CoStar Group, Inc.
Q4 2017 Earnings Call Transcript

Published: 23 Feb 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Richard Simonelli. Please go ahead.

[Richard Simonelli:]

Thank you operator, appreciated. Welcome to CoStar Group’s Fourth Quarter 2017 Conference Call. Before I turn call over to Andy Florance, CoStar’s CEO and Founder; and Scott Wheeler, our CFO, I have some very important items for you to consider. Certain portions of our call today may contain forward-looking statements, which involve many risks and uncertainties that could cause actual results to differ materially from such statements. Important factors that could cause actual results to differ, include but are not limited to, those stated in our February 21, 2018, press release, on fourth quarter and year end results and at 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 at the time of this call, CoStar does not assume any obligation to update these statements whether as a result of new information, future events or otherwise. Reconciliation to the most directly comparable GAAP measure to all of the non-GAAP financial measures discussed on this call, including but not limited to, non-GAAP net income, EBITDA, adjusted EBITDA and forward-looking non-GAAP guidance are shown in detail on our press release issued yesterday, along with definitions which have been updated for those terms. Press release is available on our website located at costargroup.com. As a reminder, today’s conference call is also being broadcast live and in color on our website where you can also find CoStar’s Investor Relations page. Please refer to yesterday’s press release on how to access the replay will be about an hour after the call. Remember, one question, make it a good one. I’ll now turn the call over to Andy. Andy?

[Andy Florance:]

Thank you, Richard. Appreciate that, that was an excellent preamble. Thank you for joining us today on our year-end 2017 earnings call. Four years ago, on a similar earnings call in which we reported $476 million revenue run rate, we’ve set a goal of reaching $1 billion in annualized revenue by the end of the fourth quarter of 2018. I’m very pleased to announce that with the fourth quarter 2017 revenue of $254 million, we have met our $1 billion in revenue run rate goal in entire year ahead of target. And I’m even more pleased that we crossed the $1 billion milestone with a stronger sales momentum I have ever seen in this business. In the fourth quarter of 2017, we generated $43 million in net new bookings, a sales increase of 47% year-over-year. For the year, we add $127 million in revenue and achieved our best sales year ever with $148 million in net new bookings, up 32% over 2016. Leading the strong momentum, CoStar Suite net new bookings increased 100% in Q4 2017 versus the same period in 2016, not that the same period in 2016 was weak. Quite literally, sales of our flagship service were off the chart in the fourth quarter. We added more new companies than ever before, with 3,100 net new North American clients added at our CoStar subscriber base, which is nearly triple the number the same quarter a year ago. We added 5,863 new users to CoStar in the fourth quarter of 2017. For all of CoStar, December was our best sales month ever by a wide margin and January was our second best ever by a wide margin. As a company, we sold more in December 2017 and January 2018 than we did in the entire year of 2011. In the fourth quarter of 2017, Apartments.com had its best net new sales bookings quarter ever. Apartments.com sales were up 36% year-over-year in the fourth quarter. This was particularly strong performance since historically, the fourth quarter for Apartments.com and all the ILS companies is normally a seasonally weaker quarter. For the full year of 2017, CoStar revenue growth was 15% year-over-year compared to 2016. Four years ago when we set that $1 billion revenue run rate goal, we also set a goal of reaching a 40% adjusted EBITDA margin for the fourth quarter of 2018. We’ve made -- we are making good progress towards our EBITDA margin goal and remain focused on achieving those very strong margins by the fourth quarter 2018 as we stated. Net income for the full year 2017 grew 44% year-over-year and EBITDA increased 10% year-over-year. Our unprecedented sales successes in the fourth quarter 2017 drove unprecedented commission paths for our sales force in the fourth quarter, that’s a good thing. The ROI on these sales are fantastic and clear. This continued into 2018 with high commission expenses in January. This suppressed our EBITDA growth in the fourth quarter, but in the intermediate term, this exceptional revenue growth is expected to enhance margins. We are in the middle of a seismic shift in U.S. commercial real estate information, analytics and marketing landscape. In the middle of December 2017, our major competitor, Xceligent, suddenly and unexpectedly filed for Chapter 7 bankruptcy and liquidation. Xceligent had been in business since 1999 and was operating in over 40 major U.S. cities. We believe that Xceligent had well over 5,000 commercial real estate customers. We believe that various investors over the years had poured over $200 million into Xceligent. When we acquired LoopNet, we agreed to divest LoopNet’s partial interest in Xceligent as part of an FTC consent decree to replace any loss competition in the merger. At the time of Xceligent’s bankruptcy, we were engaged in a major lawsuit with them. A former employee of Xceligent’s had tipped us off that Xceligent was stealing and reselling our data on an industrial scale. We investigated and found that, that was true that Xceligent had created thousands of fake passwords that have accessed our servers millions of times, in fact even 10 million times, to copy content from us. We found tens of thousands of our copyright photos shot by our employees that were copied and resold on Xceligent site. We had statements from many Xceligent employees that the theft was a widespread practice to Xceligent supported by senior executives directing their employees and contractors to steal CoStar data and photos and use them to build themselves Xceligent’s products illegally. We believe we had a clear, great case. If lawsuit contributed to Xceligent’s death, the real underlying cause of death was Xceligent’s massive and sustained financial losses. We believe that Xceligent failed to make any profit for years. In fact, we believe over the course of two decades, Xceligent never made a profit or even approach breakeven. We do not have exact numbers, but we believe that by the end of 2017, they were spending roughly $5 million a month -- they’re losing about $5 million against approximately $2 million or so of monthly revenue. So $2 of loss per $1 of revenue roughly. Immediately after Xceligent’s bankruptcy, the recently fired CEO of Xceligent launched a brand-new company called Intrepid, that claimed to have roughly the same data coverage and software that Xceligent had the prior weeks when it closed its door. The bankruptcy trustee appointed an Xceligent Chapter 7 filing shut the start up down relatively quickly. With Xceligent’s failure, somewhere around 5,000 companies suddenly found themselves without a commercial estate information system. This left us with an unprecedented opportunity to act quickly to pick up tens of millions of dollars of orphaned business, an important moment. We pulled out all the staffs to respond at the maximum level of effort. I personally worked around-the-clock on one weekend December loading up every credit card I had in order to send holiday gift baskets to almost every former Xceligent customer. I literally was debating with folks at customer service centers in India at 4

