CoStar Group Inc (CSGP) 2010 Q1 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the CoStar Group's first quarter 2010 conference call. On the call today are CoStar Group's CEO, Andrew Florance, CFO, Brian Radecki, and Communications Director, Tim Trainor. During today's conference all participants will be in a listen-only mode. Later there will be a question and answer session, instructions will be given at that time. (Operator Instructions). As a reminder, today's conference is being recorded. I would now like to turn the conference over to CoStar Group's Communications Director, Mr. Tim Trainor. Please go ahead.

Thank you, operator. Good morning, everyone. Welcome to CoStar Group's first quarter 2010 conference call. Before I turn the call over to our 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 Group's first quarter press release, and in CoStar's filings with the SEC, including its Form 10-K for the year ended December 31, 2009 under the heading Risk Factors.

All forward-looking statements are based on information available to CoStar on the date of this call, and CoStar assumes no obligation to update these statements. As a reminder, today's conference call is also being broadcast live over the internet at www.costar.com. A replay will be available approximately one hour after the call concludes, and remain available through May 6, 2010. To listen to the replay call 800-475-6701 within the United States or Canada, or 320-365-3844 outside the United States. The replay will also be available on CoStar's website for a period of time following the call. Thank you again for joining us. I will now turn the call over to Andy.

Thank you, Tim, I appreciate it. Welcome everyone to CoStar Group's first quarter 2010 conference call. I am very pleased to report the initial signs of economic improvement we reported last quarter have continued to strengthen throughout our business during this first quarter. And this has all resulted in strong organic quarterly sales performance, and a record $55.1 million in quarterly revenue. The $55.1 million in quarterly revenue for the first quarter of 2010, was an increase of approximately $500,000 over $54.6 million in revenue during the fourth quarter of 2009. It was about a $5 million increase over the revenues a year ago same quarter.

First quarter 2010 EBITDA was $8.8 million, and the Company's net income was $2.9 million during the first quarter. We are investing aggressively in our business in anticipation of economic recovery. We have invested by growing our sales force 32% year-over-year, with the addition of nearly 50 net new sales professionals. We have also invested in the quality and depth of our research by adding 100 net new researchers year-over-year. We believe that this distressed real estate market has presented a unique opportunity for us to control long-term occupancy costs. So we have invested by purchasing a new headquarters building and made the decision to consolidate leases in both Boston and London. We believe that advancing from what has traditionally been a research focused business, to one that includes analysis and applied research, presents a tremendous growth opportunity for our Company, and so we have added key personnel, and have acquired and we are integrating Property and Portfolio Research and Resolve Technology into CoStar Group.

With these investments coupled with ongoing organic sales momentum, we believe the Company is well-positioned to achieve accelerated high margin revenue growth as commercial real estate markets recover. We are pursuing these opportunities with the benefit of a strong balance sheet. At the end of the quarter the Company had a total of $218.5 million in cash, cash equivalents, and investments. And we have no long-term debt obligations. We had a very strong subscriber growth during the first quarter, adding 1,265 new subscribers to take our total subscriber base to 86,590. This is the third quarter in a row in which we have turned in strong subscriber growth. Our renewal rates remained very high in the first quarter of 2010. The 12-month trailing renewal rate for subscription based services improved to approximately 86% in the first quarter of 2010, from approximately 85% in the fourth quarter of 2009.

This improvement in renewal rates is a direct result of our successful efforts to retain the business of newer customers. 18 months ago we identified a need to improve our renewal rate among firms that have been customers for less than five years. We noted that on average our newer customers used the service less than our more established customers, and the lower usage rates were directly correlated with lower renewal probability. We attacked this problem by gradually changing our sales professionals' commission plan such that they were paid for the sale, the salesmen would get the commission when the customers use the service, rather than when they signed up to buy the service. The net result was a dramatic improvement in usage within new customer sites. In 2008, an average 38% of the authorized users at first year client sites were actively using our service, but by 2009 that active user rate had climbed to 53% among first year client sites. Our revised commission plan appears to have translated directly into higher new customer renewal rates and fewer failed sales.

The new customer renewal rate was 70% in the first quarter of 2009. That renewal rate has climbed to 85% in the first quarter of 2010. The average new contract value increased to $9,365 in the first quarter of 2010 from $9,143 in the fourth quarter of 2009. This increase was driven upward by the Property and Portfolio Research average new contract value of $107,383. We have had tremendous success with CoStar account executives introducing the PPR team to CoStar customers and vice versa, with the result being millions of dollars in annualized subscription value cross sold. The total number of subscription client sites remained approximately 16,000 companywide. All major business services CoStar US, PPR Showcase in the UK, had positive organic growth revenue in their local currencies for the first quarter of 2010.

We posted a second consecutive quarter of positive net bookings, the total for the first quarter of 2010 was approximately $1.6 million companywide, reflecting the positive impact of an increase in our overall gross sales. The increase in first quarter organic revenue we enjoyed this past quarter was our first quarterly increase in organic revenue since the economy went into a recession. A sustained increase in former subscribers returning to become subscribers again contributed to our organic revenue growth during the quarter. In addition to winning back these former clients, we are also seeing orders from existing customers to add additional users, services, and expand market coverage at a rate that we have not seen since before the start of the recession.

Overall, I am very encouraged by the strengthening positive trends we see in our sales activity over the past three quarters. Although we are realistic that a path to a full recovery could be choppy during this transition year, we remain optimistic that we will likely see continuing positive sales performance through the rest of 2010. One major reason for our optimism is the total potential size of the market that we see for our services. We firmly believe that we could earn hundreds of millions of dollars in potential additional annual subscription revenue by achieving higher penetration for our services throughout the US.

