CoStar Group Inc (CSGP) 2010 Q2 法說會逐字稿

Welcome to the CoStar Group second quarter 2010 conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time.

(Operator Instructions)

As a reminder, this conference is being recorded. I'd like to turn the conference over to your first speaker, Mr. Tim Trainor. Please go ahead.

Thank you, Operator, and good morning, everyone. Welcome to CoStar Group's second quarter 2010 conference call.

Before I turn the call over to CoStar's CEO, Andrew Florance, let me state that certain portions of this discussion contains 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 2010 press release issued yesterday, and in CoStar's filings with the SEC, including CoStar's Form 10-K for the period ended December 31, 2009, and CoStar's Form 10-Q for the quarter ended March 31, 2010, under the heading Risk Factors. All forward-looking statements are based on information available to CoStar on the date of this call, and CoStar assume no obligation to update these statements.

You can find a webcast of this conference call on our web site at www.costar.com/corporate/investor.

Thank you for joining us. I will now turn the call over to Andy Florance.

Thank you, Tim. Welcome, everyone, to CoStar Group's second quarter 2010 conference call. This is the first quarterly conference call we're making from our new headquarters building at 1331 L Street in downtown Washington, D.C.

I'm very pleased to report that, with continued signs of stabilization in the commercial real estate economy, CoStar Group can report accelerating revenue growth and climbing renewal rates. Our sales bookings doubled quarter over quarter, and our end quarter renewal rate climbed to a very impressive annualized rate of approximately 92%. We posted another consecutive quarterly revenue record of $55.8 million, which is an increase of $5.7 million over second quarter 2009 revenues of $50.1 million. The Company added $11.6 million in cash to the balance sheet during the second quarter. Our total cash, cash equivalents and investments on hand now total $230 million, and the Company continues to have no long-term debt or mortgage debt.

Because 94% of CoStar's revenue is subscription-based, and because we have historically achieved high renewal rates in the 90%-plus range, we believe that CoStar Group is not a highly cyclical business, and is generally a bit more defensive. Despite that fact, history shows that CoStar's revenues have grown dramatically faster during a stronger commercial real estate market than in a declining one. For that reason, I would like to begin today's conference call by sharing with you in more detail some important positive indications we continue to see emerging in the commercial real estate economy.

Perhaps the most significant recent development is that office vacancy rates have stopped climbing, and appear now to have stabilized. After having experienced one of the most dramatic losses in US jobs since World War II, job losses appear to have bottomed out, and we're beginning to see consistent job growth. In the last eight recessions we have had since World War II, the rate of job recovery has been roughly symmetrical to that of job losses. Economy.com is forecasting strong job growth over the next several years. If this were the case, it would indicate the potential for a strong commercial real estate recovery over these next several years as well.

The US has already experienced three consecutive quarters of office-using job growth, for a total gain of 200,000 jobs. I believe that the strong year-over-year overall growth in corporate profits we are seeing is a good leading indicator for continued job growth. Important leading indicators, such as temporary employment and weekly hours worked, are also showing a continued positive trend. While economic woes in Greece are still threatening, I find it useful to keep in perspective that the size of Greece's economy is smaller than Philadelphia's.

The nature of job losses in this recession was somewhat unique. This time around, the extensive job losses did not result in a very large amount of negative office absorption. In the dotcom bust, the job losses came from a smaller number of companies that eliminated most, if not all, of their staffs. Those sorts of job losses resulted in immediate and concentrated negative absorption of office space. This time around, job cuts were spread more broadly across many companies, many of which reduced their staffs by 10% to 15% across the board. Companies that cut 10% of their staff typically do not immediately put excess office space back into the market, so this mitigates the scale of negative absorption. And as rents have fallen over the past several years, many tenants may simply retain this less expensive excess office space. The bottom line is that less space has come flooding back into the market than most experts expected.

We have seen solid leasing activity levels over the past four quarters, and that trend continued in the second quarter of this year, as we recorded 6 million square feet of positive net absorption of US office space during the quarter. This is very good news for our core customers, as leasing commissions are a major source of the revenue. In 2009, 15 of the top 20 largest US cities suffered negative absorption of office space. But year-to-date in 2010, only nine of top 20 cities have measured any discernible negative absorption. Office leasing and absorption are recovering.

Commercial real estate construction levels in the US are stunningly low right now. Due to falling rents, declining values and increasing defaults, and incredibly tight credit, new deliveries are at their lowest levels post-World War II. In fact, we believe that the amount of commercial real estate being built is less than the physical deterioration rate of commercial buildings, resulting in a net effective contraction of commercial inventory in the US.

Commercial credit markets remain very tight, with stringent underwriting and large equity investment requirements on the part of borrowers. Most banks and traditional lenders have reduced their exposure to commercial real estate, as CMBS mortgages continue to show increasing rates of default. With the current financing constraints, we are not likely to see an increase in commercial construction starts in the near future.

Taken together, positive net absorption in the absence of new supply means that for the first time in years, office vacancy rates have stabilized and are virtually flat. Last year, vacancy rates were climbing by as much as 50 basis points per quarter. But in the second quarter of this year, they barely moved three basis points. In fact, fully half the top 20 US markets saw vacancy rates decline during the second quarter. I believe we have now seen the bottom of the supply/demand imbalance in the office market.

A recent article in the "Wall Street Journal" reported that office vacancy rates were still climbing. This article relied on a source that has a tiny fraction of the research resources that CoStar has. We believe that the source has some around 120th the number of people conducting research that CoStar has, and we don't believe they have a credible way of measuring actual absorption reliably. Therefore, they can only model it. I think the source guessed wrong in its assessments, particularly about job growth impacting negative absorption, and as a result, the article provided a terribly misleading account of the state of the industry to Wall Street.

I believe that a much more accurate, research-backed assessment, is that the commercial real estate industry is showing obvious signs of initial recovery. Rental rates are even beginning to stabilize. In fact, if the job growth that Economy.com projects materializes, and construction levels stay as low as we believe, we have every reason to expect this recovery to continue, and in fact, we might see rapidly falling vacancy rates within the next three years in some markets. This in turn would be expected to lead to rapid recovery in rents in many office markets.

