CoStar Group Inc (CSGP) 2002 Q1 法說會逐字稿

Good morning. My name is Judy, and I will be your conference facilitator. At this time, I would like to welcome everyone to the CoStar Group first quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad, and questions will be taken in the order they are received. If you would like to withdraw your question, press star, then the number 2 on your telephone keypad.

I will now turn the call over to Ms. Melanie Gibbons, director of corporate communications. Thank you, ma'am. You may now begin.

Thank you. Good morning.

I'm Melanie Gibbons, director of corporate communications, and I'd like to welcome you to CoStar Group's first quarter 2002 conference call.

Before I turn the call over to Andrew Florence, president and CEO of CoStar, let me state that certain portions of this discussion include 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 materially include, but are not limited to, those stated in CoStar's form 10-K for the year ended December 31st, 2001.

All forward-looking statements are based on information available to CoStar on the date of this call, and CoStar assumes any obligation to update these statements.

Thank you, Melanie. Welcome to the first quarter conference call. We are pleased to nouns first quarter 2002 revenues of 19.1 million, with pro forma net income of $225,000. Earnings before interest, taxes, depreciation, amortization for the first quarter were 1.3 million.

Revenues in the first quarter increased sequentially by 2.3% over the fourth quarter of 2001, which is more than double the previous quarter's sequential quarterly growth rate. As of March 31, 2002, we had 41.6 million in cash, which is nearly unchanged from year end. We have no material or long-term debt on our books. The company has a very strong balance sheet. And it is very well positioned to pursue a variety of opportunities.

Frank Carchedi will address the first quarter financials in more detail a little later in the call.

First I'd like to talk about our overall business model. We believe one of the most important attributes of our business model is our ability to grow revenues over a relatively fixed cost structure. We are now seeing the benefits of that model. We have achieved three of the big four key measures of profitability: Positive cash flow, pro forma profits, and positive EBITDA. We've now set our sights on the fourth measure, which is GAAP basis earnings. The company has now achieved positive EBITDA for three consecutive quarters. We've achieved pro forma profitability for two consecutive quarters. As you know our pro forma numbers exclude only purchase price amortization and the related income tax benefits. When these accounts are included, our net losses continue to climb -- decline sequentially from 17 cents per share in the fourth quarter of 2001 to 10 cents per share in the first quarter of 2002.

CoStar Group is showing accelerating growth and achieving profitability in the face of a recession in the commercial real estate industry. Absorption activity is a key indicator of our commercial real estate clients' economic health. In the first quarter of 2002, the net absorption of office inventory in the United States was negative 37 million square feet, down for the fourth consecutive quarter. Another direct measure of the brokerage industry's health is leasing activity, which is down 10% from the last quarter.

However, a recent study conducted by the Wharton school on behalf of the Society of Industrial and Office Realtors notes a single large brokerage firm operating in a major metropolitan area could save 150,000 annually using just one of our services, CoStar Property. Because our products help our customers cut costs and drive new revenues, we continue to sell our services despite the recession. In fact, 48% of our revenue growth in the first quarter 2002 came from selling existing products to new customers. We believe that this is a strong endorsement of the value of our products in any market condition.

Our leading market position has never been stronger. The real estate industry's largest and most influential firms have committed to CoStar as a data standard for U.S. operations. Between July 2001 and April 2002, CoStar secured multiyear national service agreements with C. B. Richard Ellis, Cushman and Wakefield, Grubb & Ellis, Marcus and millichap, Julian J. Studley, Inc., and the Staubach company, for a combined transaction value just under $20 million. For most of these clients, this is the first time they have purchased our products as a national purchasing decision on multiyear agreements.

By signing multiyear agreements, our customers are gaining control of their long-term mission-critical data costs. These national agreements reduce deal costs and risks for all parties involved. One specific example of cost savings is that in the case of one customer, we consolidated 66 agreements over two years into just one agreement. We have also gained greater visibility into our revenues from some of our key strategic customers. We see more opportunity to sell additional products and services into these national accounts, and are confident that they will likely grow.

