Costar Group Inc (CSGP) — Q3 2016 Earnings Call Transcript

Thank you very much, operator, and good morning, everyone. Welcome to CoStar Group's third quarter 2016 conference call. Thanks for joining us. Before I turn the call over to Andy and Scott, I have some important facts for you to consider. Certain portions of this discussion contain forward-looking statements, which involve many risks and uncertainties that could 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 October 26, 2016 press release on our third quarter results and in our filings with the SEC, including our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q under the heading Risk Factors. All forward-looking statements are based on information available to CoStar at the time of this call, and we assume no obligation to update these statements whether as a result of new information, future events, or otherwise. Reconciliation of non-GAAP net income, EBITDA, adjusted EBITDA and all the non-GAAP financial measures discussed on this call to their GAAP basis results and reconciliation of forward-looking non-GAAP guidance discussed on this call to the most directly comparable GAAP measures are shown in detail. As a reminder, today's conference call is also being broadcasted live and in color over the Internet on www.costargroup.com where you can also find our Investor Relations page. A replay will be available almost an hour after this call concludes and will be available for the next 30 days. And to listen to the replay, call 800-475-6701 within the U.S. or Canada, or 320-365-3844 outside the U.S. The access code is 403281. I'll now turn the call over to Andy Florance. Andy?

