantially differentiated, and we haven't seen the level of competition in any of those categories of products that has been present in the marketing area. So again, I can't anticipate where pricing is going, but I also know we've got a vast number of new products that are entering the market, many of them are in this non-leasing area. So I feel pretty bullish about our ability to continue differentiating the products that we have even within the leasing area. I mean, we have new products coming out in that area, too. So we're -- we feel good about our competitive position, but we recognize that there is a challenge in the marketing area, primarily because the overall market, in our view, is shrinking.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay. And then, I guess, final one. You mentioned, I think at the outset, Steve, some incentive stock grants tied to the stock price. Maybe a little more color on how those are set up, how they work, how far down the organization they went. And if that, I guess, down the organization, if that's a different group of people or a broader group of people or narrower, I guess, than your usual incentive plans for stock compensation.

Stephen T. Winn

Well, the first performance grant was given to me at the end of -- or the beginning of the year. And it triggers half at $25 a share and half at $30 a share. And then once it's triggered, it vests over 4 quarters. That's different from the traditional type of grant, which has been 1/3 restricted shares and 2/3 stock options. We did expand the number of participants in the performance share grant to our Section 16 officers and a small number of additional people. And then candidly, we want to see how this works. And I think the general thought is this is a good idea structurally. By the way, the details on this can be found in our 8-K filing, which just occurred.

Operator

And we'll take our next question coming from Michael Nemeroff from Crédit Suisse.

Kyle Chen

This is Kyle Chen in for Michael Nemeroff. Relative to pricing, how should we think about RPU trends over the next couple of quarters, given the pricing action that you took? And the number of customers that renewed at this lower pricing, should we expect RPUs to trend lower or to remain around this current level? Are there any opportunities to increase pricing with current customers than to discount once demand improves? Or are you locked into this lower pricing for the length of the contract?

W. Bryan Hill

You should take -- RPU, you should expect to trend higher in Q3 and Q4. A couple of drivers of that: one will be the normalization that we're expecting out of the renter's insurance. That alone is a $2 adjustment to RPU. In addition to that, selling more of our subscription-based products, the 70% that Steve referred to into the base will have additional RPU expansion as we move into 2015.

Kyle Chen

Great. And what was the acquired revenue and acquired units during the quarter?

W. Bryan Hill

During the quarter, the acquired units were fairly nominal related to the vacation rental space. Kigo provided 40,000 units approximately.

Kyle Chen

Okay. And then from a revenue perspective, fairly nominal as well?

W. Bryan Hill

It is fairly immaterial revenue.

Operator

And we'll take our next question from Nandan Amladi from Deutsche Bank.

Nandan Amladi - Deutsche Bank AG, Research Division

So Steve, you mentioned 65 new product centers by the end of the year, 10 new ones during the year. How should we think about your revenue contribution from the existing products versus these new ones? More specifically, how heavily are you reliant on customers being up-sold these new products?

Stephen T. Winn

Well, there's not going to be a material amount of revenue generated in 2014 because these are just entering the market. We would expect these just to begin contributing to revenue in a meaningful way in 2015 forward. I wouldn't say we're dependent on new products for growth. The core business is growing nicely outside of marketing solutions, but new products do help differentiate the overall suites. So I think they're important, and it's -- we're candidly on the tail end of a major development initiative larger than anything we've ever undertaken in the past. And you see that reflected in the dollars that we spent on product development, which were up 25% in the second quarter and in the sheer quantity of new products that are entering the market. Now these have been under development for a long time in most cases. So this is not -- these are not speculative. They are coming or have already arrived.

Nandan Amladi - Deutsche Bank AG, Research Division

Okay. And one follow-up, if I might, Bryan. You talked about some headcount optimization for higher-cost markets, your ability to consolidate that. How much room do you have in terms of percent of your total headcount, say, or percentage of cost that is in these high-cost regions?

W. Bryan Hill

It's more moving the functions, either offshore is always our first choice that we try to evaluate. But it's -- as a result of the acquisitions and some of disparate locations, we're undergoing an analysis of determining which functions we should centralize in Dallas and other areas of the company. We haven't quantified the margin uplift that will result from that. And again, you should see that more in 2015.

Operator

And our next question is from Brendan Barnicle from Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities, Inc., Research Division

Steve, you guys have taken the leasing revenue assumptions out of -- or at least the impact to revenue out of Q3. But Q3 is like Q2 is historically a seasonally strong quarter for leasing and turnover. Sounds like in Q2, we had some weather anomalies. Is it possible that in Q3 without weather anomalies that we'd get some catch-up there, and that you guys end up being surprised to the upside on what you're able to get out of that leasing revenue?

Stephen T. Winn

What we factored into Q3 was not a decline sequentially in our leasing business. It's a similar decline year-over-year is what we experienced in Q2. Normal seasonality is built into our guidance for Q3.

Brendan Barnicle - Pacific Crest Securities, Inc., Research Division

So the same phenomenon that you saw in Q2 you think is now sort of a permanent phenomenon in the market?

Stephen T. Winn

Based on the visibility we currently have, that's how we developed our guidance.

Brendan Barnicle - Pacific Crest Securities, Inc., Research Division

Got it. And then you mentioned competitive pricing a couple of different times. Can you remind me again who those main competitors are that you're seeing on that marketing space?

Stephen T. Winn

Marketing area has literally hundreds of companies that compete. There are large Internet listing services that are our competitors, but then you've got website companies, you've got search engine companies, you've got advertising agencies. It's really quite a wide swath of competitors that we see here.

Operator

Okay. Thank you, sir. And that does conclude our Q&A portion and concludes our conference for today. Everyone, thanks for your participation. You may now disconnect.

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