[Scott Wheeler:]

Thanks, Andy. It certainly was strong momentum exiting 2017, which, of course, sets us up for a very strong financial year in 2018 and beyond. As Andy mentioned, the revenue growth in the full year 2017 increased 15% over 2016. While our revenue growth rate in the fourth quarter of 2017 was 16% versus the prior year. Organically, our revenue growth rate in 2017 came in at 14% for the year and 15% in the for quarter, after normalizing for the three small acquisitions this year and the THOMAS DAILY acquisition in 2016. Let’s look at our revenue performance by services. CoStar Suite revenue growth increased to 15% in the fourth quarter of 2017 versus the fourth quarter of 2016. This came in above the top end of our 13% to 14% guidance range and accelerated from the strong 13% revenue growth rates in the first half of 2017. The strong revenue growth is, a large part, a result of our investment in Richmond in our research capabilities and in our success in converting the LoopNet information users to CoStar. We expect CoStar revenue growth rates to improve further in 2018 as we accelerate the LoopNet conversions and we reach more of the former Xceligent customers that are in need of commercial real estate information. Revenue growth rates for CoStar Suite are expected to be in 18% to 20% range in 2018, which is a significant increase from the approximately 13% revenue growth rates over the past two years. Revenue growth rates in the Information Services sector remained negative in the fourth quarter of 2017, as expected as we continue to wind down the LoopNet information products. As Andy discussed, we’ve decided to accelerate this conversion actively and effectively discontinuing the vast majority of our LoopNet Information Service offering by the end of February 2018. LoopNet information revenue is expected to drop from $32 million in 2017 to just $4 million in 2018, a reduction of almost 90%. Conversely, revenue from strong sales in our Real Estate Manager business and our other Information Services products line is expected to increase from approximately $40 million to around $52 million, a growth rate of almost 30%. As a result, we expect the total revenue from Information Services to decline at a rate between 20% and 25% negative on a year-over- year basis throughout 2018. Given our success to date up-selling this LoopNet information customers to CoStar, we expect more than offset all of this revenue decline with sales of CoStar Suite in the coming quarters. We had a very strong fourth quarter in multi-family, as revenue increased 26% year-over-year and 23% from an organic basis. As a result of continued strong sales, we expect organic revenue growth to continue at over 20% in 2018. With the addition of ForRent, we expect multi-family revenue growth of between 40% to 45% for the full year. Consistent with our initial estimates, we continue and expect the revenue contribution from ForRent to be the range of $75 million to $85 million on an annual basis post-integration. Finally, our commercial property and land revenue grew 19% year-over-year in the fourth quarter 2017. Organic revenue growth, adjusting for approximately $2 million in revenue from the LandWatch acquisition, was 12% in the fourth quarter. Strong revenue growth continued in our LoopNet tiered advertising products, growing over 60% in 2017 versus 2016. While our LoopNet Premium Lister revenue growth moderated somewhat in the fourth quarter of 2017, as a result of temporary disruptions from the CoStar LoopNet integration and our decision to discontinue certain non-subscription advertising products. We expect organic revenue growth in commercial property and land in the 12% to 14% range for 2018 with growth rate at the lower end of our range in the first half improving towards the upper end of our range by the end of the year, as our planned improvements are implemented and our sales force efforts accelerate. Gross margins came in at 77% in the fourth quarter, broadly in line with last quarter, down 200 basis points from the fourth quarter of 2016, reflecting our increased investments in research. Vast majority of our cost of revenue is related to our research operations, which are now broader and more effective than any time in the past. The related improvement in data and product quality is certainly producing the strong CoStar Suite sales growth we’ve been experiencing. Operating expenses for the fourth quarter of $145 million were unfavorable to our forecast, primarily due to the higher commission expenses related to our outstanding fourth quarter sales performance. This was noted in the 8-K that we filed on January 17, 2018. In addition to the higher commission cost, we increased our marketing and other sales-related cost, as Andy described, late in the fourth quarter, following the Xceligent bankruptcy in order to reach customers that were suddenly without information solutions. Although unplanned, we expect these investments in the fourth quarter and early in the first quarter of 2018 to generate significant returns in revenue growth this year and beyond. Finally, our cost associated with the Xceligent litigation and bankruptcy activities were $4 million in the fourth quarter, bringing our total spend on this matter to approximately $13 million for the year, in line with our