Thank you very much, Rich, and thank you, everyone, for joining us for our third quarter 2016 financial results call. We had another strong quarter with profitable revenue growth. Revenue in the third quarter grew 12.5% year-over-year to $213 million. On a pro forma basis in the quarter, revenue grew 14% year-over-year. CoStar Suite revenue in the quarter was up 13% year-over-year with multifamily revenue in the quarter growing 22% on a pro forma basis. We continue to see tremendous momentum in our business, and our services continue to lead in each of their respective verticals. During the quarter, you can clearly see that we've made significant progress growing margins as we emerge from successful investments we made in 2015. EBITDA margin was 27% in the third quarter of 2016 versus 12% in the same quarter last year, more than double. Adjusted EBITDA margin expanded 32% in the third quarter of 2016 compared to 19% in Q3 of 2015. I – sorry, Scott. I stole the next sentence from you. We generated $58 million of cash during the third quarter – I just had to say that. Sales continue to be strong. For the sixth quarter in a row, we achieved net bookings of greater than $25 million, adding $26 million in the third quarter of 2016. The first three quarters of 2016 are the best three quarters we've ever had selling CoStar Suite. Year-to-date, we are outpacing CoStar Suite sales in the same period of 2014 and 2015 by 52% and 33%, respectively. One of the factors behind acceleration in CoStar sales is that we have invested in growing our original sales team over the past few years. When we acquired Apartments.com, we let some of these CoStar salespeople go to Apartments.com. Recently, we have shifted their focus back from Apartments.com to CoStar. This means we have more experienced producers selling CoStar this year than last, but it also means we have fewer experienced salespeople signing Apartments.com advertising than we did this time last year. One of the things we're doing is getting prepared for the intensive selling efforts next year around the integration of the information sales. So, going back to Apartments, today, we believe we are approximately 30% penetrated in apartment properties with 50 units or more. 50 units or more are generally our core target market. This means we have a significant opportunity to grow our share in the apartment industry. We believe that we have the best product offering to market apartments online and that we could capture significantly more revenue if we were to invest in growing our apartment salesforce. Our goal is to grow from the 100 or so apartment salespeople we had at the time of the acquisition of Apartments.com to a field sales team of approximately 240. We expect 200 of those salespeople to be account executives managing relationships with our existing customers, and 40 will be focused solely on new business development. We will consider growing this salesforce beyond that point if we continue to see profitable incremental production as we reach that level. I would not be surprised if we don't see that happen. Our first priority this year for the Apartment sales team was to improve our customer service levels to nothing short of excellent. We shifted our commission plan to reward higher customer service ratings and put a range of customer service metrics in place as well. I think the evidence has been a clear success, as measured by our client satisfaction score and our growth in face time with clients. We completed 1,700 client interviews in the month of September. One important question clients were asked was, on a scale of 1 to 10, how likely are you to recommend Apartments.com to a friend or colleague? The average score from the response was an absolutely outstanding 9.6 out of 10. I believe we achieved this score because of the effectiveness of our product and the effort we're putting in getting in front of our clients more often. In January of this year, we had less than 9,000 face-to-face meetings with Apartments.com clients. The face-to-face meetings grew throughout the year, and in the month of September, we completed over 20,000 meetings. Not only are we having more meetings, but we also believe that we're having more effective and valuable meetings. We have produced a suite of customized reports that we review with the clients at each meeting that help them to understand the effectiveness of our marketing solutions and the competitive positioning of their properties within their market. Not surprisingly, our determined focus on increased productivity has resulted in some increased apartment sales staff turnover, slowing the rate of growth in the sales team. The apartment sales team has a combination of sales cultures from Apartments.com, Apartment Finder, CoStar and some new hires. Some of these cultures were not used to metrics or active management, which is a euphemism for the requirement to come to work regularly. Generally, as a company grows the size of a sales force, it's disruptive as territories change, managers focus on recruiting and training, and churn inevitably climbs. We began this year with 179 apartment sales reps and fell to a low of 141 reps in production in April. That did have a negative impact on net new sales. We still had strong net new sales, but that was retarded a little bit. As of now, we have built the team back to 212 in production. About 70 of those reps are so new that it's not likely they're producing any material sales. As these reps and additional reps we hire become more productive and are introduced into production, we believe that we'll be able to accelerate sales growth and share gains. We have already added 20 additional Apartment reps that are currently in training or have been hired for November classes, which takes the current total to 232, reflecting an increase of 65% over the count back in mid-year. So there's quite an upcoming growth in the number of producers in place. As we approach the integration of CoStar and LoopNet, we've already begun to wind down sales of the LoopNet information products. We're convinced we are trading off lower dollar sales today for much higher dollar value subscription revenue opportunities over the next several years. This product discontinuation created a headwind to sales bookings during the past two quarters. Much of the discontinuing LoopNet information revenue is not on annual subscriptions, while 100% of the CoStar revenue we often replace it with is on an annual subscription basis. Complementing this trend, we're now selling 61% of our Apartment advertising contracts on annual subscription agreements, up from basically zero on annual agreements when we acquired Apartments.com. In the third quarter, 76% of our total revenue was from annual subscriptions, up from 64% in the third quarter of the prior year. Subscription revenue reached $162 million in the third quarter, up $40 million year-over-year from $121 million in the third quarter of 2015. We like the visibility and stability that increasing our annual subscription revenue base gives us. It gives us great visibility and a little bit of recession-proofness. Our subscription renewal rate ticked up in the third quarter again to 90.7%. That's the highest level we've seen in the past six quarters. We believe that our increased focus on customer service has helped us achieve these growing and improving renewal rates. In addition, our new team of 65 CoStar field customer relations managers, working actually in our clients' offices, conducted over 8,000 customer trainings in September and 18,000 in the third quarter overall, driving up the growth of usage of CoStar products, and more likely than not, to increase renewal rates ongoing. So let's focus a little bit more on the LoopNet integration. The significant effort to integrate the two leading commercial real estate online platforms, CoStar and LoopNet, into one digital platform is well underway. Today, CoStar is an information product, while LoopNet is both a