The nearly complete withdrawal of CMBS as a debt source for commercial real estate still has the capital markets nearly paralyzed. The [values that] remain are the debt markets. Values remain down, but they are no longer falling, and in fact have begun to move back up slightly. If vacancy rates do fall, causing rents and eventually NOIs to climb, then the refinancing landmine that many analysts have feared may never fully materialize, since equity investors would likely be eager to take out the debt.

At the recent ICSC convention, it seemed that hundreds of prospective buyers came by our booth looking for ways to find distressed properties. There appears to be so much pent up investor interest targeting distressed property that any property labeled "distressed" that hits the market attracts multiple bids, and often ends up selling for a not-so-distressed price, especially in those primary markets currently favored by investors. In fact, we have seen prices for recent Washington D.C. office sales hit the $800 per square foot mark again. I think if the market is flooded with buyers, even distressed buyers, then perhaps sellers may have some reason to be optimistic. The bottom line is that we are increasingly but guardedly optimistic that we may be coming out of the worst of this commercial real estate downturn. We believe that this is great news for our revenue growth prospects over the next several years. In light of these indications of recovery, for the first time in years we have begun to reinstate modest price increases just slightly above inflation.

With the benefit of an improving commercial real estate market and larger, more experienced sales force, our sales showed good results in the second quarter. In addition to generating very high customer renewal rates, quarterly bookings more than doubled companywide, as I mentioned. Annualized net new bookings were positive for the third consecutive quarter. The total for the second quarter was $3.7 million. That's more than double the first quarter bookings that totaled approximately $1.6 million. The biggest driver of our strengthening organic revenue growth this quarter was our US flagship CoStar Property Professional Suite Information Service. So our strengthening revenue growth is coming from our core product, and it's somewhat equal across the regions of the country.

The end quarter renewal rate for annual subscription-based services jumped to approximately 92% during the second quarter, from approximately 87% in the first quarter of 2010. The 12-month trailing renewal rate also increased during the second quarter to approximately 88%, from approximately 86% in the first quarter 2010.

As I have described in previous calls, we've made a concerted effort throughout the recession to retain the business of our customers, with a particular focus on our new customers. We restructured the commission rates of our sales force to focus on driving early usage and accelerated adoption of our products at new customer sites. We believe this effort was very successful, as the renewal rate for firms that have been clients for less than five years increased from approximately 74% in the second quarter of 2009 to approximately 88% in the second quarter of 2010.

Our renewal rate for clients that have been customers for five years or more climbed to approximately 97% in the second quarter, 97%. When you consider this renewal rate figure does not exclude clients who canceled for bankruptcy or unfortunately even death, this number's phenomenal. Clearly, sales conditions for our services are better than they were last year; with leasing activity up, commissions are up. That's the core revenue driver for our clients. We're seeing a big improvement in the financial health of our clients compared with last year, and more of them are adding users and subscribing to additional territories compared with last year.

The total number of subscription clients increased to 16,200 -- or subscription client sites increased to 16,297 Companywide during the second quarter of 2010, from 15,995 in the first quarter. The total number of individual overall subscribers dipped slightly during the second quarter, to a total of 86,317, from 86,590 in the first quarter. The number of individual subscribers in the US, however, increased during the quarter by 446, but a drop in the UK subscribers offset this number.

This drop in the UK occurred for several reasons. We renewed several of our major UK clients in the second quarter that during the course of the last self years have reduced their head count. In the United kingdom, you have -- it's much more likely that the brokers or surveyors are salary-based, unlike the US, where they are commission-based. This puts more pressure on the surveyors and brokerage firms in the United Kingdom to cut head count during a downturn, and this doesn't happen the same way in the US. So when these firms renewed, they did so at lower subscriber numbers. Secondly, during the second quarter, the UK sales force devoted a very significant percentage of its time and effort to launching our Showcase product in the UK. I believe their efforts have been very successful, but they predominantly targeted existing clients; so as they sign these people up, these sales do not result in net new subscriber growth.

As I indicated last call, our first quarter average contract value reflected an unusually big sales quarter or high-ticket sales quarter for PPR. Those sales for PPR were nearly double the typical quarterly average. So the overall second quarter average contract value fell to $7,031, reflecting the return to more normalized sales for PPR during the quarter. It also reflects the large number of sales made to new customers, who tend to be small to mid-sized firms. In fact, the second quarter saw the highest total sales to new customers since the quarter of -- the second quarter 2007. While these smaller to mid-sized firms tend to sign contracts at lower price points, we believe they present excellent upsell opportunities.

During the second quarter, we introduced a new bundling of our US products targeting small firms. Essentially, this packaging consists of elements of our popular flagship information products, together with Showcase, as being offered in certain secondary and tertiary markets. Like Showcase, it is available on an individual subscription basis at an affordable rate. Excluding these agreements, we signed 570 new agreements during the second quarter, with an average annualized contract buy of $8,141.

As we've previously mentioned on our calls, we have previously invested in growing our sales force ahead of the expected recovery. At the end of the second quarter, we had a total of 194 sales reps, slightly less than the 203 on staff at the end of the first quarter. This includes 126 US subscription sales reps, seven US advertising sales reps, 38 in-house sales reps, 19 UK field sales reps, and four sales reps for PPR and Resolve.

Overall, I'm very encouraged by the strengthening positive trends we've seen in our sales activity over the first half of this year. We certainly realize and expect that we'll likely see up and down sales months during a transition year, but we remain very optimistic that we'll see continuing positive sales performance overall for the rest of 2010. Accordingly, we are revising our guidance upward for the year, and Brian will explain that shortly.

I do want to take a moment to highlight a particular benchmark of success for our retail real estate product offerings. We have now signed up as clients nine of the ten largest retail property owners in the US, as ranked by Retail Traffic Magazine. In addition, during the quarter we continued to sign up major retailers to the CoStar service, such as Denny's, Taco Bell, Dollar Tree, and a very major coffee retailer we cannot disclose.

I believe that the tremendous growth of our retail database over the past five years allows to us offer dramatically better retail property information today. Thanks to our research team, CoStar now attracts more retail properties than any other information provider. Today we have nearly 600,000 for lease and for sale retail listings in our database, with approximately 1.4 million US retail properties. With the increase in the size and value of our retail database, CoStar's becoming more of a household name in the retail industry, and we expect to see many more sales from the retail sector, which I believe offers tremendous growth potential for our services.

