CoStar Group, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the COSTAR second quarter financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer period. Instructions will be given at that time. If you should require assistance during today's conference call, please press star followed by zero. and an operator will assist you offline. Also, today's conference call is being recorded. I would now like to turn the conference over to your host, Vice President of Investor Relations, Rich Simonelli. Please go ahead.

Thank you, operator, and welcome to CoStar Group's second quarter 2019 conference call. Before I turn the call over to Andy Florence, CoStar CEO and founder, and Scott Wheeler, our CFO, I'd like to share some very interesting and important items that can actually make your day. First of all, certain portions of our discussion may contain forward-looking statements which involve many risks and uncertainties that could 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 our press release today, July 23rd, 2019, on our second quarter results and in our company's outlook and corporate filings with the SEC, including our most recent annual report on Form 10-K and our subsequent quarterly reports on Form 10-Q 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, whether as a result of new information, future events, or otherwise. Reconciliation is the most directly comparable gap measure to the non-gap financial measures discussed on this call, including but not limited to non-gap net income, EBITDA, adjusted EBITDA, and forward-looking non-gap guidance. are shown in detail in our press release issued today, along with definitions of these terms. The press release is also available on our website, located at costargroup.com. As a reminder, today's conference call is being broadcast live and in color on our website. So please refer to today's release to see how to access the replay of the call. I have a feeling you're really going to want to listen to this one again. So look up the recall number. Just remember, one question, so make it a good one, I'll now turn the call over to Andy Florence. Andy?

Thank you, Richard. You're welcome. Thank you for joining us for CoStar Group's second quarter 2019 earnings call in this, the week of the 50th anniversary of the Apollo 11 moon landing, a slightly more impressive feat than our second quarter earnings. In the second quarter 2019, CoStar Group total revenue was $344 million, up 16% year over year. That's $7 million above the upper end of our guidance for the second quarter, so this is one of our biggest revenue beats. We had our best sales quarter ever, generating $59 million in the company-wide net new bookings, an increase of 32% year-over-year. The primary driver behind our exceptional sales result was the much better-than-expected Apartments.com sales. Apartments.com net new bookings alone increased 122% year-over-year in the second quarter of 2019. In each of the past three quarters, Apartments.com has beaten all prior sales records for a quarter. For the second quarter of 2019 of the first quarter, Apartments.com net sales bookings were up 44%. In my experience, there are very few times when you get the monthly sales close numbers and are stunned by how big the number is. And this was one of those quarters repeatedly. The Apartments.com sales team is performing exceptionally well and is operating at the highest productivity level we've ever achieved. We expect to reach half a billion dollar annualized revenue run rate milestone for Apartments.com next quarter. There's a major milestone for us given that we purchased Apartments.com in 2014 with only 86 million of revenue there. From that point of acquisition five years ago to now, we have grown Apartments.com at over 40% compound annual growth rate. We believe that we have every opportunity to continue this exceptional growth rate. CoStar Suite revenue growth was strong and crossed the 600 million revenue run rate in the second quarter. We now have over 150,000 individual subscribers to CoStar Suite. Net new bookings were up 26% from Q1 of this year. Our quarter-over-quarter U.S. CoStar Suite revenue growth of 3.5% and our year-over-year U.S. CoStar Suite revenue growth of 15.1% are right in line with our five-year averages. I find it valuable to look at the revenue generated by our core U.S. Salesforce, our CoStar Salesforce, which is U.S. CoStar Suite combined with LoopNet Premium Lister subscriptions. The quarter-over-quarter growth for this combination was 3.7%, and the year-over-year was 15.7%. The 3.7% quarter-over-quarter growth rate is exactly our five-year average. The year-over-year growth number is above the five-year average of 15.5%. We are growing the CoStar Salesforce, which we believe will support future acceleration in bookings. We entered 2019 with 213 reps in production, We now have 262, and we hope to reach 300 reps selling CoStar and LoopNet by the end of the year. We've hired approximately 50 additional sales reps that are going into production over the next three months. We believe that they will impact sales results about nine months after going into production. We saw strong sales of LoopNet Premium Lister product in the second quarter, with net new bookings up 46% quarter over quarter. Real estate manager net new bookings dropped 40% quarter over quarter and 6% year over year because the booking increases of the prior year had reached so high a level at 400%. Overall revenue growth was great for real estate managers. Total subscription revenue climbed 75% year over year and 24% quarter over quarter. Net new bookings for our land business was up 27% quarter over quarter and net new bookings for our business for sale marketplaces was up 36% quarter over quarter. It's important not to overlook the tremendous value of these smaller or mid-sized businesses, CoStar, Real Estate Manager, Lands, and BizBuySell. This quarter, five years ago, those three businesses combined had annualized revenue of $28 million. This quarter, they had combined annualized revenue of $108 million. They've grown at a really impressive compound annual growth rate of 31% for five years. They're very profitable, and they have more than seven or eight times the revenue that CoStar had in total the