We also believe that there are more than 10,000 plus brokerage firms in the US that we could win as new clients. In order to pursue this opportunity, we have invested heavily in growing our sales force this year. As I mentioned earlier, we have grown our sales force headcount 32% year-over-year to take our sales force to a total of 203 personnel. This includes 127 US subscription sales reps, 8 US advertising sales reps, 43 in-house sales reps, 19 UK field sales reps, and 6 sales reps for PPR and Resolve. This was only a 3% FTE increase quarter-over-quarter.

I think it is worth noting that the quality and experience of the sales reps we have been able to onboard for this downtown has been uniformly exceptional. Our sales are benefiting from the level of sales talent available in the market, and the effective training programs we have implemented. A clear indicator of this is the average gross sales per sales rep in production. In the first quarter of 2010, this sales production measure was the highest it has been since 2007.

Sales of our Showcase online marketing service were strong this past quarter, and continue to build on the growth that our internet marketing service generated in 2009. In fact, we are fast closing in on 10,000 subscribers just two years since its launch.

At the end of the first quarter, there were approximately 9,750 total Showcase subscribers in the US, and the service is generating more than $6 million in annualized revenue. We believe that the service has been successful because of its low cost for value, its no hassle, no registration requirement before seeing the ads, and the ease of maintaining listing inventories that are already in CoStar Property. We are very pleased to announce that with the launch of Showcase in the United Kingdom this past quarter, CoStar has launched its first international service offering. We have already signed up dozens of British firms to our Showcase UK service. In fact, I think the number is 48 or 50. As we did with our Showcase launch in the US, our early adopter clients in the UK are on trial contracts. Some number of them are actually now on firm contracts.

But that is basically exactly what we do in the US, we sign people up initially on a trial contract, and a very high percentage of them went into permanent paying obligations and commitments to the service. As part of the launch, we had to complete a successful integration effort of our US and UK back end data systems. We believe that this will pave the way for more integrated and uniform international service offerings in the future. We also expect these integrated services will give us more scale in our software offerings, and I believe make our services more attractive to potential clients, thereby driving significant additional sales.

The last two quarters have provided convincing signs of economic rebound. Leasing throughout the US in the first quarter was up dramatically from one year ago, and has increased in each of the past four consecutive quarters. Tenants that put off making long-term financial commitments in the downturn, and postponed decisions in the expectation that rental rates would drop, are now getting back in the market ahead of the expected recovery, and are seeking to take advantage of the currently favorable leasing conditions.

This is driving record levels of leasing activity in the United States. And because leasing activity is the measure of total leases signed and not a measure of growth and net demand for office space or space, it is a good proxy for leasing commissions, which is likely the single largest source of revenue for our core customers. Improving leasing activity created the environment that was conducive to CoStar's first quarter solid increase in net new subscribers high customer renewal rates, and our new record quarterly revenue. Other positive economic indicators included high net absorption of vacant space, signs of vacancy stabilization, less job losses, and job growth in office-using employment segments. Also we saw continued positive GDP growth and an increase in consumer spending in March.

Most economists expect 2010 to be a transitional year for the economy. I want to take a minute to discuss the defining trends at work in the market right now, and how we believe they will impact commercial real estate for the foreseeable future, and how we expect they will affect our business. With the increase in leasing activity, flat to positive absorption, and little new construction, vacancy rates are beginning to stabilize across many markets. In fact, vacancy rates are beginning to drop in many markets.

The decline in average rental rates has slowed and rents are even turning up in some markets. One wild card, however, is that there is a lot of phantom vacancy, in the form of empty but leased office space, or space behind the thousands and thousands of companies that laid off staff during the downturn. As demand returns to the market, this phantom vacancy will likely be absorbed first which could dampen leasing demand, and ultimately the recovery itself. The investment sales debt and real estate capital markets continue to face serious challenges. Sales volumes are down from recent inflated levels.

Credit markets remain in disarray and much uncertainty exists ahead of the $1.4 trillion in commercial real estate mortgages expected to come due over the next three to four years. The combination of cap rates reverting back to long-term means, falling rents, and decreasing occupancy levels, has decimated commercial real estate values over the last two years. Last week, Dr. Ruijue Peng, Dr. Norm Miller, Dr. [Ming Zong Hong] and myself, all of CoStar, presented a paper indexing commercial real estate values via repeat sales at the National Conference of the American Real Estate Society. We co-authored this paper with Karl Case, who is famous for the Case Shiller Residential Real Estate Value Index, based on repeat sales. We believe that the index we have produced is one of the purest, most robust and authoritative indexes of commercial real estate values. Using 94,000 properties from CoStar's database that have sold more than once since 1995, we determined that commercial real estate values peaked in the third quarter of 2007, after having increased 257% from the same period a decade prior.

Commercial real estate values have since plunged 30% from that peak to year end 2009. And while commercial real estate values have climbed 4% during the first quarter of 2010, overall values are still down 27% from the third quarter of the 2007 peak. We published another paper last week at American Real Estate Society estimating the total value of the US commercial real estate stock. We estimate the current value to be approximately $10 trillion. Based on our two analyses, the industry lost approximately $4 trillion in value from the peak of the market. Keeping it in perspective, we still see our position as the leading information and analytics provider for a $10 trillion US industry as a very exciting place to be, with immense growth potential.

As for market conditions affecting current property values, we believe that more than 20% of the leveraged commercial properties in the US today have lower values than their mortgages. Because the majority of leases being signed today are at a significant discount to what they were four or five years ago, the increase in leasing activity is not expected to increase the net operating incomes of properties over the next two years. Without increases in net operating incomes, we do not expect significant increases in value. It follows that we will likely see a large number of defaults and distressed sales over the next three years. The market going forward is likely to be difficult for existing owners and lenders, but good for brokers, appraisers, and future owners. The majority of CoStar's revenue is derived from subscribers involved in leasing activity and property evaluation. We also hope to sell an increasing number of hedge funds, opportunity funds, REITs, and other future owners.

