CoStar Group, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to the CoStar Third Quarter Financial Results Conference Call. At this time, everyone joining by phone is in a listen-only or muted mode, and then later we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the call, you may press star then zero on your phone keypad. As a reminder, the conference is being recorded online, I'll now turn the conference over to our host, Mr. Rich Simonelli, Investor Relations. Please go ahead.

Thank you, Operator, and welcome to CoStar Group's third quarter 2019 conference call, everyone. Before I turn the call over to Andy Florence, CoStar CEO and founder, and Scott Wheeler, RCFO, I'd like to share some important facts. Certain portions of our discussion today may contain 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 today in CoStar Group's October 22, 2019 press release on our third quarter results, and the company's outlook and then CoStar's filings with the SEC, including our most recent admin report on Form 10-K, There are 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. COSTAR assumes no obligation to update these statements, whether as a result of new information, future events, or otherwise. Reconciliation to the most directly comparable GAAP measure to the non-GAAP financial measures discussed on this call, including non-GAAP net income, EBITDA, adjusted EBITDA, and forward-looking non-GAAP guidance are shown in detail In our press release issue today, along with definitions for these terms, and they can also be found on the press release on our website, which is located at costargroup.com. As a reminder, today's conference call is being broadcast live and in color on our investor relations website, so please refer to today's press release on how to access the replay of this call. Remember, one question, and if we have time permitting, we'll re-cue, but I'll now turn the call over to Andy Florence. Andy? Andy? Thank you, Rich.

That was extremely well done. Thank you. Thank you for joining us for CoStar Group's third quarter 2019 earnings call. CoStar Group's total revenue was $353 million in the third quarter of 2019, an increase of 15% year-over-year. During the second quarter of 2019, CoStar suite revenues moved through the $600 million annualized run rate mark. In the third quarter, Apartments.com moved past the $500 million annualized run rate mark and did so with a 20% year-over-year growth. This is outstanding sustained growth considering we're in the sixth year of owning Apartments.com. But we expect there's much more to come. Multifamily is a huge opportunity. We estimate the total addressable market in multifamily is somewhere between $8 and $10 billion. This is four to five times bigger than we initially estimated the multifamily opportunity was when we entered the space in 2014. Net income for the third quarter of 2019 was $79 million, an increase of 34% over net income of $59 million for the third quarter of 2018. EBITDA was very strong for the third quarter of 2019, coming in at $113 million. an increase of 24% versus EBITDA of $91 million for the third quarter of 2018. Adjusted EBITDA margin moved to 37%, and we achieved 80% gross margin in the third quarter. Our balance sheet remains strong, and we expect to have over $1 billion in cash at year-end and no debt even after the closing of the STR acquisition earlier today. We continue to show strong growth and profitability while we continue to invest in the future growth of the company. I'm delighted with our ability to consistently deliver on both fronts. There's a massive opportunity in both the United States and abroad in information, analytics, and marketing for commercial real estate. While I'm pleased that we are approaching 1.4 billion in revenue in 2020, we believe there are billions of dollars of opportunity not yet realized, so continued investment is optimal. We had another excellent sales quarter, generating $50 million in company-wide net bookings and increased 27% year-over-year in the third quarter. Our average net new sales of $52.5 million per quarter year-to-date in 2019 is 32% higher than the comparable period in 2018 when the average net new sales per quarter was $39.8 million. On the multifamily side of the business, the larger sales force we deployed in 2018 has delivered in a big way. In fact, both the CoStar Suite and Apartments.com sales team each achieved more than 30% growth in net new sales in the third quarter of 2019 compared to the third quarter of last year. I'm optimistic that our sales levels will continue to be strong for the remainder of 2019 and can improve in 2020 as we are proactively increasing the size of our sales force, offering new products and services, and and continue to grow share in our huge addressable market. We now have 280 field sales reps in production for CoStar Suite and LoopNet, and we look to enter 2020 with about 300. In the third quarter of 2019, we identified and distributed a list of 17,000 CRE owners as strong sales leads to our sales force. Each rep has a target owner