year we went public. We continue to focus on prioritizing and selling subscription-based services with high renewal rates over selling one-off services with non-recurring revenue. Subscription-based revenue has grown to comprise 82% of our overall revenue. As of the second quarter of 2019, our trailing 12-month subscription revenue grew 25% year-over-year, which is faster than our revenue growth overall. And for the first time, we crossed $1 billion of subscription revenue on a trailing 12-month basis. We continue to show strong growth and profitability. Net income for the second quarter of 2019 was $63 million, an increase of 44% over net income of $44 million for the second quarter of 2018. EBITDA for the second quarter was $94 million, an increase of 45% versus EBITDA of $64 million for the second quarter of 2018. With strong cash flow, our balance sheet is stronger than ever with $1.3 billion in cash and no debt. As reported by Comscore, Apartments.com continues to pull further away from the competition as we increase our industry-leading position among internet listing services by achieving all-time highs in unique visitors and number of visits. In the second quarter, the Apartments.com network had 175 million visits, up 21% year-over-year. The huge runner traffic we have built there is very valuable, particularly the clients with newly constructed properties in the lease-up phase. Today, 70% of apartments that have delivered in the last two years are advertising with us. But some properties need more exposure and are willing to pay an additional fee to sort even higher up on our site to get more leads. To meet this demand, we have recently begun selling a new higher-tiered advertising level called Diamond Plus. Very creative naming. This ad package guarantees the advertiser placement in the top three search results in a given sub-market. In the second quarter, we sold 6 million in Diamond Plus ads at an average of approximately $3,600 per month, with apartment communities in some markets paying as much as $7,500 per month. That's a new exciting price point for us. This stands in sharp contrast with our primary competitor, RentPath, who began advertising $99 a month ads if you bought social media with them. That price is 175th of our Diamond Plus price point. I think that tells you everything you need to know about the competitive landscape. Given the success of our Diamond Plus offering, we have decided to introduce a Plus option in each of our Platinum, Gold, and Silver categories. We plan to offer the Plus ads at fixed price with little to no discounting. In June, we purchased Off-Campus Partners, a leading online multifamily marketplace service for student housing in the United States. There are over 17 million college students in need of housing near universities, and they're paying approximately $100 billion in rent annually. Often their parents assist with these rent payments. We believe Apartments.com has a unique opportunity to develop a long-lasting connection with these students as they move into other stages of their lives and become renters off-campus. Off-Campus Partners enters into exclusive subscription agreements with universities to provide an off-campus housing listing service used by students, parents, faculty, and staff. Currently, it has existing contracts with approximately 130 universities servicing over 2 million off-campus students. These university partners include the likes of University of Michigan, Harvard, VCU, Clemson, Berkeley, University of Pennsylvania, and most importantly of all, an exceptional University of Princeton. We believe that this massive market with tremendous opportunities for us to partner with more universities attract more advertisers, especially small independent owners. The majority of off-campus partners advertisers are independent owners who are excellent candidates for our new online leasing features such as screening, applications, digital leases, and payments, which we plan to offer next quarter on Apartments.com. We are also planning to release a student housing upgrade to our CoStar multifamily analytics solution. We believe this additional information will be very valuable to student housing investors, property managers, lenders, and developers. We had a strong Apartments.com sales success at the National Apartment Association Annual Conference in Denver this year, held in May. It was attended by over 10,000 property managers who are our prime targets and prospects and clients. Once again, Apartments.com was front and center with an amazing presence, and we attracted more than 4,000 visitors to our booth. The Apartments.com sales force met with 916 property managers over the course of the two-day conference in Denver. As I mentioned, we bought Apartments.com in 2014. We had approximately 17,000 paying properties. Nearly 90% of those properties were from communities of 100 units or more. Today, we have just over 50,000 paying communities and nearly 13,500 of those properties are in a smaller 1 to 99 unit property size range. We have successfully grown our annual multi-family revenue from 86 million in 2014 to a run rate that we expect to reach 500 million later this year. During that time, we increased our penetration rate of the market six-fold, from 2% to approximately 12%, or an average penetration growth of about 200 basis points per year. This has truly been an amazing success story as we lead the industry in revenue, lead generation for our clients, and traffic. In the last 18 months, our Apartments.com sales have been accelerating as we added more salespeople. From the beginning of 2018 to today, we went from roughly 220 Apartments.com sales reps to 265, a 20% increase that generated a staggering 122% increase in net bookings year-over-year in the second quarter. This Salesforce is on fire and they have set all-time high bookings in the last three quarters in a row. We want to build on that incredible momentum and plan to reinvest some of our outstanding performance or our out performance back into the business to capture more market share more rapidly. With the current size of the Apartments.com Salesforce, they spend approximately 85% of their time with existing clients and only have about 15% of their time available to prospect