Costar Group Inc (CSGP) — Q3 2019 Earnings Call Transcript

Thank you, operator, and welcome to CoStar Group's third quarter 2019 conference call everyone. Before I turn the call over to Andy Florance, CoStar's CEO and Founder; and Scott Wheeler, our CFO, I'd like to share some important facts. Certain portions of our discussion today may 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 today in CoStar Group’s October 22, 2019, press release on our third quarter results and in company's outlook and then CoStar's filings with the SEC, including our most recent Annual Report on Form 10-K and our subsequent Quarterly Reports on Form 10-Q, under the heading Risk Factors. All forward-looking statements are based on information available to CoStar on the date of this call. CoStar assumes no obligation to update these statements, whether as a result of new information, future events or otherwise. Reconciliations to the most directly comparable GAAP measure to the non-GAAP financial measures discussed on this call, including non-GAAP net income, EBITDA, adjusted EBITDA, and forward-looking non-GAAP guidance, are shown in detail in our press release issued today, along with definitions for these terms and they can also be found on the press release on our website, which is located at costargroup.com. As a reminder, today's conference call is being broadcast live on our Investor Relations website. So, please refer to today's press release on how to access the replay of this call. Remember, one question, and if we have time permitting we'll re-queue. But I'll now turn the call over to Andy Florance. Andy?

