CoStar Group Inc (CSGP) 2009 Q2 法說會逐字稿

Ladies and gentlemen, we thank you for standing by and welcome you to the CoStar Group's Second Quarter 2009 Conference Call. At this time all lines have been placed in to a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.

On the call today we have CoStar's President and CEO, Andrew Florance; Chief Financial Officer, Brian Radecki; and Communications Director, Tim Trainor.

I would now like to turn the conference over to Mr. Trainor. Please go ahead, sir.

Thank you, Pamela. Good morning, everyone, and welcome to CoStar Group's Second Quarter 2009 Conference Call. Before I turn the call over to CoStar Group's President and CEO, Andrew Florance, let me state that certain portions of this discussion 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 in CoStar's Second Quarter 2009 press release and CoStar's filings with the SEC, including CoStar's Form 10K for the year ended December 31, 2008 and CoStar's Form 10Q for the quarter ended March 31, 2009. 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. A webcast of this conference call is available on our website at www.costar.com\investors.aspx. Thank you for joining us. I will now turn the call over to Andy.

Thank you, Tim, and welcome, everyone, to CoStar Group's Second Quarter 2009 Conference Call. I'm pleased once again to report that CoStar Group completed another profitable quarter, earning $4.6 million. Second quarter 2009 EBITDA was $11.6 million. Year to date net income was $10.7 million, a 3% increase over 2008 year to date net income of $10.4 million. Revenues for the second quarter were $50.1 million, down slightly from $51.4 million in the first quarter of 2009.

CoStar continues to generate consistent profits and enjoy a very strong and healthy financial position thanks to a subscription-based business model that has been battle tested through economic cycles and proven to be quite strong and resilient. We added $10.3 million of cash to our balance sheet during the quarter, increasing cash, cash equivalents, and investments on hand to more than $243 million. The majority of these assets are held in cash or invested in U.S. Treasury and other U.S. government money market funds. We anticipate that our cash balances will exceed $0.25 billion by the end of the third quarter of 2009. Later in this call, Brian Radecki, our CFO, will provide the detail on our financial results and the outlook for the third quarter.

Before he does, I'd like to offer more detail on our acquisition of Property Portfolio Research Inc. which we announced earlier this week. Boston-based PPR provides global commercial real estate analytics and forecasting, is profitable on annual revenues of $18 million and has a staff of approximately 70 professionals.

Looking past the short-term financial impact, PPR -- the impact to PPR regarding expense and deal costs in the Q3 period, the initial purchase and amortization, et cetera, the deal is actually accretive to this year's EBITDA. We believe this acquisition presents a tremendous opportunity for our Company and we couldn't be happier with the quality of PPR's products and we look forward to working alongside their talented staff. PPR has the largest team of independent economists covering commercial real estate and has a long and well deserved reputation providing exceptional independent real estate investment analysis, market forecasts, and credit risk evaluation to investors on a global scale.

In this economic environment, demand is extraordinarily high for commercial real estate analysis and forecasting, supported by comprehensive and accurate property and market data. Our customers have long valued CoStar for offering the most accurate, timely, and comprehensive commercial real estate information. Over the years, they've also expressed an increasing interest in seeing forecasting services-based upon CoStar's high quality data. PPR has excelled in forecasting and investment analysis. Its suite of analytic tools provides strategic and market level analysis supporting portfolio management, acquisitions, dispositions, and asset management activities. PPR also provides risk management analysis, including identification of market risks and a framework for understanding mortgage credit defaults.

PPR was recently selected to serve as a subcontractor to provide valuation, modeling, analytics, and reporting services for the Term Asset-backed Securities Loan Facility -- TALF program on behalf of the Federal Reserve Bank of New York. With this acquisition, combined with CoStar's existing customer relationships, the federal government is now one of CoStar's top clients. We believe that there is an opportunity to market PPR's analytic tools and services to the thousands of firms in CoStar's client base and by doing so, we expect to dramatically accelerate PPR's growth and substantially increase PPR's revenues.

Acquiring PPR perfectly addressed CoStar's long held strategic goal to significantly expand our real estate forecasting and analytic capabilities. We believe that useful and reliable forecasting requires applying insightful economic modeling to comprehensive, accurate, and granular data. By joining forces, CoStar brings its best of class data assets to bear and PPR brings its outstanding team of approximately 40 economists and market analysts to the table. Together, we expect to move quickly to become the leading provider of information and analytic services to commercial real estate investors and lenders.

CoStar and PPR also match up well in terms of geography. We both share a strong presence in the U.S. and the United Kingdom. PPR's European product offering has similarity with CoStar's Paris-based Grecam real estate information and analytic services and we believe that working together these operations will emerge even strong. PPR also has an office in Hong Kong, giving CoStar a presence in Asia for the first time. Through its partnership with Dallas-based Axiom Metrics, PPR provides clients with a wealth of valuable information on multifamily market conditions, a frequent request from our customers for the past number of years. We expect the combination with PPR to further strengthen our position in the financial services segment and help our efforts to continue securing large institutional investors as clients.