for completely new clients. As a result, we estimate that our sales force has only made contact with 3.5% of our good new business prospects in the past 12 months. This means there are hundreds of thousands of apartment communities we could sell to that our sales team has not yet had the bandwidth to reach. We believe that we can dramatically increase our 12% penetration and add billions of revenue by, among other things, growing the sales force. It's obvious to us we need more salespeople, so we plan to add another 100 apartment salespeople into an outbound sales team based in Richmond, effectively increasing the size of our apartment sales team by nearly 40%, too, about 370 people. We do not believe this will require significantly more investment. We have offset most of the additional headcount costs by eliminating 120 researcher positions this month from Atlanta. Those researchers were community callers and were tasked with finding properties with availabilities that we would place on Apartments.com for free. They added tens of thousands of units a year. This was great for the property managers who didn't have to pay for these ads. Given the enormous amount of traffic on Apartments.com, these free ads, which would sort below our paid ads, would often generate more leads to these non-paying property managers than those property managers would see from their paid ads on competing internet listing sites. When we first relaunched Apartments.com, we needed to include this free content to draw renters in. But at this point, we've grown our content and traffic many times over and now no longer need to spend so much money giving valuable advertising away. We believe by adding 100 salespeople, we will add tens of thousands of paid community ads maintained by the advertisers rather than by researchers. In effect, we are exchanging researchers for salespeople, and we think we'll end up with more data and more revenue. We believe the opportunity is gigantic. There are 345,000 mid-sized apartment properties in that 5 to 99 unit size range, and we estimate that we have less than 4% penetration in these properties. The opportunity is virtually untapped. The good news is that we've been successfully selling at this level, so there's a proven demand for our advertising solution. We feel that the online leasing tools we plan to offer will further the appeal of Apartments.com to these midsize apartment communities. Intensified marketing is the second area where we intend to reinvest our outperformance back into Apartments.com in order to accelerate our market share capture. We see a clear path to providing even dramatically more lead flow to the industry than our competitors, And by doing so, we expect to achieve a compelling ROI and build a durable, long-term leadership position. Our primary competitor's balance sheet is the polar opposite of our balance sheet. RentPath has more than half a billion dollars of debt and is handcuffed with tens of millions of dollars in interest payments, so they do not have the ability to invest to drive more leads to their clients the way we do. According to DebtWire, their first quarter 2019 adjusted EBITDA cratered as it dropped 34.5% and it underscored their liquidity pressures. Their second lien has been trading below 20 cents on the dollar. Given roughly an 11% coupon on that second lien, yielding about 11 cents a year, a likely go-away payment would be achieved in a default or bankruptcy from the first lien holders paying the second lien holders 5 to 10 cents. And you add that with some option value, and a number of people believe that the RentPath second lien debt holders think there's about a year until RentPath could default. But who knows? But it seems like a good time to accelerate our investment in order to increase competitive pressure and capture more market share. LoopNet remains the clear number one site in commercial real estate for advertising properties for sale or for lease. In the second quarter, we averaged 5.8 million unique visitors per month, up 19% year-over-year. Historically, LoopNet has not materially monetized premium ads the way Apartments.com does. We're hard at work deploying to LoopNet a number of valuable, successful lessons we've learned from Apartments.com. We believe that in the future, these significant enhancements to LoopNet will allow us to dramatically accelerate our revenue growth there. We are making our premium gold, platinum, and diamond ads even more valuable. We're adding maps, demographic information, local transportation, and more. We're also giving prominence and exclusivity to the listing broker and her firm. Visually, we're featuring the premium ads with excellent photography, 3D walkthroughs, and video. In addition to our efforts from our 160 field researchers who create visual content for LoopNet listings, we're in the process of adding a number of highly skilled professional architectural photographers who will bring these buildings to life in our ads. Our portfolio research team is helping to promote the LoopNet listings by adding original written content about the properties and the neighborhoods they're located. The landing pages continue to improve in functionality, appearance, and content. We're adding content we believe will be valuable to LoopNet's target audience of tenants and small investors. You should head over to LoopNet in a few months as new enhancements roll out over the course of the next year. I've been fortunate to witness firsthand an amazing transformation in the commercial real estate industry over the past 30 years. Digital marketing has moved from being virtually non-existent to being an absolutely essential necessity, a real critical part of selling or leasing properties. The good news for CoStar is that we own the most valuable digital real estate at the crossroads of commercial real estate and digital marketing. We have the largest audience of potential tenants and investors on LoopNet and the largest audience of brokers on CoStar. The commercial real estate professional needs to market their properties where this audience is. In the past, our researchers' primary value proposition to our clients was the information they gathered for them. While the data we gather is still the foundation of our business, the marketing opportunities our platform affords is becoming the prime value proposition we offer industry professionals. We used to reach out to brokers to collect most of our information. Now it has flipped, and many brokers come online and bring listings to us. Brokers continue to adopt our CoStar Listing Manager tool, allowing them to update listings directly into the CoStar database. It has been nearly two years since we initiated Listing Manager, and usage continues to increase. 