CoStar Group - Earnings Call - Q4 2011

Transcript

Speaker 3

Ladies and gentlemen, thank you for standing by. Welcome to the CoStar Group's fourth quarter 2011 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. If you should require your assistance during the call, please press star then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to Richard Simonelli. Please go ahead.

Speaker 8

Ladies and gentlemen, welcome to CoStar Group's fourth quarter and year-end 2011 conference call. On the call today are CoStar Group's Founder and CEO, Andrew Florance, CFO, Brian Radecki, and myself. We're delighted that you all could join us today. Before I turn the call over to Andy, I have some very important facts for you. 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 February 22, 2012, press release on the fourth quarter and year-end 2011 results, and in CoStar's filings with the SEC, including our Form 10-K for the year ended December 2010 and Form 10-Q for the period ended September 30, 2011, 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 being broadcast live and in color over the internet at costar.com. A replay will be available approximately one hour after the call and will be available until March 23, 2012. To listen to the replay, call 800-475-6701 within the United States or Canada, or 320-365-3844 outside the United States. The access code is 235325. A replay of this call will also be available on our website soon after the call concludes. Now, without further ado, I turn the call over to Andy Florance. Andy.

Speaker 2

Thank you, Rich. Thank you all for joining us on this call to discuss CoStar Group's year-end and fourth quarter 2011 results. Again, I'm happy to announce that we had another strong quarter and outstanding year overall in 2011. Here are some of the highlights of 2011. We achieved our best year ever, our best quarter ever, and our best monthly sales result ever. We had record revenue exceeding a quarter of a billion dollars for the first time and a 13.7% year-over-year growth rate. We launched CoStar Go, a revolutionary new product that puts our industry-leading information onto a mobile platform in the field where our clients need it most. CoStar Go generated nearly $5 million in annualized sales after being available for only two quarters in 2011.

It has been a key driver of sales to new and existing clients, and we expect that trend to continue in 2012. We announced the agreement to acquire LoopNet, which we believe will be a very positive potential combination of two industry-leading, complementary, and innovative companies that could better serve the industry and provide excellent cross-selling opportunities and efficiencies and cost savings. We raised $250 million in equity to help finance the potential purchase of LoopNet, and we recently signed an agreement for a $225 million credit facility that would be used to help fund that transaction. We completed the sale leaseback of our Washington, D.C., headquarters at $60 million above our original purchase price from a year after buying the building. The purchase was recognized as the office deal of the year for 2010, and maybe the sale leaseback will get similar recognition in 2011.

I believe we received a huge branding benefit within our industry since we used the CoStar database and PPR analytics to capture that opportunity. We achieved a key milestone in the integration of PPR analytics and forecasting division, replacing the very limited data previously used for analytics and forecasting with CoStar's more comprehensive and much more granular data. We believe this will provide PPR clients with a much more timely and precise understanding of the market, which we expect will give PPR a tremendous competitive advantage in the analytics space. We completed the acquisition of Virtual Premise, a leading provider of SaaS-based lease management tools. By matching CoStar's strong information and product design capabilities with Virtual Premise's lease management products, we believe we can bring significant value to our combined client base and create another strong platform for growth. Our balance sheet is very strong.

We ended 2011 with $573 million in cash and investments. We expect to use some cash on hand, along with the addition of a manageable amount of debt upon the possible closing of the LoopNet transaction. I am particularly proud of this year's 98% renewal rate with clients who have been with us for five-plus years. We now have approximately 93,396 paying subscribers, the most we've ever had. This demonstrates that we are providing very high-quality products and outstanding value to our clients. Overall, I'm very pleased with what we've accomplished in 2011, and I'm excited about where we're going as we continue to deliver leading-edge innovation in the commercial real estate information space. Let me walk you through some of the details of the quarter and where we're heading in 2012. Annualized net new sales for the fourth quarter of 2011 were $8.7 million, an increase of 86% year-over-year.

There's no need to adjust the sound on your TV set. You heard that correctly: 86% year-over-year. We have increased our sales in each of the last nine consecutive quarters. We are laying to cross the quarter-billion-dollar mark in revenues this year, and we believe that it's an important milestone on the way to achieving our stated goal of generating $1 billion in revenues. We still believe we're only scratching the surface. We believe our current penetration is less than 20% of the potential markets of users of commercial real estate information products. There's still a lot of runway out ahead of us. We're charging ahead with CoStar Go and other new software initiatives in 2012, which we believe will have equally high potential. As I mentioned, CoStar Go has been a key driver of our recent record sales.

CoStar Go integrates information from CoStar's comprehensive property, tenant, and comparable sales databases into a powerful but simple app on the iPad. CoStar Go was released in the middle of the third quarter of 2011 following a 34-city tour to introduce our new app to approximately 3,000 of the most active and influential commercial real estate brokers in the U.S. In the fourth quarter, we implemented an aggressive marketing campaign consisting of direct mail, email marketing, print and online advertising, and social media, and our salespeople conducted over 4,500 demos and trainings on CoStar Go. The results: total annualized net new sales associated to CoStar Go as of the fourth quarter of 2011 was $4.9 million, up from an annualized rate of $2.2 million in the third quarter, up from basically zero in the second quarter because we hadn't launched it yet.

Essentially, we have already recognized a return on the earnings we reinvested to launch this game-changing product. CoStar Go has been the catalyst for long-time customers who previously bought one or two products to upgrade to the full suite of CoStar products. These are companies like Cassidy Turley BT Commercial in San Francisco, we're thrilled to have on board, Colliers International and CNW Commerce in Seattle, and Studley. We also added new customers like Colliers International in Columbus, Ohio, Desco Group in St. Louis, and Flagstar Bank in Detroit. We believe we have developed a tool that's creating a sea change in how commercial real estate professionals in the field operate and access data. Already, 8,000 clients have downloaded the app and logged in. There's more every day coming in. When we launched CoStar Go, our customers told us it was amazingly fast and worked very well.