Thank you, Rich. That was extremely well done. Thank you for joining us for CoStar Group's third quarter 2019 earnings call. CoStar Group's total revenue was $353 million in the third quarter of 2019, an increase of 15% year-over-year. During the second quarter of 2019, CoStar Suite revenue moved through the $600 million annualized run rate mark. In the third quarter, Apartments.com moved past the $500 million annualized run rate mark and did so with a 20% year-over-year growth. This is outstanding sustained growth, considering we're in the sixth year of owning Apartments.com. But we expect there's much more to come. Multifamily is a huge opportunity. We estimate that total addressable market multifamily is somewhere between $8 billion and $10 billion. This is four to five times bigger than we initially estimated the multifamily opportunity was when we entered the space in 2014. Net income for the third quarter 2019 was $79 million, an increase of 34% over net income of $59 million for the third quarter of 2018. EBITDA was very strong for the third quarter of 2019, coming in at $113 million, an increase of 24% versus EBITDA of $91 million for the third quarter of 2018. Adjusted EBITDA margins moved to 37%, and we achieved 80% gross margin in the third quarter. Our balance sheet remains strong, and we expect to have over $1 billion in cash at year-end and no debt, even after the closing of the STR acquisition earlier today. We continue to show strong growth in profitability while we continue to invest in the future growth of the company. I'm delighted with our ability to consistently deliver on both fronts. There's a massive opportunity in both the United States and abroad in information, analytics, and marketing for commercial real estate. While I'm pleased that we are approaching $1.4 billion of revenue in 2020, we believe there are billions of dollars of opportunity not yet realized, so continued investment is optimal. We had another excellent sales quarter, generating $50 million in company-wide net bookings, and increased 27% year-over-year in the third quarter. Our average net new sales of $52.5 million per quarter year-to-date in 2019 is 32% higher than the comparable period in 2018 when the average net new sales per quarter was $39.8 million. On the multifamily side of the business, the larger sales force we deployed in 2018 has delivered in a big way. In fact, both CoStar Suite and Apartments.com sales team each achieved more than 30% growth in net new sales in the third quarter of 2019 compared to the third quarter of last year. I'm optimistic that our sales levels will continue to be strong for the remainder of 2019, and can improve in 2020 as we are proactively increasing the size of our sales force, offering new products and services, and continue to grow share in our huge addressable market. We now have 280 field sales reps in production for CoStar Suite and LoopNet, and we look to enter 2020 with about 300. In the third quarter of 2019, we identified and distributed a list of 17,000 CRE owners as strong sales leads to our sales force. Each rep has a targeted owner list. We have been aggressively preparing our sales force to target and sell owners both LoopNet signature listings and more CoStar Suite. I'm pleased to announce that we closed on the acquisition today of STR for $450 million. Founded in 1985, the STR team has created global industry-leading benchmarks in analytics that are the primary information tools hotel management investors rely on to monitor and optimize their assets. They provide the foundation for daily hotel and lodging pricing strategies. This is an extraordinary company that's a viable partner with the hotel industry. Ultimately, the cash flow intelligence STR provides is the fundamental value driver in the $3 trillion hospitality sector commercial real estate. The industry needs information to effectively develop finance appraise and transact hospitality properties. We are bringing together a leading provider of commercial real estate information, analytics, and online marketplaces with the gold standard, global hospitality industry for premium performance benchmarking and revenue forecasting. We are excited to add this world leader as an extension of the depth and reach of our comprehensive CoStar platform. STR aggregates data from over 65,000 hotels worldwide, representing 9 million guestrooms in over 180 countries. Hotels electronically submit their revenue and occupancy data to STR on a weekly basis. CoStar currently provides billing information on 80,000 hotels, 45,000 hotel sales comparables, and 4,500 hotels currently offered for sale. We plan to integrate the STR data with CoStar to create exciting new products that provide hotel building data, aggregate income and occupancy information, sales comps, and for sale information. STR has expanded our global footprint. CoStar now has over 4,400 employees in 19 countries with over 600 working outside the United States. For the first time, CoStar now has staff in Singapore, Australia, China, Colombia, Brazil, UAE, Indonesia, Italy, India, South Africa, and Japan. Just imagine the air miles. Smith Travel brings an unrivaled reputation within the global hospitality industry for their data integrity, reliability, and strict confidentiality. And we look forward to continuing to build on those core values in the next chapter of Smith Travel's growth. CoStar has extensive experience segregating and protecting highly confidential client information, such as accounting data, leases, lease abstractions, major deals and progress, payroll data, and sensitive banking data. Integration of STR with the CoStar product will maintain absolute confidentiality while also allowing property owners, investors, and service providers in the hospitality sector a more holistic, aggregated view of the industry at market levels. I've already had a chance to meet with the STR team in London. It's a great group. And tomorrow, I will be in Hendersonville, Tennessee to welcome hundreds of new employees to the CoStar team. I'm looking forward to working with our outstanding management team including: Amanda Hite, CEO, hello, Amanda; Elizabeth Winkle, Chief Strategy Officer; Robert Rosman, Managing Director, and many other strong leaders as we get there. We believe that combining STR's superior hospitality service offering with the CoStar platform will benefit all industry participants as we work together to create valuable new and improved tools. I'm very pleased to report that one of the world's leading property companies, JLL, has renewed its contract with CoStar with a five-year deal and a two-year renewal option. As you know, JLL recently completed its acquisition of HFF. Our contract for the combined entity is largely the same as the two firms were paying individually since now all the brokers of JLL will have access to the National CoStar Suite data and analytics. We saw a similar phenomenon when Grubb & Ellis combined with Newmark Knight Frank, confirming that the consolidation of CRE can be beneficial to CoStar revenues, particularly when it combines and expands access to CoStar services. I want to update you on LoopNet and where we are with that. Office buildings released have historically been remarketed from broker to broker via print brochures or email brochures. Owners seeking to lease up their building with a higher broker would then distribute a few hundred flyers to other local brokers announcing the brokers' availability. The landlord's broker will generally affix a sign to the building announcing the space offered for lease. But that will only reach prospects who are already at the building. Given that some of these leases can be worth more than $150 million, this strikes me as a primitive way to market space. It's understandable in historical offline contexts, as there are severe limits in the methods available to market office space. There could be tens of thousands of tenants within five miles of a typical office building availability with hundreds of thousands of potential decision influencers. Additionally, 20% or 40% of the tenants searching for space in the market are coming from outside that MSA. The size, distribution, and changing nature of the prospects have made it impossible for owners to build effective direct mail or email marketing lists. Ryan national TV, radio, or newspaper campaigns for years so it takes to lease property is prohibitively expensive. Hence, the industry has relied on marketing through a double middleman model. On a $150 million lease, an owner might pay $9 million in commissions, $7 million in free rent concessions, and $14 million in tenant improvements for a total marketing cost of $30 million. Even after investing so much money, we estimate that office owners lose approximately $40 billion annually to excess vacancy. Smaller tenants occupy approximately 35% of U.S. office space, so most owners cannot pay a mortgage without them. Yet commission brokers are less motivated to pursue small deals. Therefore, owners rely on a double broker model and face greater challenges marketing to small tenants. While WeWork has not been a complete success, one of its growth drivers has been that it's met the massive unmet need for connecting smaller tenants to space. The Internet has created transformative opportunities to market commercial real estate online and LoopNet is fortunate to be at the forefront of that opportunity. LoopNet and