May 16, 2008
Executives
Tim Trainor - Communications Director Andrew Florance - Founder, CEO and President Brian Radecki - CFO
Analysts
Jon Maietta - Needham & Company Jim Wilson - JMP Securities John Neff - William Blair Vance Edelson - Morgan Stanley Brett Huff - Stephens Incorporated
Operator
At this time, I would like to welcome everyone to the first quarter 2008 conference call. (Operator Instructions) Thank you.
Mr. Trainor, you may begin your conference.
Tim Trainor
Thank you, Tia. Good morning, everyone, and welcome to CoStar Group's first quarter 2008 conference call.
Before I turn the call over to our CEO, Andrew Florance, let me state that certain portions of this discussion contain forward-looking statements which involve many risks and uncertainties that can cause actual results to differ materially from such statements. Important factors that can cause actual results to differ include, but are not limited to, those stated in CoStar's first quarter 2008 press release and CoStar's filings with the SEC, including CoStar's form 10-K for the period ended December 31, 2007, under the heading "Risk Factors."
All forward-looking statements are based on information available to CoStar on the date of this call, and CoStar assumes no obligation to update these statements. You can find a webcast of this conference call at www.costar.com/corporate/investor.
Thank you for joining us. I will now turn the call over to Andy.
Andrew Florance
Thank you, Tim. I want to apologize for us getting going with a late start there on the phone call.
We like to start more promptly than that. We had a minor technical difficulty.
But, again, I apologize and welcome everyone to the first quarter 2008 conference call. I'm very pleased to report that CoStar Group continued the earnings momentum we began to generate last year, and we posted another strong performance in the first quarter, one in which we added a large number of new subscribers and achieved better than expected earnings growth.
By executing our strategy of adding and retaining subscribers and managing our cost structure while taking advantage of the opportunities, through our U.S. national expansion and our expanded U.K.
operations, we generated solid earnings growth for the past three consecutive quarters, and we anticipate that we will continue to do so. First quarter net income increased 178% over the same period one year ago to $5 million or $0.26 per diluted shared compared to $1.8 million or $0.09 per diluted share for the first quarter 2007.
EBITDA for the first quarter 2008 was $11.5 million, an increase of 128% compared to EBITDA of $5 million in the first quarter of 2007. Revenues for the first quarter 2008 were $52.3 million, a 16.6% increase over the first quarter 2007 revenues of $44.8 million and a 2.8% increase from fourth quarter 2007 revenues of $50.8 million.
As of March 31, 2008, we had $193.1 million in cash, cash equivalents, short-term and long-term investments. CoStar Group has no long-term debt.
Brian will address the first quarter results in more detail and provide some color on our outlook for the rest of the year and our decision to increase our guidance. Before he does, I'd like to talk about some of the trends and opportunities we see as a company as well as some of the new services and initiatives we have planned and how we anticipate they will contribute to our earnings and revenue growth.
Demand for our information products remains strong. We continue to add a large number of new users, signed the largest number of new customer firms in a single quarter ever, and we enjoyed a high renewal rate, all of which contribute to our strong first quarter earnings growth.
Overall, subscriber growth in the first quarter was very strong. We added 2,071 net new paying individual subscribers to bring our total subscriber count to 90,822.
In total, we added 591 net new subscribing firms in the U.S., the most net new customers we've ever sold to in a single quarter. 591 new firms compares to 526 firms added in the fourth quarter of 2007 and 535 firms added a year ago during the first quarter 2007.
Much of that subscriber growth can be attributed to our decision, which I discussed in last quarter's call, to concentrate the efforts of our sales team on a strategically important market segment for us, smaller sized brokerage companies that have an inordinately high number of listings where those companies are not currently our customers. We target these specific small firms, because with an average of 32 listings each, they control a higher number of listings on average than does a typical small firm, which would be expected to have one or two commercial property listings.
Since these firms would normally only purchase one or two licenses, thereby representing lower average contract values, these firms would normally not be a high priority for our sales teams. Despite the fact that the subscription revenue from these firms may not be the highest, they're valuable to have as clients, because these small firms tend to give our researchers more detailed information on their listings and deals when they become clients.