We were not satisfied with "very well." We wanted to create an application that was exceptional. We stayed close to our users, listened to their suggestions, stepped up the development, and put our senior development team intensely focused, along with the product designers, to create an even better user experience. The result was 1,600 software enhancements to the product between the launch on August 15, 2011, and now. That's just the beginning, but 1,600 enhancements is an amazing number. We plan to continue to make additional updates on a regular basis with new features and enhancements that will make CoStar Go an even more effective tool for the CRE professional. I believe that we'll benefit from the meteoric growth of the iPad into the mainstream and its increasing acceptance as a business tool. It is hard to believe that the iPad is just two years old.

It was only released in January 2010. Gartner Group estimates that annual iPad sales will grow from 47 million units in 2011 to 148 million in 2015. Doubtless, many of these units will be going to commercial real estate professionals. We believe as more brokers get iPads, more brokers will use CoStar Go. In fact, we noticed this as a mini trend during the Christmas season. As our clients received iPads for the holidays, our logins to CoStar Go jumped 15% in the week following Christmas. The iPad 3 is due out this spring, and we believe it will have 4G LTE speed, higher screen resolution, and a higher resolution camera overall. We believe as the volume of iPads shipped climbs, this will drive usage, and the expected iPad improvements will further increase the utility of the product we've designed for this device.

Since the launch of CoStar Go, we've seen a 20% increase in the usage of our web-based products. More than 1,300 clients who've never used our web products themselves began using our iPad product when it became available, and 57% of those new users also started using the web-based product as well. Many of these new users are top producers and senior brokers who may have thought it was uncool to do research on a desktop or laptop computer, but they appear to find the mobile product very attractive, accessible, and cool. We believe this will continue to positively contribute to higher customer retention. CoStar Go is not a one-off product for CoStar Group. It defines a powerful new method we're using in our product development going forward. In the past, our software design function resided within our software development group.

While that may have worked, it tended to focus product design and the engineering of the product rather than on the customer experience, the value proposition, and the visual appeal of the product. Last year, we created an independent design team that is comprised of extraordinarily talented graphic artists, staff with thousands of hours of experience working with our customers, former CoStar sales executives, former CoStar researchers, commercial real estate tech entrepreneurs, even former clients. This group reports directly into me. Since they're not all software engineers, they don't focus on how hard it will be to build something; rather, they simply focus on designing an innovative, highly refined, and perfected awesome product experience. I think our engineer teams like this process better because they recognize that this gives them the opportunity to work on more innovative, exciting, better designed, challenging new products.

All in all, I believe this new process will reduce our development costs on a per-project basis while delivering more compelling products and more products overall. With that in mind, we're in the process of reimagining our current web product. It is about to undergo a series of major upgrades and design enhancements that will incorporate a host of new features. This next generation product is called CoStar Fusion. This will be a new product that brings together CoStar's suite and analytics from PPR, financial tools, customer data, and we expect eventually Virtual Premise and Resolve. We expect this to be a premium product that we believe could become a significant revenue driver for CoStar in 2013.

Switching over to the other side of the pond, for those in the United States, we're nearing the completion of a project to integrate our UK sales research and fulfillment processes and data into our more powerful U.S. backend software systems. We believe that we can complete this phase in April. We're working on modifying our iPad product to work in the UK, and we expect to complete and release CoStar Go UK this summer. We believe we will see a solid revenue uplift from the release of CoStar Go in the UK. By the end of 2012, we expect to release the rest of the U.S. product suite to the UK market, again with the expectation of generating revenue uplift. We believe that these initiatives will take the UK to profitability by year-end 2013 and continue to grow the margin from there on out.

This will be a significant upgrade for the UK commercial real estate market and will give the professional access to comprehensive information that has not previously been available in the UK. Another place we've been innovating is on the research side of the business. We noticed that our industry was hampered by a lack of effective building quality ratings, which in turn made it difficult and practical to effectively analyze market movements and investment opportunities. The only system out there has been the ad hoc ABC rating system used for office buildings only. There have been no definitions of what really distinguishes an A office building from a B office building, and so certainly no consistency from market to market on these ratings. Just three categories cannot cover the range and quality of buildings we encounter every day.

The ABC systems often relied on the broker trying to sell the building, rating it himself, making the credibility of that rating system completely suspect. Finally, the system ignored retail, industrial, multifamily, and land properties, which is the vast majority of the value of commercial real estate in the United States. This backdrop was a perfect opportunity for CoStar Group. In 2011, we introduced the CoStar Five-Star Building Rating System under the direction of Anthony Gumma. Anthony holds a Master of Science in Real Estate and a Master of Architecture from MIT. He's practiced and studied architecture in Europe, and he gained a solid understanding of rating systems while he worked in developing products for the U.S. Green Building Council. This new rating system provides more detail and consistency in comparing property assets across markets than the old ABC rating system.

The CoStar Building Rating System also covers all property types. We are working hard to make this new system objective and responsive to the industry's needs. Since the launch, we've been speaking to and meeting with hundreds of industry professionals. We are winding up a 20-city tour of major cities all over the U.S., where we've been reaching out to owners, brokers, and research directors for feedback to learn how we can refine the ratings and make them more accurate, relevant, and to increase the transparency in the process. The launch of the rating system has also helped us to improve the accuracy and quality of some of the listings in our database, as owners are even more inclined to proactively share information about their properties in order to meet our criteria and ensure the highest possible rating. Overall, the feedback from clients in this initiative has been very positive.

During the third quarter of 2011, we completed the integration of PPR's best-in-class analytics and forecasting tools with CoStar's comprehensive commercial property database. In November 2011, we began supplying PPR clients with analytics and forecasts based on CoStar's research-verified platform. One of our priorities in 2011 for PPR was to ensure we continue to invest in and continue to grow our accomplished team of thought leaders at PPR. We believe that PPR's thought leadership was already undisputed, but adding segment specialists was even more of a value add for our clients and prospects. We added Walter Paige to lead the office sector team. Walter was previously Vice President of Research and Equity Office in LaSalle Investment Management. We also welcomed Renee Sirk, who comes to PPR with 15 years of experience as a market strategist and real estate economist at Grubb & Ellis and First Industrial Realty Trust.