its certain related sites are now generating 6.6 million unique visitors per month as reported by Google Analytics. This is a 16% year-over-year increase. No other CRE marketplace comes close to LoopNet. According to Hitwise, LoopNet has almost 2,000% more traffic than the second most heavily trafficked website, wework.com. For the 22,000 CRE keywords we prioritize, LoopNet holds the number one SEO position on Google 86% of the time. The fact is that today millions of tenants look for office space online. We believe that LoopNet is the most effective way to market commercial space today because it offers unprecedented reach, strong frequency, and elevates the property's brand. We know LoopNet's effective marketing because tens of thousands of brokers pay to market their listings on LoopNet in order to reach tenants and users. We believe we can significantly expand the property's reach, frequency, and branding by sorting the top of LoopNet and CoStar just as we do in Apartments.com. This increases the ad size, content, and by repeating across our websites, it’s growing net reach and frequency. We call these signature ads and we already can see they work. By tracing IP addresses, we can see major tenants viewing signature ads on LoopNet followed later by their brokers viewing the same ads or content on CoStar, and then we see the tenants lease space in the property we believe that the tenant originally found on LoopNet. We see specific deals in the range of 0.5 million feet, so we see some huge deals this way. The owners of an office building have a much greater economic stake than the broker, so focusing our salesforce on selling these ads to owners directly in harmony with the brokers at price points about $2,500 a month. We have recently put in place more training incentives to drive sales for this goal. We have made great strides in improving the website over the past year to better fit our clients' branding goals. We have created richer content and signature listings including photography, reviews, bios, and graphics. The signature ads can have a hugely positive impact on marketing of a building for as little as a few cents to a few dimes per square foot. When the owner already be investing $100 a foot in traditional costs and methods to lease up their space. So we're talking a point or two on additional costs to make the program more effective. We believe that marketing commercial real estate online will be a multibillion-dollar opportunity. And that CoStar Group is well-positioned to capture a major share of that opportunity. We expect that LoopNet will be a significant contributor to our 2020 sales growth. Turning to Apartments.com, Apartments.com is doing very well. Apartment's revenue is up 20% year-over-year. Net sales are up 30% year-over-year. And profit contribution has been growing rapidly as we continue to grow revenue. In July and August, the Apartments.com network reached an all-time high in unique visitors according to comScore. We had nearly 60 million visits in August 2019, an increase of eight million from August 2018. The Apartments.com network continues to pull further away from the competition by growing unique visitors, 10% year-over-year to $18.9 million in September, as reported by comScore. At the same time, RentPath saw a decrease of 4% in the same period. Our network had more than nine times the number of visits than Apartment List had and 2.6 times the visits that RentPath had. The Apartments.com network had more visitors than the Zillow Rental Network. We have just begun beta testing Apartments.com’s digital tenant screening, lease documents and rent payment system. Our first two markets are Santa Monica and Atlanta. It's only been two weeks, so it's still very early, but the initial reaction exceeds our expectations. 36% of the landlords who added our listing on Apartments.com in a test period elected to use our digital leasing tools. I'm really happy with that number. We've already begun processing applications, screening renters, executing leases, and collecting rent payments. Some of the owner comments have included, it shows me the overall quality of the specific tenant, especially compared to other potential tenants in terms of reliability, trustworthiness, responsible, etc. Another owner said it was more thorough than what I was expecting. Another said, I thought it was user-friendly, covered every detail we needed, and was quick and easy to use for both myself and my potential tenant. Finally, another owner said, it was very easy and fast. Some of the renter comments were, it was really quite simple, one application. It was much easier than expected. Another one, it was extremely simple and felt secure submitting my information. And finally, it was fairly easy. I think it's good that the comments are so short. We expect to continue rolling out the tools throughout the rest of the year and into next year. There are hundreds and thousands of mid-sized and smaller apartment communities that we're now successfully selling to. To fully capture this opportunity, we are significantly expanding our apartment sales force, by building a 100-plus person team in Richmond, focused on this middle market opportunity. I had a chance to meet with the first team of 17 reps and managers last week. It's a very promising, highly motivated group with excellent support from our Richmond technical and administrative infrastructure. I'm very excited about the growth prospects that expand sales force can deliver going forward. During last quarter's earnings call, we reported that we thought we could provide our advertisers with more value, enhance our competitive advantage, and generate a good ROI with more aggressive marketing investment behind Apartments.com. On our last earnings quarter call, we announced that we are increasing our marketing spend for the second half of 2019 by $10 million. We did that and we increased the investment in the third quarter alone. We have analyzed the results, and we achieved our desired outcomes. Beginning in August, we roughly doubled our investment in certain categories of Google keywords. Not surprisingly, we more than doubled our apartment rental click share compared to other top listing services, moving from 32% click share to 67% click share according to Hitwise. During the same time period, RentPath's click share plunged from 35% to 17%. RentPath had been making up for weak SEO by buying SEM traffic. During the trial, RentPath moved from having more click share than Apartments.com to having one-fourth of Apartments.com's click share. Apartment List had 24% of click share before it began, and their share dropped in half to 12%. We've also increased the number of times we're in the number one position in Google by nearly 600%. During the trial, we appeared in the top four Google SEM positions 95% of the time in our targeted neighborhoods. Given the success of the trial, the only humane thing to do is to immediately suspend the trials and deploy the increased investment widely to help millions of additional renters find a great apartment soon. We plan to continue to sustain an elevated level of SEM spending in the fourth quarter. By the end of the year, we will have increased our SEM spend by a total of $20 million in 2019 over our initial budget at the beginning of the year. We acquired Apartments.com in 2014, and since then we've grown profitable revenue organically and acquisitively. We expect to achieve a five-year compound annual growth rate of 38% based on our 2019 forecast. We have grown from serving just over 17,000 apartment communities to serving well over 50,000; in fact 52,000. An industry that has historically only monetized large apartment communities we’re very successfully selling marketing solutions to large, medium, small communities, and even single-family rentals of which there are tens of millions. That shows this is a massive opportunity. We are clearly in the lead position in the industry. We absolutely want to cross a billion dollars of revenue in Apartments.com soon and go well into the billions of dollars of revenue. Ultimately, we'd like to generate a billion plus of EBITDA from the apartment sector alone. In 2015, we showed our commitment to the industry with an unprecedented $100 million investment in marketing Apartments.com with $100 million plus renters in the U.S. It was not initially very popular with everybody, but it clearly worked. It helped us grow our revenue from $85 million to $500 million. In the third quarter this year, we've tested a more aggressive marketing investment and we like the returns. As we move into 2020, we plan to take Apartments.com to the next level again. We expect to increase our investment in marketing from approximately $150 million in 2019 to $250 million in 2020. That's a $100 million incremental increase in our marketing spend. This will bring our 2020 margin down, but we believe in the future, this investment will drive our revenue and margin well beyond the investment we're making in 2020. Our $250 million 2020 Apartments.com marketing budget is expected to consist of much more aggressive search engine marketing, more aggressive TV and digital video marketing with the goal of moving our unaided awareness from the 26% to 33% range to the 50% plus unaided awareness range. We also plan to invest in marketing programs to support our digital leasing initiatives. Make hay while the sun is shining. The sun is shining brightly