RealPage Inc
Q2 2014 Earnings Call Transcript

Published: 5 Aug 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to your RealPage Q2 2014 Financial Results Conference. [Operator Instructions] And as a reminder, today's conference is being recorded. And now I would like to turn it over to your host, Rhett Butler, Director of Investor Relations.

[Rhett Butler:]

Thank you, John. Good afternoon, and welcome to the RealPage financial results conference call for the second quarter ended June 30, 2014. With me on the call today is Steve Winn, our Chairman and Chief Executive Officer; and Bryan Hill, our Chief Financial Officer and Treasurer. In our remarks today, we will include statements that are considered forward-looking within the meaning of securities laws. In addition, management may make additional forward-looking statements in response to your questions. Forward-looking statements are based on managements' current knowledge and expectations as of today, August 4, 2014, and are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements and are described in today's press release. A detailed discussion of such risks and uncertainties is contained in our Form 10-Q previously filed with SEC on May 12, 2014. RealPage undertakes no obligation to obligation to update any forward-looking statements except as required by law. Finally, please note that on today's call, we will refer to certain non-GAAP financial measures, in which we will exclude certain noncash or nonrecurring items depending on the measure, such as acquisition-related and other deferred revenue adjustments, depreciation and asset impairments, amortization of intangible assets, net interest expense, income tax expense or benefit, stock-based compensation expense, any impact related to Yardi litigation, including related insurance and settlement costs, stock registration costs and acquisition-related costs. We believe that these non-GAAP measures of financial results provide useful information to investors regarding certain financial and business trends relating to our financial condition and results of operations. Please refer to today's press release announcing our financial results for the second quarter ended June 30, 2014, available on the Investor Relations portion of our website for a reconciliation of these non-GAAP performance measures to our GAAP financial results. With that, I'll turn the call over to Steve.

[Stephen T. Winn:]

Thanks, Rhett. Today, I'll review our performance for the second quarter and discuss expectations for the back half of 2014. Non-GAAP on-demand revenue grew 1% and non-GAAP total revenue was flat both compared to the second quarter of last year. Adjusted EBITDA declined 41% compared to the same period last year as a direct result of the shortfall in revenue. We ended the second quarter with 9.4 million on-demand units, representing 9% growth from the prior year period. Revenue per unit, or RPU, declined 7% over the same period as last year, as our gain in market share outpaced revenue growth. Annual customer value, or ACV, was $367 million, an increase of 1% compared to the prior year quarter. Our financial performance was disappointing and well below our expectations. The business has historically been more predictable, and no one is more disappointed in these results and more motivated to address the root cause of the miss than myself and the rest of the RealPage management team. Our senior management team was recently granted performance shares tied directly to stock performance, further aligning management incentives to what is most important to our shareholders. We are determined to bring to fruition our plan of building a $1 billion business. While it may take a little longer to get there, we still believe in the long-term opportunity, given our business model and market position. So what happened? Two factors caused the bulk of the miss. We believe one is temporary and will not impact the rest of the year. We believe the second has longer-term implications that could be felt for several quarters or longer. Today, we will discuss in detail major product family revenue and expected growth rates in order to help you better understand what is happening to the business, both good and bad. I'll address the second and larger issue first. Revenue from products that help owners lease apartments declined in the second quarter, primarily due to aggressive pricing accommodations, which we determined were necessary to maintain and expand our market share. In a separate press release issued last month, MPF Research, a wholly owned division of RealPage, reported that apartment occupancy for the second quarter of 2014 came in at 95.6%, up from 95% in the first quarter of 2014. Annual revenue growth for the multifamily rental housing market, which includes shifts in both occupancy and effective rents, accelerated to 3.5% for the second quarter, up from 3.2% in the first quarter of 2014 and up from 2.9% in the fourth quarter of 2013. This indicates the rental housing market is tightening further. Quarterly revenue growth reached a 14-year high of 1.9%, topping results not seen since late 2000. Ongoing construction for the 100 largest markets in the U.S., which are expected to be completed within 18 to 24 months, was about 383,000 multifamily units at the end of the second quarter. Construction starts have been roughly equal to completions during recent quarters, so ongoing construction has been holding between 350,000 and 400,000 units for 1.5 years. Strong leasing activity at new completions also is shaping the occupancy figures. Units at brand-new properties are being leased about as quickly as they can be delivered in most cases. Thus, new supply and lease-up isn't dampening overall occupancy to the degree that is typical. We believe this supply-demand relationship has sharply driven up resident renewal rates, with leasing velocity continuing to decelerate as it becomes apparent that current renters are less mobile than previous generation in today's environment of tight rental markets and more stringent lending standards for new houses. Supporting this are sample size of data from one site customers that's showing some of the highest renewal rates we have seen in our history. Ultimately, high occupancy and decreased renter mobility translate into a tailwind for our client base, which has led to record rent growth. These are the best of times for apartment owners and managers. However, the current macroeconomic environment presents a headwind for our leasing solutions. There simply aren't as many new units to lease, so owners and managers have been questioning why they need to maintain advertising budgets and certain transaction volumes at such high levels when occupancy levels are at an all-time high. With this macroeconomic backdrop, revenue per products related to leasing declined significantly in the second quarter, which implies that there is less perceived need for them. The lower demand -- or with lower demand comes aggressive competition, chasing a shrinking market for certain leasing products. Approximately 30% of our second quarter on-demand revenue was derived from products that help owners and managers lease apartments, which is the primary driver of lower-than-expected revenue. This represents $29 million of in-quarter revenue, including the contact center, screening, organic lead generation tools, our Internet listing service and senior referral business. Revenue from this category is comprised of subscription and transactional components and was down 5% compared to the prior year, which equates to $7 million below our expectations. Revenue for leasing solutions was primarily impacted by reduced pricing, not units. During the second quarter, we actually grew unit market share for our leasing products sequentially and compared to the same period last year. However, pricing accommodations, especially for clients who used our leasing products more than their allotted usage, increased significantly. As competition stiffened, we could have held prices higher and ceded some market share. Instead, we elected to reduce price or offer accommodations intended to expand market share. We believe the strategy of overall price leadership is important, and our size and economy of scale enable us to more efficiently respond to market conditions in the long term than our point [ph] product competitors. We believe that lower prices for leasing products are here to stay, at least until supply and demand come back into equilibrium, which could take several quarters or longer, and this expectation is reflected in our full year guidance. The second factor that drove lower second quarter revenue compared to our expectations was contingent renter's insurance. We make money in 2 primary ways from renter's insurance