list. We have been aggressively preparing our sales force to target and sell owners both LoopNet signature listings and more CoStar Suite. I'm pleased to announce that we have closed on the acquisition today of STR for $450 million. Founded in 1985, the STR team has created the global industry-leading benchmarks and analytics that are the primary information tools hotel management investors rely on to monitor and optimize their assets. It provides the foundation for daily hotel and lodging pricing strategies. This is an extraordinary company that's a valuable partner with the hotel industry. Ultimately, the cash flow intelligence STR provides is the fundamental value driver in the $3 trillion hospitality sector of commercial real estate. The industry needs information to effectively develop, finance, appraise, and transact hospitality properties. We are bringing together the leading provider of commercial real estate information, analytics, and online marketplaces with a gold standard global hospitality industry for premium performance, benchmarking, and revenue forecasts. We are excited to add this world leader as it extends the depth and reach of our comprehensive CoStar platform. SDR aggregates data from over 65,000 hotels worldwide, representing 9 million guest rooms in over 180 countries. Hotels electronically submit their revenue and occupancy data to SDR on a weekly basis. CoStar currently provides building information on 80,000 hotels, 45,000 hotel sale comparables, and 4,500 hotels currently offered for sale. We plan to integrate the SDR data with CoStar to create exciting new products that provide hotel building data, aggregate income and occupancy information, sales comps, and for sale information. STR has expanded our global footprint. CoStar now has over 4,400 employees in 19 countries, with over 600 working outside the United States. For the first time, CoStar now has staff in Singapore, Australia, China, Colombia, Brazil, UAE, Indonesia, Italy, India, South Africa, and Japan. Just imagine the air miles. Smith Travel brings an unrivaled reputation within the global hospitality industry for their data integrity, reliability, and strict confidentiality. And we look forward to continuing to build on those core values in the next chapter of Smith Travel's growth. CoStar has extensive experience segregating and protecting highly confidential client information, such as accounting data, leases and lease abstractions, major deals in progress, payroll data, and sensitive banking data. Integration of STR to the CoStar product will maintain absolute confidentiality while also allowing property owners, investors, and service providers in the hospitality sector a more holistic, aggregated view of the industry at market levels. I've already had the chance to meet with the STR team in London. It's a great group. And tomorrow, I will be in Hendersonville, Tennessee, to welcome hundreds of new employees to the CoStar team. I'm looking forward to working with our outstanding management team, including Amanda Height, CEO. Hello, Amanda. Elizabeth Winkle, Chief Strategy Officer, Robert Rossman, Managing Director, and many other strong leaders. That was just a guess there. We believe that combining STR's superior hospitality service offering combined with the CoStar platform will benefit all industry participants as we work together to create valuable new and improved tools. I'm very pleased to report that one of the world's leading property companies, JLL, has renewed its contract with CoStar with a five-year deal and a two-year renewal option. As you know, JLL recently completed its acquisition of HFF. Our contract for the combined entity is larger than two firms who are paying individually, since now all the brokers at JLL will add access to the national CoStar suite data and analytics. We saw a similar phenomenon in Grub and Ellis combined with Newmark Knight Frank confirming that consolidation and CRE can be beneficial to CoStar revenues, particularly when the combined entity expands their access to CoStar services. I want to update you on LoopNet and where we are with that. Office billings for lease have historically been marketed from broker to broker via print brochures or emailed brochures. An owner seeking to lease up their building would hire a broker who would then distribute a few hundred flyers to other local brokers announcing the broker's availability. The landlord's broker will generally affix a sign to the building announcing the space offered for lease, but that will only reach prospects who are already at the building. Given that some of these leases can be worth more than $150 million, this strikes me as a primitive way to market space. It's understandable in a historical offline context since there were severe limits of the methods available to market office space. There could be tens of thousands of tenants within five miles of a typical office building availability with hundreds of thousands of potential decision influencers. Additionally, 20% to 40% of the tenants searching for space in a market