CoStar Group, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2020 CoStar Group Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the call over to your speaker today, Sarah Spray of Investor Relations. Please go ahead.

Thank you very much. Good evening, and thank you all for joining us to discuss the first quarter 2020 results of the CoStar Group. Before I turn the call over to Andy Florence, CoStar's CEO and founder, and Scott Wheeler, our CFO, I would like to review the Safe Harbor Statement. Certain portions of the discussion today may contain forward-looking statements, including expectations for the second quarter of 2020. Forward-looking statements involve many risks, uncertainties, assumptions, estimates, and other factors 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, the duration and impact of COVID-19, the pace of recovery, customer usage and purchasing decisions, changes in investment strategy or plans, timing, and success of acquisitions, those stated in CoStar Group's press release issued earlier today and in our filings with the SEC, including our most recent annual report on Form 10-K and quarterly report 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, further events, or otherwise. Reconciliation to the most directly comparable gaps measure to the non-GAAP financial measure discussed on this call, including EBITDA, adjusted EBITDA, non-GAAP net income, and forward-looking non-GAAP guidance are shown in detail in our press release issued today, along with definitions for those terms. The press release is available on our website, located at costargroup.com under Press Room. As a reminder, today's conference call is being webcast, and the link is also available on our website under Investor Relations. please refer to today's press release on how to access the replay of this call. And with that, I would like to turn over to our founder and CEO, Andy Florence.

Thank you, Sarah. That's an unusual milestone to have a pandemic-enabled safe harbor statement. Hopefully we could avoid that the rest of my life. So good evening and thank you for joining us today. for CoStar's first virtual first quarter 2020 earnings call for virtual food management team. The first quarter was really a composite quarter with two normal months and one pandemic month. As with every business, the COVID-19 pandemic has upended normal operations. The pandemic operations in CoStar's The pandemic hit operations in CoStar's Beijing office first, giving us advance warning. And I'm sorry, I'm getting a bunch of beeps here. If we use Teams, it beeps in my ears. So I'm sorry. The pandemic hit operations in CoStar's Beijing office first, giving us advance warning and some time to prepare to transition 100% of our North American and European operations to a digital dispersed remote workplace. Employee safety and continuity of operations for the sake of our investors, clients, and our employees was our top priority. Our systems teams responded promptly, working around the clock to execute our emergency contingency plans. We're very grateful for their diligent efforts. We believe that 95% of CoStar staff has successfully transitioned to working remotely over the past six weeks at 90% productivity. These are stressful and disorienting times for our employees, and I'm also grateful to them for their resilience and continued focus on our professional responsibilities. And it's okay if our employees' kids periodically duck their heads into our many video conference calls. We're consistently keeping our customers and mission-critical needs front and center. At the same time, we continue to build and innovate for co-stars and our clients' future after this disruption subsides. We believe that our products remain mission critical to the vast majority of our clients, even as they deal with pandemic-driven market disruptions. The commercial real estate industry will continue to operate, and to do so, we'll need to sign and renew leases, find investment opportunities, value properties, dispose of properties, analyze markets, and very importantly, market vacancies to generate much-needed revenue. In a time when people cannot readily visit properties in person, digital marketing becomes even more important. CoStar Group and our digital solutions are here to meet the industry's continuing need for high-quality data and highly effective digital marketing. In the immediacy of the initial phases of our crisis, our clients are trying to assess what it all means and are trying to de-risk. This means buying new information or marketing solutions sometimes is not their first priorities initially. The clients of our clients are also putting things on hold and that's disconcerting to our clients. As I have communicated consistently over the years in the initial phases of an economic disruption, let alone a global pandemic, our gross sales drop and cancellations rise initially. We are seeing some of that now. I want to stress that our business has always been really resilient through down cycles. In the 2008 recession, which was very hard on the commercial real estate industry, that was the only time our revenue ever contracted over even a quarter. And even then, our revenue only dropped 1% in calendar 2009, 1%. We experienced a flat sales quarter, followed by two quarters of declining sales, finishing with a slightly