and we intend to make a spectacular amount of pay. Have a legal update for you on Xceligent, if you remember that, CoStar shareholders have invested billions of dollars to enable CoStar Group to build and acquire robust information systems in marketplaces that are invaluable to the commercial real estate industry. CoStar's ability to protect its intellectual property from misappropriation is a critical factor in our success. Over the course of the last several years, Xceligent as former officers and directors instructed contractors and employees to circumvent our security systems protecting CoStar Group's websites in order to steal an enormous fine intellectual property from CoStar Group. They repackage and sell that content as their own. This represented a fundamental threat to CoStar Group when we had to stop it. We relied on the protections of the U.S. copyright law in terms of use for the website, among other legal tools. We sued Xceligent and their contractors as a smokescreen. Xceligent complained to the FTC and countersued complaining of anticompetitive behavior. Faced with an iron-clad case against Xceligent for massive copyright infringement in November 2017, Xceligent's parent company DMGT returned investment Xceligent to zero after losing around $150 million investment in Xceligent. Xceligent was bankrupt. On the day DMGT announced the write-down, the loss of $150 million, its shares suffered a 23% drop, hitting a five-year low. I do not believe that DMGT was aware of the scale of the illicit things that Xceligent was doing. DMGT was just a string of investors, and Xceligent over the course of the 20-plus years lost millions, tens of millions, or $100 million. We welcome the investigation, including an audit authorized by the Federal Trade Commission to determine whether CoStar content was improperly added to Xceligent systems or vice versa. The massive investigation led by the FTC-appointed monitor concluded that Xceligent improperly derived, took nearly 38,500 images from CoStar's database. We believe this is a complete vindication of CoStar's allegation of Xceligent's unlawful activity. The Department of Justice appointed a trustee to manage the now bankrupt state of Xceligent. After the results, the FTC monitor's investigation, along with other overwhelming evidence of willful copyright infringement perpetrated by Xceligent under CEO Doug Curry, the trustee has agreed to the entry of a judgment of $500 million against Xceligent in favor of CoStar Group for copyright infringement. This $500 million judgment would be the largest copyright image judgment in history and the third-largest copyright judgment of any kind. The judgment is awaiting approval from the bankruptcy court overseeing Xceligent's bankruptcy and the court overseeing CoStar's copyright suit. Because Xceligent is bankrupt and virtually without sellable assets, the total amount CoStar will recover under the judgment is only $10.75 million, which will be paid to us by Xceligent's insurers. Of course, I never put the word only in front of $10.75 million. The trustee has also agreed that Xceligent's countersuit against CoStar would be dismissed with prejudice. In connection with Xceligent's massive illegal operation, the directors and executives of Avion, Xceligent's foreign contractor in the Philippines have been charged and indicted on cybercrime charges brought by the Philippine prosecutors. In its paper, the Philippine's DOJ stated that Avion acted in concert with Xceligent management to commit the classic example of computer crime. In the final judgment entered in Indian court in favor of CoStar, Xceligent's other foreign contractor Maxwell stated that it was misled by Xceligent and its executives and managers including Xceligent’s CEO, Doug Curry, who personally visited the operation in India to supervise their work infringing CoStar's copyrights. Shortly after Xceligent's bankruptcy, Doug Curry started another competitive CRE information business called Intrepid that sells in the few weeks of launch. Apparently after that, Doug has started another CRE information business with several million dollars of funding from Moody’s, a company you may have heard of. The scale of Xceligent's copyright infringement is unprecedented, sort of a historic marker, and CoStar Group is very grateful for the thorough efforts of the FTC-appointed monitor in completing the massive audit of the copyright violations. I believe our investors will give us credit for aggressively defending their investment in CoStar against intellectual property theft. We have ultimately achieved favorable findings or judgments in this defense in federal court in the U.S., coming up on two in federal court, in court in India, before the Philippines Department of Justice, from the U.S. Department of Justice appointed trustee and monitor appointed by the Federal Trade Commission, which sums up to five wins and zero losses in a pretty challenging case. A special thanks to our trial attorney Nick Boyle who did a fantastic job and the entire teams at Williams & Connolly. Quick look at the commercial estate economy. Despite growing concerns around the economic outlook, commercial real estate activity continues to post strong totals for leasing and investment volume. We believe this is justified given the sector's sound fundamentals. Vacancy rates remain near historic lows across all sectors, and supply is generally limited. And the recent drop in treasury yields makes returns in commercial and multifamily real estate all the more compelling. Investors may also view real estate as a defensive investment as trends in capital market and economic indicators have increased the probability of a near-term slowdown. In particular, we note disruptions in trade, falling manufacturing output and business investment, and slowing demographic growth. Despite these headlines, however GDP growth and job gains have yet to show any meaningful slowdown and continue to support demand for commercial and multifamily real estate. The property markets apartment rent growth once again topped 3% nationally. We believe the ongoing health of the apartment sector relates to the broad and growing shortage of housing in the United States. In particular, insufficient supply of new-for-sale housing units has limited homebuying and led to the unprecedented level of apartment demand. In response to this demand, apartment construction has risen to levels not seen since the 1980s. CoStar tracked just over 300,000 units delivered over the past 12 months, and we're tracking about 650,000 apartment units currently under construction. The large majority of these developers rely on the Apartments.com advertising platform to market those units. Investors continue to favor U.S. multifamily assets investment; the sector had a third quarter record this year, topping $40 billion. In the office sector, leasing has consistently set new records despite single-digit vacancy rates and limited supply. Large tech firms have demand as they expand beyond their Bay Area and Seattle footprints. Rent growth, however, has turned to just around 3%, well below typical gains in the past periods of expansion. Unlike past expansions, however, supply is limited to less than 2% of the current inventory and concentrated in a handful of markets. New York also stands out with 25 million square feet underway. We work – unfortunately we'll leave New York a little bit vulnerable since they're heavily constrained in New York, but we don't think it's a big issue. We believe that measured rankings and low supply risk in the office sector helps insulate the market from potential economic reversal, and our base case forecast calls for steady rankings. In the industrial sector, ongoing changes in how consumers shop continue to generate record levels of demand for industrial space, despite vacancy rates around 5%. Developers are responding with a record amount of industrial space as under construction, but rent growth continues to post gains about 5% year-over-year. The best among major property types investment sectors is on pace to set another record. Disruptions to trade pose some risk to the sector, but we expect fast-growing demand for local distribution space to provide same-day delivery of goods will help offset any slowdown. In the retail sector, negative headlines around store closings in e-commerce obscure the sector's strong fundamentals. We estimate retail vacancies are below 5%, the lowest across all property types, and construction underway amounts to less than 1% of current stock. The surge in space has resulted in low leasing absorption levels, but demand for retail space from grocers, discounters, fitness clubs, and experience retail is offsetting move-outs from department stores and big-box retailers. We expect the record levels of activity in commercial and multifamily real estate to continue. We expect the demand for CoStar Group's products and services to grow as we help owners, lenders, brokers, and investors, property managers make quality choices and realize successful outcomes in any economic environment. We continue to generate strong momentum in 2019 and make important investments. I'm extremely excited about the rest of the year as we continue to execute on our long-term vision within a great company. At this point, I will turn the call over to our CFO, Scott Wheeler, and he will give you more details on our earnings and our planned investments.