Mark Barry joined us in New York. Mark brings more than 20 years of experience as a portfolio manager and REIT analyst. He most recently was portfolio manager for Deutsche Bank's commercial real estate collateralized debt obligations. Prior to joining Deutsche Bank, he was a Senior Analyst with Green Street Advisors. We have also hired an accomplished multifamily economist who we expect to join the team soon and will be able to announce shortly. I know many of you on the call are with institutions that are PPR customers, and my hope is that your firms will benefit from our new colleagues' insights. Turning to some other minor news, let's touch on the LoopNet acquisition. We're working diligently in an effort to bring the LoopNet acquisition to a conclusion.

We are in ongoing discussions with the FTC staff in an attempt to reach a mutually acceptable consent order, and we feel that the process has been productive. As of yet, we have not reached a mutually acceptable agreement. We remain hopeful that these discussions might allow this deal to close in the not too terribly distant future. In the event that we reach an agreement with the FTC staff in the near future, we have recently secured the debt portion of financing needed to complete the LoopNet acquisition by entering into a credit agreement that provides for a $175 million term loan facility and a $50 million revolving credit facility. Our CFO, Brian Radecki, will give you more details on this in a few minutes.

At the time of the announcement of the acquisition of LoopNet, we were confident the proposed combination of CoStar Group and LoopNet was good for our clients, the industry, and our shareholders. After nine months, our confidence in our investment thesis is sound has grown. We believe even more now that the cross-selling opportunities, greater efficiencies, and combined innovation efforts will be great for the commercial real estate industry and our shareholders. While some may interpret my comments as optimistic, I think it's important to remind our shareholders that even in a scenario where, despite our best efforts, this deal might or could not close, we believe that this company, CoStar Group, as always, would absolutely have a great future going forward on a standalone basis. We believe the company would continue to deliver innovative products, grow revenue, and profitability for many years to come.

I also believe the reciprocal is true at LoopNet. In the meantime, we continue to make our very best efforts to work cooperatively with the Federal Trade Commission and any other relevant parties to reach an equitable and workable basis to move forward on. Finally, I want to present a brief summary of commercial real estate market conditions and how I believe they're creating an improving and positive environment for our business moving forward and potentially for some number of years to come. Coming out of the recession, commercial real estate rents for high-quality properties were well below and still are well below long-term inflation-adjusted averages, while at the same time, employment in many sectors is growing and corporate profits continue at record levels. This is resulting in some of the strongest leasing activity we've seen in years.

Leasing activity drives leasing commissions and is the best indicator of our core client base's financial health. Net absorption of office space had its seventh consecutive quarter of positive increase led by top-tier U.S. cities. At the same time, commercial real estate construction activity and hence deliveries of new competitive supply is at all times extreme historic lows. Because of this, vacancy rates continue to decline in the vast majority of U.S. cities and will likely continue to do so, which will ultimately drive rents upward. This recovery is broad, with two-thirds of all U.S. submarkets' vacancy rates continuing to move lower. This is the best we've seen this benchmark in the last 10 years.

This creates some justified optimism with commercial real estate investors who believe that net operating incomes and properties will continue to improve, creating even more attractive yields compared to the very low yields available from alternative investments. Building sales volumes in 2011 were up over 40% versus 2010 volumes. Increased volumes mean increased commissions. Sales commissions are the next largest revenue driver for many of our clients, and prospects for this potentially bodes well for CoStar. Values for larger investment-grade properties stopped falling, began stabilizing, and then climbed over the prior year. Now, in the past two quarters, values for general commercial real estate or smaller properties around the country, those values stopped falling and are now beginning to climb back up.

We believe that LoopNet's business has more exposure to that economic sector, the smaller properties, and so I believe this is a very important positive indicator for their business environment. I continue to believe that the commercial real estate markets are stable and improving at a pace that helps the outlook for CoStar Group in 2012 and beyond. In summary, we're extremely proud of our financial performance in 2011, and I have never been more excited about the prospects for this business than I am now. I believe that we will continue to bring a series of innovative and valuable products to market, drive sales into these massive market opportunities, and grow earnings as we move towards our $1 billion revenue goal. I will now turn the call over to our Chief Financial Officer and Treasurer, Brian Radecki.

Speaker 5

Thank you, Andy.

Speaker 2

You're welcome.

Speaker 5

We're very pleased with our performance in the fourth quarter of 2011. Once again, we delivered strong revenue growth and earnings while continuing to invest in our business. Today, I'm going to focus on sequential results, year-over-year trends, and also on our outlook for the first quarter and full year of 2012. The company reported $66.2 million of fourth quarter 2011 revenue, an increase of $2.4 million or 3.7% compared to revenue of $63.8 million in the third quarter. Revenue for the fourth quarter of 2011 increased $8 million or 13.7% compared to last year. Full-year revenues were $251.7 million, an increase of approximately 11.2% over revenues of $226.3 million for the full year of 2010. Sequential and year-over-year revenue growth was primarily attributable to growth in subscription revenues from our core suite of services, CoStar Property, Comps, and Tenant, which was supercharged by CoStar Go.

We also reported $5.2 million in net income or $0.20 per diluted share during the fourth quarter of 2011, based on 25.4 million shares, compared to $2.3 million or $0.09 per diluted share in the third quarter of 2011, based on 25.3 million shares. This reflects the impact of approximately $3.1 million expenses associated with the proposed LoopNet merger, a decrease of $2.7 million compared to the third quarter. Adjusted EBITDA for the fourth quarter of 2011 was $16 million compared to adjusted EBITDA of $14 million in the third quarter of 2011, an increase of $2 million or 14.3%. Adjusted EBITDA increased $2.6 million or 19.4% over the fourth quarter of 2010. Non-GAAP net income was $8.4 million or $0.33 per diluted share in the fourth quarter of 2011, compared to non-GAAP net income of $7.2 million or $0.28 per diluted share in the third quarter of 2011.