One notable aspect of this acquisition that I want to point out is that PPR's former parent, DMG, really insists on receiving CoStar stock instead of cash as a payment for the acquisition. Because of CoStar's large cash balances, CoStar would've preferred to use cash in the acquisition, but in order to complete the transaction, CoStar was willing to agree to use our stock. DMG Information, a division of the U.K.-based media giant, Daily Mail and General Trust, PLC, conducted what I think would be safe to call thorough due diligence on CoStar and the growth potential we see in commercial real estate information services. DMG opted to keep their exposure to this segment by acquiring a position in CoStar. We are very grateful that they decided to team up with us which we certainly appreciate and take as a vote of confidence in our growth strategy.

You may recall that CoStar sought to expand our market analysis and forecasting capabilities last year through an offer to acquire a company called REES Inc. While REES is a good company and has some similarities to PPR, we believe that PPR is a much better strategic fit with a much larger team of talented economists and is unfettered by an unrelated business. In addition, at approximately 1.2 times revenue, our acquisition of PPR was dramatically less expensive than the offer we had made prior to acquire REES last year. We had withdrawn that offer to acquire REES when market conditions deteriorated last year.

As we indicated in this week's announcement of the PPR acquisition, we expect to make these additional acquisitions over the next 12 to 18 months. We plan to make a number of acquisitions. We see a large number of opportunities in the current environment and we intend to leverage our strong balance sheet and experienced acquisition team to make additional investments in commercial real estate related information and technology companies.

As in the case of PPR, we're most interested in companies that can accelerate earnings growth by leveraging any of CoStar's several strategic assets, including our database of research verified commercial property information, our strong balance sheet, our extensive client base, our advanced technology platform, and our highly effective sales and marketing channel. CoStar has identified more than 40 companies as possible acquisitions. With more than a dozen successful acquisitions, CoStar's management team has extensive experience in acquiring and integrating commercial real estate information related companies.

Commercial real estate market conditions continue to deteriorate because the credit and CMBS markets essentially remain locked down and because the economy continues to suffer extensive job losses which is creating negative absorption, high vacancy rates, and falling rents. In this negative economic environment, commercial real estate asset values are plunging. Office leasing activity is off 39% from year-ago level and all but three core U.S. office markets that CoStar tracks posted negative net absorption over the firsts two quarters of 2009. CoStar documented an unprecedented 57% plunge in the average value of Class A office space per square feet since the market peaked in late 2007. The degree and speed at which these changes in market fundamentals occurred are staggering. In less than six quarters, U.S. office buildings have lost more than half of their value.

The number of office sales is also down with a drop more pronounced in the largest institutional grade office buildings. The total number of closed office sales of $5 million or less declined 58% from their peaks while the number of sales involving office properties for $50 million or more have dropped more than 91% from their peak. This unprecedented decline in property values holds major ramifications for investors, lenders, building owners, and tenants. With the plunge in asset values we've seen so far this year, many commercial mortgages are now underwater, their properties are valued less than what is owed on the building.

One major uncertainty we do face as an industry right now is how lenders are going to address these situations in the current credit constrained environment. Unlike previous downturns, this situation is not the result of overaggressive development. This is a demand issue, not an oversupply issue. In fact, we've seen office construction levels decrease at the fastest rate since World War II. This means that when a recovery occurs, it will likely occur very rapidly. While office construction throughout the nation's office markets remain at historically low levels, steep declines in office leasing activity resulted in negative 40 million square feet of net absorption during the first half of the year and the national office vacancy rate increased to 12.9% from 11.9% six months ago. With demand for new office space so low, we're forecasting the national office vacancy rate will likely cross 18% over the next two years.

In analyzing market conditions for the second quarter, we noticed a rapid decline in the average vacancy associated with newly acquired office buildings occurring within the first six months of their acquisition. Typically, you see vacancy rates remain stable or go up slightly following an acquisition. What we think may be happening in the current scenario is that buyers are able to acquire assets that save $200 per square foot in markets in which buildings just recently sold for $500 per square foot. The lower cost basis enables the new owner to compete for tenants by offering a much lower rental rate at the expense of owners that are servicing mortgages-based on the previous $500 per square foot basis. While this may be bad news for some owners, it also means that leasing volumes may pick up which is good news for many of CoStar's broker clients.

At the end of the second quarter of 2009, the Company had 160 sales representatives on staff consisting of 120 subscription sales representatives, seven U.S. advertising sales reps, ten in-house sales reps, and 23 U.K. field sales reps. This is an increase of 16 since the end of last year. I expect our overall sales force to continue to grow moderately through the rest of the year.

The current macroeconomic environment continued to adversely affect our client base during the quarter. Throughout the U.S., companies have continued to sharply curtail their leasing activity in the face of these extensive job cuts. As I previously noted, the number of commercial property sales transactions has plunged in the wake of the deteriorating credit market. As a result, many of our customers have experienced severe declines in revenues and have slowed their purchasing activity or have failed altogether. Despite these adverse economic conditions, our net subscriber count stabilized during the quarter, declining just 1% quarter over quarter to 82,746 subscribers. The overall number of subscribing sites also dropped only slightly during the quarter from 15,540 at the end of the first quarter of 2009 to 15,402 subscriber sites at the end of the second quarter of 2009. Given the widespread headcount reductions within our client's business, we believe the fact that CoStar's subscriber base remained essentially unchanged during this period is encouraging.