are coming from outside that MSA. The size, distribution, and changing nature of the prospects have made it impossible for owners to build effective direct mail or email marketing lists. Running national TV, radio, and newspaper campaigns for a year or so it takes to lease a property is prohibitively expensive. Hence, the industry has relied on marketing through a double middleman model. On a $150 million lease, an owner might pay $9 million in commissions, $7 million in free rent concessions, and $14 million in tenant improvements for a total marketing cost of $30 million. Even after investing that much money, we estimate that office owners lose approximately $40 billion annually to excess vacancy. Smaller tenants occupy about 35% of the U.S. office space, so most owners cannot pay a mortgage without them. Yet, commission brokers are less motivated to pursue small deals. Therefore, owners relying on the Doppler broker model face greater challenges marketing to small tenants. While WeWork has not been a complete success, One of its growth drivers has been that it has met the massive unmet need for connecting smaller tenants to space. The Internet has created transformative opportunities to market commercial real estate online, and LubeNet is fortunate to be a ground zero for that opportunity. LubeNet and its related sites are now generating 6.6 million unique visitors per month, as reported by Google Analytics. This is a 16% year-over-year increase. No other CRE marketplace comes close to LoopNet. No other CRE website comes close to LoopNet. According to Hitwise, LoopNet has almost 2,000% more traffic than the second most heavily trafficked website, WeWork.com. Of the 22,000 CRE keywords we prioritize, LoopNet holds the number one SEO position on Google 86% of the time. The fact is that today millions of tenants look for office space online. We believe that LoopNet is the most effective way to market commercial space today because it offers unprecedented reach, strong frequency, and elevates a property's brand. We know LoopNet is effective at marketing because tens of thousands of brokers pay to market their listings on LoopNet in order to reach tasks and users. We believe we can significantly expand a property's reach, frequency, and branding by sorting to the top of LoopNet and CoStar, just as we do at apartments.com. This increases the ad size content, and by repeating across our websites, it's growing that reach and frequency. We call these signature ads, and we already can see they work. By tracing IP addresses, we can see major tenants viewing signature ads on LoopNet, followed later by their brokers viewing the same ads or content in CoStar, and then we see the tenant's leased space in the property we believe that the tenant originally found on LoopNet. We see specific deals in the range of half a million feet, so we see some huge deals this way. The owners of an office building have a much greater stake in its economics than their broker, so we're focusing our sales force on selling these ads to owners directly in harmony with the brokers at price points above $2,500 a month. We have recently put in place more training incentives to drive sales to this goal. We have made great strides in improving the website over the past year to better fit our clients' branding goals. We have created richer content on signature listings, including photography, reviews, bios, and graphics. The signature ads can have a hugely positive impact on marketing and building for as little as a few cents to a few dimes per square foot, when the owner could already be investing $100 a foot in traditional costs and methods to lease up their space. So we're talking a point or two on the additional cost to make the program more effective. We believe that marketing commercial real estate online will be a multibillion-dollar opportunity, and that CoStar Group is well-positioned to capture a major share of that opportunity. We expect that LoopNet will be a significant contributor to our 2020 sales growth. Turning to Apartments.com. Apartments.com is doing very well. Apartments revenue is up 20% year-over-year. Net sales are up 30% year-over-year. And profit contribution has been growing rapidly as we continue to grow revenue. In July and August, the Apartments.com network reached an all-time high in unique visitors according to Comscore. We had nearly 60 million visits in August 2019, an increase of 8 million over August 2018. The Apartments.com network continues to pull further away from the competition by growing unique visitors 10% year-over-year to 18.9 million in September, as reported by Comscore. At the same time, RentPath saw a decrease of 4% in the same period. Our network had more than nine times the number of visits that ApartmentList had and 2.6 times the visits that RentPath had. The Apartments.com network had more visitors than did the Zillow Rental Network. We have just begun beta testing Apartments.com's digital tenant screening, lease documents, and rent payment system. Our first two markets are Santa Monica and Atlanta. It's only been two weeks, so it's still very early, but the initial reaction exceeds our expectations. 