And of course we are pleased to have the endorsement and continued support of the industry's leading players. I'd like to say a few words about one of our newer products, CoStar Connect, which we launched last March. this is a service that licenses CoStar's technology and content to commercial real estate firms and enables them to cost-effectively market their for-lease and for-sale listings on their company's website. Within a year of releasing CoStar Connect, more than 159 firms are already using the service. In this quarter, we signed two major national clients of note to the connect service: Jones LaSalle (inaudible) and C. B. Richard Ellis. Not only are these firms two of the largest global firms but both LaSalle and Ellis chose Connect over a competing product from a company they had invested in. I would like you to see the connect job on JOL's American website under the properties section. You can find our international site at www.JOL.com and from there, you can click over to their American website. This quarter we completed integration of an universal log-in and interface for three of our products, CoStar Comps, tenant and Exchange, thereby enabling customers to use a single name and password to access these separate products. With the release of the new web version of CoStar Property later this year, customers will be able to access all of the CoStar data sets they subscribe to over the internet through a single user interface.

Providing critical information that is both timely and accurate to the 10 trillion dollar commercial real estate industry is an enormous market opportunity. Based upon our experience with the penetration rates we achieved in the first markets we entered, we are confident that our potential market opportunity is in excess of $1.5 billion. CoStar is the dominant player in this industry and well-positioned to win a major share in this market opportunity. In our last conference call, we stated our goal of doubling revenues within the next four years. At twice this quarter's revenue level, we believe that CoStar Group would still be growing and would have reached our target margins of 35%. In pursuit of our goal of doubling revenues within 4 years, CoStar's management team is committed to excellent customer service, continuous product enhancements, research excellence, and growing our sales force in both capabilities and size. In our last conference call, we announced that because of our confidence in this business opportunity, we intend to grow our sales force from 58 quota carrying executives to 80 account executives by year end. CoStar Group enjoys relatively consistent production levels from our sales professionals. In fact, unlike many companies that drive 80% of their sales from 20% of their sales force, CoStar drives 80% of our sales from 70% of our sales force. That's a very balanced ratio. This consistency allows us to model the internal rate of return of a sales hire. In the first year a sales professional is with the company, they typically cost the company net $100,000, so they basically generate a negative earnings effect of 100,000. This negative impact on earnings is driven by recruiting costs, training and travel expenses, failure rates, manager overrides, and desk costs. The costs associated with a new sales professional is only offset by a limited number of revenue-producing months in their first year. Assuming typical production levels in the sales professional's second year with the company, we would expect them to generate a positive contribution of $160,000 to the bottom line. Given the nature of a subscription business with high renewal rates, by the fifth year, assuming typical production levels, we would expect that sales professionals -- that sales professional to generate close to $1 million annually of positive contribution to the bottom line. Given the mechanics of our business model and our dominant market position, expanding our sales force is an excellent investment right now. We made a number of enhancements to our sales department infrastructure in the course of the last 12 months to give us the best positioning for successful growth for a productive sales force. In the third and fourth quarter of 2001, we increased the number of first-line sales managers from seven to 13. That reduced the number of reports each manager had from a high of 11 down to just under 5. The management team now has the capacity to successfully mentor and guide a much larger sales force. We have developed and are deploying a state-of-the-art customer relationship management software system that integrates a variety of information our sales professionals need to manage accounts, thereby giving them a powerful internet sales productivity tool. In 2001, we expanded our initial sales training program from one week to a four-week intensive classroom program led by one of our most experienced sales professionals. That -- we're really quite pleased with the results of that program. We have a commission schedule that as a sales professional reaches additional higher levels of productivity, they ratchet into higher commission levels. The first five sales professionals this year to reach the next performance bar all came out of that new training program last year. Our -- the fourth sales class this year begins in the first week of May, and at this point we have already hired 70% of our sales force goal for 2002. We began the year with 58 AEs and today we have now hired 77 AEs -- hired to 77 AEs. 64 AEs are experienced or have completed training. We would expect the revenue growth benefit of these hires to become evident in the first -- in the fourth quarter sequential quarterly growth numbers. We are pleased with the initial results of our efforts to grow the sales force this year, and feel that these successes are integral to achieving our goal of doubling our revenues over the next four years.