Thank you, Andy. Well said. It probably didn't seem like we took a break this summer. The third quarter delivered another great financial outcome, while initiating and closing our acquisition of STR took less than 12 weeks, but who's counting? Andy mentioned a number of highlights from our third quarter results, including our second consecutive quarter of net new bookings of $50 million or more. We also achieved strong double-digit revenue growth of 15% year-over-year, marking 10 straight quarters of revenue growth of 15% or more. For those interested in EBITDA, over the trailing four quarters, we amassed over $500 million in adjusted EBITDA, that’s $0.5 billion, certainly a significant achievement for us at CoStar. Starting with revenue, we exceeded the midpoint of our guidance range for the third quarter at 15%. For the year, we expect consolidated revenue growth of approximately 16% to 17%. Looking at revenue performances by services, CoStar Suite revenue growth was 12% in the third quarter compared to the same quarter in 2018. We anticipate a revenue growth rate for CoStar Suite of approximately 13% for the full year of 2019. Revenue in our Information Services sector grew 11% year-over-year in the third quarter of 2019, largely due to CoStar Real Estate Manager’s revenue growth of 19% year-over-year. As we move past the lease accounting standards’ adoption dates, Real Estate Manager results include subscription revenue growth of 44% year-over-year in the third quarter, offset by a 20% decline in one-time implementation revenues. We project Information Services revenue to grow at 20% to 21% year-over-year in 2019, which includes approximately $3 million to $4 million of STR revenue. More on our STR outlook later in the call. Multifamily revenue growth for the third quarter remained strong at 20% compared to the third quarter of 2018; we expect full-year 2019 revenue growth for multifamily in the 20% to 21% range. Commercial property and land revenue grew 17% year-over-year in the third quarter of 2019. Our LoopNet marketplace, which accounts for approximately 75% of revenue in the commercial property and land sector, has continued to see robust growth, even as we repositioned LoopNet into a premium advertising solution for property owners. A lot of work is happening behind the scenes for LoopNet as Andy mentioned, including phasing out certain legacy products and contracts that don’t align with our strategy. Excluding the one-time impacts, the third quarter growth rate of LoopNet would have exceeded 20%. We expect year-over-year organic growth in the commercial property and land sector to be about 16% for the full year of 2019, and we anticipate stronger growth rates from LoopNet as we continue to develop that sector of our company. Our gross margins for the third quarter of 2019 were 80%, slightly up from 79% in the second quarter of 2019, due to strong cost leverage. Revenues increased by $9 million from the third quarter compared to the second quarter of 2019, while our cost of revenues remained largely unchanged sequentially. We now expect overall gross margins to be approximately 79% to 80% for the full year of 2019. Operating expenses for the third quarter were $187 million, slightly below our estimates and reduced from $197 million in the second quarter of 2019, due primarily to seasonally slower marketing spending. As we noted in our previous update in July, we increased our planned marketing spend in the third quarter and expect that to continue through the year. Our adjusted EBITDA for the third quarter was $129 million, representing an 18% increase compared to $110 million in the same quarter of 2018 and approximately $2 million above the top end of our guidance range, mainly due to favorable personnel expenses. The adjusted EBITDA margin of 37% is 80 basis points higher than the 36% margin in the third quarter of 2018. Net income for the third quarter was $79 million, a 34% increase or $20 million compared to Q3 of 2018. Our effective tax rate for the quarter was 21%, reflecting benefits related to share-based payment transactions and R&D credits. Non-GAAP net income for the third quarter rose 21% to $96 million compared to Q3 2018, or $2.61 per diluted share, adjusting for stock-based compensation, acquisition expenses, and some restructuring costs associated with previous changes in Apartments.com and related research. Non-GAAP net income for Q3 assumes a tax rate of 25%, excluding other discrete tax adjustment items. As of September 30, 2019, our cash and investment balances totaled approximately $1.4 billion, up about $91 million since last quarter. As you know, we closed on the STR acquisition today, and we expect our cash balance to be about $1 billion at the end of 2019. Now let’s review some of our performance metrics for the quarter. We had another strong bookings quarter with net new sales of $50 million, a 27% year-over-year increase for the third quarter. The sequential decline from $59 million in the second quarter is attributed to seasonal sales patterns, particularly in our online marketplace operations. By the end of the third quarter, our salesforce consisted of approximately 820 individuals, up about 40 from the last quarter and nearly 90 from the third quarter of 2018. Much of this growth is within our commercial real estate sales team, focused on selling CoStar and LoopNet. We plan to continue expanding the commercial real estate salesforce for the remainder of the year while also ramping up our mid-market sales team in Apartments.com. By the year’s end, our sales team will likely grow to around 880 to 890. The renewal rate for annual contracts in the third quarter held steady at 90%, consistent with Q2. The renewal rate for customers with five or more years of experience was 95%, also consistent with the previous quarter. Subscription revenue on annual contracts now represents 82% of our revenue in the third quarter, up from 80% last year and unchanged from last quarter. I'll now outline our outlook for the full year and for the fourth quarter of 2019, particularly concerning the STR acquisition. We expect STR to contribute between $3 million to $4 million in revenue for the fourth quarter of 2019. This estimate reflects the negative accounting impact of deferred revenue on STR's books at the time of acquisition, which is significant relative to other recent acquisitions. STR collects the full annual subscription amount in the first quarter, resulting in reduced accounting revenue post-acquisition. Similarly, our projection for STR's adjusted EBITDA in Q4 will be negatively affected by accounting adjustments for deferred revenue and integration costs, with an expected negative impact of about $5 million to $6 million. These impacts are included in our revised expectations for 2019. Looking toward 2020, STR's results will remain influenced by these deferred revenue accounting adjustments. For instance, STR's annual revenue run rate of approximately $64 million would be reduced by an estimated $10 million in deferred revenue, leading to a revenue outlook of about $55 million for STR in 2020 before any growth or integration changes. The deferred revenue effects will also carry over to EBITDA for STR. We will outline a detailed plan for STR’s integration in 2020, but we anticipate the acquisition will become accretive in the second half of the year and yield positive EBITDA for 2020. These accounting results for STR do not impact the economic benefits of combining CoStar and STR, which we have discussed before. We still expect that within three to four years, our investments in new products and the focus on combined business growth will lead to annual revenue growth above 20%, roughly double STR's current growth rate, and profit margins in line with CoStar's long-term goal of over 40% adjusted EBITDA margins by 2023. Now, let’s discuss the combined outlook for the company. We are slightly raising our revenue outlook to between $1.385 billion and $1.391 billion for the full year 2019 to include STR’s estimated revenue. This reflects revenue growth for the year between 16% and 17%. For the fourth quarter of 2019, we expect revenue in the range of $360 million to $366 million, which shows topline growth of 14% to 16% compared to Q4 2018. We anticipate adjusted EBITDA to be in the range of $494 million to $500 million for 2019, remaining relatively stable compared to our previous guidance, apart from the inclusion of STR results. We expect adjusted EBITDA growth of approximately 19% year-over-year, with an adjusted EBITDA margin of about 36%, an increase of around 70 basis points from the midpoint compared to 2018, despite short-term negative impacts from the STR acquisition. In the fourth quarter of 2019, we expect adjusted EBITDA to fall between $129 million and $135 million. This outlook for fourth quarter adjusted EBITDA incorporates impacts from the STR acquisition and higher marketing spending for Apartments.com. We've observed exceptional results from increased spending and plan to continue investing at these elevated levels. The net outcome for the fourth quarter reflects other offsets, with an additional estimated spend of around $5 million to $6 million. In terms of earnings, we expect full-year non-GAAP net income per diluted share between $9.90 and $10.02, based on 36.6 million shares. For Q4 2019, we foresee non-GAAP net income per diluted share in the range of $2.52 to $2.64, based on 36.7 million shares. Looking ahead, we believe that 2020 is the opportune moment to boost our marketing investments to significantly enhance our multifamily business. While it’s too early for detailed guidance for 2020, we expect overall adjusted EBITDA margins to decline by about 400 basis points from our 2019 outlook. This means we will need to generate around $65 million of additional profit to recover those 400 basis points. In 2019, we anticipate adding approximately $80 million in adjusted EBITDA. By amplifying our marketing investment in 2020, we expect that increased revenue growth will help us achieve our long-term revenue target of $3 billion and maintain over 40% adjusted EBITDA margins from 2020 to 2023. This investment is comparable to the initial marketing spend we made when launching Apartments.com in 2015, which resulted in substantial growth. Since then, our multifamily revenues have surged from $160 million in 2015 to almost $500 million in 2019, a 310% increase, while our annual Apartments marketing spend increased by only 15% over that same period. In 2019, our marketing costs represented only 30% of multifamily revenue, compared to 80% back in 2015. With the proposed increase in our marketing budget of $100 million, we estimate that marketing would represent about 40% to 45% of multifamily revenue in 2020. CoStar is now large enough and growing sufficiently to accommodate investments of this magnitude. If our 2020 growth matches that of 2019, we could potentially add $200 million in revenue next year, double the planned marketing increase. In summary, now is the right time to invest in multifamily. We believe the market opportunity is larger and clearer than before. We have more resources and experience to leverage for success, and the required investment is smaller in proportion to our scale, with anticipated returns being larger and quicker than in 2015. Overall, our strong results and operational enhancements position us well for the fourth quarter and beyond. We are pleased to have closed the STR deal swiftly, and we welcome everyone at STR to the CoStar team. With that, we will now open the call for questions.