36% of the landlords who added a listing on Apartments.com in the test period elected to use our digital leasing tools. I'm really happy with that number. We've already begun processing applications, screening renters, and executing leases and collecting rent payments. Some of the owner comments have included, it shows me the level of overall quality of the specific tenant, especially compared to other potential tenants in terms of reliability, trustworthiness, responsibility, et cetera. Another owner said, it was more thorough than what I was expecting. Another said, I felt it was user-friendly and takes a holistic approach. It covered every detail we needed and was quick and easy to use for both myself and my potential tenant. Finally, another owner said, very easy and fast. Some of the renter comments were really quite simple. One, application, it was much easier than expected. Another one, it was extremely simple and felt secure submitting my information. And finally, it was fairly easy. I think it's good that the comments are so short. We expect to continue rolling out the tools throughout the rest of the year and into next year. There are hundreds and thousands of mid-sized and smaller apartment communities that we're now successfully selling to. To fully capture this opportunity, we are significantly expanding our apartment sales force by building a 100-plus person team in Richmond focused on this middle market opportunity. I had a chance to meet with the first team of 17 reps and managers last week. It's a very promising, highly motivated group with excellent support from our Richmond technical and administrative infrastructure. I'm very excited about the growth prospects that the expanded sales force can deliver going forward. During last quarter's earnings call, we reported that we thought we could provide our advertisers with more value, enhance our competitive advantage, and generate a good ROI with more aggressive marketing investment behind Apartments.com. On our last earnings call, We announced that we were increasing our marketing spend for the second half of 2019 by $10 million. We did that, and we increased the investment in the third quarter alone. We have analyzed the results, and we have achieved our desired outcomes. Beginning in August, we roughly doubled our investment in certain categories of Google keywords. And not surprisingly, we more than doubled our apartment rental click share compared to other top Internet listing services, moving from 32% click share to 67% click share, according to HitWise. During the same time period, RentPath click share plunged from 35% to 17%. RentPath has been making up for weak SEO by buying SEM traffic. During the trial, Redpath moved from having more click share than Apartments.com to having one-fourth of Apartments.com's click share. ApartmentList had 24% of click share before we began, and their share dropped in half to 12%. We've also increased the number of times we were in the number one position in Google by nearly 600%. During the trial, we appeared in the top four Google SEM positions 95% of the time in our targeted neighborhoods. Given the success of the trial, the only humane thing to do is to immediately suspend the trials and widely deploy the increased investment to help millions of additional renters find a great apartment soon. That is me channeling Brad Belfort. We plan to continue to sustain an elevated level of SEM spending in the fourth quarter. By the end of the year, we will have increased our SEM spend by a total of $20 million in 2019 over our initial budget at the beginning of the year. We acquired apartments in 2014, and since that, we've grown profitable revenue organically and acquisitively. We expect to achieve a five-year compound annual growth rate of 38% based on our 2019 forecast. We have grown from serving just over 17,000 apartment communities to serving well over 50,000, in fact, about 52,000. In an industry that has historically only monetized large apartment communities, we are very successfully selling marketing solutions to large, medium, small communities, and even single-family rentals, of which there are tens of millions. That shows this is a massive, massive opportunity. We are clearly in the lead position in the industry. We absolutely want to cross a billion dollars in revenue at Apartments.com soon and go well into the billions of dollars of revenue. Ultimately, we would like to generate a billion plus of EBITDA from the apartment sector alone. In 2015, we showed our commitment to the industry with an unprecedented $100 million investment into marketing Apartments.com to the 100 million plus runners in the U.S., It was not initially very popular with everybody, but it clearly worked. It helped us grow our revenue from $85 million to $500 million. In the third quarter of this year, we've tested a more aggressive marketing investment, and we like the returns. As we move into 2020, we plan to take Apartments.com