Our Showcase online marketing service reached an important milestone during the second quarter, by exceeding 10,000 subscribers in just a little more than two years after our initial US launch. I definitely have to congratulate our sales force for that accomplishment. At the end of the second quarter, there were approximately 10,110 total Showcase subscribers in the US, and the service is generating approximately $6 million in annualized revenue. Focusing on individual subscribers paying for Internet CRE advertising, we believe that we have succeeded in achieving a market share nearly comparable with that of our major competitors in that space in a very, very short period of time.

As I mentioned, we recently introduced Showcase to the United Kingdom. Since this is CoStar's first truly international software offering, this launch represents an important milestone for the Company. Just as we did when we launched Showcase in the US, many of our first UK subscribers are on trial contracts. We expect to convert a large percentage of early clients in the UK who are now on these trial contracts, just as we did in the US. At this early initial point, we already have nearly 1,000 individual Showcase subscribers in the UK, 372 of which are already paying subscribers, not on trials.

I'd like to take a moment to also brief you on several initiatives of this past quarter. In two weeks, CoStar's releasing the industry's first comprehensive repeat sales index for commercial real estate. We believe that this is the first reliable repeat sales index for our industry. The index is expected to provide investors with the clearest and most rigorously accurate insight on price movement in commercial real estate assets. Over the past two decades, repeat sale regression analysis has become the most acceptable method for analyzing and understanding price movements within markets, in part because of the popularity established in the housing market by the Standard & Poor/Case-Shiller repeat sales index. The CoStar commercial repeat sales index is made possible because of our unique database of 1.3 million sales comparables, with nearly 85,000 usable repeat sales pairs.

We presented the methodology and model for the repeat sales index at the American Real Estate Society earlier this year in a paper lead-authored by Dr. [Raju Pang] of CoStar Group, and assisted by Dr. Norm Miller of CoStar Group and Dr. [Ming Jan Hong], along with myself and Dr. Karl "Chip" Case. Chip is famous as one of the founders of the Case/Shiller residential real estate value index, and I believe was Dr. Pang's thesis advisor. Investors in other industries have come to value these indices for providing greater transparency and insight into market dynamics. We expect to produce monthly updates on the first Thursday of each month, to serve as timely indicators of the overall health of the commercial real estate industry. CoStar subscribers will have access to the full of indices, which will include subcategories by price level segment, property type and by region.

We announced during the second quarter that we plan to develop powerful discounted cash flow CRE evaluation software, and ultimately introduce specialized automated valuation modeling AVMs for commercial real estate assets and portfolios. To direct this ambitious effort, we recently hired Jeff Wells, who joined our Resolve technology team in Boston as Vice President. Jeff has a long and distinguished career developing and refining much of the real estate valuation software in use today. Over the course of his career, he's worked with hundreds of real estate clients to create software products that address a wide range of real estate investment applications.

Discounted cash software is widely used by investors to evaluate portfolios, and analyze the expected future financial performance of potential real estate investments. However, the forecast and financial performance projections they make are only as accurate and useful as the data used in their analysis and underlying assumptions. Building and updating these models is an arduous and expensive task, but very, very important. We see an opportunity to take advantage of our unique extensive research-based data, analytical expertise and software development resources resulting from the combination of CoStar, PPR and Resolve, to provide automated, easier to use discounted cash flow forecasting and valuation capabilities. Our primary goal is to produce tools that make our research and analytics even more valuable to current and prospective clients.

PPR continued to see strong demand for its analytic and forecasting services during the quarter, both from its own client base and in cross-selling opportunities with CoStar's existing clients. We signed $500,000 in cross-sell contracts during the second quarter of 2010. With its continued strong sales performance, PPR remains ahead of year-to-date plans. We also continue to benefit from the growing recognition in the market of the value of the combination of CoStar and PPR. Several new clients have cited our combination as the determining factor of a selection of their selection of an information provider.

During the first two quarters of this year, CoStar's research team continue to expand our database, adding more than 64,000 listings net, and approximately 173,000 properties, and approximately 865,000 new digital images. We now have more than 3.7 million properties in our database. We believe that our impressive database growth corresponds to long-term potential revenue growth, and creates increasingly high barriers to entry.

Let me close my remarks by saying that I'm very pleased with our Company's performance over the first half of this year. Increasing sales, higher renewal rates and solid revenue growth clearly demonstrate renewed strength in our business. Based on our outlook, we fully expect to continue to achieve high margin revenue growth as the economic recovery strengthens in the second half of this year, and continuing into 2011.

At this point, I'll turn the call over to our Chief Financial Officer, Mr. Brian Radecki.

Great. Thank you, Andy.

As Andy mentioned, we're very pleased with our second quarter 2010 results. We achieved record revenues for the third consecutive quarter, and saw positive momentum continue in many, many areas of the business. Today, I'm going focus principally on sequential results for the second quarter of 2010 compared to the first quarter of 2010, and also on our outlook for the third quarter and full year. We believe 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.

Our second quarter revenues came in stronger than anticipated at $55.8 million, an increase of $700,000 over the first quarter, and increase of $5.7 million compared to revenues of $50.1 million in the second quarter of 2009. Our record revenue performance during the quarter was driven by strong organic Companywide net new subscription sales, and as Andy mentioned, based on the core CoStar suite. Subscription revenue for the second quarter accounted for 94.1% of total revenues.

On a functional currency basis, international revenues was approximately 3.1 million pounds, essentially flat when compared to the first quarter of 2010. International revenues were approximately 8.3% of the Company's total revenues in the second quarter. As of June 30, 2010, our 12-month trailing renewal rate, which is a measure of renewing subscription revenue, was approximately 88%. We are thrilled to see our 12-month trailing renewal rate move back towards our historical average of approximately 90%, as our customer retention efforts and Companywide contract bookings continue to improve.

As I've publicly stated for at least two years now, we had expected our trailing 12-month renewal rates to decrease in the mid 80s during the downturn last year, and then begin to recover in 2010. Currently at the mid-point of the year, I'm pleased to report that our renewal rates are trending ahead of our expectations, as demand for CoStar services has been strong, and we expect to continue to see our renewal rates remain strong for the remainder of 2010. Please note that the renewal rate, which is total dollars renewing in the quarter, will fluctuate from month to month or quarter to quarter. Therefore, the trends and overall level on a 12-month basis are important. Just remember, moving from the low 80s to the high 80s, and eventually into the 90s, all within a year, is extremely positive news.