Good afternoon, guys.

Hello, Brett.

Hi, Brett.

Scott, thank you for your insights regarding the additional ad spend; that is very helpful. Could you please explain that again? Also, can you discuss where the ad spend goes from here? Andy, you mentioned that after the first Apartments deals, there were concerns that growing this business might require even more ad spend. Could you share your thoughts on how you see this moving forward? The 20 times return is impressive, but please explain your long-term perspective on this. Thank you.

All right. Okay, Brett. Let me walk through that one more time, so the financial perspectives around this thing. So, definitely we did the initial investment in marketing in 2015, $100 million. We had a report that said that the marketplace is $2 billion in size. And then, as you know, we worked through the large end of that marketplace. We've seen the opportunity in the mid-market, we've seen how the opportunity in the I/O large-scale market. And we know that that estimate is now growing to between $8 billion and $10 billion opportunity. So, we think the $100 million to go after $2 billion was a great move. We think the $100 million to go after the next $8 billion is an even better move. So, that was one important note. The other time when we made that investment, the total company multifamily was not nearly as big and strong as we are now. So, we had $130 million marketing spend and that was 80% of the revenue. Clearly, we've grown that now to be almost $500 million in revenue and saw an incremental $100 million spent against that fast-growing business. There's much lesser portion of the business, much less of a bigger bet. The other thing I think is important to notice is that we've now grown the sales force much bigger than it was before and produces a very high level. The site traffic has grown significantly. The amount of data we have, the amount of electronic feeds, all the strength of that site are there to leverage into this next size of the market that will make that $100 million even much more effective, softening up the beachhead before the troops all go in on the attack. And then I think when you look at just the ability of the company now when we're growing as rapidly as $1.4 billion in revenue, we had a couple of hundred million of revenue in year at our current growth rates. We've added over $110 million, $115 million in costs this year. So, adding investment in costs are just – they're going to be bigger numbers; they scare people a bit because they're big. But when you look at the relative size of the company, these are the best we should be making to keep increasing the scale and the growth on the topline. So, that's what I probably comment on. And let Andy add a little more.

We have been continually increasing our investments in marketing since 2014, which reflects our concerns during that period. What sets us apart in this industry is that we are one of the few aggregators making significant investments. This is not a zero-sum game where we're just trying to keep up with competitors. We have observed that when potential customers are informed about our products and services, they tend to purchase and renew at higher rates. With unaided awareness in the 20s to low 30s, many people are still unaware of what we offer, and we aim to increase that awareness. We view this as a strategic advantage in investing ahead of others in the market. We are confident that we will eventually surpass the $1 billion revenue mark in the apartments sector and are focused on positioning ourselves for that scale rather than following trends from a few years ago. Our decision is driven by improved metrics, return on investment analysis, and an understanding of our market. We recognize the opportunity ahead and consider our current investments relatively small compared to the potential upside. While some may question the opportunity in the apartment sector, we strongly believe in it and are committing our resources accordingly. We are not influenced by competitive rivalry as we operate in a unique position within a multi-trillion dollar asset class, which makes us quite optimistic about our prospects.

Hi, guys. Good afternoon.

Good afternoon, Andrew.