marketing product and an information product. After the integration, we plan to position LoopNet as a pure marketing product. We believe there's brand confusion around the LoopNet dual value proposition that will be resolved with the repositioning around a more straightforward, single marketing value proposition. The LoopNet users can be broken down into two general profiles. There are nearly 5 million small business owners, tenants, or small investors who come to the site each month looking for a single new facility or a potential investment, making LoopNet by far the most visited website in commercial real estate. These small business users or tenants are not recurring users, and their highest value to us is the lead value they represent to our paying advertisers. The second segment consists of hundreds of thousands of LoopNet users who are basically commercial real estate professionals. Approximately 130,000 active LoopNet members logged in to LoopNet over the past 12 months and conducted more than 100 searches each. An additional 300,000 visitors to the site conducted more than 100 searches each in the past 12 months. This pool of approximately 430,000 intensive or more professional users is our target upsell audience for CoStar over the next few years, and I believe will result in a tremendous revenue opportunity for years to come. These users are in the market continuously, and many are willing to pay for higher quality information. Today, LoopNet and CoStar are powered by two separate databases. The CoStar database is a higher quality curated database, maintained by our very large research team. The LoopNet database, while very large, is updated and maintained via broker user entry, and accordingly, is not as comprehensive or as quality-controlled as the CoStar database. Nonetheless, there's a lot of valuable content in the LoopNet database that is missing from the CoStar platform today. After integration, both LoopNet and CoStar will be powered by one unified database. 100% of the content that is entered into LoopNet will be immediately available in the CoStar platform, and it will be more tightly quality-controlled and monitored, making the CoStar platform much more comprehensive and more viable. Only the paid advertised content will be visible on the LoopNet platform after integration. This will draw a much sharper distinction in value proposition between CoStar and LoopNet for the brokers and professionals who really need to find the most effective information solutions to do significant transactions. Post-integration, CoStar will always have dramatically more information available than LoopNet in virtually all cases. We plan to market this reality aggressively in highly targeted online campaigns. We've identified about 24 segments that will break users into and will be tailoring highly-customized messages to each one of them to get them to the optimal upgrade path. We believe that this is going to put us in an excellent position to upsell many of the hundreds of thousands of regular consistent LoopNet searchers. We believe that the scale of the potential upsell opportunity is more than $200 million over the period of several years. Simultaneously, we believe that by clarifying the brand value proposition of LoopNet as the essential tool to leverage the Internet to market commercial real estate, we can significantly accelerate the LoopNet marketing revenue as well. Once we integrate LoopNet and CoStar, we expect to grow and strengthen our curated research and simultaneously look to capture the value, efficiency, and preference of some of our clients to enter their own data. I'm really pleased with the quality of the new interfaces we're now building to empower our clients to more effectively manage their content in our future integrated environment. We believe it'll make it much easier for our clients to manage their data and to communicate with their CoStar researcher. This should, in turn, result in much higher quality data. We see clear indications from our clients and prospects that our value proposition to them grows very significantly as we improve the timeliness and quality of the data we can offer them. We believe there's a direct relationship between the improvements we can make to the quality of the data and just how much that $200 million plus potential LoopNet to CoStar user upsell revenue we can achieve and how fast we can achieve it. This revenue growth would be at extraordinarily high margins, so it's particularly important that as we approach this concentrated upsell event, our research, data quality, and software is the best it's ever been. In addition to the revenue upsell opportunity, the LoopNet integration also presents us with an opportunity to dramatically increase the number of CoStar users, thereby increasing the network effects benefiting CoStar and potentially accelerating sales into completely new segments of commercial real estate professionals. In an effort to improve the likelihood of success of our LoopNet upsell efforts, we are accelerating our investment in CoStar marketing, sales personnel, software, and research throughout 2017. We are planning to hire approximately 400 additional researchers to dramatically improve the depth and accuracy of our research, particularly with respect to tenants and retailers that occupy space in commercial properties. At the same time, we're eliminating 70 offshore research positions, making the increase 330 net new. Of these 330 net new researchers, 150 are property portfolio researchers added to ensure that our data quality remains high as we're handling intensive research tasks related to the integration during 2017. The need for some of this incremental headcount will fall post-integration. Our Washington HQ facilities, along with our Columbia, Atlanta, and San Diego research centers, are completely full already. So rather than leasing more space in Washington, D.C., where the cost of living is high, we conducted a nationwide search to find the best possible location to place our anticipated research staff growth, as well as to relocate a significant portion of our existing staff. Our goal has been to find a city with a much more affordable cost of living so that our researchers, many of whom are recent college graduates on starting salaries, can have a better quality of life. We believe that translates to greater longevity with our company, which translates to lower training costs, higher-quality work, and better client relationships. We searched for cities with apartment rents half of those in D.C. We looked for cities that are accessible to our corporate headquarters. We looked for cities that had high-quality office properties at half the cost of D.C. and for cities that have a significant college student population from which to recruit at half the cost. Earlier this week, we announced that we are opening a research and technology hub at 501 5th Street in Richmond, Virginia. It's a beautiful building, and we're getting a great value. Greater Richmond is a 1-hour and 42-minute drive from Washington D.C., and has – if you leave at the right time – office and apartment rents half of Washington's. Richmond also has tens of thousands of new college graduates each year. We intend to provide competitive salaries to our staff who could then be able to afford a relatively higher quality of life, and we believe we'll be able to achieve higher longevity and quality. The State of Virginia, in concert with the City of Richmond, provided more than $10 million in potential incentives to CoStar to support our new research center in Richmond. Over a period of years, we expect to have over 700 professionals in Richmond – 730 exactly, including tenant researchers, portfolio researchers, and software developers. We will incur costs at the start-up, but over the intermediate and long-term, we believe that this investment will lead to lower costs and allow us to further strengthen the quality of our CoStar information services. Richmond