Now turning to gross margin. Gross margin was $35.5 million in Q2 of 2010, and was up approximately $1.6 million compared to Q1 of 2010. Gross margin percentage [increased] from 63.5% to 61.5% in Q1 of 2010, due to higher revenue and lower research costs, which mainly resulted from timing differences between Q1 and Q2. Also, Q2's gross margin includes the full impact of PPR and Resolve, and investments in research, when you compare it to last year, as we've discussed on previous calls.

Moving down the income statement, total operating expenses in the second quarter of 2010 were $31 million, compared to $28.8 million for the first quarter 2010, which mainly reflects the $2.8 million in one-time accruals for legal settlements. As stated in the press release last night, CoStar reached favorable preliminary settlements on two legal matters in the second quarter that will avoid potentially years of additional litigation. In connection with these anticipated settlements, the Company accrued $2.8 million as one-time costs in our second quarter general and administrative expenses.

Specifically, the Company accrued $2 million in anticipation of resolving a dispute with its former landlord in the UK, Nokia, concerning the Company's termination of a lease agreement for its former London office. The Company's decision to terminate the agreement to lease with Nokia back in 2009, and subsequently sign a new lease for our London office located in the West End, was one of a series of moves made as a part of our overall strategy to consolidate offices and substantially reduce our long-term occupancy costs.

We also accrued approximately $800,000 in anticipation of a settlement of payments will resolve a class action lawsuit filed in California alleging violation of wage and hour laws. The company vigorously denies any wrongdoing, and believes this settlement to be in the best interest of shareholders. We can't go into much more details than I just described on the settlements, but needless to say we're pleased to put it behind us.

Looking at profitability, net income for the second quarter of 2010 was $3.3 million or $0.16 per diluted share, and our non-GAAP net income was $6.8 million or $0.33 cents per diluted share. These results reflect both the recognition of a one-time discrete tax benefit, and our accrual of the legal settlements, which mainly relate to our UK operations. If you "normalize" the second quarter by taking out both of these items, we came in well above our GAAP and non-GAAP guidance ranges. If you are evaluating the core operations of the business, it's important to adjust for both of these items, since neither were factored into analyst models, and they belong together. If you only adjust for one or the other, you'll come up with a strange result that does not really reflect how the business performed.

Quite simply, we're very happy with the results on both a GAAP and a non-GAAP basis, basically due to stronger operating results. Non-GAAP EPS is slightly above our previous guidance range, due to higher than expected revenue, and small shifts in some operating expenses that did not occur in Q2, that we expect to occur later in the year. HQ transition costs added back to non-GAAP earnings of approximately $1 million came in slightly higher than expected, largely due to timing between the quarters. We still expect those costs to be in the range of $3 million to 3.3 million for the year, which is slightly lower than we originally expected.

Adjusted EBITDA for the second quarter of 2010 was $13.3 million, an increase of $2.5 million compared to adjusted EBITDA of $10.8 million in the first quarter of 2010. EBITDA of $7.8 million in the second quarter of 2010 compared to $8.8 million in the first quarter. As I described earlier, the second quarter included a $2.8 million accrual for the anticipated settlement of the legal matters. Reconciliation of all of our non--GAAP net income EBITDA and non-GAAP financial measures discussed on this call to the GAAP-basis results are shown in detail, along with definitions of those terms, in our press release issued yesterday, which is available at our website at www.costar.com.

Turning to the balance sheet, we ended the second quarter of 2010 with approximately $230 million in cash, cash equivalents and investments, an $11.6 million increase from March 31, 2010, obviously driven by strong cash flow from operations; the Company has no long-term debt. Our cash increase was positively impacted by improved accounts receivable collections and improved DSOs, which also translated into lower bad debt expense on the income statement. Clearly, the health of our clients continues to strengthen quarter over quarter. As a result, our collections cycles continue to shorten; our accounts receivable balance as of 12/30/2010 is at its lowest point since 2007.

Also, a couple other items to note on the balance sheet are that prepaids and other assets, which increased by $2.5 million from the end of 2009 to the first quarter of 2010, was due to the fact that we prepaid our corporate taxes, and that has now declined by approximately $3 million, which again, mainly relates to our corporate tax payments. Contrary to any negative speculation, the Company has not capitalized any software development or other costs and put them in prepaids. If the Company is required to capitalize software development costs at any point, it would properly classify them in intangibles and other assets, and the specific detail would be listed in the notes of the financial statements in our 10-Q. If you'd like to look at an example of how CoStar does this, pull out our reports any time from 2000 to 2004. We haven't done it in years. Thank you.

I'll now speak to our outlook for the third quarter and full year 2010. Our guidance takes into account recent revenue growth rate trends, and our results may be impacted by the economic conditions in commercial real estate or the global economy. Our forward-looking guidance reflects our current expectations as of July 22, 2010.

We expect revenue for the third quarter of 2010 in the range of $55.8 million to $56.5 million, and for the full year we are raising the high end of our annual guidance range by $2 million from approximately $222.5 million to $224 million. Continued strong demand for our services, demonstrated by our 12-month trailing renewal rate moving back towards our 90% historical average, combined with the consistent revenue growth in the first two quarters, gives us a lot of confidence in our higher annual revenue outlook.

Our guidance on the impact for foreign exchange fluctuations on the top line results remains consistent. We do not attempt to predict foreign exchange rates fluctuations, and our guidance assumes little to no volatility from the current rate. The average exchange rate in the second quarter was up US$1.49 to one British pound, and our 2010 guidance assumes a rate of $1.45 for the remainder of the year.

As discussed earlier, the Company's income tax expense decreased in the second quarter due to the recognition of a one-time discrete tax benefit related to the UK operations. We continue to expect the annual tax rate for 2010 to be approximately 44%; therefore, our third and fourth quarter rate will be slightly higher, at approximately 49%. That said, any acquisitions or large one-time gains or losses would affect the tax rate at any point.