We see an opportunity to make information and market analysis CoStar offers available to the owners and lenders dealing with the new realities of the current environment. More than ever, we believe investors, lenders, appraisers, government agencies, and others involved in establishing the value of commercial property in a volatile sales market, stand to benefit from CoStar's information and applied research. For all of these reasons I believe CoStar is extremely well-positioned to capture the significant opportunities we see resulting from the current market dynamics in commercial real estate.

We have continued to see strong demand for PPR's enhanced analytic and forecasting services from CoStar's existing clients, and for CoStar's information services among PPR's existing client base. We signed $1.1 million in cross sale contracts during the first quarter of 2010, to continue the strong trend we had established in the third and fourth quarter of 2009. The integration of our two back end systems is proceeding smoothly, and PPR is now using more CoStar information to support their analysis and forecasting capabilities. Vice versa, CoStar is using a lot of the PPR analytics in our various presentations, webinars, and the like.

In the first quarter of 2010, CoStar's research team continued to expand our database to unprecedented levels, adding more than 42,000 listings, approximately 97,000 properties, and 500,000 digital images. We now have close to 3 million buildings in our US database. We have doubled the US database since the peak of the market, adding more than 1.5 million buildings since 2007. I really think that is, if you stop and reflect on that, that is an amazing number. Adding 1.5 million buildings to our database in basically a three year period. Over the last 12 months, customers accessed information on 100% of these properties. So in other words, customers actually accessed and looked at 100% of the 3 million buildings in our database. On average the average property was viewed 385 times in the last 12 months. So 3 million properties viewed almost 400 times. We believe that our impressive database growth directly corresponds to the growth in long-term potential revenue and creates increasingly higher barriers to entry.

Let me close my remarks by saying that we couldn't be happier with the clear signs of renewed strength in our business. We believe the continued improvement we have seen in sales, high renewal rates, and increasing subscriber counts are clear indications that we have entered an initial recovery and growth phase. We fully expect to achieve high margin revenue growth as the market recovery strengthens. During the downturn last year, we took the opportunity to invest in and expand our business in a number of important areas, and set the stage for increasing shareholder value in the recovery period.

CoStar has experienced tremendous growth over the past twenty plus years, and we believe that we now have become an indispensable information utility for the commercial real estate industry. Achieving a leadership position in serving the information needs of a dynamic $10 trillion industry, should not be confused with reaching a saturation point for our business. We believe CoStar Group is still in the early stages of realizing the total market potential for our research and services. Certainly, the recent severe industry downturn has slowed our progress towards our goal of reaching over $1 billion in revenue, but also reconfirmed the value of our research-based information and proven business model, with a recovery emerging some of the headwinds appear to be fading, and before long we could potentially see some tailwinds for our business. We remain singularly focused on growing CoStar's business towards $1 billion in high margin revenue. At this point, I am going turn the call over to Brian Radecki, our CFO who will walk you through the first quarter numbers. Brian.

Thank you, Andy. As Andy mentioned we are pleased to report we have achieved solid financial results for the first quarter of 2010 with record revenues, as we continue to see positive momentum in many areas of our business. Today, I am going to principally focus on the sequential results for the first quarter of 2010 compared to the fourth quarter of 2009, and also our outlook for the second quarter and full year of 2010. We believe the sequential trends offer the most insight into the performance of our business, as we continue to progress through the current economic and commercial real estate cycle.

As Andy mentioned, first quarter revenues came in stronger than anticipated at $55.1 million, an increase of approximately $0.5 million over the fourth quarter of 2009. Our record revenue performance during the quarter was primarily driven by organic companywide net new sales as Andy mentioned. Subscription revenues in the first quarter accounted for approximately 94.5% of all of our revenues. On a functional currency basis, international revenues was approximately 3.1 million pounds, which had positive organic subscription revenues in the first quarter, and in line with our expectations. International revenues were approximately 8.7% of the Company's total revenues in the first quarter. As of March 31, 2010, our 12-month trailing renewal rate, which is a measure of renewing subscription revenue was approximately 86%.

As I have publicly stated for about two years now, we expect that our 12-month trailing renewal rate to decline to the low to mid-80s in 2009, and then begin to recover in 2010. We ended 2009 at approximately 85% with our Q4 in quarter renewal rate turning up significantly. We are pleased to see our 12-month trailing renewal rate continue to increase, and move back towards the historical average of approximately 90%, as customer retention efforts and companywide contract bookings continue to improve.

Turning now to gross margin. Gross margin was approximately $33.9 million in the first quarter of 2010, and it was flat compared to Q4 of 2009. Q1's gross margin includes the full impact of PPR & Resolve's lower overall gross margin, and the investments in research, which we have discussed on previous calls. Moving down the income statement, total operating expenses for the first quarter of 2010 were $28.8 million, compared to $27.8 million in the fourth quarter of 2009, in line with our outlook for the first quarter. The increase in operating expenses as we discussed on the last call was principally due to seasonally higher payroll taxes and benefits in the first quarter, our January annual companywide sales conference, and some initial building carrying costs related to the new corporate headquarters in Washington, DC.

Turning to profitability, our first quarter 2010 net income was $2.9 million, or $0.14 per diluted share, with non-GAAP net income per diluted share of approximately $0.25, and EBITDA or earnings before interest, taxes depreciation and amortization of approximately $8.8 million. Reconciliation of EBITDA, non-GAAP net income per share, and all historical non-GAAP financial measures discussed today on this call are shown in detail in our press release issued yesterday, which is available on our website at www.costar.com.

Looking at our balance sheet, we ended the first quarter with approximately $218.5 million in cash, cash equivalents and investments. Our balance sheet also reflects the acquisition of the office building in Washington, DC for our corporate headquarters of approximately $41.25 million in cash, which we announced in February. The Company continues to have no long-term debt. I will now speak to our outlook for the second quarter and full year 2010.