We would still collect their content if they were not clients, but it's easier to do so and results in higher quality if they are clients. Many of these small prospects with high numbers of listings have recently experienced steep price increases from other vendors, so we thought it was an opportune time to go after them.
Our efforts in this area over the last two quarters have been a major success and thousands of listings have been converted to client listings, giving us overall higher quality data and thereby increasing our value proposition to all of our clients and prospects. Given our historical ability to renew and up-sell firms once they become subscribers and benefit from the value of our higher quality research report information, we believe that expanding our customer base could be immediately beneficial from a sales perspective and we expect it will also lead to long-term growth opportunities.
For these and other reasons, we believe there was value to targeting these previously untapped segments. And as I reported last quarter, we implemented a number of incentives for our sales teams and certain special pricing offers to focus our salespeople on selling into these smaller accounts.
As I indicated, this incentive program essentially covers the first half of the year, by which time I believe we will have largely accomplished our strategic objectives in this segment. We are well aware that we made a decision that was a clear tradeoff between maximizing contract bookings during the quarter and gaining an intermediate term competitive advantage.
While this incentive program has been very successful in signing a large number of contracts, the relatively small size of the firms results in contracts at a much smaller average price point, which also results in a lower average contract price for the quarter overall. The average new contract value decreased 26% quarter-over-quarter from 9,277 in the fourth quarter 2007 to 6,864 in the first quarter 2008.
Because of that, U.S. subscription contract bookings were also lower in the first quarter 2008, totaling 3.7 million, down from 5.8 million in the fourth quarter of 2007.
As we complete this initiative in the second quarter, we anticipate the average contract value will increase significantly back towards historical norms. Showcase will be a primary priority for the sales force for the rest of 2008.
And with a current average contract value of $11,400 annually, it will put upward pressure on our average contract values and our quarterly bookings. We believe the strategy of targeting these strategically important smaller size firms will continue to generate a record number of new subscribing firms through the end of the second quarter.
Our customer renewal rate was slightly lower in the quarter, but still at 90%. The renewal rate is slightly lower due to January seasonality, some customer anxiety, given the negative media that's out there, and an increase in bad debt.
At 90%, the renewal rate remains the highest in our industry by a wide margin, which I believe affirms the usefulness of our information and its central function are subscribers day to day missing critical business activity. In order to try to increase the renewal rate back to 92%-plus range, we are reemphasizing training customer attention focus within our sales force.
At the end of the first quarter, the company had 131 U.S. subscription sales reps, 9 U.S.
advertising sales reps, 7 in-house sales reps and 24 U.K. field sales reps for a total of 171 quota-carrying sales representatives.
This compares with 169 on staff at the end of the fourth quarter last year. Commercial real estate market conditions are mixed right now.
They are neither clearly negative nor are they universally positive. Many key industry indicators reflect unprecedented strengths right now.
Rents are generally at multi-year highs. Property asset values are at multi-year highs.
Cap rates remain low. Construction activity is robust.
Vacancy rates are generally moderate and well within range considered healthy for a commercial real estate market. There are pockets of rising vacancy rates in a number of U.S.
markets, but there is no clear dramatic national trend one way or another in the vacancy rates. Absorption, leasing activity and sales volumes are trending down.
Let me make it clear. Commercial real estate is not experiencing the obvious negative market conditions that residential real estate is currently experiencing.
In my mind, the proper commercial real estate downturn is characterized by consecutive quarters of clearly rising vacancy rates, falling rents and asset values, negative absorption and stalled construction activity. The plain reality here is that the expected downturn that many have been expecting has so far failed to clearly materialize.
Based on our analysis, the facts and statistics in this commercial real estate market do not support the conventional wisdom that the commercial real estate market is in a significant downturn. Our latest analysis based on performance of a core set of major U.S.
markets that CoStar researchers tracked since 2000 found that office, retail and industrial rental rates finished the quarter at multi-year highs, while demand for commercial real estate did soften somewhat this past quarter. Total office absorption remained positive at just 655,000 square feet this past quarter compared to a much higher 14.6 million square feet of positive absorption one year ago.