In terms of earnings, we expect a third quarter 2010 fully diluted net income per share of approximately $0.13 to $0.15, and non-GAAP net income per share of approximately $0.29 to $0.33. Our third quarter outlook for GAAP net income per diluted share includes $1.3 million to 1.5 million of costs related to the transition to our new corporate headquarters in Washington D.C., approximately $1 million to $1.3 million for restructuring and consolidation of our three Boston offices for CoStar, PPR and Resolve into one single location, and approximately $1.8 million to $1.9 million in equity compensation charges. For the full year 2010, we expect GAAP net income per diluted share of approximately $0.58 to $0.63, and non-GAAP net income per diluted share of approximately $1.17 to $1.25.

We expect to achieve our earnings outlook even with the short-term dilution to net income resulting from the legal settlements, and ongoing efforts to reduce our long-term facilities costs by moving our headquarters into a corporate-owned facility, and by consolidating offices in Boston and the United Kingdom.

For our annual guidance range, we essentially adjusted the $2.8 million accrued for the settlements, which was partially offset by the higher expected revenue we now have. On an annual basis, our expected tax rate is still approximately 44%, which is what we have expected all year; therefore, it only impacts the fluctuations between the quarters for the discrete item, and has no effect on the annual guidance range. In addition, for the full year 2010, we expect approximately $3 million to [$3.3 million] of costs related to the transition to our new corporate facilities, approximately $1.1 million to $1.4 million in restructuring lease charges, and $8.3 million to $8.5 million of equity compensation expenses.

The costs in 2010 related to the acquisition and transition of our corporate headquarters in Washington D.C. are expected to primarily include overlapping occupancy costs to the end of our current lease term, and carrying costs associated with the new building. The current headquarters' office lease expires on October 15, 2010, and while we have already begun to move certain employees to the new building, we do not intend to complete the move to the headquarters until October. After this period, we expect to save approximately $2 million a year in occupancy costs for our headquarters beginning in 2011. Once we get past these transition costs this year, which the majority are in the second and third quarter, we believe we will have created significant long-term value by reducing long-term structures for the foreseeable future.

In closing, we're very pleased with our record second quarter revenue results and momentum we're seeing in the business. Our business model remains strong, in the fact that we have a 94% subscription-based business model with high renewal rates, a unique proprietary database, market-leading position, strong balance sheet, no debt, and very high operating cash flow. We expect to return to more normalized organic revenue growth rates and expanding margins as we have enjoyed over the past decade in the very near future, and are well on our way. CoStar's management team believes there is significant opportunity for additional high-margin revenue growth following the investments that we have made.

We remain focused on our long-term goal of growing CoStar's business towards $1 billion of revenue and high margin. We expect to continue to report that progress to you.

With that, I will open up the call for questions. Thank you.

Thank you.

(Operator Instructions)

We'll go to the line of Chris Mammone with Deutsche Bank. Please go ahead.

Good morning, Chris.

Good morning. Could you guys -- I think you said that the Showcase platform was generating about $6 million of annualized revenue. Could you just give us what the end quarter contribution was from Showcase for I guess the second quarter and also the first quarter?

Do you want revenue or contribution margin?

You know, the quarterly revenue contribution from Showcase. I think you gave annualized numbers.

We're not giving out quarterly numbers, but annualized it's approximately $6 million, and obviously it's only been out for 18 months, so that's been growing each quarter.

It's been growing each quarter, so we shouldn't assume that it's sort of $1.5 million per quarter?

It would assume that you're obviously at a $1.5 million or higher rate now, that's correct.

Okay. And then similarly, I think you said that PPR was a bit ahead of plan. Is PPR the main source of, you know, the higher revenue guidance, or is it a combination of things? Could you maybe give more color there?

As we mentioned, the core acceleration is occurring in our traditional flagship products. So CoStar Property Professional, so it's basically reflecting economic recovery.

I guess you would characterize, you know, your higher revenue guidance as coming from, you know, a combination of the core and the acquired platforms, or is that sort of weighted more one towards the other?

I think, Chris, you know, if you look at it, you know, again, the suite of service property comps and tenants that we sell was the major driver this quarter, with PPR also continuing to drive, but again PPR's 10% of the business, and the UK is 8% of the business. So again, the core -- 80% of the growth is coming from the core platform, which is very positive. You know, all annual subscription contracts. So it's very good, high-quality revenue.

Okay. And then the -- you know, the end quarter renewal rate looked pretty good. How high should we think that that number could get?

Wasn't it beautiful?

92%. I know that, you know, your trailing renewal rate has topped out at the 93%, 94% level in the past. So give us a sense for how high we could think of the end quarter, and also maybe where you think the last 12 months' renewal rating is heading as well?

It's definitely an impressive testament to the utility and nature of the products, but we're pretty stringent with how we calculate that number. So we have a lot of clients who are small partnerships and if, you know, a partner passes away and the business is dissolved, that counts as a nonrenewal, or if someone retires or someone goes bankrupt. There's only so high you can go, unless your clients have life expectancies of several hundred years. So I think it maxes out at that sort of historical level of, you know, 93%, 94%. And that 97% number on the five-plus is really quite phenomenal.

Chris, I talked about that. I mean, you know, renewal rates can't continue to go up every single quarter. I do think they sort of -- when you look at where we were in 2005, 2006, 2007, we were always over 90% each quarter, you know, in the maxing out of the 93%, 94%. So I think that the trailing 12 months is going to go up, and I've said pretty openly, into the high 80s, the close of the year in the high 80s, and I believe we can get up into the 90s on the trailing 12 months into next year, which means would you have quarters obviously continuing to post the 90-plus, between the 90% and 94% range. But it will fluctuate a little in between quarters.

Is there any way to aggregate what the renewal rates would be ex- the Showcase platform?

The Showcase platform is split into two pieces. One piece is subscription-based services for Showcase firms, and then there's the monthly individuals that go on and off each month. We do not count the monthly individuals; the renewal rate is on the 94% of the business that's subscription-based services, so it would include those firms on annual contract for Showcase. It is not on the 6% of the business which we don't consider subscription-based, or somebody who would be on the monthly basis.

And half of that is not -- is advertising.

Correct. That's why it's a renewal rate for subscription-based services.

Right. So it's only a portion of the Showcase platform?

That's correct.

Is the portion that is subscription-based in the Showcase, is that helping to bolster the overall subscription rate? Has that been a source of --

No.