As is typical, our guidance takes into account recent revenue growth rates and results may be impacted by the economic conditions in the commercial real estate or overall economy. Our forward-looking guidance reflects our current expectations as of April 21, 2010. We expect revenue for the second quarter of 2010 in the range of $54.5 million to $55.5 million, and we reiterate our full year guidance of approximately $218 million to $222 million of revenue. After the first quarter of organic sales, we are confident that we are tracking towards the middle to upper end of the annual guidance range, as we continue to expect to see positive sales trends continue as Andy mentioned. Our guidance on the impact for foreign currency exchange fluctuations in our topline results remain consistent. We do not attempt to predict the foreign exchange fluctuations, and our guidance assumes little or no volatility for the current rate. The average exchange rate for the first quarter of 2010 was GBP1.56 to US dollars, and our 2010 guidance which is unchanged, continues to assume 1.6 for the majority of the year.

Now that we have layered in full quarter of PPR Resolve and investments in research we expect cost of revenues to be stabilized, and to be in the $21 million range plus or minus a few hundred thousand. Moving down the P&L, we expect selling and marketing expenses in the second quarter of approximately $12.5 million to $13.5 million, which includes our typical second quarter increase for the annual ICSC Trade Show in May. We expect software development of approximately $4.2 million to $4.7 million, and G&A expenses to remain relatively consistent in the $10.5 million to $11.5 million range. The mechanics of our effective tax rate continue to be affected by the amount of income or loss in our UK entities. Tax expense or benefits in the UK will not be equivalent to the US rates, and therefore effective rates may be blended. In addition, any acquisitions, tax planning strategies, or large one-time gains or losses, may affect the actual tax rates for 2010.

With that in mind, we continue to currently expect the effective rate to be in the 40% to 44% range for the year, with individual quarters possibly being a little over, a little under this range. As we indicated in recent earnings calls beginning with the first quarter of 2010 results, we began adding additional non-GAAP financial disclosures. We believe that both management and investors can benefit from referring to the non-GAAP financial measures in assessing performance, and planning and forecasting future periods. For additional information please refer to the non-GAAP financial measures section of our press release posted on our website.

In terms of earnings we expect second quarter 2010 fully diluted net income per share of approximately $0.13 to $0.15, and non-GAAP net income per diluted share of approximately $0.22 to $0.24 per share. Our second quarter outlook for GAAP net income includes approximately $300,000 to $500,000 of costs related to the transition of our corporate headquarters in DC, as defined in our press release for non-GAAP net income per diluted share, which is excluded in the transition and related equity compensation costs.

For 2010, we reiterate our expectation for GAAP net income per share of approximately $0.60 to $0.65 per share. Non-GAAP net income per diluted share of $1.06 to $1.22 per share, as we expect to grow earnings in the second half of 2010 and achieve our outlook, even with the short-term dilution with net income resulting from our investments over the past 12 months that Andy mentioned, for the larger sales force, expanded research, and recent acquisitions of PPR and Resolve. For the full year 2010 we continue to expect approximately $0.04 to $0.06 per share of dilution, due to investments in Resolve Services, which we anticipate will result in additional penetration among the commercial real estate owners and investors in the future. In addition, for fiscal year 2010 we continue to expect $3 million to $3.5 million in costs related to the acquisition and transition of our corporate headquarters in Washington, DC, and approximately $1.5 million to $1.8 million in restructuring and other costs related to the leases and the consolidation of CoStar, PPR and Resolve's offices into a single location in Boston, which we expect to occur later this year.

The costs in 2010 related to the acquisition and transition of our corporate headquarters in Washington, DC are expected to primarily include overlapping occupancy costs through the end of our current lease term, and the carrying costs associated with the new building. Our current headquarters office lease expires on October 15, 2010, and we anticipate moving just slightly before that. After this period we expect to save approximately $2 million a year in occupancy costs for headquarters in 2011 compared to 2010. Once we get past the transitionary costs this year, we believe we will have created significant long-term value by reducing the Company's long-term cost structure for decades and decades to come.

In closing, we are thrilled with our record first quarter revenue results, and the momentum we are seeing in our business. Our business model remains strong, based on the fact that we have a 95% subscription based business with high renewal rates, a unique proprietary database, a market leading position, strong balance sheet, no debt, and continued high operating cash flow. We expect to return to more normalized organic growth rates and expanding margins that we have enjoyed over the past decade in the near future, as we continue to see positive trends in our business, and provided we continue to see positive trends in the overall economy. CoStar's management team believe there is significant opportunity for high additional revenue margin growth following the investments we have made in research sales and strategic acquisitions like PPR and Resolve. We continue to look forward to reporting that progress to you. And with that, I will open up the call for questions.

Thank you. (Operator Instructions). The first question comes from the line of [Peem O'Connor] with William Blair. Please go ahead.

Good morning, guys.

Good morning.

Thank you for the commentary.

You are welcome.

A couple of questions on renewal rates. Do you have any additional color around the in quarter renewal rates for first quarter?

The in quarter renewal rate was higher than the 12-month trailing. It was slightly lower than last quarter, but it was higher than the 12-month trailing quarter. So we continue to see a lot of progress there. DSOs continue to get better. Bad debt expense was down, write-offs were down, so we continue to see progress there, and we believe that the 12-month trailing renewal rate will continue to improve throughout the year, end up in the kind of high 80s.

You see quarter-over-quarter remaining in the high 80s?

Yes, we have reasonable visibility looking forward a quarter, and we don't have any reason at this point to believe that we are seeing anything but improvement in renewal rates, that is correct.

Thank you. Would you mind going over, I know you covered it earlier but again over the usage levels, especially by customer segment?

Sure. So, I think you are referring to our efforts with new customers?

Yes, that is correct.