52% of all spaces were added online by users in the second quarter of 2019. We now have over 41,000 power users who are updating their listings monthly. CoStar Listing Manager is providing greater convenience to our clients and at a much lower cost to us than our historical data collection methods. Our move to Richmond has been an amazing success in us transforming how we collect and present data. We're having more collaborative and productive conversations with our clients. This increases the quality of our data immensely and builds stronger relationships with our users. As a result, one of the recent changes we've made in the research department is updating the researchers' titles to better reflect our marketing focus and expertise. The researcher job title is now Marketing Research Advisor. Additionally, as we further establish Richmond as our marketing researcher headquarters, all East Coast research opportunities are being consolidated into our Richmond office. We believe this will lead to better collaboration and synergies among the research teams and significant cost savings. In addition, since the development teams that build our research systems are in Richmond, This consolidation creates more opportunities for our marketing research and technology teams to work hand-in-hand to build the most efficient back-end systems. We believe this will also create additional career growth opportunities for our marketing research advisors. As a result, we are relocating the 145 marketing research advisor positions currently in Washington, D.C., and the multifamily research positions in Atlanta to Richmond. We will soon have close to 950 people based in Richmond. Commercial real estate activity continues to grow. Leasing volume and investment activity in the second quarter of 2019 rank among the strongest quarters on record. We believe the high level of interest to be justified given the sector's sound fundamentals. Vacancy rates are in single digits across all sectors, and supply remains limited. And compared to low prevailing interest rates, returns in commercial and multifamily real estate offer compelling relative value. The U.S. economy at large set a post-war record in the second quarter of 2019, reaching 105 months of consecutive job growth, and recent data releases show ongoing strength. In turn, U.S. commercial real estate has enjoyed 36 quarters of positive demand among the longest periods on record. In the property markets, apartment rent growth has accelerated once again, posting gains above 3%. We believe the ongoing health of the apartment sector relates to the broad and growing shortage of housing in the United States. In particular, insufficient supply of new for-sale housing units has limited home buying and led to the unprecedented level of apartment demand. In response to this demand, the apartment construction has risen to levels not seen since the 80s. CoStar tracked about 300,000 units delivered over the past 12 months, and we're tracking nearly 675,000 apartment units under construction. The large majority of these developments rely on Apartments.com to market those units. In the office sector, the national vacancy rate has fallen below 10% for the first time since 2000. In spite of the limited space available, leasing has consistently set new records as the large tech firms continue to expand beyond their Silicon Valley and Seattle footprints. New office construction has been limited but impactful. Mega projects at Hudson Yards in New York, the Seaport in Boston, South of Market in San Francisco, and the 8th Street and Noma Corridor in D.C. and the West Loop in Chicago have upended gateway markets and forced landlords of traditional CBD product to compete for signature tenants. As a result, rent growth has trended at just 2% despite the single-digit vacancy rates. This has not deterred investors. Deal volume last quarter could set a second quarter record. In the industrial sector, demand remains at historically high levels driven by the ongoing trend towards same-day delivery, which requires regional and local distribution close to population centers. However, vacancy rates appear to have bottomed out amid heavy supply and have edged higher from the 5% low. Rent growth continues to trend above 5%, and investment continues to favor the industrial sector in no small part for the development or redevelopment potential for infill product. Based on our property level value estimates, we believe industrial prices rose by 7% year by year, leading all property types. In the retail sector, negative headlines around store closings and a shrinking share of brick-and-mortar sales obscures the sector's superb fundamentals. We estimate retail vacancies are below 5%. the lowest across the property types, and construction underway amounts to less than 1% of current stock. We expect the record levels of interest in commercial real estate and multifamily real estate to continue. To meet the complex needs of the industry, CoStar Group offers products and services designed to help owners, lenders, brokers, investors, and property managers realize successful outcomes in any economic climate. We've had a tremendous start to 2019 with an exceptional second quarter. I'm extremely excited about the rest of this year as we continue to execute in our long-term vision within a great company. At this point, I will turn the call over to our CFO, Scott Wheeler, who will, among other things, hopefully reiterate that net income for the second quarter was $63 million, an increase of 44% over the second. Our balance sheet is strong with $1.3 million in cash and no debt. And Very importantly, that we had our best sales quarter ever with $59 million in bookings. But what co-star investors ever get tired of hearing about all of that?