Reconciliation of non-GAAP net income, EBITDA, adjusted EBITDA, and all our non-GAAP financial measures discussed on this call to their GAAP basis results are shown in detail along with definitions of those terms in our press release issued yesterday and is also available at our website at www.costar.com. If you have any further questions on those, email Richard Simonelli. The company had $573 million in cash and investments at December 31, 2011, a decrease of approximately $10 million since the last quarter. We used approximately $15 million in cash to complete the acquisition of Virtual Premise in the quarter. As previously reported, last week we entered into a credit agreement that provides for a $175 million term loan facility and a $50 million revolving credit facility, each with a term of five years.

Drawdown of these facilities is subject to the closing of the LoopNet acquisition, and the proceeds of the term loan facility are expected to be used, along with the net proceeds of CoStar's June 2011 equity offering, to pay a portion of the merger consideration and transaction costs. The credit facility includes a group of six banks with JPMorgan Chase Bank as the administrative agent and sole lead arranger, and effectively replaces the fully committed term loan and revolving credit facilities disclosed at the time of the merger announcement. This credit agreement carries a rate of LIBOR plus 200. This $225 million term loan A facility will save the company 3% to 4% in interest costs for approximately $20 million over the duration of the loan versus the term loan A, B, term loan B structure as indicated in the initial merger announcement.

By the way, my title is actually just Chief Financial Officer. I want to thank Charlie Colligan, our Treasurer, who we hired last year, and his team and the finance team and accounting team and legal team that worked tirelessly to get this done. It's a tremendous agreement. The term loan facility amortizes beginning with 5% in year one and gradually increases to 50% in year five. The entire amount of the revolving facility is available through its five-year term. Our customers continued to renew subscriptions at a very high rate during the fourth quarter of 2011. The end-quarter renewal rate exceeded 93%, which is an improvement from 91% one year ago. Additionally, the 12-month trailing renewal rate for subscription-based revenue remained at approximately 93%, which is an improvement from approximately 90% one year ago.

The renewal rate for clients that have been our customers for five years or longer held constant at an outstanding 98% for the fourth quarter, an increase of two percentage points from the same period in 2010. The renewal rate for firms that have been clients for less than five years is approximately 86%, which is consistent with 2010. Subscription-based revenue accounted for 94% of the company's whole revenue in the fourth quarter. During the fourth quarter of 2011, the average annual new contract value was $9,277, up 4% from the third quarter of 2011, and our sales headcount totaled 209 sales reps, a 5% increase from 199 on staff at the end of the third quarter. Total number of paying subscribers increased to 93,396 in the fourth quarter of 2011, a net increase of 2,386 over the last quarter, which is just great.

The total number of subscription clients increased by 286 during the fourth quarter to 18,183. I will now quickly cover other results from our income statement in the fourth quarter of 2011 and also provide the outlook for the first quarter and full year. Gross margin was $44.2 million in the fourth quarter of 2011, up approximately $1.5 million compared to $42.7 million in the third quarter. This performance results in a 3.3% year-over-year improvement in gross margin percentage from the fourth quarter to 66.7%. We expect gross margins to be slightly lower in the first quarter due to the seasonal expenses and then grow thereafter. Total operating expenses in the fourth quarter of 2011 were $36.4 million, a decrease of $3.3 million compared to $39.7 million in the third quarter of 2011.

As we indicated in the last quarter's call, the fourth quarter of 2011 sales and marketing expenses were expected to decrease as the third quarter included the launch of CoStar Go. These are partially offset by higher commissions, which resulted from our record sales quarter. G&A expenses were $15 million, which included $3.1 million expenses associated with the proposed LoopNet merger, which was down $2.7 million compared to expenses in Q3. As you are probably already aware, one of our clients, Grubb & Ellis, recently filed for bankruptcy. This is not a material event for CoStar Group and will not significantly impact our financial results. No one client represents over 5% or more of our total revenue, and Grubb's annual revenue is significantly below that number.

We have been in communication with the senior management of Grubb since we were made aware of the financial uncertainty, and the impact of these events is already reflected in our published 2011 financial results. We expect to continue to provide services to Grubb, and be paid for those services on a priority basis going forward in bankruptcy unless our contract is terminated as a part of the bankruptcy process. If the contract were to be terminated, the impact would be approximately a 5% point drop in our in-quarter renewal rate in that quarter, and our reported annual rate would drop by about 1.5%. While there are many possible outcomes related to Grubb & Ellis' bankruptcy proceedings that I previously mentioned, we believe our revenue guidance range adequately accounts for all these scenarios. I will now discuss our outlook for the first quarter and full year of 2011.

Our guidance takes into account the recent trends, growth rates, renewal rates, which all may be impacted by the economic conditions in commercial real estate or the overall global economy. Our outlook includes Virtual Premise, but does not include the impact of the proposed acquisition of LoopNet or costs that are contingent on the closing of the acquisition, as we're not able to reasonably forecast whether or when certain acquisition-related costs may take place. Therefore, we're providing an outlook on a standalone basis reflected as our current expectations of today. Our guidance on the impact of foreign currency fluctuations remains consistent. We do not attempt to predict foreign currency exchange rate fluctuations, and our guidance assumes little to no volatility on that rate. The average rate in the fourth quarter of 2011 was $1.57 U.S.

dollars to £1 British pound, and our 2012 guidance assumes a similar rate for the remainder of the year. We expect revenues for the first quarter of 2012 in the range of $66.7 million to $67.7 million, and for the full year of 2012, we expect revenue of approximately $281 million to $285 million. The continued strength of our core information sales over the past several quarters gives us a lot of confidence in our annual revenue outlook. In terms of earnings, we expect the first quarter of 2012 fully diluted non-GAAP net income per share of approximately $0.27 to $0.31 based on 25.4 million shares. For our business, as I mentioned earlier, first-quarter expenses traditionally include seasonally higher costs related to our annual sales conference and just increased personnel, payroll, taxes, and benefit costs in the first quarter.