[W. Bryan Hill:]

Thanks, Steve. As Steve mentioned, total revenue for the second quarter was $94.8 million, flat compared to the second quarter of last year. The details on the components of revenue are as follows

[Operator:]

[Operator Instructions] It looks like our first question that's coming from Jeff Houston from Barrington Research.

[Jeffrey L. Houston:]

Regarding the guidance for the back half of the year, does that guidance assume that the contingent insurance fully recovers? And that the other industry headwinds remain? And then lastly, that the rest of the business continues to grow in the low- to mid-teens? Just want to make sure I heard that correctly.

[W. Bryan Hill:]

It does, Jeff. The way to think about our guidance in the back half of the year is our non-leasing on-demand products will continue to grow in the low- to mid-teens level. That does include the contingent renter's insurance revenue returning back to normal levels. When you think about the leasing products, during the quarter, the leasing products actually declined 5% year-over-year. We are not building improvement in the back half of the year to that trend.

[Jeffrey L. Houston:]

Great. Then separately, shifting to adjusted EBITDA margin. I think it was about 24% in the first quarter, close to 13% in the second quarter. And you mentioned the several margin initiatives to get it back up to where it was, closer to the 24% range. Trying to get a sense of when you think those initiatives should come to fruition. Is that more of a later 2015 or into 2016? Just a little bit of timeframe there is -- would be great.

[W. Bryan Hill:]

Well, you'll see the EBITDA margins improving sequentially by virtue of some of the revenue improvement that we have built into the back half of the year. The majority of the reason why our margins dropped in Q2 were pricing-related and the sharp decline in revenue. However, related specifically to the initiatives that Steve and I mentioned, we would expect those to start coming into play more in the back half and on into 2015 -- the back half, so Q4, that is.

[Operator:]

And our next question is from Pat Walravens from JMP.

[Patrick D. Walravens:]

Steve, I was thinking it might be helpful if you could walk us through how your understanding of the challenges facing the leasing products has changed. What did you think before and what do you think now? And when did you realize that the original way of thinking about it wasn't right?