Is that one of the success stories that you would say to why the renewal rates have improved?

The core driver of the strength of the businesses is our traditional CoStar Property, CoStar Comps, CoStar Tenant; these products are just real solid utility staples in the industry, and as our clients are seeing some relief and some cash flow, we're enjoying that benefit. So it's really -- you know, it's really about the core of the business.

Okay. I guess my last question, let's see. I'm sorry for so many questions, but I appreciate you taking them. Why did the sales head count drop sequentially?

It's not material. It's what is it, 2%. It's just a fluctuation. Someone went to graduate school, somebody got married. We moved offices, so we didn't have a training class. It's not really material. In general, Chris, we expect that sales number to be sort of in that range, and it's not -- it's at this quarter and the first quarter, you know, for the foreseeable future. We're not anticipating that number going up or down by 50, it's going to stay pretty much in that range. It's a good, healthy number.

Thanks, guys.

You're welcome, Chris.

We will go to the line of Brett Huff with Stephens. Please go ahead.

Congratulations to both of you on a good quarter. My first question, I want to make sure I'm getting the EPS guidance right. I'll tell you what I think the math is, but then please correct me. You start out with the original guidance. Then you have to ding the number by what I'm assuming is $2.8 million tax affected, and divided by the share count. Then you have to add back something in order to get to your new guidance. That's about $0.06. Is that the right math to think about it?

For the quarter, basically what you do is you essentially take out the $2.8 million and you multiply it by the 44% tax rate versus the 30, and it'll sort of tell you excluding those two items that we are well above the range for both GAAP and non-GAAP.

For the year, the trick there is that the tax rate really will still essentially be the same for the year. So that $2.8 million is really what's sort of reducing the annual guidance range, because the tax rate is really only a fluctuation between quarters. And of course, you know if you divided -- if you put a $2.8 million at a 44% tax rate, you would get more than the $0.02; if we move the range, you'd get a lot more than that. Obviously, we're projecting some little upside on the revenue from what we originally projected. So we're sort of offsetting some of that.

So again, I think it's -- the quarterly numbers are great. I think up in the revenue and then even the guidance range coming in where we're going -- with having to take those $2.8 million charges, is very positive.

A follow-up question to that is, what is the -- so clearly revenue is getting better, but profitability is also getting better. Is the -- what is the driver of that? Is it tight budgets -- sorry, tight costs, or is it reduction of expenses on Resolve or -- can you give us a sense of what the drivers are?

Yes, no, we haven't reduced any expenses and as I talked about in the annual guidance in the beginning of the year, we actually will be investing in Resolve and the DCF, and some of the things we've been talking about. There are fluctuations in between quarters. There's a lot of noise going on moving the building, so I talked a little about there's some costs that are shifting from the first quarter to the second quarter, and some from the second quarter to the third quarter. But in general, if you take out all of those one-time items, you know, the cost structure's essentially sort of flat this year, and now we're starting to grow revenue, so that's why you're seeing improved earnings. It's the simple business model that people have seen from the Company for years.

It's important to remember we've got -- investment activities here are pretty significant. So we've invested in sort of building that sales force ahead of the market turn. We're investing in several different software initiatives. We scaled the research team to make sure we maintain -- the middle of this downturn, we did not gut the research organization, which would have been an easy thing to do. We grew the research organization, which resulted in that 97% renewal rate.

And the other thing we're doing here which, you know, I'm sure someone will come up a creative writing exercise to make it like negative, but what we're doing on the real estate side is, in the United Kingdom, I believe we've saved ourselves somewhere around $10 million in real estate occupancy costs over a five-year period by moving our research to Glasgow, consolidating several different offices together in London, and then by consolidating some operations into our headquarters building in Washington. While we're taking a hit for it now, ultimately it will be much more cost-effective.

In Boston, the consolidation of real estate is expensive these quarters, but -- and it doesn't have a real big bang cost savings, but it's critical to operations as we bring together Resolve, CoStar and PPR in Boston. So I think that we're -- over a 24-month period we've got a number of, I think, good cost control initiatives that are playing out here. They certainly don't work in our favor this quarter.

That's helpful. And then on the new CoStar product that you mentioned targeted the secondary and tertiary markets, can you remind us or give us a sense of -- I'm assuming it's the 50 or 60 expansion markets primarily that happened three or four years ago? Is that the right target to think of?

It's actually probably about 200 markets, so it's a decent-sized opportunity. It's tens of thousands of these very small firms across the country that we have not historically pursued as aggressively, just because we weren't going to fly field sales people out to -- a lot of times flying field sales people out to Lubbock, Texas. Nothing against Lubbock, Texas. So this is a way to do it through telesales, and keep our cost of sales low. It's doing quite well. In the first month or so, you know, we've sold well over 100 units this way. I think we'll be able to get some good traction here.

Last question related to that, over those markets, I do think probably a good number of them are partially overlapped with the markets you expanded into during your last investment phase; can you characterize the revenue percentage of those "small markets," however you want to define it, both on a revenue and maybe a profitability point of view, can you give us even a qualitative sense?

Very challenging to do. I'll let Brian address that.

Sure. I think, you know, we obviously just expanded into those, so sales are actually -- as everybody knows, we take about two years researching it before we even have a product to sell. So we've really only been starting to sell in those markets for a short period of time. As Andy said, some of the very small markets like a Lubbock, Texas or a Syracuse, we weren't going to fly people in for the very small accounts. If there's large accounts, we would. So I would say we're still very early on, and so I would say it's below 5%. It's not huge numbers for CoStar.

So far as profitability goes, I think we're actually, you know, not exact numbers but I think that we're probably approaching sort of a break-even point in those and, we'll probably hit that over the next year or so. So I think that it's very positive, and things are going well in those markets. You know, as people remember, going into some of these smaller markets it's much easier to do the research. It's not as complex as the larger markets, so the overall costs to do these markets on sort of a per billing basis is a lot less than it would be sort of our large core markets.