will allow us to provide even stronger data service to our customers. Stronger data means we expect to sell more services. We believe it will absolutely help us to convert on the huge opportunity we have in moving hundreds of thousands of LoopNet information users to CoStar information products as we seek to deepen our overall penetration with brokers in the United States. We expect some of the research headcount increases to drop after we complete the integration. I just want to reiterate that. Maybe someone could ask a question about that. Turning back to Apartments, we have reached an important milestone for Apartments.com. After 2.5 years of successful investment in the site, revenues have grown to now transition the product from losses to profits. I'm proud to say that we have turned the corner, having reached the breakeven mark in the third quarter of 2016, and we expect to be profitable with Apartments.com in the fourth quarter of 2016. We believe that we're now entering an extended period where Apartments.com can contribute materially to our future earnings growth, rather than being a drag on earnings. Our investments over these past 2.5 years have transformed Apartments.com, which was number three when we acquired it, to now becoming the clear number one ILS based on traffic, SEM, momentum, total communities, and leads delivered. We believe we are number one in annualized revenue in the multifamily space, with approximately $0.25 billion in marketing information revenue on an annualized basis. From a competitive position, we have the size and scale to provide what I believe is the best marketing site and information services available in multifamily. According to comScore, Apartments.com increased its lead as the most trafficked apartment Internet listing site as unique visitors increased 28% while total visits were up 39% in the third quarter of 2016 year-over-year. Our apartment network had 37 million unique visitors in aggregate in the third quarter 2016, which is 26% more than the former top network in the apartment listing space. While renter traffic to Apartments.com has grown year-over-year, our closest competitor site traffic continues to fall off. Our leads delivered to clients grew 20% quarter-over-quarter and 35% year-over-year. Since we have more than doubled the number of leads we're delivering to our clients on a quarterly basis since we acquired Apartments.com, we are now able to achieve higher prices for the superior service. Our average revenue per advertised apartment community on Apartments.com has climbed 56% to $602 per month, up from $385 per month in the first quarter of 2014 when we announced the acquisition of Apartments.com. So it's quite a significant increase there. Our average revenue per community has climbed 28% year-over-year from $471 per month in the third quarter of 2015 to $602 per month in the third quarter of 2016. In the same timeframe, the number of properties advertised on Apartments.com has climbed 38% or 8,692 properties from the third quarter of 2015 to the third quarter of 2016. This was assisted by the integration of the Finder acquisition, but the net result has been very successful as we've achieved higher pricing, more volume, and we believe very high customer satisfaction. Reflecting continued strength in the U.S. economy, commercial real estate markets are very healthy. A lot of questions about that, but I'd have to say that I really feel quite bullish about where the markets are right now. National employment is at 6.3%; that's 4.6% over last cycle's peak in 2008. What's more, the combination of solid job growth and low unemployment rates have supported personal income gains of 3.1% over the past year, which is pretty significant when you consider that inflation is at about 1%, so it's a really good result. As a result of steady economic and job growth, occupancy rates for all property types except apartments reached a new business cycle high in Q3 2016. Because of high occupancy rates, rent growth for all property types is well over the national inflation rate, ranging from 2.9% for retail to 7.1% for light industrial properties. Construction activities are very low in office, warehouse, and retail sectors, and we're only adding 1% to the inventory of commercial space across all product types. The apartment sector is the only property type that stands out for healthy levels of supply; about 4% of apartment inventory is underway for delivery over the next two years. However, the apartment sector also has very high occupancy rates and needs additional supply to satisfy very strong demand. Overall, commercial property occupancies are high, but supply is relatively modest. As we reported last quarter, the pace of commercial real estate sales has slowed for all property types. Specifically, year-to-date, real estate sales are down 9% from the same point in 2015, but those were very high peaks back in 2015. Year-to-date, sales changes range from a 4% increase in the multifamily sector to a 20% decline in industrial sales. In summary, real estate markets maintain a high level of liquidity, which is a strong indicator of investor confidence in the sector. Analysis of the apartment market shows it's becoming increasingly competitive as rent growth has slowed to 3.2% from 5.9% a year earlier. The slowdown of rent growth in part reflects the 134,000 new units delivered in the first three quarters of 2016, which is 35% more than the 10-year historical average. Net absorption of apartment units totaled 127,000 units year-to-date, which marks a 26% decline from year-earlier levels. Again, frame of reference is important because the current net absorption rate is still 19% over the 10-year historical average. Since apartment advertising spend is highly correlated with weaker apartment markets, a more competitive market is likely to benefit our apartment ad sales. So a more competitive apartment market is good news for CoStar. One of the things I do want to highlight is that we are currently, in the United States, building about 0.6 apartment housing units for each new household formed in the U.S., so we fundamentally have a housing shortage. And you see that reflected when you look at young millennials in Washington, D.C. spending 55% of their salary to rent a modest one-bedroom or studio. So, I think, while there's discussion of oversupply, with the dramatic drop in single-family home construction, these elevated levels of supply in the apartment market are actually inadequate. Office fundamentals remain very strong, with occupancy rates up 40 basis points year-over-year earlier levels to a business cycle high of 89.5%. Year-over-year rent growth of 3.6% marks the 12th consecutive quarterly period of annual rent growth exceeding 3%. Office net absorption of 63 million square feet year-to-date is down marginally from 69 million square feet from the same period of 2015, but this level is 25% over the 10-year historical average. So I have to say that with steadily declining office vacancies, very modest supply of new inventory, and clear-cut housing shortages across the United States, I don't think I've been more bullish about where the commercial real estate economy lies. Upcoming economic shocks are certainly not coming from commercial real estate supply activity. So, in summary, the third quarter of 2016 was highlighted by solid revenue growth, strong sales particularly in CoStar Suite, and significant margin expansion year-over-year. Our transformation of the multifamily information and marketing industry is just the latest iteration of our innovation. I am very proud to lead our team of professionals who are accomplishing remarkable things. We have made important investments that I believe position us for a long period of top-line growth and market penetration. The upcoming LoopNet integration is on track, and I'm very optimistic about the potential outcome. So, at this point, I'd like to turn the call over to our CFO, Mr. Scott Wheeler.