Now I'd like to turn the call over to Frank Carchedi, our chief financial officer.

Thank you, Andy. As reported in our press release yesterday, revenues increased 1.7 million from 17.4 million in the first quarter of 2001 to 19.1 million in the first quarter of 2002. Gross margin has improved from 9.4 million in the first quarter of 2001 to 12 million in the first quarter of 2002, and margin percentages have improved from 54% to 63%. Operating expenses have declined 22% from 17.6 million to 13.8 million. Pro forma net income improved significantly from a loss of 4.6 million or negative 29 cents per share in the first quarter of 2001 to earnings of 225,000, or positive 1-cent-per-share for the first quarter of 2002. Meanwhile, our GAAP basis results have improved dramatically, from a loss of 7.6 million, or 49 cents, in the first quarter of 2001 to a loss of only 1.6 million or 10 cents per share in the first quarter of 2002.

The year over year progress we have made is substantial but as usual, I'm going to focus on a discussion of the first quarter results as they compare to the fourth quarter of 2001. The sequential results of Q4 and Q1 are important in understanding where the company is in its business model and why we believe we are currently positioned for continued revenue and earnings growth. Revenue grow sequentially by 2.3% overall from Q4 to Q1, increasing from 18.6 million to 19.1 million. This represents an upturn in sequential quarterly growth from the 1% growth we experienced in Q4. The growth for the quarter was principally the result of further penetration of the potential customer base across our national platform, as well as the successful cross-selling of products into our existing customer base. Subscription based information products, including CoStar Property, Tenant, Comps, Exchange, and Connect, continue to account for over 90% of revenues. Gross margin increased by 604,000, from 11.4 million in Q4 to 12 million in Q1. As margin percentages grew from 61% to 63%, and cost of sales declined 182,000 from 7.3 million in Q4 to 7.1 million in Q1. Included in the reduction of costs of sales for Q1 is a decrease in purchase amortization of 457,000 that was somewhat offset by higher personnel costs over the fourth quarter of 2001. We expect to have continued growth in margin percentages over the longer term. With regard to operating expenses, overall operating expenses, excluding purchase amortization, increased by less than 1% from Q4 to Q1. On a more detailed level, selling and marketing expenses increased from 5.4 million in the fourth quarter of 2001 to 5.7 million in the first quarter of 2002. This was the result of increased training costs for new hires and for the national sales force during the quarter.

Software development increased from 1.2 million in the fourth quarter of 2001 to 1.4 million in the first quarter of 2002. The company continues to focus on product enhancement and development, as well as development of internal information systems. General and administrative expenses decreased from 6.2 million in the fourth quarter of 2001 to 5.9 million in the first quarter of 2002. This decrease resulted from reductions in administrative head count, consulting, and travel costs during the quarter. I'll summarize these results by discussing our pro forma earnings for the first quarter. Pro forma results exclude purchase amortization and the related tax benefit. Pro forma net income per share was 1 cent for the quarter, which was consistent with the fourth quarter of 2001. This represents the second consecutive quarter of pro forma earnings for the company. The recent consistent improvement in pro forma results is a by-product of three main areas. First, sequential revenue growth. Secondly, growth in margins which over the last year have decreased from 54% in Q1 2001 to 63% in Q1 of 2002. And finally, operating expenses, excluding purchase amortization, which have declined consistently for six quarters before experiencing a light increase as expected in Q1 of 2002. We continue to have strong indicators of potential for earnings growth. Overall operating margins from our markets were approximately 45%, which again is consistent with Q4. More mature markets are continuing to see contribution margins over 60%.

Also, it is important to note that during Q1, 49 of the company's 50 markets were profitable. Our EBITDA for the first quarter increased slightly by $18,000, remaining essentially consistent at approximately 1.3 million from Q4 to Q1. The calculation of EBITDA for the quarter starts with loss from operations of 1.9 million and excludes 954,000 of purchase amortization that's up in cost of revenues, 893,000 of purchase amortization in operating expenses, and 1.4 million of depreciation and nonpurchase amortization imbedded throughout the cost structure. We reported that we experienced a $1.4 million reduction in purchase amortization in Q1 of 2002 compared to Q4. Approximately 900,000 to a million dollars of this related to a change in accounting guidelines which took place on January 1 -- excuse me -- and eliminated the amortization of goodwill from acquisitions. The remaining 450,000 was a reduction in cost of revenues and resulted from the full amortization of intangible assets with two-year lives resulting from the contact position in February of 2000. We closed the quarter with approximately 41.6 million in cash and short-term investments, nearly unchanged from December 31. We continue to believe we have adequate resources to operate our current business plan and that we are in a very strong financial position coming out of the quarter.