expectations. Our fourth quarter adjusted EBITDA of $78 million is approximately $9 million, below the midpoint of our guidance range, due to the higher commissions, CoStar marketing and selling expenses just mentioned. The resulting adjusted EBITDA margin came in at 31%. Our EBITDA of $237 million for the full year of 2017 represent to 10% versus the full year 2016, while adjusted EBITDA of $280 million increased 9% versus 2016. Net income for the full year of 2017 was $123 million, 44% ahead of the prior year and $9 million higher than we had expected. This $9 million of additional net income is primarily the result of lower income tax expenses, along with the reduction in interest expense related to the recent debt restructuring. There are a number of positive developments impacting our tax numbers this year, so let me walk you through the individual components. First, we recorded a $7 million tax benefit related to the change in accounting rules during the second quarter of 2017 for share-based payment transaction. Second, we recently completed the study of our research and development cost over the past five years, and we were able to recognize $8 million of research and development tax credits in the fourth quarter. Finally, we revalued our deferred tax liabilities in the fourth quarter to reflect the lower corporate tax rates prescribed in the new U.S. tax law that was passed in December 2017. this resulting in a $7 million benefit. Altogether, these items reduced our effective tax rate to 26% for 2017, down from the rates that were in the high 30s previous. Non-GAAP net income for the full year of 2017 was $154 million and includes our traditional adjustments for stock-based compensation, acquisition-related expenses as well as adjustments for the writeoff of prior debt issuance assets related to our Q4 debt restructuring. Our cash investment balances were approximately $1.2 billion as of December 2016, and we currently have no outstanding debt and maintain an undrawn revolving credit line with $750 million of capacity. Yesterday, we used $350 million of our cash to close the ForRent acquisition, and we’ll continue to evaluate investments in strategic acquisitions, in line with our growth strategy. Now let’s take a look at some of our performance metrics for the quarter. As Andy mentioned, our sales force, which totals approximately 725 sales reps at the end of 2017, delivered $23 million in net bookings in the fourth quarter of 2017, increasing 47% versus Q4, 2016, an all-time high for the company. This $43 million of net bookings includes a negative $9 million in net bookings in LoopNet information services. You recall, we stopped selling LoopNet information products when we integrated the CoStar and LoopNet databases in October. In the first quarter of 2018, we will discontinue the vast majority of our LoopNet information products. As a result, we expect almost $20 million of negative net bookings from LoopNet info products in the first quarter, as we terminate substantially all of our agreements with the month-to-month LoopNet information subscribers. Over time, we expect our sales team will continue to sell these customers our flagship CoStar Suite products for a net positive revenue result, but expect lower total net new sales in the first quarter of 2018 when compared to the $42 million of net bookings we delivered in the fourth quarter of 2017. Renewal rates on annual contracts were 91.3% in the fourth quarter of 2017. These were up 90 basis points from the 90.4% in the fourth quarter of 2016 and 30 basis points above the renewal rate achieved in Q3 of 2017. The sequential increase in the renewal rate is most notably a result of improvements in our multi-family business. The renewal rate for customers who have been subscribers for five years or longer was 97%. Subscription revenue on annual contracts accounts for 87% of our revenue in the quarter, up from 77% this time last year. I expect this number may temporarily decline, as we add the ForRent revenue to our metrics in the first quarter of 2018, similar to the impact of prior acquisitions in the space. I’ll now discuss our outlook for the full year and the first quarter of 2018. We expect revenue in the range of $1.17billion to $1.19 billion for the full year of 2018, which includes partial year ForRent revenue in the range of $65 million to $75 million. Excluding the ForRent acquisition, we expect revenue for the existing organic business to be in the range of $1.105 billion to $1.12 billion, which implies an annual growth rate of 15% to 16% over 2017. When we complete the integration of ForRent, we continue to expect full year revenue in ForRent in the range of $75 million to $80 million with eventual adjusted EBITDA margins in the range of 45% to 55%. Currently, ForRent EBITDA margins are around 15%. We believe it will take 12 to 24 months to fully integrate the business. Accordingly, we expect the acquisition to be dilutive to our expected 2018 adjusted EBITDA margins by approximately 200 basis points. We expect revenue for the first quarter of 2018 in the range of $269 million to $272 million, which includes our assumption of $7 million to $8 million in revenue from ForRent, representing approximately one month of revenue. Gross margins for 2018 are expected to remain at approximately the same