One of the things that strikes me is remember, markets that are three or four years old are not exciting for profitability over our 20-year history. Markets that are seven, eight years old, nine years old, are very exciting for profitability. So you get an awful lot of markets in that young zone. What I would note is that as I look around all those different markets, I am pleasantly -- I don't want to use the word surprised but I will for want of a better word, I'm pleasantly surprised by the amount of revenue, the little pockets of revenue coming from all these different markets, that are again 300 some markets. There's -- I'm not stuck by any of them that you think, wow, there's nothing happening here. There's a lot happening in a lot of these markets. But the reality remains for quite some time that those 20-year-old and 15-year-old markets will be the big profit and revenue drivers in the business.

And just one final note on that is that when you go back to sort of 2007 time period, when we were dropping revenue from the top line to the bottom line very consistently quarter over quarter, what I would always tell people was, you know, remember that whether the markets are profitable or not, we already have put the investment into them, we already have our cost structure baked into our cost of revenue for those markets. So each dollar that you put in the top line, if I sell $1 or $1,000 in Lubbock, Texas, I'm paying out some commissions and those types of things, but I'm dropping 70% to 80% of it to the bottom line. So from here on out, it's very positive, every sale in those markets that we get.

That's what I was trying to get at. I appreciate your time.

Thank you very much.

Thank you. We'll go to the line of Jon Maietta from Needham & Company. Please go ahead.

Thanks very much.

Hey, Jon.

The first question I had was, if you could just remind me, you've done a great job getting those customers who have been with you for less than five years, getting that renewal rate up to 88% today. Was the big hurdle rate -- does most of the attrition typically happen within the year or within the first six months, if you could just remind me?

It historically occurred in -- the first three years were the really tough time. So you had -- historically, you probably saw, as the economy slipped, I think you were saying, you know, in first year 20% drop rates, up to something like that. It had some noise and it fluctuated, but the real danger zones was the first three years.

What we did is we shifted -- we increased the commission structure, but we only paid it out based on prorata usage of the produce in the first 12 months. So the sales people, if they couldn't get the people using the product in the first 12 months, they didn't get paid the full commission or much commission. As a result, the sales people really got in there and implemented the product right up front, and that made the renewal rates climb and the failed sales drop. So it was a big success.

They say compensation changes behavior.

Yes. Coin-operated.

And just the other question I had, Andy, around the analytics front with regard to PPR in particular, and as you product tie that effort, is there going to be a gestation period and then maybe six, eight months from now, we'll see a whole slew of modules coming out of PPR? Or are you going to incrementally roll out services, you know, consistently over time for the first, you know, two or three years?

Yes, I think there have been some new, you know, minor new products that are not mega revenue drivers. Their peak sales index, which will start being distributed through PPR, is an example of something that only could happen with the merger of CoStar and PPR. Our data and [Raju Pang's] mathematical skills. So that would be an example of a small incremental sort of thing.

What we're doing is we're focusing on utilizing our sales and increasing our marketing infrastructure to try to reach more of PPR's potential and hit the cross-selling opportunity. We'll probably be looking at a gestation period of a year or so, after which there is a, you know, significant product upgrade that we think will drive revenue in both the CoStar and regional, sort of local markets, as well as the PPR, more institutional markets. So I think we're going to put our heads down and build what we think is a pretty good product combining the strengths of both of the companies. Realistically, that's going to take a little bit of time and effort. We're not going to try to whip it out real quick. We'll do it right.

Okay, that's helpful. Thanks, guys.

We'll go to the line of Brandon Dobell with William Blair. Please go ahead.

Hi, guys.

Hi, Brandon.

Andy, maybe some color on what the receptivity is these days to cross-sell or up-sell pitches from the sales force? I know those things take a while to get traction. With the gradually improving market, I would think you would be seeing some sort of leading indicators that people were more receptive, asking for second callbacks, that kind of thing. Trying to get a feel for either how do you think about the trajectory for the cross-sell opportunity, either within the core products, or between core and analytics, or the opportunity moving somebody from Showcase as a customer last year up to a bigger number?

Yes, I think that definitely happens. One of the things going into a recession, you have good clients who may be buying five or six modules, and they shave that down to three modules that they really, really need. I anticipate that as we get some recovery, people begin adding back modules, and people that didn't have multiple modules start picking up modules. We are, in fact, seeing anecdotal evidence of that. We are seeing people add additional seats. We are seeing people add additional geographies again.

Now, the reality of our business is that, you know, it tends to be usually half cross sell, half new business, and moves up a couple points, it moves down a couple points. So it might move up a couple points. I'm still very focused, especially with the analytic products, just on completely net new customers. I think there's a huge potential for completely net new customers over the next three years in these analytic products, and I think that'll be the big story. So cross-selling will go up -- you know, I hope cross-selling goes up, net new customer acquisition goes up, and the 50/50 fight will continue to get to the upper end.

Okay.

And one other thing is you mentioned that Showcase thing. You mentioned that Showcase thing, I think our sales team did a great job of ramping that up from zero to 10,000 in about two years. In the process, we probably didn't do as good a job as we could have in recognizing that those customers weren't just Showcase customers, they were Property Professional potential customers. So only one in seven of those individual Showcase customers are property information customers, leaving six out of seven as prospects for information -- or broader information products.

So what I really want to try to focus the sales force on is going back and cross-selling that group on up the line. That could, you know, double the revenue from that segment. And the Head of our telesales group is really focusing on that now. So I think you hit the nail on the head with that potential.

One quick one for Brian. Any change in terms of how customers are interacting with you guys from a cash flow or DSO perspective? Are they asking for better terms, longer terms, different terms? Or has stabilization in the market giving you the opportunity to come back and get better terms from them?

Yes. I mentioned it a little bit, but you know, just everything overall is extremely positive, and the health of the client base is just night and day compared to last year where, you know, clients are really looking to extend, you know, making a payment every other month. Of course, you know, as we go back to conference call scripts, you know, 80%-plus of all the people we lost last year really just turned their lights out and shut the phones off to CoStar right before they left.

Right.

So really -- I sort of talked about that last year. Whoever was unhealthy in the client base was going to disappear, and they pretty much did. I look at bad debt is down, DSOs continue to improve each quarter. Lowest AR -- our AR is the lowest it's been since 2007, and we've added two companies and we've added a lot of revenue.

So much improved conditions, obviously $11.5 million of cash flow. People are paying us again, they're not extending credit as much. Just very, very positive. That was through some other major change in the overall economy, you know, it can't go up forever like that, but I think -- I expect those numbers to basically continue at these types of levels starting -- moving forward, which again, is very positive for the business.