Now I will discuss the outlook for the second quarter. For the second quarter, as we indicated in our press release, we expect quarterly sequential revenue growth consistent with the first quarter at approximately 2% and pro forma earnings of 1 cent per share consistent with the first quarter. We expect quarterly sequential revenue growth to trend upward during the back half of the year to 4 to 5% by the end of 2002. The total 2002 year over year growth rate is expected to be in the 10 to 12% range, and our goal is to reach 10 cents of pro forma earnings for the year. This expectation reflects the current quarterly revenue run rate, the impact on CoStar of current economic conditions, and the mechanics of a subscription-based model in which revenue growth rates will typically ramp up or down gradually. Gross margin percentage is expected to increase by another 2% in Q 2. Margin percentages are expected to continue to trend upward by 1 to 2% quarterly throughout the year. Operating expenses, including selling and marketing, software development, and G&A, are expected to increase by approximately 3 to 4 percent overall in Q 2, principally from growth in the sales force. Operating expenses are continue -- are expected to continue to increase by approximately 3 to 4% per quarter during the year, as we invest in the buildup of the sales force to drive stronger long-term revenue growth. Purchase amortization included in operating expenses is expected to remain consistent at approximately 900,000 per quarter during the year. The recent decrease in purchase amortization does not affect pro forma earnings, but will result in a decrease in accounting losses. We are making progress toward GAAP basis earnings and expect to reach GAAP earnings in the first quarter of 2003.

In conclusion, we believe we have and will continue to demonstrate the strength of our business model and our ability to execute our plan. We believe we are well positioned to continue to achieve revenue and earnings growth, much as we have in a difficult business environment throughout 2001 and the beginning of 2000. We continue to expect more rapid growth rates upon the improvement of business and economic conditions, and we look forward to reporting our progress to you. And with that, I'll open the call for questions and answers.

At this time, I would like to remind everyone in order to ask a question, please press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q and A roster.

Good morning, and congratulations on a good quarter.

Good morning, James.

Thank you, James.

Basically just wanted to ask two quick questions. Andy, you'd mentioned a focus on GAAP basis earnings. I was wondering if you could give us an idea of what type of revenue environment do you need to see in order to start to achieve positive GAAP basis earnings. And then secondly, in terms of CoStar Connect, you're obviously seeing some good momentum year over year, and I was wondering what type of adoption rate you might expect for your larger clients. Thank you.

Okay. James, let me answer the first one on GAAP basis earnings. We expect to reach GAAP basis earnings by Q1 of 2003, and we think we can reach that, you know, on the revenue guidance that we've given for -- you know, principally for the rest of this year. Keep in mind that as I mentioned and as you saw in Q1 -- in Q1 of this year, some of that movement toward GAAP basis earnings is resulting from a mechanical decline in purchase amortization, either because of the accounting rules or because purchased assets from acquisitions are becoming fully depreciated and -- or fully amortized, which is eliminating that amortization charge as we move forward here. So expect to continue to see some decrease in amortization.

And then James to reinforce some of the color on the revenue growth side, I think in that goal of -- in that focus on GAAP basis earnings, we are assuming that we do not get a lot of help from the economy. We're assuming that through the mechanical side of growing the sales force, some product deployments, we can continue to see that acceleration in sequential quarterly growth rates.

I think if the economy were to -- in commercial real estate specifically were to recover, that would actually be a benefit we're not anticipating and not planning on.