Lots to absorb as usual. One of the things I think you touched on, Andy, in LoopNet is the changing behavior of commercial property owners and managers and more of a focus on online. What if you could provide a little texture around that and why you think we’re at a tipping point and what specifically you're doing at LoopNet to capture that opportunity? May not get as much airtime or attention as that big marketing spend in multifamily, but it sounds like a structural change in the market you're addressing?

Yes, I've been fortunate to spend around twenty years in this industry, witnessing its evolution from a completely offline environment to the initial stages of online marketing. In the early days, online marketing for commercial real estate was minimal, like saving a small amount on staff costs by sending PDFs of flyers to brokers. However, now we can clearly see the traffic on LoopNet, which commands over 80 percent of the audience searching for commercial properties. Through reverse IPs and Google Analytics, we can identify these users mostly as Fortune 100 companies, including Walmart, Amazon, and McDonald's, as well as major law firms. Just like people use the internet for various personal services, they also look for commercial real estate online. It may surprise some in the industry that companies like Facebook search for commercial space online, as many are still caught up in an outdated mindset believing they cannot market to end users due to their numbers. This perspective needs to shift because potential clients are actively searching online, and we are developing tools to ensure property owners are visible to them. I am optimistic about this trend, which I believe is a clear mathematical certainty. We intend to raise awareness about this shift. While the traditional broker model works well at a high level, it struggles at lower transaction volumes, which is where most transactions occur. We are focusing on this area and are confident we will achieve success, though it won’t be instantaneous. We are in the process of revamping LoopNet. If you visit the site, you'll notice that we are no longer presenting data in a simplistic manner like Craigslist. We are now emphasizing the branding of the buildings online, showcasing the image of the architect, owner, and brokers. We control the visibility of listings through how they are sorted and presented, including placard size and branding. I believe we are developing some of the most effective marketing tools the industry has ever seen, creating an exciting revenue opportunity. It's a significant endeavor, and I think we have the potential to make a substantial impact.

So congratulations on closing the STR deal.

Thank you very much, Bill.

Could you provide some insights on LoopNet? Specifically, I'm interested in the pricing strategies for real estate brokers compared to those for property owners. Additionally, you mentioned an update on the total addressable market for multifamily is between 8 billion and 10 billion. Could we also get an update on LoopNet's total addressable market?

Yes, historically LoopNet was marketed mainly to brokers. Since LoopNet operated as a standalone company without a Research Department, it relied on broker ads for content. They offered large quantities of ads to brokers at very low prices. Brokers had limited financial stakes in transactions, usually taking a small percentage of the economics. Unlike property owners, the final sale or lease price doesn't significantly benefit brokers as they only received a small portion of the deal. When we first acquired LoopNet, the average ad price was around $6 per building. Now, property owners who have a much larger share of the economics are willing to invest more, spending $5,000 to $6,000 for high-quality promotional materials like drone videos and larger placards. In the past, we sold ads to owners in print for amounts reaching $12,000 to $50,000 per building. This transition in pricing strategy is not at odds with brokers; in fact, brokers appreciate this approach as it enhances their visibility when representing these properties. This way, owners paying for promotions can expand their reach and improve branding, benefiting brokers as well. It's exciting to see price increases driven by shifting focus to a different segment with a distinct value proposition without alienating anyone. Regarding the Total Addressable Market (TAM), we are currently under $200 million, previously estimated at around $160 million. The last general estimate of the market size was between $2 billion and $2.5 billion. We haven’t updated the TAM yet, but as we delve deeper into sales and assess the take rates and the complete salesforce for our new products over the next few months, we should be able to provide an update by mid-next year. At this point, we see significant value in aspects of the industry, such as reducing workloads for smaller leases, confirming that the TAM is sizable and that we have a competitive edge.

Hi. Thanks. Good afternoon.

Hi.

You're planning to increase your Apartments.com marketing spend by $100 million in 2020, which amounts to about 600 basis points of margin headwind. You mentioned earlier that you expect margins to decline by about 400 basis points next year. So can you discuss where you expect positive margin offsets to come from? Whether it's from productivity gains or cost-cutting elsewhere in the business?

Yes. There's a certain amount, George that we'll spend each year. You know outside of marketing, it's natural to the business. Heads we've added this year. Salary increases, those things. They'll go into next year, but they won't go as fast as these increases in marketing. So our forecast now looks at around 36% margin at the midpoint for 2019. So if you take into account an extra $100 million in marketing and then the rest of those costs will say personal cost and related nearly will grow nearly as fast. And so that will provide a bit of an offset. So in the end of the day we'd expect to have about that 400 basis point drop off the 36 as a rough guide. Now obviously, there'll be some variety around that when we get into specific planning and we'll share that in February. But that's really where we are. We don't see there needs to be a bunch of cost cuts out there. It's more of – it’s managing after we've done a nice bit of investing this year, our cost base into next year.

Good afternoon. Thank you, everyone. Andy, considering the significant increase in marketing spending, how can you ensure that you achieve the right efficiency when targeting the independent owner category as opposed to the broader category? What is the strategy to ensure that efficiency?

That's a great question, and it's something I consider often. In simple terms, we're not specifically targeting the independent owner strategy. Instead, we're focusing on raising general awareness and ensuring we're capturing a growing percentage of renters who are searching online, regardless of whether they choose a high-end or low-end property. This approach adds value and is relatively easy to manage. Our experienced team is effectively handling our supply chain management for apartments, with a solid understanding of the best keywords and desirable neighborhoods. This strategy is a secure investment that drives demand for our clients. In addition, we've tapped into a significant middle market opportunity. We've made substantial inroads with larger properties, particularly those with 100 to 200 units, while also selling over 10,000 ads in a segment that was previously overlooked, which includes communities of five to 100 units. We're working to raise awareness among owners of smaller buildings, paving the way for the many members of our sales force who are promoting the same offerings that have been successful. This awareness also indirectly benefits our independent owner efforts by increasing site recognition. We're currently seeing a 36% opt-in rate for renter tools when someone lists an apartment on Apartments.com. Thus, general site awareness supports our independent owner initiative. Focus groups have yielded positive feedback from both renters and small property owners about our offerings, especially from renters. Our main goal is to ensure a large pool of property owners are opting into these tools, enabling renters to utilize them. We're investing time into fundamental strategies while fine-tuning our messaging to the 300,000 apartment building owners we aim to target over the next few years. It's a significant investment.