Thank you very much, Andy, for that very informative and comprehensive update. So, as Andy mentioned, we're pleased with our performance in the third quarter of 2016. Let me provide a bit more color around the results in addition to what we already communicated in the third quarter press release that we issued yesterday. My comments will focus on the financial results, performance metrics, and then our outlook for 2016. With regard to our financial results, revenue in the third quarter of 2016 was up 12.5% over prior year, which translates into a 14% growth rate on a pro forma basis. The pro forma results 포함 revenue from Apartment Finder for 2015, which is net of the revenue streams that we eliminated, such as FinderSocial. Breaking down our revenue performance by services, we're very pleased with the growth in CoStar Suite of 13%, which is 14% year-over-year excluding the effects of foreign currency movements. In constant currency terms, this is 200 basis points higher than the comparable year-over-year growth rate of 12% in the third quarter of 2015 and a full 300 basis points higher than the comparable growth rate of 11% we achieved in CoStar Suite in the fourth quarter of 2015. This acceleration of the growth rate in 2016 is a result of continued strong sales of CoStar Market Analytics and the shift in focus of our 200-plus person information salesforce back to selling information products following the Apartments integration that Andy mentioned. With this strong performance, we believe CoStar Suite will continue growing towards the upper end of the 12% to 14% range that we've communicated for the fourth quarter. The information services revenue, which is approximately $19 million per quarter, grew in the low single digits in the third quarter as expected. You recall that information services includes the revenue from our LoopNet information products, which we are not actively selling in advance of our planned integration of LoopNet and CoStar. Accordingly, we expect the revenue growth rates in information services to turn negative in the fourth quarter of this year. In multifamily, our revenue increased 17% year-over-year, which is 22% on a pro forma basis in the third quarter, adjusting for $2 million of discontinued revenue from 2015. For the full year, multifamily revenue growth is expected to be in the 20% to 25% range that we previously communicated. For the fourth quarter, we expect the multifamily revenue growth rate to be slightly below 20%, primarily as a result of lower multifamily sales in the second and third quarters of 2016, as we work through the sales force transitions and increases that Andy mentioned. Going forward, we expect the long-term sales levels to improve in multifamily as a result of the increased sales headcount and our sales force productivity effort. Rounding out our service performance, commercial property and land services grew 10% year-over-year in the third quarter and remain in the low double-digit growth range that we expect for the year. Our gross margins came in at 80.2% in the third quarter, a high watermark for the company. The vast majority of our cost of revenues relates to our research operations, which we are expanding with the recent announcement of our new research center in Richmond, Virginia. Beginning in 2017, the net research investment is expected to be in the range of $25 million to $30 million per year. Accordingly, we would expect gross margins to moderate in 2017 into the 75% to 80% range as we scale up our team in Richmond. As Andy mentioned, there are a number of important benefits we expect to realize from expanding our research capabilities in Richmond. First, we're out of space in our existing centers; expanding our facility in Richmond costs less than half of what it would have cost to expand here in Washington D.C. In addition, the cost of living in Richmond is almost 50% lower than Washington D.C., which allows our employees an improved lifestyle, which we believe will result in lower turnover and a longer tenured quality workforce. Finally, our incentive package from the state and local government is valued at over $10 million, making Richmond an attractive solution. Our operating expenses are down $5 million year-over-year as a result of previously announced plans to reduce marketing and advertising spend and from lower headcount levels as a result of the integration of Apartment Finder. Seasonal marketing expenses are expected to decline further in the fourth quarter, partially offset by higher personnel costs in the areas of sales and customer service. As a result of our continued strong revenue growth and cost management, our third quarter adjusted EBITDA results are favorable to the third quarter guidance range we've provided in July by $5 million at the midpoint. Now, let's take a look at some performance metrics for the quarter. At the end of September 2016, we had 665 salespeople, an increase of around 80 people from the end of June 2016 and up 155 people from March of 2016. We added sales resources across all of our major service areas; the largest increase in our apartment sales force. We expect these higher sales staffing levels will produce a positive tailwind in net bookings in the coming quarters. As Andy mentioned, we added $26 million in net bookings in the third quarter of 2016, along with annualized net new sales on annual subscriptions of $24 million. We continue to see strong net booking levels in the CoStar Suite, while net bookings in Information Services are down year-over-year, consistent with the second quarter of 2016, as we prepare to sunset the LoopNet information product in 2017. We expect these headwinds will continue through the rest of 2016 and into the first part of 2017. Our cross-selling efforts of LoopNet users to CoStar is expected to result in increased bookings in the second half of 2017, with the resulting revenue contributing to growth beginning in 2018. I'll now discuss our outlook for the fourth quarter and the full year of 2016. With only one quarter remaining in the year, we're tightening our revenue guidance range around our previous midpoint of $837 million. Our updated full-year 2016 revenue range is approximately $835 million to $838 million, which represents pro forma annual growth in the upper end of the 13% to 14% range we previously discussed. Our fourth quarter revenue range of $216 million to $219 million implies a year-over-year growth rate of 12% to 13%. This will be the first quarter without pro forma adjustments related to the Apartment Finder acquisition. We continue to see positive trends in our expense profile and are again raising our full-year 2016 non-GAAP earnings per share outlook. Our revised range of $4.20 to $4.25 per diluted share is an increase of $0.13 at the midpoint compared to our previous outlook. For the fourth quarter of 2016, we expect non-GAAP net income per diluted share in the range of $1.23 to $1.28. For the full year 2016, we expect to deliver adjusted EBITDA margin of around 30%, which represents a significant increase over the 19% adjusted EBITDA margin of 2015. Moving forward, we expect to increase the level of investments we are making in key areas of the business to support future growth, such as the expansion of our sales teams, adding to our product development capabilities, and the recently announced research center investment in Richmond. As a result, while it's too early to give any detailed guidance for 2017, we expect minimal expansion in our adjusted EBITDA margin in 2017 compared to 2016, while we remain confident and committed to our long-term margin expansion target of exiting 2018 at a 40% adjusted EBITDA margin; we don't expect the path between here and there to be a linear one. Overall, we'll continue to focus on investing to deliver profitable revenue growth, and I believe we are increasingly well-positioned to achieve revenues in excess of $1 billion in 2018. With that, I will now open the call for questions.