Thanks.

Thanks, Brandon.

Thank you. We'll go to the line of Ian Corydon of B. Riley & Company. Please go ahead.

The decline in the number of [audio dropout] sequentially that was caused by the UK, is that expected to continue?

It would probably -- UK's a relatively small part -- I mean it's 10% of our business, and their per-unit pricing is lower over there. I think that -- I believe that the big UK firms have now cycled renewals, so probably -- we've probably seen the reduction in head count and subscriptions already.

Again, the big difference between the UK and the US is the surveyors in UK are on salary, so there's incentive for the firms to cut people. Here they're on commission. There wasn't an incentive for the firms to cut people. So I think that's happened.

The other thing is that just sort of tactically or on a noise level, you've got two things going on. You've got this sales force in the UK all the sudden going after Showcase, and the real story is they signed up 1,000 for our first new international product. But that doesn't translate to net new subscribers. So sort of question of you know are you using the metrics to manage the business, or are you managing the business to achieve the metrics? And metrics are a tool, they're not what we're trying to do here; we're trying to grow the business.

So I think this quarter, with that, I'm glad they increased the -- I'm glad they launched the Showcase product successfully over there, even though it didn't grow subscribers, because they were cross-selling, and I understand tactically what our VP of Sales in the UK is doing, where he's trying to get the head counts down as low as possible, so as the UK firms begin to recover, he can charge them for incremental ads back again. So the metrics -- you want to report positive metrics across the board every day, but this time around you get sort of a noise factor, and I'm comfortable with it.

Just to add a couple pieces of other information on to that, Ian, what would I expect is that in the UK, as we said, a lot of these -- and we did a very similar thing in the US, we're sort of going after our current clients, so even if they are signing up for Showcase and they start paying us dollars, we're not adding new paying [subs]. What I think over the next few quarters, the more important thing, again, metric that I would be looking at -- I would be looking at all of them as we always do, but I think more important one would be the number of firms that we sort of -- new firms and firms that we sign up, and our site numbers.

I would not expect to see significant paying sub-numbers over the next few quarters because again, essentially the ones we're selling sort of already are -- might already be on some other type of CoStar service. So again, we'll keep looking at those numbers; they're obviously important numbers, along with all the other ones we report, but I think that the focus of the next few quarters will be less on that paying subnumber and more like firms and sites.

Got it. Last question was just on the cost of goods, that came down by about 800,000 sequentially; what's the right number going forward?

I mentioned that a little bit. It's really more just a transfer of costs between quarters. It's when research training classes go, it's when we send out our ACS postcards. So I think, you know, again, kind of back to my original guidance, I think it will come back up to more normalized levels. Because of the size of research, having 900 to 1,000 people, that number can fluctuate in the quarter, you know, $500,000, $600,000 from quarter to quarter, but overall for the year, again, we're not making any significant reductions there. It'll just be shifting a cost between quarters and when things happen.

Got it. Thank you.

Great. Thanks.

And we'll go to the line of Jim Wilson of JMP Securities. Please go ahead.

I guess, Andy, you sort of answered -- or you answered my first question, which was timing of when you think it might complete and/or rollout the AVM product and your real estate evaluation tools. Sounds like sometime next year is most likely?

Yes. I probably could give you better color on that over the next two quarters, as we narrow down the specifications a little tighter. You know, this is what I perceive to be, you know, one of -- over a multi-decadal timeframe, I think it's going to be one of our biggest flagship products. The potential for what we can do here, I think, is tremendous. I'm very optimistic about it. I think it'll have a huge impact, a positive impact for our customers. It is an ambitious construction project, which takes a lot of effort. So it's not something that's going to happen in two, three quarters. It'll be four, five quarters. We'll keep you updated on it as we get more information.

Thanks. I agree on the prospects, given what I've heard from banks, et cetera, and the need for something like this.

The other question is just was wondering a little bit, not sure I've been able to figure that math out of what average new signed contract values look like in the quarter, either I guess in general or versus the ones that rolled off? I know they've been smaller new contracts for a while; I was just wondering if that was changing or evolving as things have gotten a little better?

Jim, I think there are a lot of things happening this quarter that are going to challenge the analysts. We'll let Brian try to answer that.

Sure. Real quick, Jim, on the average contract value, it has been running in the $7,000, $8,000, $9,000 range, and it popped up last quarter when we talked about the fact that the average contract value for PPR went up to just over $100,000. The prior two quarters that we owned them, it was around $50,000. Sort of this quarter it went back down more to a normalized level. So we had a couple of nice, very positive, big contracts come in there. We sold another $500,000 or so of cross-sells, that's still continuing to go well, but we're sort of back down to a more normalized level.

The other thing that decreases a little bit, and I did talk about this our last quarter, it's sort of like the renewal rates, you can't expect it to go up every quarter. A lot of it depends on the focus in that quarter of the sales force. You know, as Andy mentioned, we sold over 100 units of this new product, which is a very low end product that we're starting to push. So that -- and it is a subscription product, on annual contracts. So it is counted in that number. That probably reduced the average by a $1,000 or $1,500 in the quarter.

So, you know, these again are numbers that are very good numbers to keep tracking. There will be reasons why they go up and down each quarter, depending on the focus of the sales force. But, you know, all positive reasons why it's gone up or gone down.

And did you look for it in your guidance? I mean, maybe you would know if there's any big contracts on the horizon; PPR is super big, but is that sort of assuming $50,000 kind of normal rate for the rest of the year on PPR contracts?

Yes. We sort of always assume the normalized thing. Obviously, if you get something in that's large or big, you'd rather have that as sort of upside than sort of making assumptions for it and have it not come in. So when you look at my guidance ranges, you know -- obviously, you know, people forget it was literally only three quarters ago revenue was dropping. So I'm of course being cautious. So I'm assuming average stuff and then if something comes in like that, it's upside.

Right. Okay. Good. Thanks. That's all I had.

Appreciate it. Nice talking to you.

With this, we're going to go ahead and wrap up the second quarter earnings call, and we appreciate that you all joined us. We look forward to updating you on our progress next quarter, and I hope you join us, and crossing your fingers that the economy continues to show strength. Thank you.

Thank you, ladies and gentlemen.

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