In addition, the average new contract value for the second quarter was $7,497, a significant increase compared to the $4,964 for the previous quarter. We added 494 new subscribing firms during the second quarter. The 12 month trailing customer renewal rate for CoStar's subscription-based services was 86% and renewal rates with customers who have subscribed to CoStar for more than five years remained approximately 89% which we believe is very encouraging, given that many of these firms have seen significant declines in their revenues. We're pleased to report that renewal rates with customers using our product less than five years, i.e. our newer customers, increased from 70% in the first quarter to 74% in the second quarter.

Our research team continues to do an outstanding job in increasing, in researching all the buildings and markets CoStar covers, aggregating more and more listings and verifying their accuracy in an extremely efficient and timely manner. Thanks to their efforts, every quarter CoStar adds thousands of listings for sales properties and hundreds of thousands of available square feet representing billions of dollars in opportunities for CoStar subscribers. Over the past year, the total number of research and verified commercial real estate properties in CoStar's U.S. database grew 21% from approximately $2.263 million in the second quarter of 2008 to approximately $2.733 million in the second quarter of 2009. For sale properties valued at more than $514 billion were available in CoStar's database at the end of the second quarter, an increase of 11% over the same period last year.

In total, both our U.S. and international operations, in total the two companies combined, the U.S. and U.K. operations have 1.3 million listings now. To the best of my knowledge, this represents the largest aggregation of commercial property information ever assembled within a unified database anywhere in the world. This aggregation represents a tremendous value for our subscribers. It's difficult to truly appreciate the enormity of the task our research team undertakes to provide us with this high quality information. Take the 1.9 billion square feet of available space added over the prior 12 month period. That's more than all the office space in the entire state of California. It's also amazing to see the growth in our database. Just over three years ago on January 1, 2006, the number of active for sale and leased listings in our U.S. database totaled 349,000. At the end of the second quarter of this year, we had 1.18 million, a 239% increase. It took us 19 years to get to that 350,000 listings in 2006 and a little more than three years to nearly quadruple that amount. We also had 98,000 retail listing on January 1, 2006. There were 517,000 in our database at the end of the second quarter, a 400% increase.

We continue to invest in and rollout enhanced versions of our products. We just released an upgrade to our CoStar Comps and Property Professional product to provide subscribers with expanded capabilities for conducting in-depth analysis and reporting on trends in sales and leasing activity in CoStar's data. These new tools offer subscribers greatly expanded capabilities for analyzing sales transactions from CoStar's database of more than one million sales comparables. These enhancements are providing even more ways to use CoStar's information to analyze trends, identify market risk, and forecast future investment performance more accurately. These new analytic tools are fully integrated and display trend data derived from the specific set of search results selected by the subscriber for analysis. Not a preprogrammed or canned market average. Also, CoStar's tools support macro to micro analysis providing the ability to view the data trend for the entire results set and drill down to the data associated with any of the individual properties or comps included in the analysis.

In addition, CoStar's new analytic tools enable subscribers to export their trend results to a spreadsheet for even greater flexibility. The new comps analytic search tool can provide a wide of trend analysis on the aggregated sales transaction data, instantly showing how key investment indicators have performed over time, including cap rate, total dollar volume, total number of sales transactions, sale price, sales price per square foot, sales price per acre, and time to sale, among others. CoStar also added several new features to the existing property analytics search, including the ability to analyze available space, which can provide a useful leading indicator of future vacancy within specific markets. Also, the trend information that can be gleaned from analyzing CoStar's data can be extremely useful in providing a solid basis for some of the assumptions called for in popular applications for developing discounted cash flow models. These new additions, along with PPR's forecasting capabilities really strengthen our value proposition to those people responsible for producing discounted cash flow models. With these and other analytic tools and enhancements we are bringing to the market, CoStar is committed to providing our subscribers with even more value.

Before I turn the call over to Brian for a more in-depth discussion of our quarterly financial performance and outlook, let me reiterate that we remain very focused on managing our business efficiently, minimizing spending, and preserving value to continue to operate profitability in this difficult environment. We are excited at the prospect of integrating CoStar's industry leading research and property data with PPR's unmatched analytic and forecasting capabilities and believe that this combination will generate significant earnings growth for CoStar. We believe the fact that we continue to generate strong earnings during what certainly appears to be the worst recession since World War II reflects the strong fundamentals of our business. I am confident that we will continue delivering long-term value to our customers and shareholders as well as opportunities for our employees. Brian?

Thank you, Andy. As Andy mentioned, we are pleased to report CoStar's achieved solid financial results for the second quarter of 2009 and year to date. We continue to manage the business well in the face of a market environment that continues to be challenging.

I'll first discuss our second quarter and year to date financial performance which, of course, does not include any PPR numbers and then I will provide an overview of what we expect for the remainder of 2009 which will include the impact of the PPR acquisition. Let me point out that in the face of one of the most challenging economic environments anyone can remember, CoStar's year to date gross margin was up. Our total operating expenses were down and both year to date net income and year to date EPS were up. Everybody just think about that for a second.