We expect this number will likely be revised upwards as more deals are captured. Retail turned in the strongest first quarter performance of the three major property types with positive absorption of 10.3 million square feet, although still down from 26.8 million square feet of retail absorption one year ago.
Again, this number will likely be revised upwards as more transactions for the quarter come in to our researchers. The biggest change took place in the industrial property sector, which dipped into negative territory for the first time since 2002, posting 1.4 million square feet of negative absorption this quarter compared to 40.9 million square feet of positive absorption one year ago.
Construction levels, which had been trending somewhat lower, essentially remained unchanged during the quarter. The total amount of office space under construction was 142 million square feet compared to 134 million square feet last quarter, a 6% increase from last quarter and a 2% decrease from the first quarter 2007.
These are not meaningful changes. Industrial construction totaled 118 million square feet compared to 126 million square feet last quarter.
This represents a 7% drop over the last quarter's level and a 27% drop from the previous year, a slightly more significant change. A total of 104 million square feet of retail space was under construction at the end of the first quarter, just a 3% change from the 101 million square feet under construction last quarter, but a 20% decrease over the same time last year.
Declining absorption levels combined with modest levels of continued new development has caused a national vacancy rate to go up just slightly in each of the property types. Office vacancy rates edged up just slightly from 11.2% at the end of last year to 11.5% in the first quarter, while the industrial rates went from 8.3% to 8.5% and retail rates went from 6.4% to 6.6%.
We also see mixed results in the commercial real estate capital markets. The changes we've seen to date can just as easily be characterized as a return to mean rather than a dramatic drop off as sales activity came from superheated levels they reached over the past 24 months.
Office sales volume was down 36% from the same quarter last year from $20 billion to $18 billion, but only down 5% from levels we saw two years ago. The average office sales price rose 19% over year-ago levels from $240 to $280 per square foot and is up 41% over the average sales price from two years ago.
Average office cap rates are 14 basis points lower than the same quarter last year from 7.1% to 7.0% and 57 basis points lower than two years ago. In the industrial property market, sales volume was down 11% from $7.3 billion in the fourth quarter 2006 to $6.5 billion in the fourth quarter 2007.
Industrial sales volume is down 18% from two years ago. However, the average industrial sales prices are up 7% higher than last year at this time and also 9% higher than two years ago at $67 per square foot.
And cap rates for industrial property sales are lower, averaging 7.2%, 45 basis points lower than one year ago and 78 basis points lower than two years ago. Retail property sales volume is down 36% from the same quarter last year from $6.2 billion to $4 billion, down 44% from sales volume levels two years ago.
The average sales price for retail property increased 21% over year-ago levels from $149 per square foot to $180 per square foot and 29% higher compared with average sales prices from two years ago. All in all, we believe the first quarter market conditions remain fairly resilient.
Obviously, the market could weaken further. We believe that any further softening would have a greater impact on revenue growth than on earnings growth.
In last quarter's call, I addressed CoStar's proven ability to operate profitably through real estate cycles. We have successfully managed our business through several real estate cycles over the years.
As each cycle has come and gone, we have grown the total number of subscribers, increased revenues every quarter since our IPO more than a decade ago. So far, this downcycle has failed to fully appear.
Again, I want to reiterate that while residential real estate is in a clearly down market with almost all indicators in a significant decline, commercial real estate is not showing clear or consistent, across-the-board signs of being in a downcycle. As I reported in our last call, we have taken appropriate steps to stabilize our cost structure after substantially completing the multimillion dollar investment required to complete our coverage of the U.S.
and U.K. commercial real estate markets.
Having completed the difficult and very expensive phase of adding the additional markets to our database, we believe that costs associated with maintaining the information our research teams evaluated in those markets have stabilized and may decline over time. Of course, the job of updating, verifying and enhancing information we provide our subscribers never ends.
Based on current patterns of growth in our listing database, we project that our research team will add the one-millionth listing to CoStar's database sometime during the second quarter of this year. To the best of my knowledge, this represents an unprecedented and unmatched aggregation of commercial property information within a unified database.