Hi. Good evening, everyone. The revenue profile of the businesses has obviously evolved a lot over the past three years, and it seems like that will continue to be the case as Apartments.com's reach expands, the prospect for LoopNet owner initiative seems strong, and of course, the push into hospitality with STR. So Andy, I was hoping you could provide us with your updated thoughts on the resiliency of the business model through a downturn as these new businesses grow? And how your efforts to manage the revenue quality of the business are perhaps governing your decisions with respect to new investments across the CoStar platform?

It's an important question. We are clearly in a very mature cycle. The current market conditions for commercial real estate are showing improvement, and we are not observing any weaknesses in the industry. However, it is reasonable to conclude that we are not at the end of this cycle. One positive aspect is that a significant portion of revenue, particularly from CoStar, is now coming from banks and major owners. In economic downturns, banks typically increase their buying activity rather than pull back, which provides a stabilizing influence. We have learned from past experiences, particularly from 2008, to discourage salespeople from focusing too much on transient companies and instead prioritize major owners, banks, and investors who generally exhibit more demand in these economic conditions. In terms of operational aspects, we manage Showcase and observe LoopNet across cycles. Interestingly, when a sizable property loses a tenant, owners are often willing to invest in marketing to fill that vacancy. Those with experience in the apartment sector understand that this is a particularly challenging cycle, but it can prompt increases in marketing budgets for rentals. While complete bankruptcies can occur, they are usually followed by other investors acquiring the properties with strong marketing resources, which is a positive sign. We believe STR revenue is quite resilient, and our renewal rates are impressively high, indicating a strong foundation. This performance is integral for hotels, as it is a utility they rely on regardless of economic conditions, assuming they remain operational. Historically, CoStar's sales only dropped by 3% during the 2008 downturn, which is notable considering the broader economic challenges. We feel well-positioned with a diversified and resilient business model for the next cycle. In fact, downturns can present excellent opportunities to acquire high-quality companies at discounted prices, which we are eager to explore.

Thank you. Good evening. I know that you give the margin guidance, but you could at least qualitatively talk about the revenue outlook for next year, just in the context of should we expect the growth to accelerate, given the investments, or will that be more of a 2021 scenario? And then should we look at the 2019 growth rates across the different product lines as maybe a baseline for 2020?

Yes. Thanks, Mayank. It's always a tricky spot and we're in the third quarter. We don't have our specific guidance ready to forecast or budget prepared for 2020. I alluded in my comments to continuing growth next year like we've seen this year, which certainly what we've been planning for and investing for. And we expect certainly with the increased investments in marketing to help underpin that. What we more look out was, we gave that five-year outlook previously. And obviously, when you make a new marketing investment, you want to be sure that the business one can absorb it, make it invested effectively, and then the outcomes of that will get us more assurance that we'll hit those goals. And I think as we work through that exercise, you could see just by the scale of the business we're now you can invest $100 million and you may take a bit of a margin drag on that. But with the size and the speed of our growth, you could recover that margin drag within a year and then go back on top of it quickly in the second year out. Now these are all financial models. They're not plans or budgets yet. So I don't want to get out ahead of ourselves on what that means. But we certainly expect that these investments will continue the growth rates where we are, and we want them to move us forward into the mid-later part of next year and really see the benefits of them into 2021. And so we have to invest now to get that to happen. Hopefully, that helps give you some direction on how we think about it.

Yeah. Thanks. Hi, guys.

Good evening, Sterling.

Good evening. On the marketing, Andy, you've said a number of times that this actually is the tougher time of the multifamily cycle where occupancy rates are so high, vacancies are so low. So, is the incremental investment more tied to just where you think the competitive position is? So you can just take a disproportionate amount of market share because of the healthier competitors? And it's not about the cycle, or is it in preparation for to have vacancy rates rise in 2020 not only the competitive position but maybe get a little bit of a tailwind from the cycle as well?

The primary driver is not about an upcoming cycle, although that's true. The focus should be on greater awareness and increasing our market share. It's more about the open field we see ahead. There is a significant shift from offline to online in the apartment industry. We are leading this transition, and as we gather more information about the market, we realize it's larger than we initially expected. Instead of aiming for disproportionate share, we believe in capturing a substantial share, considering nothing is disproportionate. Our goal is to secure a large share. Right now, this is a unique time in the industry's evolution where we can purchase at the lowest possible price because there isn't aggressive bidding or competition for it. While there are other players in the space, it seems that most are not investing despite the opportunities available.

Great. Thanks. It's actually Josh on for Stephen.

Hey, Josh.

I just want to get your quick thoughts on the delayed timeline of ASC 842? And how it might impact Real Estate Manager results for the rest of the year? And then is there anything else that you guys are watching that could act as a headwind or tailwind to the adoption of that product over the near term? Thanks.

The delay in adoption has created a temporary slowdown as some people may hold back. However, we believe that adoption will increase next year as more requirements are put in place. Right now, we think we are missing out on implementation revenue, which is a one-time effect that is declining. On a positive note, our subscription revenue continues to grow over 40%. We anticipate that growth will stabilize to a range of 15% to 20% over time. Looking ahead, the future growth of our business will rely less on accounting teams and more on how we integrate with CoStar, providing additional services and tools for clients to manage their real estate portfolios. This approach should drive the growth of Real Estate Manager more sustainably and effectively than the short-term impacts from the accounting teams.

Great. I believe we have no more questions. Thank you very much for joining us for the third quarter earnings call. We look forward to updating you on our progress at the year-end call in February.

In February.

It's a big thing. It's exciting.

Happy holidays, everyone.

Thank you, everyone, for joining us. And we won't see you until you're through Thanksgiving and the holidays, December holidays, Christmas, New Year's and everything else, but we'll see you soon.