First, looking at profitability, our year to date 2009 net income was $10.7 million or $0.55 per diluted share. This compares to net income of $10.5 million or $0.54 per diluted share for the six months ended 2008. EBITDA for this quarter which is earnings, interest, taxes, and depreciation and amortization for the second quarter of 2009 was $11.6 million, only a slight decrease compared to EBITDA of $12.8 million for the second quarter of 2008. Reconciliation of the EBITDA and all non-GAAP financial measures discussed on this call to GAAP basis results is shown in detail in our press release issued yesterday and is also available on our website at www.costar.com. Our EBITDA margin for our U.S. operations was 26.2% in the second quarter which remains a testament to the earnings power of the business in this challenging economic environment. Our consolidated EBITDA margin in Q2 of 2009 was 23.3% which is fairly flat, to the 24% we saw in Q2 of 2008.

Revenue in the second quarter of 2009 was $50.1 million, was in line with our prior guidance. During Q2, our subscription-based revenues accounted for 95.7% of our total revenues while non-subscription-based revenues accounts, again, for less than 5% of CoStar's total revenues.

On a functional currency basis, international revenues totaled GBP2.9 million in the second quarter of 2009 compared to GBP3.1 million in the second quarter of 2008. International operations contributed 8.8% of total revenues in the second quarter of 2009 and international subscription revenues accounted for approximately 91.2% of that international revenue in the second quarter of 2009. Our trailing 12 month renewal rate which is a measure of renewing subscription revenue was 85.5% or approximately 86%. We consider the 12 month trailing customer renewal rate to be a good indicator of the strength of the business model as subscription revenue accounts for most of the total revenue of the Company and the majority of our subscribers are in annual or long-term agreements. As we have publically stated for almost two years now, we expect the trailing 12 month renewal rate to decline to the low to mid 80s for the calendar year 2009 in this current economic cycle and then begin to recover next year.

Moving to gross margin, gross margin was $33.3 million in Q2 of 2009. Gross margin percentage decreased only slightly to 66.6% in Q2 of 2009 from 67.1% in Q1 of 2009. Total operating expenses in Q2 were $25.1 million in the second quarter which includes legal costs of approximately $2.1 million in the second quarter which is in line with our expectation of an additional $1 million increase over the first quarter. As you're aware, we are currently involved in a number of law suits and could be involved in others aimed at protecting our intellectual property rights. As a reminder, we follow U.S. GAAP-based accounting and we report all of our legal expenses in the income statement, our EBITDA, and our earnings outlook for the year.

Also as expected we had seasonally higher selling and marketing expenses of approximately $750,000 in Q2 of 2009 primarily associated with the ICSC Trade Show and marketing showcase that Andy talked about earlier. In addition, we incurred a one-time cost related to a termination of an agreement to lease in the U.K. totally approximately $600,000 in Q2 that ran through the G&A line. Again, we are taking advantage of a soft leasing market to reduce our costs by millions of pounds over the next five years while upgrading the quality of our HQ space in Central London.

With respect to our balance sheet, we ended the second quarter of 2009 with approximately $243.8 million in cash, cash equivalents, and investments, an increase of $10.3 million since March 31, 2009 and as always we have no long-term debt. Capital expenditures in the second quarter of 2009 were approximately $2 million. These were investments primarily in facilities to upgrade field office hubs, as well as network equipment and work stations to support the ongoing operations.

Now I'll turn to our financial outlook for the third quarter and full year 2009 in detail. As is typical, our guidance takes into account the recent growth rates, our recent results impacted by the uncertainties surrounding foreign exchange rate fluctuations as well as challenges in the global economy. We remain confident in our earnings guidance, as we believe one of the strengths of a subscription-based business model is it provides good earnings in cash flow visibility.

Just to remind everybody, our guidance for the third quarter includes pro-rated projections for the PPR deal which we just closed. The transaction resulted in an increase of approximately 575,000 shares of CoStar stock. PPR currently has annual revenues of approximately $18 million and EBITDA margins of approximately 5%. As Andy explained, we are very excited about the growth opportunities PPR brings to CoStar. Looking past the short-term financial impact of PPR with regard to expensing deal related costs in Q3 the acquisition is actually accretive to this year's EBITDA.

As a matter of fact, we believe the acquisition would be accretive to 2009 EBITDA even with these included. Also, as we stated in our earnings press release, we expect PPR to be accretive to overall earnings per share in 2010 as a result of the expected revenue growth. Considering all factors and putting it into what I'd call baseball terms, this deal at 1.2 times revenue multiple in a low single digit forward EBITDA multiple was a home run. In addition, we also do not expect this acquisition to result in any significant investments in the near-term.

As we look out to the third quarter, we expect third quarter 2009 revenue in the range of $51 million to $52.5 million which includes $2.5 million to $3 million of pro-rated PPR revenue for the quarter. For the full year we expect approximately $205 million to $208.5 million in revenues which includes $7 million to $7.5 million of pro-rated PPR revenue for the year.

We expect cost of revenues which is approximately $16.7 million in Q2 to rise slightly in the back half of the year. As we explained prior, for the remainder of the year, we continue to expect to hire and staff our research group in order to continue to provide the highest quality information to meet the needs of our clients during this difficult economic environment. This is not new investments. We just continue to staff the research group as appropriate.