On the Connect adoption, we're pretty excited about that. We have -- the product has done really quite well in the first year. It's a high-margin product. There are not a lot of direct costs associated with that product. It's basically reconfiguration of our existing data streams, and in addition to being a revenue driver, it also enhances our data -- our customers to pay even more attention to keeping our data current and up-to-date when it is populating their internal inventory system and their external website. The -- we have some product enhancements that we're going -- some -- actually some major product enhancements we will be making to the connect product in the fall, which for competitive reasons we won't go into a lot of detail on, that we think will make it a much more compelling offer, and since it's already been pretty successful to date, we're pretty optimistic about the fact that we'll see more adoption of the product amongst our major customers.

Great. Once again, congratulations. Thank you.

Thank you.

Thanks.

Your next question comes from the line of Gary Nyrowith J. P. Morgan.

Hi Frank. Hi, Andy. What was your capex in the quarter?

It was approximately 500,000.

And your cash balance was flat.

Yeah. Cash -- you know, we're at sort of a point here where cash is going to bounce around a little bit with working capital changes, even though pro forma earnings are positive and EBITDA is positive. I mean, if you look at the EBITDA of 1.3 million and you look at the capex of 500,000, then you can see that there is substantial cash flow at this point. On the working capital front, though, there was a significant paydown of accruals for payroll and year-end bonuses, and if you flip over to the balance sheet on the press release, you will see a significant reduction in accrued expenses, and -- and that's where that use of cash is coming from.

Okay. Great. Thanks. And do you have a breakdown of your revenue by property, tenant, and comps?

Yes. Property accounted for 47% of the revenue. Tenant, 19%. Comps, 22%. Exchange, 2%. And that's the bulk of the, you know, subscription-based information.

Okay. And I just want to clarify, Andy, when you were talking about the sales force, it was -- you had 58 salespeople at the end of the year?

Yeah. We had -- we probably came in with just slightly higher than that, but there were several nonproducing salespeople who were probably -- you know, the one I'm focusing on is we had about 58 producing that were with us in the first, second week of January. So that's our starting argument Mark.

And you're at 77 now?

We are at 70 now, with 7 hired basically out of that new class.

Okay. And where were you at, say midpoint last year.

Midpoint last year, we were probably in the -- in the 60 range. The sales force has been largely flat for about 18 months, plus.

Okay. And at the beginning of the call, Andy, you mentioned you've got the 40 -- I guess 42 million in cash and made some allusion to opportunities.

Can you just touch on that?

Sure. We're -- you know, we're -- you can break the business into three phases. You know, Phase I was proving out the business model, which we did successfully. That was probably five years ago.

Phase II is taking that successful business model and deploying it into scale, taking it to a national operation.

We feel, on the management team, that reaching our earning goals in a timely fashion, as we were saying, really concludes Phase II, proving that it can scale to a national level.

Phase III is now we have a profitable platform for providing commercial real estate information to the real estate industry. There are a lot of opportunities that will present themselves. You know, an example of that would be, you know, (inaudible) sales force to take advantage of the opportunity a little bit faster. There are, I think in general, the acquisition (inaudible) probably better now than it has been. You know, you had a period where the company didn't want to really look at a lot of acquisitions because we wanted to focus on our own operations and invest in ourself, and also the period before that where valuations were absurd.

Now we're seeing some, you know, greater probabilities of good valuations and solid companies that have strategic and financial, you know, click-in with what CoStar Group is doing. So while there's nothing immediately on the deck, we're constantly evaluating those opportunities and wouldn't be surprised if we saw something happen in the next 12 months along those lines.

And are the companies more small regional competitors or something to broaden the product line?

They're most likely small regional competitors. We do not have any competitors that we're aware of in any market that have a larger market share than we do or a larger revenue base than we do, so we're in the markets we want to be in for right now, so we don't see a lot of value there. The sort of acquisitions we'd be looking at were things that drive growth in related product areas, like complementary product areas or new product areas that make a lot of sense inside of our mix or drive additional functionality in some of our core products by adding different (inaudible) product that will synergize well with our data streams.

Great. Thank you very much.

Again, if you have a question at this time, please press star, then the number 1 on your telephone keypad.

Your next question comes from the line of Dalton Chandler with Edamancompany.

Yeah. It's still Needham and company.