level as 2017, prior to any purchase accounting amortizations from the ForRent acquisition. The amortizations related to acquired intangible assets will impact our cost of revenue, and this will likely increase. We’ll be able to provide more clarity on gross margin after our Q1 earnings release when we complete the purchase accounting for the acquisition. We expect total marketing cost to increase approximately 5% in 2018, prior to the ForRent acquisition, which is the first increase in our marketing spend level since 2015. The focus of our spend will shift towards increasing brand reach in our multi-family business, as Andy mentioned. Because in prior years, the advertising spend is more heavily weighted in the first half with the second quarter expected to be our largest marketing quarter, but as much as 40% of our annual marketing budget expended in Q2. As a result, we expect the second quarter to be the low point for adjusted EBITDA margins for the year, as was the case in 2017. In 2018, we expect to continue to invest in growth initiatives, while, at the same time, growing our adjusted EBITDA margins. Our investments are focused on taking advantage of these unique growth opportunities, that Andy mentioned, in both our CoStar and multi-family businesses. For CoStar, we continue to build our product capabilities by expanding our field research, improving our tenant products, building on our news content. We’ll also add to our commercial real estate sales force to improve both the reach and market coverage of that team. In addition, we’re expanding our research capabilities in London. For multi-family, we’re investing in new software capabilities to benefit renters in Apartments.com, and we’re expanding our sales capabilities, primarily through inside sales. Additional investment initiatives are planned that will capitalize on these unique market opportunities. Overall, we expect approximately $25 million of spending in 2018 against these initiatives. Additionally, we will continue to incur legal fees related to the wind-down of the Xceligent litigation matters in order to protect our stolen data through the bankruptcy process as well as to conclude the open litigations that were ongoing in both India and the Philippines against the subcontractors. We’ve assumed approximately $4 million for ongoing Xceligent-related fees in the first quarter of 2018 with this cost diminishing in the second quarter and beyond. Considering these investment initiatives and before the impact of ForRent, we expect our adjusted EBITDA margin to increase by around 350 basis points over 2017’s adjusted EBITDA margin. This equates to full year 2018 adjusted EBITDA margins of around 33% at the midpoint of our range. Adjusted EBITDA margins for the year, including the ForRent acquisition, is approximately 31%, at the midpoint of our guidance range. We expect the adjusted EBITDA in a range of $365 million to $375 million for the full year of 2018, which includes approximately $5 million to $7 million of adjusted EBITDA associated with ForRent. Regardless of the near-term margin dilution associated with the ForRent acquisition, we remain confident that we’ll achieve our goal of the 40% margin exiting 2018. In the first quarter, we expect adjusted EBITDA in the range of $70 million to $74 million, which includes the negative impact of approximately $2 million from ForRent. The ForRent results are negative as a result of typical purchase accounting adjustments. In addition to the dilution from ForRent, as in prior years, the first quarter expenses include seasonally higher costs related to payroll taxes, our annual sales conference and annual standard increases for personnel. Our marketing cost also increased in Q1, as we increased spending ahead of the apartments rental season. Finally, we’re discontinuing the LoopNet information services in February, which has a negative impact to both revenue and EBITDA, again, that we expect we will recoup this as we continue to upsell these clients to CoStar over the coming months. We expect 2018 non-GAAP net income for diluted share in the range of $7.01 to $7.21 based on 36.5 million shares. For the first quarter, we expect non- GAAP net income per diluted share in the range of $1.32 to $1.40 based on 36.3 million shares. These ranges include a revised non-GAAP tax rate of 25%, which is well below our previous 38% non-GAAP tax rate. This is primarily the result of the tax law changes enacted under the Tax Cuts and Jobs Act passed in December 2017. This rate reduction has the effect of increasing our non-GAAP net income by approximately $44 million or $1.22 per diluted shares at the midpoint of our guidance range. In addition to the tax changes, CoStar will conform to the new accounting standard for revenue recognition in 2018, known as ASC 606, beginning in the first quarter. Impacts to revenue expenses are not material and are included in the 2018 outlook. Overall, I believe we are well positioned in 2018 to continue the acceleration of our revenue growth rates, while managing cost and investment to continue expanding our margins. I look forward to updating you on our progress as it goes throughout the year. With that, I will now open the call for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of George Tong from Goldman Sachs. Please go ahead.