Okay. Right. So if we end up putting 100 authorized users into a decent sized site, like a major institutional investor or something like that, we do not expect all 100 IDs to be used. We typically see about 80% plus of the IDs consistently actively used. One of the things we've noticed was that we had lower renewal rates among brand new customers, and that is because basically a manager or an officer that signed up to take on the CoStar service, once they have made a decision that doesn't necessarily mean the staff will use the product. And it could take up to five years before the staff at a particular location were really integrating CoStar in their day-to-day operations. Because of that we saw a lower renewal rate, about a 70% or 65% renewal rate among our newest customers, so we went at that by paying our sales people for actually getting new customers to use the service, rather than for signing them up, and it has been extremely effective.

The usage levels have gone from, what 30-some percent to 50-some percent among the newest customers. And we are now getting our new customers up to established customer usage levels within about two years or so, and that has translated to us seeing almost the same renewal rate for new customers as for old customers. So we are really quite happy with that, and that accelerated our path to organic growth.

And did you see the customer renewal rates for five year plus customers staying roughly in line with fourth quarter?

Correct.

Thank you. Cross sell progress with analytics, would you mind covering that a little bit? I think you mentioned $2 million in quarters 3 and 4 of PPR cross sell to CoStar subscription clients. Do you see that continuing?

Yes, that was $2 million some in the third and fourth quarter of '09, and we saw $1.1 million in the first quarter of '10. So I couldn't be happier with that. That is a phenomenal level. And we have got a very large pond of fish in there; PPR has 190, 180-some customers, and CoStar has hundreds and hundreds and hundreds of institutional customers that don't currently subscribe to PPR. So we are basically introducing the PPR sales team to those folks and continuing to get good cross sales.

And really CoStar resolves any product issues that PPR had, where they didn't have the granularity of data, and PPR resolves a lot of product issues where CoStar didn't have multifamily, or didn't have forecasting or debt modeling, so we have really got a new solution that is meeting a comprehensive need set for these institutional players, and we are having a lot of competitive wins. So as I understand it, I am hearing that a very high percentage of these cross sells are wins from a direct competitor. So that should continue on through 2010, and we will also be looking to release a new product that is somewhere between the CoStar lower price point for an institutional player and the PPR higher price point, either late 2010 or early 2011. I think that will enable us to do even more cross selling.

Very good.

I am very happy with that. Now we haven't yet begun in earnest, we have not yet begun the cross selling process between Resolve, CoStar and PPR, but I think that likewise has an awful lot of potential. We will be able to sell PPR data into Resolve, and CoStar data into Resolve, and Resolve back into the CoStar and PPR customers.

Great. Thanks. And on the sales force you mentioned net new increases, but what about on the retention side?

We have seen a dramatic improvement in retention. So obviously in this economy we have seen our turnover rate drop in half probably across the board. And we also are really quite pleased with the quality of candidates we are selecting from right now, so we have, we are bringing onboard some real A players out there on the sales side.

Okay. Average deal size increased slightly, especially, mainly driven by PPR. Could you provide a little more context about the increase, especially on the subscription side?

Sure. It is this million dollars in cross selling activity on PPR was probably ten accounts, or nine accounts. So we are selling into high value solutions into large institutions on that PPR side, so that is driving the average price point way the heck up. And as we put more financial sales people out there we should see that continue to go up. In the CoStar traditional product lines, subscription product lines in the US, I think they are basically stable, roughly the same price point. We do have some initiatives in the rest of the year, which will be targeting, actively targeting higher volume low price points on some particular customer segments, so it will probably drive the CoStar side down a little bit because of higher volume and a low end, but the PPR will be pulling it back up. So we are doing well at the high end and we are doing well at the low end pretty much (multiple speakers) competing forces.

Makes sense. And then finally just a real quick question on trends and broker headcount. What are you seeing with new customers, especially on the mid-sized brokers?

Well, I think many of those who were going to die in this downturn have died, and I have had a couple of lunches with industry leadership recently, where I think they are extremely bullish. So if you were looking at commercial real estate brokerage firms out there, I think many of them have had their best quarters ever, and I wouldn't be surprised if you didn't see some earnings surprises.

So this whole thing with leasing activity hitting a new high, it is really real. We hit the highest leasing activity number in the fourth quarter of '09. It takes about a month or so after the end of the quarter to really get a sense of where it is going to finally land, but the fourth quarter leasing number of '09 was a blow-away number. It will likely be higher than the leasing activity number we saw in 2000, which was still in the dot-com zone. So it's well above anything anything we saw in '07 or '06, and that is going to translate into leasing commissions, which is broker revenue.

So I don't see brokerage firms today reducing headcount. The only folks who would be reducing headcount would be boutique shops that really did investment sales only. But they would have reduced their headcount in the middle of '09, and they are watching their brethren over on the leasing side of the equation make a lot of money right now, and they are hoping that their turn is next. I think we are sort of past the headcount reduction phase.

Very good. And one more, I promise this is the last one. Any changes in how customers are paying? Payment cycles? Are you seeing them move from one year to quarterly perhaps?

No, actually they have been pretty consistent. The majority of our customer base pays monthly. We do have some larger accounts that like to pay quarterly or annually. But the majority have always paid monthly, even though they are under contract for a year or longer. But what I can say is that as I mentioned earlier the Accounts Receivable, the days that people are extending payments is reducing. Receivables are getting much better, bad debt write-offs are also reducing. You can definitely see it in a lot of different metrics in the business, that the clients are starting to get healthier.

Great. Thanks for the commentary. I appreciate it.

The next question comes from the line of Jon Maietta with Needham & Company. Please go ahead.

Thanks very much.

Good morning, Jon.

Good morning. First question I had was around just to piggyback off that question around cross sell opportunities. To what extent is the installed base -- CoStar's installed base familiar with PPR Resolve? I am just trying to get a sense as to what level of education has to be put forth when you are trying to upsell those two platforms.