We currently assume a 38% tax rate in order to approximate a long-term effective corporate tax rate. For the full year of 2012, we expect non-GAAP net income per diluted share of approximately $1.27 to $1.39. As Andy Florance discussed earlier, we expect to continue to make incremental investments to improve our existing services as we launch new product offerings. We expect to invest an additional $3.5 to $4.5 million in 2012 to develop the CoStar suite of products for the UK market, including the CoStar Go iPad app, which is expected to accelerate revenue growth in the UK. We plan to increase our investment in new products in the U.S. by approximately $3 to $4 million and expect to support these new product initiatives with some marketing programs later in the year.

We are extremely excited about this robust pipeline of new products, and we believe these investments will provide a basis for continued strong revenue growth and even stronger earnings growth next year and beyond. In summary, I'm very pleased with our record revenue results and strong earnings growth. The business model remains strong based on the fact that we have a 94% subscription-based business coupled with a 93%+ renewal rate for our services, a unique proprietary database, market-leading position, strong balance sheet, and very high operating cash flow. As Andy Florance mentioned, we crossed a quarter billion in revenue this year, which is a great milestone with momentum, and we are operating in a very large multi-billion dollar space.

I believe with the sales trends we are seeing and the investments we are making in our industry-leading products, CoStar Group is positioned to continue to progress towards our previously stated goal of a billion dollars of revenue at 40%+ adjusted EBITDA margins. I look forward to that progress and reporting to you each quarter, and now I'll open up the call for any questions.

Speaker 6

Thank you, ladies and gentlemen. If you wish to ask a question, please press the star on one of your touch-tone phones. You may remove yourself from queue at any time by pressing the pound key. If you're using a speaker phone, please pick up the headset before pressing the number. Once again, if you have a question, press the star one at this time. Our first question comes from the line of Bill Warmington from Raymond James. Please go ahead. Sir, your line is open.

Speaker 1

Thank you. Good morning, everyone, and congratulations on a strong quarter.

Speaker 6

Thank you.

Speaker 1

A question for you on the 2012 guidance. I just wanted to ask what kind of EBITDA guidance you are implying in that. I just want to make sure I'm doing the calculation correctly.

Speaker 6

Sure, Bill. I mean, I think we're giving just the non-GAAP EPS numbers, but you can in the back of the press release, I won't spend on the call going through every line. We detail out the reconciliations of the guidance, so you'll be able to see all the different lines. You'll see exactly what we're sort of forecasting for the year for, you know, deal fees and everything like that. We put a detailed reconciliation in there.

Speaker 1

Got it. It sounds like it's going to be weighted. The expense, the $6.5 to $8.5 million, would be weighted out throughout the year. It sounds like the $3 to $4 million would be more towards the second half for the U.S.

Speaker 6

Yeah, I mean, we're actually starting hiring right now for all those positions. Anybody, developers anywhere in the country, please email us, let us know. We're looking for a lot of great developers here. In the first quarter, I think it's just typical seasonality. You have higher payroll taxes and benefits, and then we'll be ramping up pretty evenly throughout the year after that. We're definitely looking to obviously ramp up development this year. That's the main focus.

Speaker 1

Okay. I wanted to also ask another housekeeping question on the contribution from Virtual Premise in the quarter. I know it was probably small, but I just wanted to check that.

Speaker 6

Yeah, it was pretty small. That was pretty small. As far as this year goes, we've just incorporated their numbers into ours. They were on about a $7 million run rate. Of course, that's prorated. We also lost about $2 to $3 million in purchase accounting of their deferred revenue. The number ends up being fairly small. I think with the Grubb & Ellis putting the range in there, they sort of offset each other. All that's pretty much incorporated in the guidance. I think the 11.5% to 13% range is a very comfortable range for us. Obviously, we feel great about it.

Speaker 1

For the fourth quarter contribution, you're looking at less than 50 basis points to the growth?

Speaker 6

Yep.

Speaker 1

It sounds like, okay. I wanted to ask about the expansion into the UK and whether you guys have the data in place there to support a CoStar Go type product.

Speaker 6

I would answer the question. I'd say two things. One is I believe we do. It's not in the exact same format as the U.S. data structure, but it was probably about four years ago that we shut down the 15-person research operation in London and opened a 100-plus person operation in Glasgow so that we could get to the same level in nature and quality of data in the United Kingdom that we have in the United States. There's no material anticipated ramp-up in the United Kingdom around research. The UK research team will be working very hard this year as they are tweaking the data to move it from the UK research system, UKR, into the U.S. enterprise system. That has been, to date, surprisingly well managed and looks like it's going smoothly.

When we actually release the product, when we see it the first time in the UK, I'm sure we'll see things that there'll be some gaps in the teeth that don't look quite right. We will fix those quickly. Ultimately, this is not really an expansion of cost. I think this should ultimately reduce our costs in the UK. We're pretty optimistic about it, and we're glad we're on the track we're on.

Speaker 1

Got it. For the last question, if you could comment on the strength that you're seeing in multifamily and whether that creates an opportunity for you guys.

Speaker 6

I think we're seeing strength across most all the sectors. I think multifamily is getting a little more media attention, a little more hype than the other sectors. Actually, I'm pretty jazzed about all the sectors. We have been collecting more and more data on multifamily. We're definitely climbing a curve there, and we do provide multifamily advisory services and economic forecasting through PPR, which is being well received.

Speaker 1

Thank you very much.

Speaker 6

All right.

Next question goes to the line of Brian Hoff from Stephens. Please go ahead.

Speaker 1

Good morning, Andy, Brian, and Rich.

Speaker 6

Hey, good morning.

Speaker 1

Congrats on a nice quarter.

Speaker 6

Thank you very much.