[George Tong:]

Hi, thanks, good morning. I’d like to dig into your margin outlook. You’re continuing to target 40% EBITDA margins exiting 2018, but you’re elevating your investment spending in the first several quarters of the year. Out of the categories of investment spending that you’ve outlined, how much of that investment do you expect to be temporary in nature, thus giving you confidence that you can actually hit your 40% target?

[Scott Wheeler:]

Yes. Hi, George. This is Scott. When you look at what we’re investing in, I listed a number of things, the expansion of our sales force, improvements in research, to continue expanding a little bit internationally, all those things are intended to go after these revenue growth targets that we have and also increase the revenue pace as we go forward. So what we’d rather do now is we go forward, unlike 2017 where we made significant investments and didn’t grow our margins. As we go forward, we want to keep pacing in these smaller investments as we go and keep raising the margins, like we’re doing now, the 350 basis points. So we balance the investing we need to fuel growth in the future with the margin improvements that we need to make to bolster our commitments and to give the returns that we committed to. So I don’t think I would call them temporary. The litigation cost we had in Xceligent, obviously, were temporary and we’ll see those moderate as we go through the year. But the rest of these things are worthwhile investments for the business.

[Andy Florance:]

For things like integration of ForRent are temporary or the roadshows are temporary or the unusually high commission costs are temporary or the $0.5 million of chocolate baskets for Xceligent customers are temporary. High budgets are temporary. There’s a lot of temporary stuff in there that is spent in the first half.

[Scott Wheeler:]

Definitely in the first part of the quarter, we had a good, at least, $5 million of those types of things.

[Andy Florance:]

A man with the kids is impressed when I said I bought $05 million of chocolate over the weekend. I won’t do that ever again.

[Operator:]

Your next question comes from the line of Peter Christiansen from Citigroup. Please go ahead.

[Peter Christiansen:]

Thanks guys. Super helpful commentary here. I know that you haven’t given us margins by segment in the past. And I was just wondering if you could just at least give us a sense of what the margin trajectory has been like, I guess, the last 12, 18 months in the multi- family side. And as you scale that to cover your fixed cost, how has that progressed generally?

[Andy Florance:]

I’ll take a rough shot there. We aren’t describing -- we’re not reporting it at that level. However, I can give you a feel for it. I did a simple chart the other day of investments being big read, negative bar charts and then 4-wall profit being green. And basically, we went through -- in 2015 and 2016 -- 2015, we went through a very significant year of investment as we ramped up the nationwide brand advertising. Sales kicked up in 2016. Those investments basically dropped. Net investment dropped in half, as revenues offset. And we were -- I was very pleased in 2017 to see clear-cut strong 4- wall profitability in Apartments.com. And then after we get through all the noise and friction of closing a major acquisition, and even without it, then you move into even stronger margin growth. So I think the margins we’re seeing now, the contribution we’re seeing from Apartments.com is very successful and, certainly, dramatically more margin than we ever saw from the individual acquired company. So really good results of, I think, people that we’re very happy with.

[Operator:]

Your next question comes from the line of Brett Huff from Stephens, Inc. Please go ahead.