But let me ask -- well, let me start by asking about the contracts that you mentioned earlier, the big national deals that you indicated were, combined, 20 million plus in value. I assume that's over the -- that's the total value over the life of all those contracts?

That's right, Dalton.

So can you give us the average length of contract?

I think they're typically -- it's probably 2.5 years.

Okay. And can you talk about, you know, what the pricing trends have been? For example -- well, on renewals, I know you renewed Cushman and Wakefield this quarter, which I think was probably your first big deal a couple of years ago, and also GMAC. What you've seen in terms of both pricing and product up-sell as you go through the renewal process?

Sure. The -- there are a couple things going on there. This is major because historically we'd gone out there and we have sold our products to a Cushman and Wakefield one market at a time, you know. We deal with the Baltimore manager, the Washington manager, the Philadelphia manager, a fairly difficult sales process. We probably have not been on the radar screens of the national purchasing decision-makers in those organizations, and the fact that they're now taking over that purchasing and proactively entering into longer-term agreements with us shows a different phase for the company, where the purchasing is shifting from local to national, which favors the only national company in the business. We were -- what we're trying to do with our customers, our major strategic customers, is they -- they're looking at a situation where CoStar Group has emerged as a very clear dominant market player, and we wanted to give them comfort and visibility on what their information costs would be and have them feel very comfortable about the level of service they'd received from CoStar, and that there would be no surprises in pricing over time.

So we largely renewed those customers at slight increases. I think -- I don't think there's really any real decreases in any of those renewals. They're generally slow increases with revenue visibility some number of years out. They -- the one thing we do want to stress is that we've got the additional opportunity to sell new products and some new cities into those existing accounts. Also, we should point out that those major customers generally only account for, you know, 10% of our revenue in any given city, and by being able to sell those -- have those major customers solidly in our court on multiyear agreements, that allows us to focus on the other 90% of the market share and drive revenues there with major customers solidly in our court.

No, that was -- that was helpful.

What about, you know, with the new deals that you signed? For example, you -- you announced Staubach today. In the past, I know you've been willing to discount a little bit in order to open some doors. Are you seeing less of a need to discount for new customers?

Well, we're actually not doing -- we're not discounting right now, and -- and we're not discounting to open doors for new customers. In point of fact, we took our pricing -- our -- say our CoStar Property product generally is at 200 and some dollars for a site, plus $75 for each licensed brokered location. We've recently taken from $75 up to $85. So we -- in fact, there's probably an upward movement there.

Now, these big renewals on multiyear agreements, we are holding there. We're not -- we're not looking to raise their prices. We're giving them assurance on pricing and relatively level pricing. So with Staubach, I think it will probably be a renewal that's probably a 10% increase, something like that.

Okay. And what was the process like in landing that business? I mean, was it an RFP process or .

I believe Cushman and Wakefield put out an RFP, but we're really -- the CoStar Group is uniquely positioned to respond to that RFP.

Generally, it's a process where we have a director of major accounts, so it is our general counsel's working with our major accounts person. Our COO, Larry Dressel, and myself are directly involved in these negotiations.

I think some of them were much more complicated. One -- the most complicated of those probably required 20 face-to-face meetings over 10 months, and contributed to five or six new gray hairs on my head.

Another actually was one face-to-face meeting and one phone call.

So they're -- all told, surprisingly a smooth process.

Okay. Last question and I'll let you go.

When you signed the Staubach deal, did you actually get to meet Roger Staubach?

We have a lot of -- we have a lot of exStaubach brokers who work in the company, or people that have worked with Staubach, so we have a number of Roger Staubach signed footballs lying around the office. I did not get the opportunity to meet Roger Staubach, and I do hope that sometime when I'm down in Dallas, I can meet him and shake his hand.

Maybe on the renewal.

Okay. Great.

Thanks, guys.

At this time, there are no further questions.

Well, thank you very much for joining us in our first quarter 2002 earnings conference call. In summary, we expect our revenues to grow approximately 2% sequentially for the second quarter, and we expect pro forma net income consistent with the previous two quarters. As we continue to grow and mature our sales force, we believe we will see a further acceleration to higher sequentially quarterly growth. Thank you and good day.

This concludes the conference call. You may disconnect at this time.