Speaker 1

A couple of questions. One, just want to make sure I understand what's in and out of the guidance. I guess, Brian, this is for you. The additional marketing spend you talked about, is that in the $3.5 to $4.5 million and/or the $3 to $4 million that you called out in the release, or is that in addition to? The second question related to that is, whether it's in or out of that number, is it contemplated? Is the additional marketing spend contemplated in the guidance?

Speaker 6

Sure. The numbers I talked about, the three and a half to four and a half and three to four, those are pure development numbers. That's really the investment in the development group, with there being a big state piece in the UK and U.S. The UK piece, that number that I outlined there is not just development. There are some other costs in there, but I would say the majority of it's development. The U.S. piece is almost all development. The guidance does include some marketing spend this year. We've got some numbers in there. Clearly, we'll keep evaluating things. A lot of it depends on when the timing of the marketing spend is all going to depend on when the products are released and when they come out. Some of it's a little bit hard to predict, but I think overall, we're trying to account for all that.

It just depends on the timing.

Speaker 1

Okay. You mentioned again the long-term 40%+ pro forma EBITDA margin, and I think that was a combined company goal. Is that still right?

Speaker 6

That's correct. I think it's obviously a CoStar Group goal too, but it is also, if the proposed merger closes, a combined company goal.

Speaker 1

Any thought on the, you know, one of the things that I think we and investors try and suss out is just how much you guys need to invest in order to continue your, you know, your nice top-line revenue growth. Can you give us more color on how the spend that you've recently announced just yesterday, is that going to be ongoing? Does it stop? How does it figure into that 40+ goal?

Speaker 6

We look at this investment as more opportunistic. As we look at some of the product concepts that we have developed and things that we want to do and bring to market, we think we have a number of very compelling, potentially very high-margin products we can bring to market. We don't have to bring those things to market. We can continue to grow without bringing those things to market, but we think they're very compelling and that we should bring them to market. We're basically reinvesting into high-margin initiatives. They're optional only in that we would feel stupid not building them if we can.

Speaker 1

Gotcha. Last question for me, the gross margins, Brian, you mentioned a little bit, obviously, they were very good, much better than we thought. Can you tell us what's driving that? Is this just the business or is there something going on there? You mentioned they'd come down a little bit in Q1 but then continue to grow. What kind of expansion can we expect, assuming standalone basis?

Speaker 6

Yeah, I mean, I think that, you know, clearly, when you're growing revenue, I mean, we've always talked about it, you know, when you got a relatively fixed cost structure, you know, in sort of the research area. I mean, each year we do invest a little bit more there. Essentially, you're going to continue to see margins grow. The first quarter is always just a function of the fact that, you know, you've got, like I said, a lot of the seasonality and payroll benefits in that. The 1,000 researchers in there, obviously, a big chunk of all that seasonality ends up showing up in that line. In general, yeah, the first quarter is always going to be a little bit lower seasonality-wise. The expectation is when you're growing revenue, you're going to be growing the margin line.

I would expect it to be a little, you know, lower in the first quarter. I think Q4 was exceptionally strong. We had a couple of expenses that didn't happen there that might flow over to Q1. In general, I think that, you know, you're going to continue to see gross margin expansion after the seasonality in the first quarter based on strong revenue growth.

Speaker 1

Okay. That's fine, Andy. Thanks again for your time.

Speaker 6

All right, thanks.

Thank you. Once again, ladies and gentlemen, if you do have a question, you can press star one. Next, we'll go to the line of Michael Hong from Needham and Company. Please go ahead.

Speaker 4

Good. Thanks very much. Just a few questions for you guys. First of all, I believe you mentioned that you did $4.9 million of CoStar Go related bookings in the quarter. How much of that was from new customers and how much was from upsell? I just wanted to clarify your comment around the holiday season and iPad shipments. Was the strength of this at all due to that? As a consequence, how should we assume the level of this type of booking in Q1?

Speaker 6

I'm going to take an educated guess if Brian wants to provide different color. That's great. My feeling is that this has been that CoStar Go associated sales have been a relatively even combination of completely new customer acquisitions and existing customer upsells. Maybe a little skewed slightly to existing customer upsells, but it's probably in the 60/40 range there. I don't know that we had specifically an immediate revenue enhancement from the holiday season iPad shipping. What we saw was more of a usage jump, but it was material and clear. It was watching a line. It just stair-stepped up to a new level following the holiday season. I think ultimately it will definitely result in more revenue. If there's a very popular iPad launch in March, I would expect another stair-step in two things. One, slight limitation of the current product is the 3G speed.

LTE speed would definitely make it an even better client experience. Looking at photos and aerials and maps on a high-resolution screen would be an even better customer experience. An increase in volume of units as the new iPad 3 comes out, along with a better customer experience, I think will ultimately drive sales. It's a little frustrating to me. We have a number of customers who are bringing home $500,000 in commissions a year, who are slow to open up their wallet and drop their $700 on probably the most important business tool they could get. With the iPad 3 coming out, we imagine they'll probably reduce prices on iPad 2 significantly, which will dramatically increase volumes. We think all that this spring is good, good, and better to keep the sales going for the CoStar Go. This is not a product that taps out in two quarters.

I think this product will be driving revenues for 8 quarters, 10 quarters solidly. We're only at, I mean, we're not even at 10% yet of our customer base on this.

Speaker 4

Just to add on to that and make one clarification, it was $5 million annual sales for sort of the two quarters that it was out. It was not $5 million in the fourth quarter. My comment on bookings and where can those go, I think I said this last quarter and the quarter before, and I'll say it again now. You can't, it's hard to predict, breaking records every single quarter. The fourth quarter also tends to be seasonally one of our strongest quarters. I think you got a combination of obviously growing momentum, iPad, and then seasonality. My expectation is the first quarter probably will not be as high as the fourth quarter, but I believe growing all year long. Of course, overall great growth rate for the year. We're projecting up to 13%, even factoring in for something like the Grubb.