[Brett Huff:]

Good morning guys. In the – I want you to reiterate what you said on something, the incremental amounts that you guys are making on the incremental LoopNet user. I think you said the blended rate between the non-payers and the payers was something like $50 a user per month, and you’re making net $500. So just reiterate -- I want to make sure I got that right. And then how does that -- is that the data that we’ve gotten so far on the 5,400? And do we expect that same kind of pricing lift to continue? Or will it taper? I mean, are we getting the most juicy leads now and it should get less juicy over time in terms of pricing? Can you kind of go through that?

[Andy Florance:]

Sure. Yes, so you’re right. It’s again just like the last time, we really pushed this a couple of years ago. The majority of the folks choosing to subscribe go from heavy searching in LoopNet to subscribing to CoStar to get better information product. There are folks paying absolutely nothing to LoopNet currently. So most of them are paying nothing. Those who are paying are $149. The blended rate is $49. We’re picking them up at about $520, $540 net, as they go into CoStar. So fantastic, 10 times sort of uplift. To answer your question, we gained the low-hanging fruit first, absolutely not. I sat there -- I’ve been in 20 or 30 cities in the last month and sat in a lot of focus groups watching people talk. And this is pretty straightforward to us. But as people sort out the differences between the different products and LoopNet as a marketing platform, CoStar as an information platform, it takes a little bit of time. Still, the number one competition of CoStar is these folks using the -- being heavy searchers in LoopNet or formerly using Premium Searcher. With the changes in integrated back-end, when these people go into LoopNet product today, they’re now seeing all the CoStar icon showing listings that they can’t see using their LoopNet account, and it’s a very compelling. And it will take a little bit of time. People aren’t going to immediately commit to a one-year, two-year, three-year CoStar contract. They’ve got actually sort out. Sales people got to have to meet with them. Honestly, we have a bigger opportunity than we have in a number of salespeople. We mitigate that. We’re shifting our resource around. But it’s something that takes time. And there isn’t something -- there’s still very significant system flow of folks who, we think, will continuously come in and upgrade to CoStar. February will be -- we are eliminating some of the center pricing we had in December, January. We’re being more rigorous in our pricing controls. But big picture, we anticipate it will flow throughout the year and into 2019, and it’s a very compelling proposition -- value proposition to folks. But it just isn’t something that would turn a switch and people will jump over. It takes time.

[Operator:]

Your next question comes from the line of David Ridley-Lane from Bank of America. Please go ahead.

[David Ridley-Lane:]

So LoopNet had roughly 1,700 paying customers. You had another 80,000 pretty intensive users. Given the conversions to date, you converted just 5% of the base. I’m curious what drove the decision to accelerate the conversion, particularly because you had the Xceligent bankruptcy, which is obviously a large opportunity that you need to capitalize on as well.

[Andy Florance:]

Okay. So I think the number of subscribers is close to 32,000 because you have to look at folks who were getting Premium Lister with a subscriber element or unlimited listers. So the numbers is not -- I think it’s higher than 17,000. It’s closer to 32,000. And then you had another 50,000, 60,000 that we classify as heavy searchers on LoopNet. The reason you would accelerate -- like, so you’re -- originally, we had contemplated rolling out that Premium Searcher over a 12-, 18-month time frame just to continue the rolling time period. When you look at the folks who are using Xceligent as an information system, a very, very large number who were supplementing adequacies of Xceligent system by using LoopNet, so it’s actually one and the same thing. And the changes that occurred at Xceligent, you’re working against yourself when you are providing a Premium Searcher product to someone that you’re trying to convert into CoStar. So you’re probably -- you’re providing a low-cost, low-value product to them to prevent them from making a decision to go over to CoStar. And you plan to eliminate it anyhow and you communicated to them, prior to the Xceligent bankruptcy, you’re going to eliminate it anyhow. And also I think we have to work to a slightly higher standard now on how we treat all our customers given our increased competitive position. So we didn’t want to be in any situation where we are picking and choosing which markets or which people we eliminate Premium Searcher on and have any image that we were handpicking discontinued Xceligent clients to discontinue their Premium Searcher. So we went ahead and just did across-the-board and including, in some cases, making the right choice, but difficult choice to eliminate Premium Searcher with a person who was also subscribing to CoStar currently, so it’s just good customer service. But they’re related. They’re directly related. It’s one and the same decision-making process. And by doing this, we facilitate a faster, good result across the overall, though you take a -- it requires a little bit of extra character in the first half of the year. By the way, I listen to -- we have (65

[Operator:]

Your next question comes from the line of Sterling Auty from JPMorgan. Please go ahead.