negative sales quarter after that cycle. Again, revenue dropped 1% in the worst year in our 34-year history. Sadly, in any economic cycle, some number of our clients' businesses will fail. Some clients will exit the business for good. Others will lose buildings to bankruptcy. We share their pain. They're deeply empathetic for any of our clients whose businesses succumb in this downturn. We have often seen clients going through bankruptcy organization now and continue to pay for our mission-critical services. As some building owners lose their buildings, these buildings remain valuable assets through bankruptcy, and new investors step in to buy them, and many of those investors purchase our services as they begin to operate their new purchases. The fact remains that every past cycle, the majority of our customers continued to operate their business and continued to rely on our services. Typically, sales of properties slowed dramatically for several quarters to a year or so, after a disruption like this. Fortunately, we're not as heavily impacted by the property investment sales cycle. Our broker clients tend to derive a lot more of their revenue from leasing commissions. In the cycle, leasing pauses initially for quarters or so, but tends to rebound sharply, like a sharp V. This is for the simple fact that any given time, The bulk of leasing activity is driven by leases expiring that need to be renewed. Lease expiration dates have no respect for an economic crisis, and most companies remain in business and continue to need their facilities, so they sign leases even in a down cycle. And as they sign those leases, our clients earn commissions. I've asked our economists to use the wealth of information we have on past cycles and to run Monte Carlo simulations to estimate expected leasing activity over the next 12 months. We believe there will be close to a million leases signed in the next 12 months. We believe that these will generate more than half a trillion dollars of leasing value and more than $20 billion of commissions. While leasing has initially seized up, eventually there's still a lot of business to be done in the back half of the year. This analysis refers to total leasing activity, not growth in demand. We expect there will be a significant contraction in demand overall, but the commissions are not normally impacted, or are normally impacted by that. Rates fall a little bit, doesn't really hit the commissions too hard. In fact, with high leasing values and some contraction of demand, there's something like a game of musical chairs for building owners going on. There's a lot of leasing activity, but every time the music stops, there are few owners left without a critical tenant income or, by analogy, a chair. Marketing commercial space and apartments becomes even more important when it becomes harder when a tenant met vital revenue in a shrinking pool of tenants. The pandemic and social distancing make this economic downturn harder than other downturns. The physical leasing process of prospective tenants driving by properties Being signed and touring through the buildings has, in most cases, ground to a halt. Just when owners desperately need to promote their buildings and tour tenants to fill growing vacancies, the physical inspection of properties are becoming impractical. The digital marketing departments.com, LoopNet, Riala, Belbex, Lands of America, or BizBuySell offer can become a critical replacement for the loss of the traditional physical leasing process. Prospective tenants can tour their options on apartments.com, see what the buildings look like, use aerial drone videos to understand the area, use Matterports to walk through the apartments virtually, and even potentially use our online leasing tools to apply, sign a lease, and pay the rent without ever exchanging stacks of paper with a stranger. If Fortune 500 executives are touring potential new office space and high-rise tower right now, I believe that it's much more likely they're in their PJs at home doing it on LoopNet rather than touring in person. It's much safer that way. I believe that this phenomena is why Apartments.com had its second best sales month ever last month. And in fact, if you exclude a convention sales month like NAA, it was our best sales month ever last month. Even if this happened, we achieved that best sales month last even after most of the country was locked down and our entire sales team was working from home. At this point in April, salesforapartments.com is pacing ahead of April of 2019. To be clear, we expect that revenues overall may contract in the near term, but we feel that there are a number of drivers that make our business resilient or even somewhat counter-cyclical over the course of the next year. With 34 years of experience running a company that provides economic insights through multiple cycles, there's no doubt that this pandemic has created more uncertainty than any other scenario I've seen. The pandemic has created too much tragedy for too many. It has created serious economic uncertainty. Good thinkers I respect hold diametrically opposed outlooks. So from where we stand today, it's essentially unrealistic to predict with the certainty we need what the detailed consequences of this pandemic will be on our business over the year to come. So we'll provide guidance for