It could be even higher on that. I definitely would not expect Q1 bookings to be the same. Again, overall, I think we're in for a great sales year.

Speaker 1

Great. I know it's still early around kind of CoStar Go, but how have you seen this impact cost of acquisition for these new subscribers and length of sales cycle? Have you seen any notable changes that you could share with us?

Speaker 6

Yes, I do believe it's a shorter sales cycle. You're bringing in a piece of technology that, frankly, is, you know, sexy. If all sales are emotional, this is definitely a faster sales cycle. Some of the bigger ones may not be that much faster, but the smaller ones, I think, definitely.

Speaker 1

Okay. Last question for you. Given CoStar Fusion and the launch in the UK, what would you expect that to do to growth rates in 2013? I know you have no formal guidance around that, but could we see acceleration from 2012 levels, assuming no material change in the end commercial real estate market? What's your kind of first blush thought on what this could do?

Speaker 6

We'll take the two separately. I think with the UK, even if the UK were to triple its growth rate or quadruple its growth rate, I don't think it would materially move the dial for CoStar Group overall because it's a relatively small percentage of our revenue. It's more of a proof of concept that what we're looking for there is to be able to show that we can do a 30% margin, grow revenue in an overseas market. The much more meaningful revenue would be from a major enhancement to our U.S. product suite in the United States. That is the juggernaut where no matter how fast these other initiatives grow, the core initiative grows at any pace. It's outgrowing the others. This would go right to that core market.

While it's extremely early, we're sitting here in the first part of 2012, and this is a product that would be really about the first quarter of 2013. I am extremely enthusiastic about the way this product looks, and if it's well executed, I think it will have a material and significant impact on our per salesperson productivity throughout 2013. It will certainly re-energize any kind of momentum we have from CoStar Go.

Speaker 4

Just to follow up with that, the UK, you know, people can look at the separate financials, and they're presented in US dollars, but if you convert them back, they've been actually generally relatively flat or low growth the last few years, you know, compared to CoStar Group, which has been growing. One of the things we've identified there is it's because of the software. We believe we have great data. I think the investment in the UK, I believe, will generate higher revenue growth in the UK as you roll out CoStar Go this summer and into the fall, and then the full suite of products by the end of the year or early next year. As Andy mentioned, the UK is 8%, 9% of our business. If we were to close a proposed merger with LoopNet, it would drop to 4%.

It's not a huge piece of our business, but clearly, we're focused on getting their revenue growth rate up to ours in the US or higher and also getting them up to profitability. The way to do that is to invest in the software, which we haven't done yet. I think that's the UK piece. On the US piece, I think it's a little too early to predict growth rates, but clearly, the way we invested in CoStar Go this past year, we are now investing in some new products in the US to obviously release and hopefully then keep the momentum going on growing revenue into next year. Where we sit today, we feel pretty good. As the year goes on, we'll obviously have a better feel for that as we know when the products come out and we see what the reaction to those are.

Speaker 1

Great, thanks very much.

Speaker 4

Thanks, Mike.

Speaker 6

Thank you. Next, we'll go to the line of Brandon Zobel from William Blair. Please go ahead.

Speaker 1

Thanks. Good morning, guys.

Speaker 7

Good morning. A couple of quick ones. Maybe comparing sales cycles in new markets versus kind of more mature markets these days. Are you seeing any, I guess, demonstrable impact either from CoStar Go or just with the improving environment in commercial real estate? Are you seeing any shortening of the sales cycles, or is it still about what you've seen in the past couple of years?

Speaker 6

We are seeing something, I think, very materially different in the newer markets. The newer markets, I would say, I would call newer markets that last round of 200 we entered after the, you know, the 80 big ones. If I'm looking at the established ones being New York, Washington, Baltimore, Philadelphia, Phoenix, so on and so forth, you know, those are doing well, moving along. When I was preparing for this year's sales conference and I was reviewing the sales numbers in some detail, I saw one thing that really shocked me, and that was our performance in tertiary markets. I was looking at numbers like our Buffalo, New York, our Lubbock, Texas, our Boise, Idaho numbers, and I was, they're relative, you know, they don't move about in the whole company that quickly. I was sort of shocked at how well those markets are doing.

The markets like a, you know, a Buffalo where we could, you know, as an example, we could be doing, you know, we were doing, you know, very little revenue before. We're now doing, you know, $100,000, $200,000 in revenue. What's driving that is a successful centralized selling model. People selling into these markets with a cleaner, simpler product offering from our centralized call center in Washington. Also having a career path where people evolve out of our centralized call calling center, selling center into a, you know, sort of a periodic visit to these secondary markets. It's a pretty good trend. I think if that holds up and that keeps going, we're going to feel very good about our decision to go into those tertiary markets. They look really, really high interesting right now.

Speaker 1

Okay.

Speaker 7

There's a lot of them.

Speaker 1

Okay. During the fourth quarter, something came up with, I guess, call it between you guys and CBRE about, I think it was about the power broker rankings. Maybe a little color on what those rankings actually are and how what this issue has, if there is an issue with this between you guys or if that has kind of gone away as the quarter progressed.

Speaker 6

I don't recall what you're talking about. No, CB and CoStar Group have a very important, mutually symbiotic relationship through the years, and we provide a lot of value to them, and they're a very, very important customer to us. They have had a policy that changes from time to time where they don't want comparable sale data getting out to the market because they believe it, or comparable leasing data getting out to the market because they believe it gives their competitors some advantage and neutralizes their scale.

Speaker 1

Right.

Speaker 6

It's inconsistent. I think a short paragraph piece or two came out in Washington Business something about it, and it's sort of blown over. I had a very good and productive meeting with my friend Mike Lafite, who's the President of CB over in Dallas last week. I would say that things are on a very good footing.