[Sterling Auty:]

So I want to go deeper into the conversions and the price. So you’re netting out $500 out of lease conversions. Given that huge untapped base that you still have yet to convert, based on the focus groups that you’ve done, what do you think is realistic in terms of how -- what percentage that you can bring over and at what price point? Because I think, at the beginning of the process, you’ve talked about maybe doing a $200 level of functionality, maybe a $400 level of functionality in CoStar. Has that kind of pricing approach or strategy more of that you’ve done more work in the space?

[Andy Florance:]

Yes, it changed a little bit. So it’s a -- we initially were focusing on, as you said, the $200, $400. We’re not getting a lot of pickup in the $200. People are -- if they know what -- if they don’t know what they’re doing, some of them accidentally buy the $200. But this is what they do for a living. This is their trade. This is their Bloomberg terminal. And the $400 solution is incredibly powerful and gives them an amazing information solution with tons of revenue-generating opportunities. The $200 is adequate and meets everything that LoopNet Premium Searcher was doing and a lot more. So I think it’s probably 19 of the $400 to one of the $200. And that’s just what people are opting for it. And I think it’s actually shifting even further. So I think it will be like sub 5%, sub-3% of the lower cost solution at the customers’ behest. So -- and again, the focus groups is just amazing how they’re all just trying to figure out what’s going on. You’ve got Xceligent. You’ve got these board systems. You’ve got LoopNet Premium Searcher, Premium Lister. You’ve got CoStar. And you would think it was pretty easy for them to sort it out. There’s a lot of confusion out there. And what we’re doing is we’re really simplifying that decision-making process for them. And it will take years, so -- to sort of really simplify this and get them migrated into the right products. But we’re highly confident that a very substantial portion of these folks will ultimately be using CoStar for information and LoopNet for marketing. One of the things I don’t think we spend a lot of time on the call that did come out loud and clear in this most recent rounds of focus groups is one of the beautiful things here is LoopNet remains viewed by our customers as an essential utility to marketing their listing to end-users. CoStar is viewed as an essential utility for -- a very valuable utility for information solution. So as we’re doing this, the marketing side of LoopNet, to me, has never looked stronger. The information side in CoStar has never looked stronger. And there’s a whole bunch of painful confusion in the middle there in those information products, and it’s going to take years to sort it out.

[Operator:]

Your next question comes from the line of Andrew Jeffrey from SunTrust. Please go ahead.

[Oscar Turner:]

This is Oscar Turner on for Andrew. I was wondering if you can provide more color into line of sight to the 40% exit rate margin target by year-end. And how should we think about the likelihood that sustained strong sales momentum leads to higher-than-expected marketing expenses through the fourth quarter?

[Scott Wheeler:]

So when you look at the progression, we expect -- as we commented on it, as our marketing ramps up into the second quarter, margins seasonally go down and then they pick up into the third and then go up higher in the fourth. We’ve seen that same pattern in the last couple of years and our spend is concentrated around the TV and the broadcast for the apartments marketing in the summer months. So we really don’t see that kind of pressure coming into the fourth quarter, unless something unusual happen. Like this year, with the bankruptcy of Xceligent, we went around and spent quickly and mobilized. That put in a few amount of dollars. There’s not enough time there to spend than the whole lot. So we don’t see a whole lot of.

[Andy Florance:]

There’s a lot of competition, but there’s no Xceligent there.

[Scott Wheeler:]

That’s right. So we feel pretty confident with where we’re pacing the marketing spend. And we don’t think it will cause any issue, as we go towards the margin at the end of the year.

[Operator:]

You next question comes from the line of Bill Warmington from Wells Fargo. Please go ahead

[Bill Warmington:]

(72

[Andy Florance:]

Bill, what sort -- Just remind me again, when you talk about issues, what sort of things come to mind.

[Bill Warmington:]

The -- when you started to put the sales forces together that there are a lot of salespeople on the Apartment Finder side that you were changing around the commission structure, the sales territories, and a number of them left and had to be, either voluntarily or not, had to be replaced and that set us back.