We believe that to try and replicate the breadth and scale of the property information CoStar's researchers assembled would cost hundreds of millions of dollars. Our research team provides the core data that is the source of our value and identity as a company.
The fact that they have done an outstanding job in researching these new markets and aggregating so many listings in such an efficient and timely manner in no way infers that our job is done, but the cost structure has been stabilized. Total research and verified commercial real estate listings in the CoStar's U.S.
database grew 23% year-over-year from approximately 724,000 in the first quarter of 2007 to approximately 889,000 in the first quarter 2008. In total, between both the U.S.
and U.K., the company had approximately 985,000 active listings in our database, and the total U.S. square footage of gross building area tracked and maintained by CoStar now exceeds 57 billion feet.
By the end of the quarter, our U.S. research team tracked detailed information on more than 2.15 million individual properties across all types and classes of commercial real estate.
The total number of retail listings in our U.S. database at the end of the first quarter was 390,000 listings, and our database of for-sale listings continued to expand during the first quarter, adding 14,398 new properties listed for sale for a total of 340,000 with an aggregate value of $450 billion.
And I am also pleased to report great progress towards our goal of becoming the preeminent source of commercial real estate information in the United Kingdom and eventually all of Europe by building as strong U.K. product offering as we have currently in the United States.
Last year, we made a number of key executive appointments, opened a new Glasgow-based research center and restructured our research operations. We introduced many of the same processes and systems we have in place in the U.S.
in order to achieve the same degree of accuracy and comprehensive coverage that remains one of our key value propositions in the United States. The U.K.
research team is now in high gear and has added nearly 126 million square feet of available space in the first quarter alone, taking the U.K. database to 957 million square feet, a 15% increase from the fourth quarter 2007.
The total number of listings in the U.K. increased from 54,560 in March of 2007 to 840,000 in March of 2008.
The U.K. database is now approaching the sort of levels we would expect to see relative to the U.S.
on a GDP basis. This impressive growth has been accompanied by an increase in overall productivity and implementation of rigorous quality assurance processes similar to the ones used in our U.S.
research operations, including a telephone recording and training system. This valuable coaching tool has enabled managers to impart best practices and effective strategies for making the most of client interactions.
I believe that our Glasgow Research Center is now one of our best and most productive research centers globally. Not surprisingly, our clients and prospective clients are taking note of our improved research quality.
We believe the improved quality and comprehensiveness of our information will translate into increased sales over time as we work to become the clearinghouse for property listings in the United Kingdom. Revenues attributable to our European operations increased year-over-year from $4.65 million in the first quarter 2007 to $5.86 million in the first quarter of 2008.
We believe that the quality of our European management team now in place, our improved technology and our experience in our European operations and the demand we are seeing from our client base for a standardized research-verified information service will continue to give us the competitive advantage in that marketplace. One sure sign that we are delivering our customer expectations is the increase in product usage we're seeing in both the U.S.
and U.K. as clients continue to log into our system, run more queries, produce more reports and set up more alerts.
Usage of our U.K. products has doubled first quarter over first quarter and continues to grow.
In fact, usage of our FOCUS product in the U.K. recorded its highest ever customer usage level earlier this month, reaching a level that was roughly 250% higher than the level we were seeing in the first quarter of 2007.
In the U.S., total customer usage increased 15% in the first quarter over the fourth quarter 2007. We strongly believe that the higher overall usage levels bodes well for continued high customer renewal rates into the future.
Another area of our business where I was pleased to see substantial progress made in this past quarter was our ongoing efforts to protect legitimate subscribers from those who seek to fraudulently gain access to our information or who otherwise use our images or information illegally. Unfortunately, when you provide an extremely valuable service, some will attempt to use it without paying for it.
Our clients expect us to take every reasonable measure to ensure that they are the ones who benefit from the competitive advantage of CoStar's information services and that those who aren't paying for it and resort to theft aren't getting the benefit. Fortunately, technology is available today that makes it very easy to detect theft and identify illegal password sharing.