I would actually think that the awareness would be fairly low at this point for Resolve realistically. I think Resolve has one sales person to cover the United States of America. PPR had four or five sales people to cover the United States. Neither firm engaged in aggressive marketing activities. These firms are historically targeting the very top of the institutional stack, and what we are doing is bringing a much broader sales and marketing approach to their organization. So, with an average price point north of $100,000 annually, where you are expecting to have multi-year contracts these are reasonably high end sales, and they are done with direct field sales force, and typically two meetings. So it is something with education process occurs face-to-face, and it is fairly straightforward.

But I think that when you bring 100 sales people to bear on something where you had one or four, you can expect a lot of cross selling potential. And these are great products. The PPR products have the forecast, the analysis that our economists are doing there. It is very high quality stuff. We believe it is industry-leading. The Resolve product I believe has a ton of potential. Once you get that meeting, the education process is fairly straightforward, and I think this whole cross selling has a lot of legs to it.

Got it. Okay. That is helpful. And a question for you around property owners, that is certainly the segment in the economy that is suffering the most. Do you have a sense as to when do you think the owners face sort of the toughest time period? Is it 2010? Is it 2011? Is it 2012? When does pretend and extend sort of come up and hit these guys in the face?

Right. I can also give you some specific numbers. We just did a survey in the UK, and 72% of the, I believe it was 72% of the respondents were familiar with CoStar, and I believe it was single-digit were familiar with PPR. Unaided so very boutique. On the when do owners confront extend and pretend, well, I noticed the owner of our building is now turning off every other light in the stairwell and in the lobby, so I am guessing that is an aggressive cost cutting move or an effort to try to get Energy Star.

So I am thinking that you have got a high percentage of the loans that were issued in 2007 at the peak of the market were five year bubble loans, non-amortizing loans so they are going to roll, the peak of the worst loans will roll in 2012 but there was still a lot of very bubble-like activity in 2006, which will roll in 2011. So I think '11 and '12 will be, you look at the volume of activity that occurred in '06 and '07, and it was phenomenal and so that will be, '11 and '12 should be a fairly hairy year and they are going to be hoping that the lack of supply will bring up rents in time to make it possible to refinance those loans.

But I think you will be seeing a steady stream of folks coming to reality, the mid-part of '10 all the way through to '17, 2017. Because you have got the ten-year CMBS loans from '06 and '07, '05, '06, '07, rolling ten years off that. So I think you are going have small percentage, single-digit percentage of the owners really facing the music each year for the next five or six years.

Okay. And then just the last question from me is where does the UK sit, in terms of what they are seeing with regard to absorption trends, vacancy rates, so on and so forth?

Identical.

Okay.

For example, they would argue that there are, I think they are probably a bit overly euphoric about the pace of recovery. To me it feels about the same. As an example, though, rents in the city are up 12% quarter-over-quarter. And now I think they are not really looking at free rent, so they are probably up 7% to 8% but that is actually happening in a couple of US markets right now, so I think it is similar. One of the differences is they have got more supply than we do, so I think that their vacancy recovery will be a little bit slower. But pretty much the atmosphere is identical in both markets. There is an optimism that things are actually improving dramatically.

Got it. Okay. Thanks, guys.

Thanks, Jon.

The next question comes from the line of Ian Corydon from B. Riley & Company. Please go ahead.

Thanks. On the SHOWCASE side, what is the renewal rate like for that product, and will you continue to give us subs on a quarterly basis just for modeling purposes?

Yes, we will give subs on a quarterly basis for modeling. The product is being, I guess there are two answers there. One is the firm level subscriptions where the renewal rate would probably be closer to our traditional 80%-plus renewal rates. We also have the individual subscriptions which are going to be sold on a month-to-month basis, and often they are sold to people who have one or two listings, so when those listings actually lease up they don't renew. So you have a much lower renewal rate on the individual Showcase. It is better as I understand it, we have a higher renewal rate on the individual subs than do some of our industry competitors, but it is not as high as our firm level subscriptions, and it is sort of stabilizing as it is finding a balance point.

Okay. And on PPR, you mentioned you got a couple of competitive wins. On what basis are you getting those, and then are there any other milestones we should be looking at for integration of that business, besides the late 2010, early 2011 release?

We have an incredibly compelling value proposition to an institutional player right now. Many of our competitors, if you look at the evolution of this business of providing analysis and forecasting for commercial real estate, back ten years ago, nobody had a database for commercial real estate for the United States. So people were out there reading, economists would read the tea leaves of what was happening in employment and GDP, and try to guess as to what was occurring in vacancy rates, leasing activity, rental rates, and the like.

There was a lot of sampling and estimation occurring in producing key industry indicators. CoStar Group if you look at our budget for research over the last 15 years it has been approaching 10,000 people year, or man year effort with nearly $1 billion expended in collecting this information, and millions and millions of interviews. So we actually have the first census level representation of what is happening in the market within CoStar Group. And so we are sampling the majority of the active buildings on a 30 day cycle.

Our second closest competitor is sampling a subset of that on an annual cycle. Imagine that you were trying to buy equities information service from someone, and you needed to know what the NASDAQ closed at yesterday, and one company was sampling all of the stocks of the NASDAQ every day, to come up with what the NASDAQ closed at, and the other company was sampling 1/52 of the NASDAQ each week for the prior year, and they were, the stocks they hadn't sampled in 30 weeks they were estimating what they would be at today based on what they sampled yesterday. That is what our competitor does. They do a lot of sampling and estimation where we are actually presenting actual numbers, or 30 day cycle numbers.

You take that level of advantage and granular data, and then you bring on the PPR analytics team where we have more PhDs and Masters economists than some of our competitors have total staff including the receptionist, and so we have got incredibly robust. So watching Dr. Ruijue Peng present the mathematics on our repeat sales index to a room of 40 or 50 real estate professors at the American Real Estate Society, and watching their eyes glaze over at the math she was presenting and the alternative methods, and whatnot, as to how she would do this index, we are at the cutting edge on the forecasting and analytics side, while we have this advantage in granular data, and this is fairly easy for our sales people to present on the strength of this combination.