Hi. Good morning, guys. Thanks for taking the question. I appreciate it. I guess I'd like to understand a little bit, Andy, sort of the sales force refocus, if you will, the shift of some of those resources back to Suite. What – can you just talk a little bit about the rationale behind that and your confidence in the ability to hire, train, and drive productivity of some of the new hires within the Apartments sales force, and I guess as a corollary, whether or not you think the path toward sort of market dominance defined by more than 50% share has changed at all?

Sure. So when we acquired Apartments.com, they had the smallest sales force in that industry, and it was – and relative to the investment and the improvements we were making in the software and the branding of Apartments.com, it was too small to be appropriate for what we were doing. So we leveraged a very strong CoStar sales force and pulled them in, and they began leading a lot of the sales efforts for Apartments.com. But that means you are, to a certain degree, robbing Peter to pay Paul. You're taking good resources off of your flagship products and moving them to Apartments, and we were able to continue growing both while we're doing that. But as we begin to stabilize, and as we've begun to build up our dedicated Apartments resources that are not coming from CoStar, we wanted to move the CoStar sales team back out of that Apartments focus in preparation for what we think is going to be the huge selling event for the next several years, which is the LoopNet and CoStar integration. As a sales organization, we are probably a little more intense than the average sales organization. We're in the process of building up an Apartments team that's a little bit more in our mold of folks that want to earn more and work harder, and that's a transition period. We're achieving it. We've now built up a much more robust management team than was there when we acquired these companies. We are having no trouble hiring people. We are filling up these slots very quickly. And I have confidence that we will enjoy the benefit of two strong sales forces, two strong relatively independent sales forces in 2017, one that is completely adequately staffed to capture the opportunity on the Apartment side and one that's prepared to execute the opportunity on the LoopNet upsell, and that makes me feel very optimistic. Growing sales forces is not new to us. That's one of our core competencies, and we're just executing on that.