To help protect customers and combat data theft, we have established an internal anti-piracy group that uses extensive fraud-detection technology to continually monitor CoStar's online information products and detect and prevent unauthorized access. In the past year, CoStar obtained in excess of $1.7 million in court-awarded judgments and out-of-court settlements as a result of our anti-piracy efforts.
These judgments included $1 million against Centers & Malls, a company that stole and unlawfully resold CoStar's retail database, and a judgment of $100,000 against two other companies that shared a single passcode to gain access to CoStar's information service. CoStar has received additional significant out-of-court settlements with a number of companies engaged in passcode sharing, and we will continue to prosecute individuals and firms that engage in this unlawful activity.
Last call, I briefed you on an assessable lawsuit involving CoStar and a competitor. In that case, we challenged the competitor on the grounds that it was wildly overstating its online audience of 2.5 million registered users, giving prospective property listers a misleading perception number of people who actually use their service.
In a statement that appeared to validate CoStar's false advertising lawsuit, the competitor's CEO admitted at an investor conference in February that it does not have 2.5 million active users. The day after the first quarter ended on April 1st, we expanded our user base in Atlanta, a key market for the Southwest U.S., by acquiring the online commercial real estate information assets of First CLS, an Atlanta-based provider of local commercial real estate information operating as The Dorey Companies and DoreyPRO.
Under the agreement, former DoreyPRO customers will use CoStar's information service and will be served by the company's existing Atlanta research and sales team. Essentially, we acquired this local competitor's non-duplicative client contracts at a cost of approximately three times EBITDA with a potential earnout that could bring the total cost up to five times EBITDA.
The conversion process is proceeding very smoothly, and we are pleased to expand our client base in this strategically important market without incurring significant additional overhead. We basically believe that this revenue transfers over the operation without almost any increase in cost.
Given the current economic environment, we believe this is a good time to focus on similar, low-risk, immediately accretive acquisitions. This is not the time, in our opinion, to try to expand in new areas or invest in new software ventures with all the risks and additional support costs that would accompany such endeavors.
Currently, we are more interested in doing acquisitions like this Dorey acquisition, which are creative, and we'll be pursuing those as they present themselves. Finally, I want to quickly provide an update on our new marketing service called CoStar Showcase that we plan to release in the next several weeks.
We have downloaded this new service to a select group of our existing clients, and quite frankly, the response has significantly exceeded our expectations. Prior to launch and with limited marketing, we have signed more than $0.25 million in annual contract value.
And this morning, I was watching that number climb pretty significantly. These contracts do have a trial period, and they do have an option to cancel.
So, we wouldn't be booking the revenue for another quarter. Based on the response we've received to date, we believe CoStar Showcase will be a very compelling and effective solution for those interested in marketing their listings online.
Using a substantial web traffic generated at costar.com and at leading search engines through the latest keyword linking strategies, we've created an all new marketing service for displaying property listings to this online audience. From both the user and advertiser's perspective, CoStar Showcase will provide a number of advantages over other online property marketing services.
One, it will be a completely open system with no registration barriers. All the listings that subscribers select to post will be available online to anyone who visits costar.com and will be readily accessible through very basic and straightforward search functionality.
Secondly, posting content will be a very simple process. Once you've become a subscriber, your listings will automatically appear on the external CoStar Showcase site with the appropriate listing content, including images, space available and description, with no extra keying in text or uploading images.
Third, listings market on CoStar Showcase will benefit from one-click access from costar.com, Google, Yahoo! and other major websites and search engines.
We believe the keyword linking strategy and the audience we expect CoStar Showcase to attract will prove effective at generating inquiries for those who list their properties online. We believe those responsible for finding tenants or buyers for commercial properties will find that CoStar Showcase can provide a competitive advantage for marketing online listings by providing additional valuable exposure and generating qualified inquiries from a large audience of potential prospects.
We also believe CoStar Showcase has the potential to be a significant contributor to our revenue in the third and fourth quarters of this year. Our experience in marketing this service to date has been very positive.