[Stephen T. Winn:]

Well, we've always said that the marketing area was the most competitive category of products that we offer. We've always said that we felt that organic lead generation was a more cost-effective way to generate leads than traditional Internet listing services, and we still believe that to be true. The market has tightened, and I think owners and managers have become, candidly, more aware that they simply don't need to spend as much money generating leads as they did in prior quarters and years because they don't have as many vacant units. And so our choice was to potentially have owners switch to alternatives or to issue pricing accommodations, and we elected to do the latter. Which, while I don't like the idea of lowering price, I do think that the strategy was effective because we expanded usage of all of our marketing solutions by doing that. I don't see this environment changing going forward. It looks to us like the market's going to stay tight for some time. And I think owners are simply going to spend less money on advertising. So our challenge and our opportunity is to convince them that spending money on organic lead generation is the most efficient way to spend a shrinking dollar on advertising.

[Patrick D. Walravens:]

Could you do something similar -- when you talked about Zillow, you mentioned that now you're thinking about partnering with Internet listing services. Were you against doing that before? And again sort of what's the thinking behind the change?

[Stephen T. Winn:]

I think owning our own Internet listing service precluded us from partnering at the level we'd like to partner at with the ILSs, and MyNewPlace has gotten smaller over time. And I think at this juncture, it makes a lot of sense for us to expand the relationship we have with Internet listing services to Live Agent-enable their listings. If you put a contact center on a listing, it can almost double the conversion rates. So it's a very productive expenditure for the clients to add contact centers. And we think working through the ILS is going to make it easier to sell contact center services. We also think we can syndicate more content to the ILSs. The pricing availability is one example but there are many others. RealPage has a vast repository of very current and valuable information that the ILSs can use to improve their search engine optimization results. And so I think a partnership, which was not possible when MyNewPlace was larger, is very possible now. And Zillow has certainly demonstrated that at least they're willing to work with us, and I think you'll see others.

[Operator:]

So we'll take our next question coming from Brandon Dobell from William Blair.

[Brandon Burke Dobell:]

Maybe you can -- if you could bridge us from Q2 to Q3. I'm assuming the majority of the sequential increase in revenues is tied just to normalization of some of the insurance products. But I want to make sure I'm not missing anything else that was either exaggerated or enhanced seasonality or something in the surface that gives you a little more confidence in, I guess, the non-leasing part of the business that's going to make up that Q2 to Q3 bridge.

[W. Bryan Hill:]

That's correct. Brandon, there is a lift that comes from the normalization of the renter's insurance. But in addition to that, the 70% of the business, which is predominantly subscription and non-leasing-related, we're expecting a sequential lift from that.

[Brandon Burke Dobell:]

Okay, fair enough. Given the, let's call it, pricing changes or pricing strategy changes on the leasing-focused products, I guess, what's to say that, that might not be a broader opportunity or alternative, take a different pricing approach with some of the other products or their customers? Or is it a risk that the pricing changes on the leasing side will lead to your existing customers looking for different pricing on their existing products outside of leasing-focused ones?

[Stephen T. Winn:]

Well, I guess, that risk always exists. But the other product centers are substantially differentiated, and we haven't seen the level of competition in any of those categories of products that has been present in the marketing area. So again, I can't anticipate where pricing is going, but I also know we've got a vast number of new products that are entering the market, many of them are in this non-leasing area. So I feel pretty bullish about our ability to continue differentiating the products that we have even within the leasing area. I mean, we have new products coming out in that area, too. So we're -- we feel good about our competitive position, but we recognize that there is a challenge in the marketing area, primarily because the overall market, in our view, is shrinking.

[Brandon Burke Dobell:]

Okay. And then, I guess, final one. You mentioned, I think at the outset, Steve, some incentive stock grants tied to the stock price. Maybe a little more color on how those are set up, how they work, how far down the organization they went. And if that, I guess, down the organization, if that's a different group of people or a broader group of people or narrower, I guess, than your usual incentive plans for stock compensation.

[Stephen T. Winn:]

Well, the first performance grant was given to me at the end of -- or the beginning of the year. And it triggers half at $25 a share and half at $30 a share. And then once it's triggered, it vests over 4 quarters. That's different from the traditional type of grant, which has been 1/3 restricted shares and 2/3 stock options. We did expand the number of participants in the performance share grant to our Section 16 officers and a small number of additional people. And then candidly, we want to see how this works. And I think the general thought is this is a good idea structurally. By the way, the details on this can be found in our 8-K filing, which just occurred.