In addition, including the addition of approximately $1.5 million in pro-rated cost of revenues from PPR, we expect cost of revenues to be in the $19 million range for Q3 of 2009. Moving down the P&L, we expect selling and marketing in the third quarter of 2009 of approximately $10.5 million to $11 million which will include selling and marketing expenses of PPR of approximately $1 million.

With the addition of the PPR, we expect approximately $3.5 million of software development for both the third quarter and fourth quarter of 2009. G&A in Q3 of 2009 -- I'm sorry. We expect G&A in Q3 of 2009 including the PPR costs to approximate $11.5 million. Specifically with regard to legal costs in the third and fourth quarter, we expect those to be in line with levels we experienced prior to Q2 of 2009 of approximately $1 million per quarter. In terms of purchase amortization, we expect purchase am specifically attributable to just PPR of $200,000 to $300,000 in Q3 and approximately $0.5 million for the year 2009 as we explained in the earnings release.

Continue to expect the interest rate for interest income to be approximately 0.25% to 0.5% in 2009 while the majority of our approximately $243 million in cash, cash equivalents, and investments is currently invested in U.S. Treasuries and other government money market funds. As we continue to invest internationally, the mechanics of our effective tax rate calculation continue to be effected by the income or loss in the U.K.. The tax expense or benefit from the U.K. operations is not equivalent to the tax rates of our U.S. operations which can have an impact in our overall effective blended rate. Overall, we expect the effective rate to be in the 45% to 47% range.

In terms of earnings, we expect the third quarter 2009 fully diluted net income per share of approximately $0.19 to $0.21 on approximately $20.3 million of fully diluted shares outstanding. In addition to the purchase amortization I mentioned prior, our third quarter outlook includes approximately $500,000 of deal related costs and approximately $150,000 of equity compensation, all related to the PPR acquisition. For the full year 2009 we expected fully diluted net income per share of approximately $0.95 to $1.00 on approximately 20 million of fully diluted shares outstanding.

As I explained in the press release, full year outlook includes approximately $1.3 million of added expense from the PPR acquisition. This includes $500,000 of purchase am and approximately $500,000 of deal related costs and $300,000 of additional equity compensation.

In total, our full year guidance includes approximately $6.5 million in pre-tax non-cash equity compensation charges related to the vesting of restricted stock and stock options. We continue to expect capital expenditures for 2009 in the range of $4 million to $7 million which we continue to invest in the facility upgrades in the field offices and network equipment, workstations, just to support the ongoing operations. We may also, again, consolidate or move office space in 2009 to save money and take advantage of upgraded space at much lower costs which may create one-time lease settlement gains or losses for the Company just as we had this quarter.

In conclusion, the entire CoStar management team remains focused and fully committed to achieving our current outlook for 2009. We believe our second quarter results demonstrate that we are managing the business very well as we pursue initiatives to expand our market share and enhance our services. Our business model remains strong based on the fact that we have a 95% subscription-based business with high renewals, a unique proprietary database, with a market-leading position, a strong balance sheet, no debt, and high cash flow. We also believe our services are core to our clients' ability to deliver their businesses to the markets they need for services.

We fully expect to return to the more normalized revenue growth rates we have enjoyed over the past decade and expanding margins once we see positive GDP growth and encouraging employment figures. For now, we continue to deliver on mission critical service information and marketing needs to our clients in this economic climate and to pursue a number of initiatives that position the Company for higher growth opportunities that may be created when an economic recovery surfaces. We believe these challenging times will continue to create opportunities for us as a market leader. The CoStar management team believes there is significant opportunity for high margin revenue growth following the investments we have made like the strategic acquisition of PPR. As I've said many times to people, no Company is totally recession-proof and CoStar is not immune to the challenges facing our economy today. But without a doubt, 2009 has been a tough year, but we are clear on our priorities and very, very confident in our plans.

With that, we continue to look forward to reporting our progress for you and open up the call for questions.

Thank you. (Operator Instructions) Thank you. We'll take our first question then from Vance Edelson with Morgan Stanley. Please, go ahead.

Hi. Thanks a lot. With LoopNet out with what they're claiming to be a legal victory today, can you just update us as you have in the past on the status or the resolution of that case? Thanks.

Sure. I was actually, I guess, not terribly surprised to see that release out the morning of our earnings call. But the -- actually the judge did not reach any decision on the merits of The Street one way or another and in fact in the prior [slot] motion, she had declared that CoStar was likely to prevail on the merits of the case. So, I thought it was an excellent example of creative writing that went out this morning. In a creative writing class, it would get an A plus. In fact, the judge ordered LoopNet to continue to give us access to their website per the contract we had in place with them. So, the bottom line on that is, I would say that an enormous waste of shareholder value. The two companies are spending millions and millions of dollars on litigation that I'm not really sure what the goals and objectives are, other than serve an emotional satisfaction. We would obviously just say that we think the lawsuit is frivolous and we would disagree with LoopNet's interpretation of where things are with that.

Okay. Got it. I appreciate that.