Compared with our core subscription-based information sales, which tend to have a sales cycle of a couple weeks or even months, the sales cycle for CoStar Showcase appears to be a matter of days. And, again, the average contract size of $11,400 is larger than our first quarter average contract value of $6,846.
Before I turn the call over to Brian, I want to reiterate that the company is very focused on adding and retaining subscribers across the U.S. and U.K., controlling our costs, pursuing customer service excellence, enhancing the already high quality of research we conduct, expanding the type of services that we provide to our clients and reaching out and finding thousands of prospects out there who will find real value in the array of marketing information and services we offer.
We have moved quickly to maximize the opportunity we created from our investments in the U.S. and U.K.
to generate consistent earnings growth as we move through 2008 and into 2009. As you may have heard me state in previous calls, our first goal is long-term, intermediate-term and short-term earnings growth.
I believe this quarter's results have clearly delivered on that earnings goal, and our raising guidance today shows our confidence in our ability to continue to deliver on that goal throughout the rest of this year. At this point, I will turn the call over to Brian.
Brian Radecki
Thank you, Andy. As stated in the press release last night, net income accelerated in the first quarter of 2008, increasing 178% over the same period one year ago to $5 million or $0.26 per diluted share compared to $1.8 million or $0.09 per diluted share for the first quarter of 2007.
Now, I am going to focus principally on the sequential results for the first quarter 2008 compared to the fourth quarter 2007 and our outlook for the second quarter and full year 2008. Total revenues grew sequentially by 2.8% from Q4 2007 to Q1 of 2008, increasing from $50.8 million to $52.3 million.
Core U.S. subscription revenue increased by 3% from Q4 of 2007 to Q1 of 2008, consistent with last quarter.
And our renewal rate remained solid at 90.3 for the quarter. International operations contributed 11.2% of total revenues, and total subscription revenues for the company continued to account for 95% of revenues during Q1 of 2008.
International revenues decreased slightly from $6.1 million in Q4 of 2007 to $5.9 million in Q1 of 2008, mainly due to lower foreign currency exchange rates and a slightly lower ad hoc revenue during the quarter. Quarterly international subscription revenue sequential growth remained relatively consistent with the business.
Again, let me remind everybody the company has reported sequential revenue increases at every quarter since its IPO in 1998 and through several commercial real estate cycles since 1987 when Andy founded the business. We have and continue to expect that we will add and renew subscribers, increase usage and grow our revenue each quarter through the current economic and real estate environment.
Gross margin increased by $1.7 million from $30.8 million in Q4 of 2007 to $32.5 million in Q1 of 2008 on a $1.4 million increase in revenues. Overall, gross margin percentage expanded to 62.3% in Q1 of 2008 from 60.6% in Q4 of 2007, as expected.
This increase in both gross margin dollars and percentage demonstrates the strength of our subscription-based business model. Now that we have completed the step-up and research costs, all of the revenue during the quarter dropped directly to the gross margin line.
Excluding the lease settlement gain in Q4 of 2007, overall operating expenses decreased approximately $800,000 from $26.1 million in Q4 of 2007 to $25.3 million in Q1 of 2008. This decrease was principally in selling the marketing due to the completion of multiple direct mail campaigns in Q4 2007.
Our revenue growth coupled with our lower operating expenses in Q1 resulted in EBITDA for the first quarter of $11.5 million, an increase of $2.3 million or 26% compared to EBITDA of $9.2 million in the fourth quarter of 2007. Again, please note that I excluded the $7.6 million one-time gain of our London lease settlement for comparative purposes here.
Reconciliation of EBITDA and all non-GAAP financial measures discussed on this call to get basis results is shown in detail on our press release issued yesterday. The press release is available on our website at www.costar.com.
Capital expenditures for Q1 of 2008 were approximately $1.5 million, which is well within our expected range for the quarter. As Andy stated, we ended the first quarter with approximately $193.1 million in cash, cash equivalents, short-term and long-term investments.
And, again, the company had no long-term debt. Now, I will discuss the outlook for the second quarter of 2008.