the next quarter, but not the full year. However, we continue to believe that our data, analytics, and marketing tools will be among the most valuable sources of information, leads, and potential traffic for our customers. Therefore, we remain very confident in our business model and the role we play supporting the CRE industry. We're maintaining our investments to strengthen our position, both from a brand as well as a product perspective, and believe that we will exit the present uncertainty in a stronger position than before. With that qualifying prologue, I want to continue and quickly review our Q1 results. I'm very pleased that the first quarter we delivered at the high end of our guidance range across the board. CoStar Group's total revenue grew 19% year-over-year to $392 million. Across all of our service lines, our revenue growth was ahead of expectations, with LoopNet revenues leading the pack at nearly 23% year-over-year growth. Barbers.com was strong with revenue growth just above 20%. In the context of significant investments we were making in the Departments.com brand, this quarter's net income was strong at $73 million. Majestic, but it was solid at $124 million. During the course of the first quarter, our sales team generated $48 million in net new bookings, despite the pandemic's disruptive impacts. Again, Apartments.com was the true standout, achieving its second-highest quarter ever of net new sales, up 34% versus the prior year quarter. Brad Saint, Paige Forrest, and the whole multifamily team delivered an amazing, resilient, and adaptive performance throughout the first quarter. They never missed a beat. LoopNet had an exceptional start to the year also, but the CRE industry slowed a little harder in March in reaction to the pandemic. Let's go into apartments.com a little deeper. In 2019, we invested approximately $150 million to market apartments.com to consumers. We continue to feel that apartments.com represents a huge market opportunity for CoStar Group and that we can achieve an outside return by increasing our investment in marketing apartments.com to our previously communicated level of $250 million in 2020. Our enhanced marketing campaign launched in March just as runners began quarantining at home, and they consumed unprecedented amounts of media. The initial results from the first month of the campaign were strong, with 1.5 billion impressions, nearly double that seen last year. The total visits to Apartments.com reached a new all-time high. Our unaided brand awareness also continues to climb with a new high of 35%. I believe Jeff Goldblum and RPA and the whole team did a fantastic job with the creative, and we're really happy with the whole series of ads we're going to be able to present to consumers over the course of the months to come. After a dip in March, as quarantine efforts across America began, leads have recovered substantially and are now trending above the levels we saw at the same time last year. So without a doubt, our marketing investment is paying off, and combined with the efforts of our sales force, we hope this will allow us to maintain good net new bookings levels. We continue to work diligently through all the required regulatory processes required before we can close on our acquisition of rent back. The bankruptcy proceedings are following the expected course. In late March, no auction was held. Okay, that's a virtual earnings call. When the kids call you in the middle of the call waiting to get your phone. Sorry. The bankruptcy proceedings are following the expected course. In late March, no auction was held because no qualified bidders came forward. From the public filings, we can see that the vast majority of the debt holders support the planned reorganization, which includes the contemplated sale to CoStar. The FTC review is ongoing, and we expect a second request. which will extend the review on a timeframe that is consistent with our previous estimates of 3 to 12 months from signing. As always, we respect the FTC process and will cooperate fully to provide the agency with all the information they need to perform their investigation. There is no additional information we can provide on the outlook for the process at this time. LoopNet started the year very dynamically, continuing the positive usage and sales trend that we saw in the fourth quarter. As we and the rest of the country transitioned to home in early March, we experienced a drop-off in daily average users that lasted for about a month. Over the past couple of weeks, we've seen a steady increase in users, just about back to last year's levels. More importantly, the number of searches now exceed last year's level, and that's what counts for our customers. As I mentioned, LoopNet sales dipped in March as people transitioned to work from home. LoopNet sales have not yet shown the same resilience that apartment sales have shown. I think one thing to remember is the digital advertising value proposition has been well understood for many years now in the multifamily industry, whereas we're in the early stages of adoption for the commercial real estate industry. Ultimately, we believe that the current situation will actually accelerate LoopNet adoption. but it may take more time. I'm a huge believer that LoopNet will be an essential virtual solution for owners looking to