You're welcome.

Second, just given the increase in the average new contract value, what are the forces at place there? Maybe if you could just comment on pricing from a broader perspective too? Thanks.

Sure. It's a fairly volatile number and it's going to be a mix of whether or not a large institutional deal comes in during the quarter. Right now it's more a question of the mix of contracts from the quarter than it is any change in our pricing strategy. Our pricing is remaining constant right now and specifically we're avoiding making any price increases during a difficult economic time. There is a shift towards more property professional suite purchasing, comps purchasing, and probably a little bit less of the lower dollar volume CoStar showcase product. So, it's just a mix of what's being purchased.

Okay. Got it. And maybe just one last question, this one for Brian. Given the tough industry conditions that were described, any update on where you think the retention rate is likely to bottom out? I think in the past you've mentioned kind of mid or low 80s?

Brian has mentioned that he thinks he expects it will bottom out at the 83% level or something like that which is roughly what we saw, the worst of the last downturn. We're actually looking at something -- it looks like stabilization in the cancelation rate. So, it was actually the dollar value, the total dollar value of cancels in the second quarter was lower than the dollar value of cancels in the first quarter.

And another number I mentioned that I think is good news is the cancelation rate amongst our newest customers which is usually your big concern during a downturn, so, those customers who have been a customer for less than five years. That renewal rate increased from 70% to 74% from the first quarter to the second quarter and I think that's a direct result of our efforts in that area to try to put more training and implementation focus over the last six months on those newer customers. If you stabilize that newer customer segment, then you're going to begin to trend towards your 89% renewal rate that you see with your most established customers.

So, big picture I think we'll keep our eye on it, but there's some reason for guarded optimism right now.

Yes. And just to add to that, I agree. I think that I definitely feel like we've kind of stabilized a little bit there. But obviously you have to give it a few quarters. It will still trend down a little bit because it's a trailing 12 month but I feel very confident that number is going to stay in the low to mid 80s as I've been saying for years. I actually think it will then start to recover as we move into next year. So, I feel like we're actually right where we thought we would be and maybe even slightly better and it's very encouraging to start to see all the signs happen the way we thought they would. But again, we want to be cautious because it is a pretty difficult environment out there.

Okay. I'll leave it there. Thanks a lot, guys.

Thank you.

Thank you. And next we'll go to the line of Jon Maietta with Needham. Please, go ahead.

Thanks very much. Congratulations on the PPR deal. It's nice to see a deal that's accretive on a non-GAAP basis and it sounds that Frank got to keep his sneakers on with 40 opportunities to evaluate in the mid and near-term.

Thank you, Jon. I plan to work Frank Carchedi to the bone. Thanks, Jon.

The first question I had, Andy, I'm just wondering if you could talk to maybe the market opportunity both here in the U.S. around PPR, particularly as you productize that offering?

Sure. I think you have to look at the value of PPR in combination with CoStar. While PPR is a great company with a well respected track record, PPR has not historically had a high quality data source from which to do their economic forecasting. With the combination of CoStar, they're going to get access to basically the best and most comprehensive database that's out there for the U.S.-U.K. and increasingly Europe. So, we should be able to produce some of the best decision support for debt and investing that's out there and that is obviously an enormous opportunity. We've done very well in that specific. PPR's done very well in that space. Combined, we think there are north of 10,000 potential customers for that kind of a product.

If you look at a global $20 trillion to $30 trillion asset class, you can have tens of thousands of interests or entities who have more than $1 billion at stake in debt or equity in commercial real estate. Right now, those folks are all universally flailing, trying to figure out what's happening in their portfolios and what direction values are taking.

So, if we're producing products that are less than a tenth of a BP of their portfolio value and there's no other entity that has our capabilities, we think it is a market segment that is well over $0.5 billion of potential revenue. We did not base the rationale for valuation of PPR on PPR's stand-alone results from this year. Rather we look at it as something that we can go in there and similar to the acquisition of comps, we think when we enhance that product with our data assets and cross sell it into our much larger customer base, we think we can dramatically grow their revenues and pursue that $0.5 billion market opportunity in that space.

And then just a follow-up, maybe if we could talk about the cross sale opportunity, what exactly is involved there from a training perspective with the sales force?

Sure. So, PPR I believe has 180 some customers. CoStar Group has more -- 1,000 to 2,000 customers that are similar to the 180 in profile, the 180 that PPR has in profile. And often those customers are paying us north of $100,000 a year for access to granular property data. The PPR product is similar to our product, but complementary in that it approaches it from the top down, from the market level down, where we approach it from the building up. We think it's a fairly straight forward training task for our sales people.

The sales force was very enthusiastic about this acquisition because the customers they talk to all the time have been saying, "Can we get multifamily data? Can we get forecasting? Can we get NOI forecasting? Can we get debt analysis tools?" And what we're doing is basically giving our sales force what they've asked for. We'll probably focus first on perhaps three dozen sales people who typically sell to institutions and we should have them cycled up by the end of the summer. The PPR sales team will continue to sell the higher end accounts for PPR but we actually think that by having the combined PPR CoStar product become more of an industry standard, the PPR existing sales team will be able to sell even more than they sold before. So, we think as we go into third and fourth quarter, this is going to be the headline of what's happening in CoStar sales.