As indicated in our press release, we anticipate a sequential quarterly increase in revenue from the first quarter to the second quarter of 2008 of approximately 2% to 4% and fully diluted net income per share of approximately $0.24 to $0.26 in the second quarter, which includes the seasonally high selling and marketing expenses associated with the ICSC trade show and the pending release of CoStar Showcase. In addition, during the second quarter the company expects a charge of approximately $300,000 resulting from the termination of a lease and write-off of certain leasehold improvements that will save the company approximately $1.2 million over the remaining two-year term of the lease as we consolidate excess office space in Maryland.
This savings is a direct result of management's focus on identifying operational efficiencies in the business that reduce both short-term and long-term costs. As we have previously stated, we continue to expect to grow earnings from the U.S.
operations through 2008 as a result of the consistent core revenue growth and our relatively fixed cost base. Based on the strong first quarter results and our confidence that we'll be able to execute our plan, we have raised the outlook for net income for the full year of 2008 to approximately $1.05 to $1.10 per diluted share.
We also continue to anticipate for 2008 overall revenue growth in the range of 14% to 16% over 2007. Our full year guidance also takes into account the effect of lower overall interest rates and our cash balances compared to last year.
We continue to believe there is upside sequential revenue growth potential in the back half of 2008. Revenue growth continues to be largely dependent on the successful growth and productivity of the sales force, particularly in the view of revenue opportunities that we believe may result from momentum in the established markets, new markets, new products like CoStar Showcase and international opportunities.
Gross margin percentage is expected to continue to improve from Q1 to Q2 as we leverage our stable U.S. cost structure.
Also, operating expenses are expected to increase slightly, as I discussed, due to ICSC's trade show and the anticipated release of Showcase. As we continue to incur losses internationally, the mechanics of our effective tax rate calculation continue to be affected by the amount of income or loss in the U.K.
where we do not get an equivalent tax expense or benefit to offset the U.S. corporate tax.
This results in an overall blended tax rate, which may increase or decrease over the current rate. We continue to anticipate our overall effective rate in the range of 43% to 45% for 2008.
In conclusion, we continue to expect earnings growth from our core U.S. business, and that will be the story for 2008.
Our Q1 results demonstrate that we are delivering on these expectations. We also expect our international operations to continue to move towards breakeven by the end of 2008 while we develop the next generation of international software, which will position us for long-term growth opportunities in the U.K.
and Europe later in 2009 and beyond. I can truly say the entire CoStar management team remains fully committed to achieving the 30% EBITDA margin in the U.S.
and breakeven in our international operations by the end of 2008 as cost structures for the various investments previously made are expected to remain relatively stable as we grow our revenue and significantly leverage earnings. We look forward to reporting our progress to you.
And with that, I'll open up the call for questions. Operator, are you with us?
Operator
(Operator Instructions) Your first question comes from Jon Maietta with Needham & Company.
Jon Maietta - Needham & Company
Hey, thanks very much. Hi, Andy.
Hi, Brian.
Andrew Florance
Hi.
Jon Maietta - Needham & Company
The first question I had, Andy, I was wondering if you could talk qualitatively about any differences in behavior with regard to your larger customers today in this environment versus the smaller customers on purchase decisions.
Andrew Florance
Yes. There is no question that the general anxiety in the economy is causing people to take a little bit longer in the sales cycle.
So, people are putting off some decisions here and there. I would have to say, though, our middle to upper clients are very stable with us in this environment.
These are situations where they absolutely need this information that we provide, and they're not going to try to save money by replicating our information processes in-house and our research processes in-house. It is dramatically cheaper to outsource to us.
Where we see friction right now in the cycle is with the very small firms. So, the 1%, 2%, 3%, 5% sort of marginal customers.
Those are the folks who may have been new to the industry in the last several years and are losing confidence. So, it's really strong in the middle-upper, a little weaker at the small client.
Jon Maietta - Needham & Company
Okay. And then could you talk about how you're actually going to rollout the Showcase product?
Andrew Florance
Sure. We've been test marketing it over the last three to four weeks.
We're first selling it really to our existing customers. And we've met with maybe 60 customer sites, and we've gotten a very positive response, signed a significant number of deals.