Speaker 1

Okay. Perfect. Since nobody's asked the big elephant in the room question, I guess I'll be the guy to ask it about the LoopNet transaction. Maybe I'm reading too much into the words, but should we assume that the transaction process is at this point or has taken this long because the FTC didn't like the deal? They saw there was something they didn't like, either market concentration or what have you. If the transaction does go forward, should we expect it to look like you guys thought it would back when you announced it mid-year 2011?

Speaker 6

I have a lot to tell you about that. I want to basically open up and tell you everything.

Speaker 1

That'd be fantastic.

Speaker 6

I'm going to have John Coleman answer that for you.

Speaker 4

Yeah. Unfortunately, I mean, we're going to have to stick to kind of what the disclosure is we've given. I think Andy Florance said it best. We're working extremely hard to bring this to a close. The conversations have been very productive, and we're hopeful to wrap this up in the near term. I think we can't really get into more specifics than that at this point.

Speaker 6

I think what he said was, want what?

Speaker 1

Yeah, that's pretty much what I heard, I think.

Speaker 6

Yeah.

Speaker 1

Maybe more of a process question. Is there something that we should look for that, let's call it quote-unquote, "restarts the clock" for, you know, kind of final runner discussions? Could the next data point just be, "Hey, we got it completed," or, "We didn't get it completed"? Is there some interim step that gives us a better timeline for how this may play out just from a pure process perspective, or is there some part of the FTC review process that we need to be aware of that you guys need to tell us about?

Speaker 4

I think, you know, as we disclosed, there's this kind of 45-day period. I mean, you know, we would likely tell you if that 45-day trigger was pulled. That would be, you know, if that happened, you would certainly hear about that. Otherwise, hopefully, the next thing you hear is that we've gotten where we're all trying to get to.

Speaker 1

Right.

Speaker 6

I can tell you that they don't offer coffee in their conference rooms.

Speaker 1

I would have thought they would have offered coffee, but bad coffee, like one of those bad cop show movies, that would have been more appropriate for me.

Speaker 6

No, it's self-serve.

Speaker 1

How do we think about research and Salesforce headcount additions in 2012? You know, and I think Brian talked about a 5% uptick this past year for Salesforce. Should we think about the same kind of number this year, or are you guys happy with how the headcount looks right now?

Speaker 4

Yeah, I think as far as sales and research goes, sales, you know, we're always adding a little bit, 5%, 7% each year. I would expect to see sort of similar range there. I mean, nothing significant, but you know, obviously, as the revenue base grows, we continue to grow the Salesforce a little bit. Yep, very similar with research too, very minor, you know, minor adds in research. You know, nothing significant there. I think this goes to the conversation of gross margin growth. The first quarter is seasonal, but then after that, with revenue growth, we would continue to expect to grow gross margins. Some minor investments on both of those, but eventually, you know, we think we've got great teams there.

Speaker 1

Okay, thanks, guys. Appreciate it.

Speaker 4

Thank you.

Speaker 6

Thank you. Once again, if you do have a question, you can press star one. Now we'll go to the line of Toni Kaplan from Morgan Stanley. Please go ahead.

Speaker 0

Hi, thanks for taking my question.

Speaker 1

Oh, no problem.

Speaker 0

I was wondering, are you having success in selling to cut-height brokers within NewHead? I mean, it's sort of geared towards the larger sort of broker segment. You know, I know brokers are the largest sort of client type that you have, but you know, just wanted to hear if there was any surprising success with other customer types as well.

Speaker 6

It's a good point because I think we tend to, when we write things, we tend to always focus on the broker side of it. The brokers have responded very well to this product. I actually think that we're getting an equal and potentially even greater reaction from both retailers and institutions. If you think about retailers, if you're a regional manager for a Starbucks, you are traveling all over the Southwest going to different sites. Actually having all that data in your hand is pretty valuable and much more interesting to have it in your office.

Speaker 3

One of the things we do hope to do is eventually integrate the Virtual Premise lease management, the software that a lot of these retailers use to house their leases, directly into the CoStar Go application. When one of these real retail acquisitions folks is in the field, they can see their existing leases plus all of our data wherever they're going on a location-centric interface. Also, some of the heaviest users of the product are some of our institutional customers. Our very best customers each year come to our PPR conference up in the Cape, the institutional customers. We show them the iPad application, CoStar Go, and we actually gave the attendees an iPad. I was looking at usage, and the heaviest usage I'm seeing is from some of those attendees. These are not brokers.

These are folks who manage, you know, a $50 billion, $100 billion, you know, $50 billion portfolio. They actually find a lot of value 'cause they're from Cedar City, and being able to look up local market conditions, I think, is of interest to them. We've probably done you a disservice not focusing on all and talking about all the different segments that are using it, but it's being used across the board. We also have an upgrade coming to it, which is pretty cool. I know from competitive purposes I shouldn't be blabbing, but Steve Jobs would look down on me.

We have a cool thing coming where you can, if you're in a submarket in Austin, Texas, and you're looking at investment there, you can actually zoom into the neighborhood, and it is real-time calculating statistics on vacancy, absorption, price trends, and the like on the area you're actually in, which is, for the commercial real estate world, pretty mind-boggling. That's something we think we can bring out later this year.

Speaker 8

Okay. Great. Once someone has the required suite for getting the iPad application, what's the upselling opportunity from there?

Speaker 3

If someone has purchased the iPad application and stepped up and are now purchasing all the items to get the iPad application, the next upsell opportunity would be, depending on the customer, additional geographies. It could be Virtual Premise. It could be Resolve. It could be PPR. There are a whole range of other services. Almost nobody in our client base is buying everything we've got. I mean, we should actually look into that. I doubt there's anybody buying everything. Should that day occur, we'll develop something new.

Speaker 8

That makes sense. Okay, thanks very much. Thank you.

Speaker 3

Thank you.

Speaker 2

Thank you. I currently have no further questions. Please continue.

Speaker 3

At this point, I'd like to thank everyone for joining us for this year-end, fourth quarter conference call. We look forward to updating you on our progress on all the various initiatives we're pursuing at next quarter's conference call. Thank you.

Speaker 2

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.