We are doing very well on the competitive front and our primary competitors in this area are only competing on price at this point. So they are going downmarket on price. If you were managing a $100 billion real estate portfolio, I would question, how often are people going to go for a $20,000 annual cost savings for information, when they are managing a $100 billion portfolio or larger. So that is why I think we are doing really well.

And now going forward, we are very excited and this has really captured the imagination of the traditional CoStar staff and the traditional PPR staff, because the kinds of products and tools we can produce in combination are phenomenal. We are actually having a retreat next week where we are going over some of these products and tools.

I think we are going to be able to make a quantum leap over the state-of-the-art, and there will be, there won't be any one release or any one integration point. Like integration is already occurring. We have already, all of the comparable sale data that PPR is using is now coming in directly in from CoStar. Within the year will be all their vacancy and that sort of information will be coming in from CoStar. But the product evolution that will be created through this integration, that will be ongoing and you will be seeing product releases, biannually for years off of this combination. And the Resolve product integration releases will probably be even more impactful beginning in 2011 most likely. So this thing has got a lot of legs to it and it is pretty exciting.

Okay. And last question is just on the market size. What do you think the size of the market for that kind of product is today, and how big can it be, five or ten years from now?

I think it is multi-hundreds of millions of dollars. CoStar is doing tens of millions of revenue selling institutional customers. PPR is doing roughly in the $20 million plus range. We see competitors in other foreign cities doing more than $10 million in individual cities in revenue. You can interpolate that out pretty quickly to that being a north of $200 million, $250 million revenue market in the United States, if one competitor can do those kinds of numbers in one city. So we think it is a very significant marketplace.

Then when you start building in the ability to do what Resolve does, which is warehouse all of the different data streams on a portfolio of properties for an institutional player, and apply continuous valuation and risk information to that portfolio, I think that is a whole new market which I think is, I wouldn't be ready to hazard a guess, but I think that is a pretty significant marketplace as well.

Great, thanks a lot.

The next question comes from the line of Brett Huff with Stephens. Please go ahead.

Good morning and congratulations on a nice quarter.

Thank you, Brett.

Thanks, Brett.

Brian, somebody asked the beginning question, and I was distracted what the in quarter retention rate was?

The in quarter retention rate is above obviously the 12-month trailing, and that is one reason why we believe that number will continue to go up. It was slightly below what it was last quarter, but it was above the 12-month trailing.

Okay. Thank you. Did you give Resolve and PPR revenue? I know they are being integrated, but just to try to get to an organic growth calc, any estimates there?

I think last year when we talked about earnings for this year, we said that PPR was in the $18 million range or so when we got them, and Resolve was in the $3 million to $4 million range. So you will be able to kind of back into the organic growth rate this year based on those numbers.

Okay. And then Andy, you had talked about organic sales strength, I guess both you and Brian did. When you say organic sales are you using sales and revenue interchangeably, or should we take that as both revenue organic growth was pretty good, but the sales and bookings were also good and we should see that roll forward? Can you just distinguish those, if you can?

Sure. I think they were both strong. So that would be, your are right. So retrospectively and forward-looking things are looking good. The other thing is that it is looking good across the board. So there was no one region in the United States that appeared to be, or the United Kingdom that was still lagging. All regions and all sectors appeared to be doing well and moving upward. So it was across-the-board good news.

And Brett, Andy does use that interchangeably. What I will say to that is that, it is not like we have a big installation lag like some companies you might buy a product and have to install it, so you can kind of take a bookings number and say gee, it is a really strong bookings number and it will roll through the next quarter or two quarters. Ours everything is fairly instantaneous. You could have a little bit from March sales going into April, but essentially us believing that we are going be organic again for the second quarter is more about our confidence in the pipeline, and what we actually think we are going to actually sell in the second quarter, to just to kind of keep a little clarity.

Helpful. Can you just update us on what you think sort of the margin profile does? I know that you are optimistic this is sort of a transition year and you have got some diluted things going on that will help in the medium term. You have talked specifically about the $2 million year-over-year that should go away presumably out of G&A, because of the building costs. Can you point to any other things specifically where, the 2011, say expenses should be flat or down, versus what we presume will be sort of a rising revenue environment?

Yes, I mean I think in my guidance I kind of always walk through the sections and we talked with cost of revenues, I believe that this quarter is kind of our first full quarter where we have got PPR, Resolve, the investments in research. It will fluctuate a little bit, a couple hundred thousand dollars here and there, depending on headcount. We moved down to DC, that might fluctuate that number a little bit. I think you can view that as a fairly stabilized rate. At some point here, we will go back to having, right now there is no CPI increases in revenue, there are also no CPI increases for the staff. At some point between here and the end of the year next year I am sure we will get to that.

Eventually you will get back to a more normalized environment where all of your cost structure will go up by some CPI escalation number, but of course that will be mainly offset by revenue. I think you can look at that line which is $21 million, it is the majority of our cost structure is relatively stable now, so as you start dropping revenue from the topline, it will obviously drop right through to the cost of sales into the gross margin line. As far as the other operating expenses go, I gave pretty specific guidance on each one of those. I think the sales force as Andy talked about is relatively stable. It has obviously increased a lot last year, so if you look at year-over-year the numbers are going to look significant, but quarter over quarter they only went up three. That cost structure will be relatively stable also.

Again, taking into account just some of the seasonality of things that we do, like our annual sales conference, or ICSC, those types of things. Development line, that is actually a pretty small number, it is always in the $4.5 million range, plus or minus a few hundred thousand dollars. That might increase slightly this year. We are doing some investments in development in Resolve, and some other areas. Again, it is not significant. And then G&A, of course that is the big number that you talked about, obviously we will definitely see a couple million dollars savings as we go into next year, as we eliminate some of these duplicative costs on headquarters.