win an outsized and important share of the hundreds of billions in commercial leasing dollars that are likely to occur this year. Right now, industry participants really need to know what's going on. They need to have the best information available for forecasts, availabilities, listings, and the pricing information that CoStar provides. we remain committed to continuously improving our user experience and the utility of our CoStar product. For CoStar Sweden in particular, 2020 will be a year of significant product development initiatives. We are deeply engaged with the backend integration of the STR platform. As the year progresses, we plan to integrate STR into the CoStar product at the front end as well. While CoStar operates in dozens of countries around the world, our product is not yet one seamlessly integrated, multilingual system, multi-localized system. While in the short term, commercial property sales volumes will fall dramatically, we expect they'll surge again in a year or so. Much of that investment activity will be multinational. In order to provide the most value and capture the most value for that opportunity, we want to provide our clients with a truly CRE global transaction analysis and marketing platform. We're hard at work on that initiative and expect to release the first phases of our global system in the third quarter of 2020. We expect to support a dozen or so languages by the end of the year. Ultimately, a customer from one country will be able to use one platform to seek, analyze, and compare investments across multiple countries and cities. SDR's clients are clearly one of the hardest hit segments of our client base in this pandemic. Retailers definitely have had a hard time here. This downturn will be more damaging to them than 9-11 and the Great Recession combined. We expect STR will likely see the drop in revenue and profit, but we expect the fallout to be relatively or comparatively mild. For our STR subscriptions, we've been able to handle about 80% of the client financial assistance requests through payment deferrals. For the other requests, we have offered two- to three-month contract extensions that represent a total of $300,000 in annual revenue. We also have $54,000 in annual canceled product subscriptions. At this point, it's remarkable, but it suggests less than 1% of canceled revenue. STR subscribers are our key partners, and they're least likely to cancel their products. These are hotel operators that know that data is vital to understand the market and what is happening with their competitors as well. They also want to make sure they have continuity in reporting so they're able to track as soon as recovery is beginning in their market. Due to the number of hotel closures in some markets, especially outside the U.S., we have a plan to continue to provide value to these subscribers even if we cannot report on market numbers for some period of time. We are providing custom analysis such as a deep dive on the average daily revenue declines that uncovered the fact that ADR declines were not from hotels slashing rates but rather from a rapid shift in the mix of demand. The feedback from these clients in our exclusive content series developed for them has been overwhelmingly positive and underscores the importance and value of maintaining their contract with SDR. SDR is the most risk associated with the ad hoc revenues. Ad hoc revenues are off, but we expect the revenue will begin recovering in June. This is revenue that will come back. The industry will begin recovery and development activity will restart, which will result in trend sales. Or if we have a prolonged downturn, there will be trend sales happening with distressed assets or portfolio evaluations or dispositions. We are releasing for the first time tomorrow monthly profit and loss analysis for U.S. hotels. The data has continued to come in, even with so many hotels closed, and there's even more desire from hotels to see this profit-loss information. The entire industry is watching the recovery in China to hopefully shed light on what a recovery in their part of the world will look like. We have been reporting on China Weekly and have now added a video series focused on China recovery that we're producing both in English and Chinese. As of last week, 90% of the hotels in China are open, and we have a couple of markets that are inching towards 50% occupancy. Overall, though, occupancy in China is at 35%, and that's certainly nowhere near the normal 70% to 75% occupancy we would expect, but it's well up from the low of 10% occupancy a few months ago, slow but measured. recovery in a matter of months. I want to update you on the state of the commercial real estate economy overall. It's really still too early to empirically see the full and ultimate impacts of the pandemic on the commercial real estate industry. The data so far shows an unprecedented collapse in economic activity. Jobless claims over the past four weeks exceed 26 million, and this figure would likely be higher if it were not for the overwhelmed application websites and offices. Most high-frequency economic indicators are showing unprecedented declines from manufacturing output to poor traffic to retail sales to consumer confidence. Consensus forecasts are calling for a 4% decline in GDP in 2020 and for the unemployment rate to