[Operator:]

And we'll take our next question coming from Michael Nemeroff from Crédit Suisse.

[Kyle Chen:]

This is Kyle Chen in for Michael Nemeroff. Relative to pricing, how should we think about RPU trends over the next couple of quarters, given the pricing action that you took? And the number of customers that renewed at this lower pricing, should we expect RPUs to trend lower or to remain around this current level? Are there any opportunities to increase pricing with current customers than to discount once demand improves? Or are you locked into this lower pricing for the length of the contract?

[W. Bryan Hill:]

You should take -- RPU, you should expect to trend higher in Q3 and Q4. A couple of drivers of that

[Kyle Chen:]

Great. And what was the acquired revenue and acquired units during the quarter?

[W. Bryan Hill:]

During the quarter, the acquired units were fairly nominal related to the vacation rental space. Kigo provided 40,000 units approximately.

[Kyle Chen:]

Okay. And then from a revenue perspective, fairly nominal as well?

[W. Bryan Hill:]

It is fairly immaterial revenue.

[Operator:]

And we'll take our next question from Nandan Amladi from Deutsche Bank.

[Nandan Amladi:]

So Steve, you mentioned 65 new product centers by the end of the year, 10 new ones during the year. How should we think about your revenue contribution from the existing products versus these new ones? More specifically, how heavily are you reliant on customers being up-sold these new products?

[Stephen T. Winn:]

Well, there's not going to be a material amount of revenue generated in 2014 because these are just entering the market. We would expect these just to begin contributing to revenue in a meaningful way in 2015 forward. I wouldn't say we're dependent on new products for growth. The core business is growing nicely outside of marketing solutions, but new products do help differentiate the overall suites. So I think they're important, and it's -- we're candidly on the tail end of a major development initiative larger than anything we've ever undertaken in the past. And you see that reflected in the dollars that we spent on product development, which were up 25% in the second quarter and in the sheer quantity of new products that are entering the market. Now these have been under development for a long time in most cases. So this is not -- these are not speculative. They are coming or have already arrived.

[Nandan Amladi:]

Okay. And one follow-up, if I might, Bryan. You talked about some headcount optimization for higher-cost markets, your ability to consolidate that. How much room do you have in terms of percent of your total headcount, say, or percentage of cost that is in these high-cost regions?

[W. Bryan Hill:]

It's more moving the functions, either offshore is always our first choice that we try to evaluate. But it's -- as a result of the acquisitions and some of disparate locations, we're undergoing an analysis of determining which functions we should centralize in Dallas and other areas of the company. We haven't quantified the margin uplift that will result from that. And again, you should see that more in 2015.

[Operator:]

And our next question is from Brendan Barnicle from Pacific Crest Securities.

[Brendan Barnicle:]

Steve, you guys have taken the leasing revenue assumptions out of -- or at least the impact to revenue out of Q3. But Q3 is like Q2 is historically a seasonally strong quarter for leasing and turnover. Sounds like in Q2, we had some weather anomalies. Is it possible that in Q3 without weather anomalies that we'd get some catch-up there, and that you guys end up being surprised to the upside on what you're able to get out of that leasing revenue?

[Stephen T. Winn:]

What we factored into Q3 was not a decline sequentially in our leasing business. It's a similar decline year-over-year is what we experienced in Q2. Normal seasonality is built into our guidance for Q3.

[Brendan Barnicle:]

So the same phenomenon that you saw in Q2 you think is now sort of a permanent phenomenon in the market?

[Stephen T. Winn:]

Based on the visibility we currently have, that's how we developed our guidance.

[Brendan Barnicle:]

Got it. And then you mentioned competitive pricing a couple of different times. Can you remind me again who those main competitors are that you're seeing on that marketing space?

[Stephen T. Winn:]

Marketing area has literally hundreds of companies that compete. There are large Internet listing services that are our competitors, but then you've got website companies, you've got search engine companies, you've got advertising agencies. It's really quite a wide swath of competitors that we see here.

[Operator:]

Okay. Thank you, sir. And that does conclude our Q&A portion and concludes our conference for today. Everyone, thanks for your participation. You may now disconnect.