Good morning, everyone. And congratulations on formally achieving the number one rank in the apartment space.

Thank you very much.

You mentioned the figure of 430,000 users or frequent users of LoopNet, who would make prime prospects for the conversion to CoStar Suite. So, you guys have been at this now for let's say four years. What is the data now in terms of your ability to convert those users?

Okay. So, let's just look at this as phase one and phase two. Phase one began immediately after we acquired LoopNet several years ago. That was the first time we were able to see who some of these very intensive users of commercial real estate information were that we, prior to the acquisition, did not know about. We put a lot of focus on our sales force to try to upsell those high-value users. We were extremely successful. We upsold, I believe, about 10,000 users for $80 million. The typical upsell was about 500% of what they were paying for LoopNet versus what they would pay for CoStar. It was very successful, and it exceeded investor expectations. At the end of phase one, it became clear that the next phase, in order to optimize what you could pull from this revenue opportunity, needed to create that one database. You need to ensure that there was nothing in the LoopNet system of value that someone wouldn't get if they spent significantly more to go into CoStar. That is no small feat, that integration effort. You're dealing with millions of properties that you have to resolve and integrate. And in addition, we wanted to be very respectful of every element or potential element of our FTC agreement, so we wanted to wait until after that first three-year period before we really started to do that. And at the end of that period, the opportunity with Apartments.com came up, and we frankly shifted our focus on software – putting a lot of software resources on what has clearly been an outstanding investment. As we have completed the integration of Finder and Apartments.com, we can now shift toward the integration of that backend database, and that tees us up for Phase 2, which I believe is more significant than Phase 1. We'll be able to seamlessly electronically market to people who are these 430,000 users. We'll be able to show them exactly the differences between what they're using and what they could use. We divide them into 24 different user profiles. We'll be serving up specific marketing content and retargeting them around those profiles. I believe that we have the opportunity to sell significantly more than we did in Phase 1. But preparing for Phase 2 has been a patient process involving a lot of technology and a lot of data flow modeling, but I look forward to when we can begin to pursue that in mid-2017. And as we do that, we'll be able to report to people some of the progress we're making in the summer of next year, but it won't really majorly move the dial in revenue recognition in the middle of the year. It will be more so when it kicks in the third and fourth quarter – first quarter of the following year. But we'll be able to clearly communicate the upsell activity we have, just like we did in Phase 1 where we're providing real good statistics on that.

Thanks. Scott, just to make sure I understand how you guys are talking about margins in 2017 and the phasing of some of these expenses as we go through. Maybe just a little more color on how we get to minimum margin expansion, what minimal may mean for you, guys. It could be zero or a couple hundred basis points. Just help us understand how you're getting from where you're going to finish out 2016 to that 2018 exit target and what that curve may look like?

Yeah. Sure, Brandon. As we go through our planning process, which we're doing now and we'll finalize our specific 2017 plans as we get into December, we'll definitely have a lot more to share with you in February on what that curve looks like. I think what we wanted to do today was, as we've obviously pushed very hard on the margin pedal this year with major growth, to do some of these investments to underpin the growth rates in the future. We don't want the expectation to be that it's going to be a straight line between here and the 40% at the end of 2018. What we do expect is that the seasonal margin pattern we see in the business, particularly driven by marketing and advertising, will continue next year where you have your highest margins in the fourth quarter, your lowest margins in the second quarter, and then the first and third quarters end up somewhere in between that. We think the margins we've achieved this year are certainly sustainable with the investments we plan to make. We think they will probably move forward a little bit next year. Exact basis points, we haven't set that number. But we just wanted to make sure that there wasn't a straight line between where we are today and there and that we're going to pause that straight line and reduce it a bit into next year and then we'll see a return to accelerated margin improvement in 2018.

Yeah. Thanks. Let's follow-up on that line of thinking. It would seem to me that in order to hit the 40% EBITDA target exiting 2018, based on the commentary, it really looks like you'll have to cut expenses, so we'll see operating expense declines in 2018 over 2017 in order to get there. Is that correct? And when should we see – it sounds like some of the nuance to your revenue target was at least $1 billion. So are you suggesting that either in 2017 or the beginning of 2018 the trajectory of growth would improve because you're making these investments in what should be revenue-yielding assets?

I'd love to – so, Sterling, I think you could achieve it on the revenue side, but I do want to remind everybody that CoStar has shown again and again that we are able to reduce costs after an investment initiative. We are very good at that. I think we get credit for that. So it is possible that costs could come down post-integration. But that isn't necessary in order to achieve that 40%. Given what we're doing, our number one priority is to move any and all ammunition required to the front and to support the offensive next year. We expect to complete it next year and then move on to the next thing. And then the second part of your question? It's horrible when asked compound questions to avoid the one-question rule, and then I forget the second one, do you remember the second part?