approach 20%, levels not seen since the Great Depression. We're already seeing the effects of the outbreak on commercial real estate. Continuing with the hotel theme, hotel revenue per available room is down more than 80%. We have simply never reported figures like that. The immediate impact is less profound than the other property types, though, thankfully. Our daily apartment rent series shows that asking rents have fallen by about only one percentage point since peaking on March 10th. That's not much compared to what we've been seeing in hotels. But normally, we'd expect apartment rents to be up about a percent over the same period. But all in all, given everything, you know, there's no problem there. But we believe that many Americans are actively looking for new apartments. And as we've seen, search activity at apartments.com is exceeding pre-outbreak levels. In the commercial sectors, leasing volume over the past few weeks has fallen to about half of typical levels. And we expect it will fall further in May before it begins rising again in June or July. We expect the retail sector to be the hardest hit, as many shops have closed due to social distancing measures. Demand for retail space has already turned negative so far this year. Many shops, restaurants, bars, and coffee shops sadly may never reopen. Our forecasting models predict occupancy losses of as much as 300 million square feet, and that vacancy rates could rise 350 basis points to levels well above the peak of the last downturn. Rent losses could reach 15%, topping the 10% losses in 2009. Outcomes for office at this point look less severe as vacancies are lower and construction is about half of the level in 2007. Still, we expect occupancy losses ranging from 100 million square feet over four quarters to a quarter billion square feet over the next two years, compared with just 57 million square feet over the seven quarters of the last downturn. Our models predict asking rent losses of 10 to 20% compared with 14% 2008. Declines in effective rents will be larger as landlords offer concessions and TI packages to retain tenants. Demand for industrial has held up better thus far. First quarter leasing set an all-time record. And while the pace of leasing has slowed mid-March, Amazon has leased more than 6 million square feet in April alone. Can't help it. I need to point out that Amazon is one of the single heaviest users of LoopNet. And we can see their staff looking at LoopNet at many of these properties they eventually lease. Need a commercial in there in the economic section to pay for the economics. Amazon has also announced that it's already hired 100,000 workers to cope with the demand and plans to hire 75,000 more. But even industrial will see occupancy losses and rising vacancies. Demand falls even in our upside scenario. So positive absorption returns quickly and rents resume trend growth by the middle of next year. With negative net absorption, will likely suppress the losses and last downturn. The 2008 experience also gives us some confidence that leasing activity won't fall by nearly as much. In 2008, total leasing volume across the commercial property types was down just 7% from the pre-recession average, and 2009 was down just 4%, even as occupied space fell by more than 300 million square feet. By 2010, leasing was up 10% from pre-recession levels. In the capital markets, it's too soon to know the effect on deal volume, but initial indicators suggest investment activity could be down by as much as 50%. In the last downturn, deal volume fell by 75%. Swift and unprecedented action by the Fed has shorted financial markets and thus far prevented the worst, but we expect prices to fall by at least 10%. And... potentially by as much as 30% or more. In the most dire outcome, prices remain at the depressed levels for the next decade. Our baseline scenario, though, predicts conditions start to improve next year. Whether this prediction comes to pass depends on containment of the outbreak and progress towards treatments and a vaccine, two variables that are almost impossible to predict and difficult to incorporate into economic models. We can say with some certainty that many firms will fail, rents will fall, and vacancies will rise. We also know that the day-to-day business of commercial real estate will continue as leases expire, tenants seek new space, brokers and landlords negotiate, borrowers refinance, lenders underwrite deals, appraisers determine value, and opportunistic buyers come in strong looking for bargains, and Americans continue to look for new apartments. CoStar Group is on a strong foundation as we face the full impact of this pandemic. With 19% year-over-year revenue growth, $73 million of net income in the quarter, and $1.9 billion in cash on the balance sheet, we had a great quarter in the overall context. Our staff has successfully transitioned to remote working. We believe that we will have a rich set of attractive acquisition opportunities ahead, and we're currently exploring a number of such opportunities. We continue to support our clients' mission-critical needs, and we're hard at work building the innovative products that will drive our future growth. At this point, I would like to turn the call over to our CFO, Scott Wheeler, for the much more interesting and entertaining section of the call.