Okay. And then, Andy, maybe in terms of other potential acquisitions, what are the some of the characteristics that you're evaluating and how do you weight them? I'm thinking of the technology architecture, sort of the features, functionality that the product the service may address in the market. How do you weight those things and what exactly are you looking for?

Sure. First of all, just looking at timing, commercial real estate, real estate has always been a cyclical business. We are clearly in a nadir. We're at the bottom of a cycle here. If we had attempted to acquire PPR on their earnings from last year or the year before at then current multiples we would have probably paid 300% more than we've paid now. And if you try to acquire PPR three years hence when the markets are recovered, you'd pay three times what you paid now.

So, we think the values right now are pretty reasonable. We like buying low as opposed to buying high generally. And what we're looking for in these companies and unfortunately there are a lot of opportunities out there this way, we're looking for a Company where if they had unfettered access to our massive content, they could dramatically increase their value proposition and could reach a much larger audience or achieve a major competitive advantage over all the other competitors in their space. That would be one thing we're looking for. We think we got that with PPR.

Another thing is we're looking for a Company with a high quality product but with a limited distribution vehicle or without a large installed customer base where we can bring our 200 some person sales organization to bear and bring our 14,000 customers to bear and our brand strength to bear and dramatically leverage their sales numbers. We think PPR fits in that category and we think we've -- the past 20 acquisitions we've definitely proven our ability to grow companies tenfold in revenue once we apply our more sales oriented culture.

Further, there are a number of companies out there that may be high quality but they may have taken on a little bit of debt and that's crippling to them. With our strong balance sheet we can actually provide liquidity to a high quality company that's stuck in the mud because of a liquidity problem. Then also, our technology is fairly transferable across the whole spectrum of real estate, commercial oriented real estate. Our data, our field research technology, and all the patents we've got there, our search and mapping capabilities, our data modeling capabilities.

Often we can go and look at a smaller scale player in this space, dramatically increase their technology capabilities and take them to a broader market. I've never, in my 20 years, I don't think I've ever seen more opportunities to basically jump in there and pick up quality names while the market's down and expand the breadth and scale of what CoStar's doing and increase the brand strength here.

Great. Just last question, Brian. If you happen to have free cash flow from the quarter and stock compensation from the quarter?

Yes. Stock comp was about $1.5 million. That's been running about $1.5 million every quarter. Obviously it will step up as I said with about $150,000 or so with equity comp each quarter with the PPR acquisition and I think it was something like $9 million or so in free cash flow.

Great. Thanks very much, guys.

Thanks, Jon. Thank you.

Thank you. And our next question then is from the line of John Neff with William Blair. Please, go ahead.

Hey, guys. Thank you.

Hi, John.

Couple questions for you here on the PPR deal and maybe, Andy, could you maybe just quick take a big picture view? I mean, between the average subscription size for REES and the average subscription size for PPR are not as big as REES but still six digits. Can you just maybe make a broad comment on why these analytics subscriptions are on average much larger than your average -- it's sort of an up market database type of subscription like you're selling?

Sure.

And what are the implications as you look to get, to have more of those over time?

Actually I'm not sure. Actually it could be that the PPR is a much higher price point than REES. So, I think there's been some conflicting data about that but, as we look at it more, we actually think that the average subscription is probably about three times higher for PPR than REES but I can't be sure but I think that's the case.

So, what's going on there is that there's a little bit more of customer involvement with a PPR and a REES than there is with a CoStar. So, our products tend to be more productized. We'll have 1,000 to 2,000 customers in that investor-owner segment. We're going to a slightly lower price point. The only customer involvement is initial training and ongoing training to make sure they're using the product, general sort of customer support and then inviting them to participate in large scale webinars. A PPR would have more direct one-on-one customer contact with PPR's economists and that tends to drive a higher price point and lower volume.

One of the things we want to do is we want to protect and evolve that sort of customer involvement in consulting that PPR has, but we want to basically take the intellectual property and productize it across our whole customer segment. We would probably end up with price points that are lower than the high touch customer involvement price points of PPR but higher than our traditional pricing. So, we're going to try to lever their forecasting, sub-market forecasting on office, multifamily, retail, industrial. We're going to try to lever the value across 2,000, 5,000 customers and in order to do that we have to be a slightly lower price point but much more significant overall are numbers and very high margin business.

Thank you for that. Then another question, could you give us the specific date that the PPR deal closed and when the shares were issues? The sort of pro-rated revenue for the rest of the year is $7 million to $7.5 million. I'm just wondering, how do we reconcile that with most of half a year left still to go and $18 million in PPR revenue that you described the company as having? Is there some deferred revenue write-down associated with the acquisition that we should be aware of?