to the next level again. We expect to increase our investment in marketing from approximately $150 million in 2019 to to $250 million in 2020. That's a $100 million incremental increase in our marketing spend. This will bring our 2020 margin down, but we believe in the future this investment will drive our revenue and margin up well beyond the investment we're making in 2020. Our $250 million 2020 Apartments.com marketing budget is expected to consist of much more aggressive search engine marketing, more aggressive TV and digital video marketing, with the goal of moving our unaided awareness from the 26% to 33% range to the 50% plus unaided awareness range. We also plan to invest in marketing programs to support our digital leasing initiatives. Make hay while the sun is shining. The sun is shining brightly, and we intend to make a spectacular amount of pay. I have a legal update for you on intelligence, if you remember that. CoStar shareholders have invested billions of dollars to enable CoStar Group to build and acquire robust information systems and marketplaces that are invaluable to the commercial real estate industry. CoStar's ability to protect its intellectual property from misappropriation is a critical factor in our success. Over the course of those last several years, Accelgen, as former officers and directors, instructed contractors and employees to circumvent our security systems protecting CoStar Group's websites in order to steal an enormous volume of intellectual property from CoStar Group. They repackaged and sold that content as their own. This represented a fundamental threat to CoStar Group, and we had to stop it. We relied on the protections of the U.S. copyright law in terms of use for websites, among other legal tools. We sued Acceligent and their contractors, As a smokescreen, Acceligent complained to the FTC and countersued, complaining anti-competitive behavior. Faced with an ironclad case against Acceligent for massive copyright infringement, in November 2017, Acceligent's parent company, DMGT, wrote down its investment in Acceligent to zero after losing somewhere around $150 million in investments in Acceligent. Acceligent was bankrupt. On the day DMGT announced the write-down and loss of $150 million, its shares suffered a 23% drop, hitting a five-year low. I do not believe that DMGT was aware of the scale of the illicit things that Excelligent was doing. DMGT was just a string of investors in Excelligent over the course of the 20-plus years that lost millions, tens of millions, or $100 million. We welcomed an investigation, including an audit authorized by the Federal Trade Commission to determine whether CoStar content was improperly added to Accelagant systems or vice versa. The massive investigation led by the FTC-approved monitor concluded that Accelagant improperly derived took nearly 38,500 images from CoStar's data brace. We believe this is a complete vindication of CoStar's allegation of Accelagant's unlawful activity. The Department of Justice appointed a trustee to manage the now bankrupt state of Acceligent. After the results of the FTC monitor's investigation, along with other overwhelming evidence of willful copyright infringement perpetrated by Acceligent under its CEO, Doug Curry, The trustee has agreed to the entry of a judgment of $500 million against Exelogen in favor of CoStar Group for copyright infringement. This $500 million judgment would be the largest copyrighted image judgment in history and the third largest copyright judgment of any kind. The judgment is awaiting approval of the bankruptcy court overseeing Acceligent's bankruptcy and the court overseeing CoStar copyright suit. Because Acceligent is bankrupt and virtually without sellable assets, the total amount CoStar will cover under the judgment is only $10.75 million, which will be paid to us by Acceligent's insurers. Of course, I never put the word only in front of $10.75 million. The trustee has also agreed that Xelligent's countersuit against CoStar would be dismissed with prejudice. In connection with Xelligent's massive illegal operation, the directors and executives of Avion, Xelligent's foreign contractor in the Philippines, have been charged and indicted on cybercrime charges brought by the Philippine prosecutors. In his papers, the Philippines DOJ stated that Avion acted in concert with Acceligent Management to commit the classic example of computer crime. In final judgment entered in an Indian court in favor of CoStar, Acceligent's other foreign contractor, Maxwell, stated it was misled by Acceligent and its executives and managers, including Acceligent's CEO, Doug Curry, who personally visited the operation in India to supervise their work infringing CoStar's copyrights. Shortly after intelligence bankruptcy, Doug Curry started another competitive CRE information business called Intrepid that failed within a few weeks of launch. Apparently after that, Doug has started another CRE information business with several million dollars of funding from Moody's, a company you may have heard of. The scale