We'll have him repeat the second part this time. We have an exception to the rule.

If you can still hear me... it was really around the revenue acceleration from these investments, so the timing of it. So if you're saying you can get there based on revenue without expense cuts, the market is obviously reacting negatively to the comments around margins, but if there's near-term visibility that you're going to get pay back on those investments, I think that might be a different reality than just saying, hey, the margin expectations were out of whack.

Right. Well, thank you. What you said, yeah, for sure, right? The reason we are making the investments we're making is because we believe that they have outsized returns. We expect that as that sales force grows on the apartment side, trailing maybe six months of deployment at a new hire steady state, you would see material increases in sales associated with those folks. Per person productivity is really quite good there. On the LoopNet integration side, we clearly believe and are reiterating and saying for everyone to hear that we believe that you'll get significant sales off that upsell. We think that is what's going to happen. But we also know that as you discontinue low dollar sales to replace them with high dollar sales, the discontinuation is upfront and then the upsells are trailing that. Yes, someone would have to have a complete lack of imagination if they were to think that we are just shifting our margin expectations for the business. We're not.

Hi. This is Blake on for Brett. Thanks for taking my question. If you're using the midpoints for 2016 revenue, you guided the top end just down a little bit, and so that maybe reduced the midpoint down by $0.5 million or so. Is that the right math? And then I'm just wondering, ex these increased investments you now expect, was there anything maybe fundamentally you're seeing differently in the market that's maybe the reason for that little bit of weakness into Q4, and any of that would trickle over into next year?

Yes. When you look at the guidance, as we said, we're tightening up the range for the rest of the year. As this business continues to grow bigger and bigger, we look at $0.5 million movement around the midpoint, up or down, in the middle. I just don't think we should read much into that as you look at the pace and the growth of the business. The strength that we're seeing in CoStar, we obviously expect to continue, and that's a very positive thing. We'll see the revenue rates that I mentioned in the fourth quarter of apartment slightly below 20%, and then a bit of the headwinds from info solutions. You're going to see a little bit of lumpiness in there like we've talked about last quarter over the next quarter or so, but we're still very confident about the long-term trajectory of the growth of the business and the improvements that we're making are going to deliver that type of revenue growth.

Oh, great. Thank you. Andy, I'd love to hear sort of how you're thinking about M&A at this point with the projects you currently have on your plate. I mean, what's your appetite for it, and where would you be interested in doing it?

Well, there is a lot of M&A potential out there. There are probably a dozen different opportunities that we are tracking, watching, and engaging with. But realistically, we're interested in doing things at a little more scale. Given the efforts we've got going right now with the LoopNet integration, we wouldn't want to be distracted from that effort. We want to complete that before we do larger deals. But there are many other opportunities similar to that, just like Apartments.com had a lot of intersections and parallels vertical to the things we were doing and we're good at. But again, right now at this moment we've got 110 software developers working on the LoopNet integration, so we're focused on that.

Thank you, good morning. I'm sorry if I've already missed this, but I wanted to just clarify the LoopNet revenue that is tailing off to $40 million or so over the next couple of years. How does that trend over the next two to three years? And then how do you offset that with the incremental revenue that I think you've talked about, the $100 million to $150 million that is coming from the free searchers transitioning over to the CoStar Suite product?

Sure. So some of that, about $10 million, $11 million is Property Comps, Property Facts, which is a service we're just going to discontinue in 2017. That's something where people are paying as little as $20 a month to have a product that we normally – that's a low-quality comparable sale product that would compare with something that we normally charge several hundred dollars a month for. So that $10 million will disappear pretty quickly, and we anticipate that we'll be able to recapture most of that in the course of the following 12 months or so into CoStar Suite subscriptions. The other revenue on Premium Searcher, which is close to the $37 million, will not immediately tail off because we will continue to provide those Premium Searchers with access to a little bit more content in the LoopNet site. Much of that revenue will tail off in the process of a conversion sale. If someone's paying $70 a month for Premium Searcher, that Premium Searcher will discontinue when we move them into a CoStar property subscription, which typically is about $500 a month. So that revenue will sort of – we'd like to see most of that revenue be one-to-one upgrade to activity. The property comps and property facts drop-off will be a little more immediate in that $10 million in the second quarter.

Yeah. And that'll happen in midyear, so you'd expect half of that revenue and half in next year and then half kicks over in the following year of 2018.

Great. Well, thank you very much for joining us for the third quarter earnings call, and I look forward to updating you at year-end. Thank you very much.