All-in-all I think as you get through this year as a transition year, and get to dropping revenue from the topline and the bottom line, it will start looking a lot more like it did back in 2007. I think everyone remembers what the business model can do when you are in a normalized environment, so I think we are pretty excited about that.

Okay. And then Andy, did you give new customer sites? I think you gave total new customer subs, but did you give sites?

I thought it was about off the top of my head about --

It was the same as the usual.

About the same. I think it was 16,000 or so. I can give you that exact up in. It is about 16,000. I have got it here some where. It was pretty flat.

I just wonder because --

New subscribing firms in quarter went from 423 in the fourth quarter of 2009, to 494 in the first quarter of 2010.

All right, that is what I need. Thank you for your help. That is all I have.

Thanks, Brett.

The next question comes from the line of Jim Wilson with JMP Securities. Please go ahead.

Hello, Mr. Wilson.

How are you?

Good, hi Jim.

Thanks for all of that demo two or three weeks ago. That was helpful. Wondering kind of out of, we talk a lot about cross selling and the distinct products of three, and how powerful they are, which I agree from what I have seen. How about integration of them, and the process of it in the sense of being able to integrate the tools right inside a CoStar desktop of what PPR and Resolve offer, how long that will take, and how you see customer interest in that, or that some might be waiting for a kind of fully integrated desktop before they take the next step of paying you more money? How would you characterize that or outline it?

Our goal is to, we have a big conference on the institutional side up in Cape Cod each year in the fall. And our goal is to demonstrate some prototype product for that conference. We will not actually release that likely until beginning of 2011. And then Resolve integration, for the Resolve integration what you are really trying to do there is take key variables used in valuing or reporting on the assets inside of a portfolio, and automate the flow of those variables from CoStar and PPR into Resolve. I think that will likely happen in 2011. And that is in process. One of the things we are doing, which we mentioned when we consolidate all of those leases in Boston or reconsolidate the various leases in London, we are putting the people from Resolve in the same physical office space as the people from PPR and the people from CoStar, we are moving technical and analytic personnel up to Boston, so that everyone is in one zone so they can work as productively as possible on this integration effort, which is fairly quantitative and hardcore. I don't think we have a issue where, I don't think we have a big issue where customers are waiting to see this happen.

I think they get it, they understand wow, when you put these things together it will be pretty powerful, but integration is already occurring. They are already seeing the number of comparable sales that go into the analysis of valuation trends increase tenfold. So they are already seeing a benefit from it right now. I think there will be there will be some things we look forward to getting past, like when we change the forecast models to use a different dataset, and have to align the different indexes, that will be something that happens within the next 12 months. But I think we are already well on path. And right now the IT organizations for CoStar and PPR are already integrated, so we are already basically one group is already controlling the code for both organizations. It is definitely easier than integrating a European and a US information set, for instance.

All right, great, that is all I had left.

Thanks.

The next question comes from the line of Vance Edelson with Morgan Stanley. Please go ahead.

Hi, thanks a lot. First just a housekeeping question. With net new customers of 1,265, any idea what the gross add number was? In other words, how many actual customers came online before you back out those who left?

Vance, I don't think we have been reporting that. We have just been reporting the net numbers so we will probably continue to report the net number moving forward. It would probably similar to the renewal rate so you can back into it if you want to.

Okay, got is.

And I am not sure what the number is.

Just trying to find out how many customers were added. Given that net adds declined sequentially, what would you say the reason for that was? It sounds like things are looking up a bit for the targeted customer base, with leasing activity picking up dramatically as you mentioned, so just trying to get a feel for why the net adds would decline? Is there some seasonality there?

It is actually the mix is the issue. Again, we are selling our organization is selling product that is $600 a year to subscribe to, and simultaneously selling product that is $1 million dollars a year to subscribe to. So what happened between Q4 and Q1 was the mix changed, and so you had fewer of the low end sales and more of the high end sales occurring, and that is why it went from 1,700 net new adds to 1,200, but got more organic growth.

And I think, Vance, I think that you will continue to see that flip around all year long because of some of the things that Andy mentioned before. We are kind of selling barbells at the high end, and cross selling with PPR, but as Andy mentioned, we are also introducing new low rent service products in certain geographies this year. So just depending on when we release those, that mix could keep flipping all year.

And it will change based on for an example we had 20 sales people being repositioned and retrained for a new product area, and so as those folks go online and are being transitioned to a new product initiative, you have got a brief pause in low end sales on another product area. So it will be a little bumpy that way, but the overall revenue result will be fairly predictable.

I think that is where I end up on it, Vance, is that that could flip back and forth based on the initiatives that we have going at lower end product or higher end product, but ultimately as we produce organic revenue growth that is really the end result.

Got it and that also covers what would have been my next question on the customer profile. Maybe one last one for you. The acquisition pipeline, anything you can comment on? Are you looking for more M&A out there?

We definitely are. We think that there are still opportunities out there we are interested in. We are actively and continuously out there talking to people, and looking for things. So I would not say that shut down or is over. It is just a question of timing, and when something we like comes up, and we are still, we are probably walking away from four out of five deals because we don't like the valuation.

Okay.

And so, Vance, and anyone listening out there, we are still very interested. It is Andy@CoStar.com or Brian@CoStar.com. We would love to chat if you are reasonable on valuation.

We will try and get them in touch with you. Thanks, guys.

But we are not looking to pick up Morgan Stanley. Can't afford it.

Right.

There are no more further questions. Please continue.

At this point I would like to thank everyone for joining us for the Q1 earnings call update, and I hope you appreciate that I kept my comments down to nine pages. Look forward to talking to you again in the second quarter. Bye-bye.

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