Sure. John, I'll answer both questions. The deal closed last Friday at the end of the day. So, essentially Monday was our first day there. You're basically going to get about two-thirds or so of the revenue associated with that. The revenue is mostly subscription revenue but they do have some consulting, so they are on about an $18 million or so run rate. So, let's say $4.5 million or so a quarter. But it's not as smooth as ours so you will have some consulting going up and down. So, the pro-ration for Q3 is about two-thirds of a quarter of revenue. And then you can see the guidance for Q4 is $4 million to $4.5 million. It's right around the $18 million mark or so. The share count, what we did do is put the exact numbers in the 8K. I didn't bring it with me. But it's about 575,000 shares. We had a 25% holdback which I believe will be issued at the end of September, early October so essentially what you're going to get is you're going to get 75% of those shares will be issued, you'll have about two-thirds of a quarter where they're outstanding. And then you'll have almost all of them outstanding in the fourth quarter and then obviously you have to weight all that for the year. That's kind of how the revenue and the share counts roll off on that.

Okay. And then, here's another question and it's got some numbers so I'll go slowly here. $18 million in PPR revenue. 5% margin. I assume it's about $900,000 in EBITDA. And you talked about getting to about a 30% margin there. So, if we assume -- I'm just picking this number -- 70% of incremental sales above and beyond $18 million fall to the EBITDA line, then by my math we would need to get to about $29 million in revenue or 61% more revenue to get to that 30% EBITDA margin.

So, my question is what does that suggest about the timeframe that you're thinking about in terms of when that margin target could be achieved and what does that say about how accretive the acquisition could be in 2010?

Sure. The deal will be accretive in 2010 on an EPS basis and it is accretive for EBITDA this year. It will be accretive for EBITDA next year. We're going to be adding more EBITDA this year and more EBITDA next year. As far as when do we think we'll get to the 30% target margin, we didn't put that in there. We believe that will happen over the next few years. Obviously you have a pretty decent calculation there and I think you can back into it from there. That would be 2.6 times on the bottom line. It would be very accretive. You should be a securities analyst.

Last question, Andy, for you. Maybe a little more color on what PPR is doing for the New York set? Thank you.

The New York set is probably not keen on broad discussion of what PPR is doing for them. So, I'll keep the comments sort of brief and light and respect confidentiality. But basically, providing sort of forecasting services and market analytics, and evaluating the CMBS issues that are qualified for the TALF program.

Thanks, John.

Thank you. And we'll take a final question from Brett Huff with Stephens Inc. Please, go ahead.

Good morning, guys.

Good morning, Brett.

Hey, Brett.

I have a quick question. I'm trying to make sure that I understand the guidance and if the sort of underlying guidance changed at all for the year after adjusting for the various calculations from the PPR acquisition. I don't know what the best way to do it is. But in general, if I take for the year, I take your $1.00 to $1.05 and I adjust for the $500,000 of the deal expenses, the $500,000, the amortization, the $300,000, the equity, and then I kind of assume $400,000 add back for the EBITDA, round numbers, from the deal, I get about $0.03 of a negative impact. So, that would imply $0.97 to $1.02 for the adjustment to guidance, assuming just PPR. But you guided $0.95 to $1.00. I'm just wondering is there something in there that I'm missing or is there rounding, or just give me a sense?

No. I think it's just -- it's about $0.035 and then you've got probably about $0.01 or $0.015 based on the increase in share count. So, you've got it coming from both directions because there's a share count deal. It's plus or minus $0.04 to $0.05 all completely related to PPR.

Okay. And then also on the top line, I think this answered my question, the prior question. It sounds like there is -- you're expecting a run rate - in order to get to the $18 million in revenue, you're expecting a run rate really of 4.5% times four gives you $18 million. Is that a more reasonable estimate? Or are you more closer to the four? I'm just trying to reconcile what -- if you could give some more color on that?

Yes. It's $4.5 million not percent and, yes, the $4.5 million would be obviously equate to the $18 million annually. Their revenue though is not completely subscription-based like CoStar's. They do have some consulting services which makes their revenue pop around a little bit more. So, I think in general their revenue is going to be about between $4 million and $4.5 million a quarter depending on that consulting piece and then obviously for the third quarter you have to pro-rate it for about two-thirds of the quarter.

Okay. And then the last question is in terms of the -- you guys have talked about $100 million run rate EBITDA goal. I'm just curious. How are you guys thinking about that now? I know there were a couple factors. One was when is unemployment going to kind of moderate? What are acquisitions going to contribute? Any thoughts on that? Reiterations of that? Or color on that goal?

Yes. I think we've been saying it for a couple of quarters now. We expect to see expanding margins when we start to see positive GDP growth and some more encouraging employment figures. We believe, as we've said for a long time, that CoStar pops back fairly quickly because once you start dropping $1 million plus to the top line at 70%, 80%, you can get there quite quickly, within two, three, four quarters, for the numbers that we're talking about. We haven't seen that GDP growth and we haven't seen very encouraging employment figures. Of course, we all hope to see that over the next few quarters.

Okay. And will -- obviously you guys are going to get incremental EBITDA as you do some acquisitions and it sounds like you want to be reasonably aggressive on that. Is that part of the deal as well?

I think the core business is capable of getting to $100 million in a reasonable timeframe but that is part of the deal. We'd like to get there and go beyond. That's correct.

That's all I had. Thank you.

Great. Thanks, Brett. I believe that's our last question. With that, I'd like to thank you for joining the 2009 Second Quarter CoStar Earnings Call and we look forward to updating you next quarter.

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