of intelligence copyright infringement is unprecedented. It's sort of a history marker, and CoStar Group is very grateful for the thorough efforts of the FTC-appointed monitor in completing the massive audit of the copyright violations. I believe our investors will give us credit for aggressively defending their investment in CoStar against intellectual property theft. We have ultimately achieved favorable findings or judgments in this defense in federal court in the U.S., coming up on two in federal court, in court in India, before the Philippines Department of Justice, from a U.S. Department of Justice-appointed trustee and a monitor appointed by the Federal Trade Commission, which sums up to five wins and zero losses in a pretty challenging case. A special thanks to our trial attorney, Nick Boyle, who did a fantastic job in the entire teams at Williams & Connolly. Quick look at the commercial real estate economy. Despite growing concerns around the economic outlook, commercial real estate activity continues to pose strong totals for leasing and investment volume. We believe this is justified given the sector's sound fundamentals. Vacancy rates remain near historic lows across all sectors, and supply is generally limited. And the recent drop in treasury yields makes returns on commercial real estate and multifamily real estate all the more compelling. Investors may also view real estate as a defensive investment as trends in capital market and economic indicators have increased the probability of a near-term slowdown. In particular, we note disruptions in trade following manufacturing output and business investment slowing demographic growth. Despite these headlines, however, GDP growth and job gains have yet to show any meaningful slowdown and continue to support demand for commercial and multifamily real estate. The property market's apartment rent growth once again topped 3% nationally. We believe the ongoing health of the apartment sector relates to the broad and growing shortage of housing in the United States. In particular, an 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, apartment construction has risen to levels not seen since the 1980s. CoStar tracked just over 300,000 units delivered over the past 12 months, and we're tracking about 650,000 apartment units currently under construction. The large majority of these developers rely on the Apartments.com advertising platform to market those units. Investors continue to favor U.S. multifamily assets. Investment in the sector set a third-quarter record this year, topping $40 billion. In the office sector, leasing has consistently set new records despite single-digit vacancy rates and limited supply. Large tech firms have driven the demand as they expand beyond their Bay Area and Seattle footprints. Rent growth, however, has turned at just around 3%, well below typical gains in the past periods of expansion. Unlike past expansions, however, supply has limited at less than 2% of current inventory and concentrated a handful of markets. New York also stands out with 25 million square feet underway. WeWork, unfortunately, will leave New York a little bit vulnerable since they're heavily concentrated in New York, but we don't think it's a big issue. We believe that measured rent gains and low supply risk in the office sector help insulate the market from potential economic reversal, and our base case forecast calls for steady rent gains. In the industrial sector, ongoing changes in how consumers shop continue to generate record levels of demand for industrial space, despite vacancy rates around 5%. Developers have responded. A record amount of industrial space is under construction, but rent growth continues to post gains of about 5% year-over-year. The best among major property types and investment in the sector is on pace to set another record. Disruptions to trade pose some risk to the sector, but we expect fast-growing demand for local distribution space and provide same-day delivery of goods will help offset any slowdown. In the retail sector, negative headlines around store closings and e-commerce obscure 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. The shortage of space has resulted in low leasing absorption levels, but demand for retail space from grocers, Discounters, fitness clubs, and experiential retail is offsetting move-outs from department stores and big box retailers. We expect the record levels of activity in commercial and multifamily real estate to continue. We expect the demand for CoStar Group's products and services to grow as we help owners, lenders, brokers, investors, property managers make quality choices and realize successful outcomes in any economic environment. We continue to generate strong momentum in 2019 and make important investments. I am extremely excited about the rest of the year as we continue to execute our long-term vision with a great company. At this point, I will turn the call over to our CFO, Scott Wheeler, and he'll give you more detail on our earnings and our planned investments. Thank you, Andy.