[Andy Florance:]

That’s a good question, Bill. So we -- we have grown the sales force over time and improve, globally reorganize it from time to time, as we have an unbelievable amount of opportunity to reach new customers on both the CoStar side and the Apartment side. In the Apartment side, one of the big drivers there is that people with smaller and smaller communities are spending money advertising on Apartments.com network. So we get to all of our customers or 95% of our customers every quarter for service, but we only get to 10%, 15% of the prospects every quarter. And we want to get to all of them every quarter. And one of our goals is to try to get to everyone with 50 units or up during the course of the quarter. Having a larger sales force helps us do that. The -- without a doubt, there are -- in any acquisition, there’s always cultural issues. Someone has been in a pattern doing something within a company for 15 years and there’s a big change like a merger with another company. People make decisions about what they want to do, and that’s healthy and that’s good. Some significant number will find the opportunity with Apartments.com really exciting. They’ll -- we think being on the clear-cut winning team is exciting. There’ll be, without a doubt, more earnings potential for them with the Apartments.com network. And some people may have been -- alternately, some folks will decide that the last 20 years at ForRent had been great and they’re going to do something else or hang it up now. They’re both fine. And we do anticipate and have planned for some number of people to decide to do something different. So that number will come down a little bit during the year. Eventually, we’ll rebuild it at a slow pace. But net-net, you’re going to end up with a great infusion of talented people that decide to make this their long-term hold -- home. And it won’t be the whole number that you start with, but it will be a good number. And they’ll also bring a lot of knowledge and culture and is valuable to us to rev up on everybody. So we’re sort of co-pathetic with -- change drives decisions in people’s career. And either way, we’re really glad to have the opportunity. So I don’t want. I hope -- I don’t to be too mellow about it, but that’s what I think.1

[Operator:]

Your next question comes from the line of Patrick Walravens from JMP. Please go ahead.

[Patrick Walravens:]

So a question for you, Andy, I think, which is how long do you think it will be until you’re ready to make your next major acquisition?

[Andy Florance:]

31 days, six hours and two minutes. Why do you ask? We -- there’s a lot out there, as you know, right? So we’re -- this is a pretty big one and we have to be reminded, right after closing ForRent, we were -- we’re spending a lot of time and effort continuing to look at all kinds of opportunities out there. There is a broad field. There’s a lot going on. I do think we’ll spend a little bit of time just focusing on ForRent and making sure we do that right. You have to respect -- when you close one of the largest acquisitions by revenue and headcount, you have to respect that and make sure you do it right and not get too confident. But no sure just stuff and -- so part of the bigger problem is selecting among an embarrassment of riches of opportunities to pursue. We are selective. We’re selective on valuation, so we won’t rush. But again, if you are betting against CoStar continuing to do acquisitions, you wouldn’t be a very good better.

[Operator:]

Your next question comes from the line of Stephen Sheldon from William Blair. Please go ahead.

[Stephen Sheldon:]

Hi guys, thanks for taking my question.

[Andy Florance:]

Stephen, we really excited to have you on the phone.

[Stephen Sheldon:]

Thank you. So yes, you talked about seeing research cost starting to trend down some this year. So a few questions on that. First, is that commentary on an absolute basis or as a percentage of revenue? And second, as we look out over the next few years, how much leverage would you expect to see in your research budget? I mean, do you need to add much more headcount to research at this point? Or just given the database integration and the improvements in data quality and automation from products, like Lifting Manager, could you keep your research headcount relatively steady over the next few years?

[Andy Florance:]

I think it’s a thing that changes, and research is a -- as a percentage of revenue, it’s a pretty modest event -- investment. And it is a huge competitive advantage in the market. It’s the one thing that people continuously underestimate when they try to compete with us. As Xceligent failed, they joined a long list of folks who have invested well over $1 billion in competition with us, and haven’t gone anywhere. The number one reason is they just don’t invest in doing the research. So it’s been a long-term competitive advantage. But things are changing pretty rapidly. We have so many people in our network now that a lot -- the things are changing. A lot of people have a long-term relationship and doesn’t want to enter the data electronically, and they do it well. We are conservative about it. We don’t release this new ability to edit your listings in CoStar and then, overnight, make dramatic changes to our research process. We are studying it, discussing it. The focus groups were helpful in understanding that. And only when we know we’re not going to harm product quality, we make decisions to actually shift resources. There’s continuously new demands for different kinds of research. But my general sense is that, as the year moves on, we’re going to find that some significant portion of our traditional workload becomes automated. And that will allow us to keep the same headcount over time and not really grow headcount, so we can staff new initiatives without adding people, but that is sort of in the gut feeling category done from an extremely conservative operational point of view.

[Stephen Sheldon:]

Got it. Appreciate the color

[Operator:]

And at this time, there are no further questions.

[Andy Florance:]

Well, thank you very much for joining us on the call. And we look forward to updating you on our progress towards our 40% adjusted EBITDA margin goal in the Q4 of 2018, as we promised you in April of 2014.

[Operator:]

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