And we will go live with the product in about two weeks, and we'll be pushing out to the entire sales force and going very aggressively on it. It will be a centerpiece of our ICSC presence, the International Council of Shopping Centers' big spring convention.
And we have a number of marketing campaigns around it, and it will be probably the primary priority in sales over the second, third and fourth quarters of this year.
Jon Maietta - Needham & Company
Okay. And then how are you actually pricing the product?
Andrew Florance
We are pricing it with an algorithm that I couldn't begin to explain on the phone call. What we are doing is we are looking at each client's inventory of listings, both sale and lease.
Roughly speaking, we're looking at the value of those listings, and then we're getting discounts for their bulk purchasing of these advertisements on our website. So what we're trying to do there is incentivize our customers to buy ads for all their listings, not to cherry-pick some listings over others.
And we're trying to make sure that we aren't charging more to advertise a little less than they're going to earn in commissions. And so we're sort of setting the value relative to the value of the ads on the properties they're trying to move.
And so far, the response of this pricing model, which is fairly new and unique, has been very positive. So we've been out there.
We've tried it on 60 customers. And they look at it, and they say overall they feel like it's right.
And we haven't had a lot of pushback on the price. So, it seems to be working pretty well.
Jon Maietta - Needham & Company
Got it. Okay.
And then just last question, Brian, what was cash from operations in the quarter?
Brian Radecki
Cash from operations, I think it was around $6 million, something like that. EBITDA was $11.5 million.
Jon Maietta - Needham & Company
Got it. Okay.
Thanks very much.
Andrew Florance
Thanks, Jon.
Operator
Your next question comes from Jim Wilson with JMP Securities.
Jim Wilson - JMP Securities
Thanks. Good morning, guys.
Andrew Florance
Hi, Jim.
Jim Wilson - JMP Securities
Let's see. I guess two things.
It's a great color on the sales efforts this quarter and the size of firms. Anything you can give color on the geography of success of sales or are those markets you have now fully completed with the most information or have those been your target points or have those been your most successful sales locations or anything else you can give that that would color?
Andrew Florance
And you're referring to Showcase?
Jim Wilson - JMP Securities
No, not Showcase, but back to sales piece of new subscribers, the core products during the first quarter.
Andrew Florance
Okay. So, one of the things we were doing in the first quarter was we were again going back to this effort we made to put all of our sales group focusing on the smaller high listing count firms.
They really probably concentrated in our weaker market areas. They would not be in Washington, D.C., New York City or Los Angeles.
They would be in newer territories. So, a lot of the sales from the quarter came from weaker or mid-level market areas.
And you didn't really ask, but I'm going to tell you anyhow, on the Showcase side, one of the unusual aspects of the Showcase sales are some big sales are coming from some of our smallest markets. So, we're seeing some unusually positive selling activity in markets like Omaha and that kind of market.
Jim Wilson - JMP Securities
I guess maybe then another Showcase question. You gave us the average contract size so far and what you've worked on, but what about average number of listings?
How big are these guys in terms of listings that you're signing up?
Andrew Florance
We don't know. Initially, what we're doing is we're focusing only on firms with five or more listings.
So, we're not even talking to firms that have less than five listings. I don't have precise numbers, but it appears to vary.
It seems to vary from as little as, I've seen some contracts come in at 10 listings, 15 listings on up to a contract that probably came in for 1,000 listings. So, it's a range.
Jim Wilson - JMP Securities
Okay. And it's probably too early to have a terribly meaningful average anyway, I guess?
Andrew Florance
Yes, and you tend to focus on the ones that come in at the bigger number.
Jim Wilson - JMP Securities
Right. Sure.
Okay. All right.
Good. That's helpful.
Thanks.
Andrew Florance
Thank you, Jim.
Operator
Your next question comes from John Neff with William Blair.
Andrew Florance
Hi, John.
John Neff - William Blair
Congratulations on the quarter.
Andrew Florance
Thank you very much.
Brian Radecki
Thanks, John.
John Neff - William Blair
A few questions for you. The 17% decline in selling and marketing, from my numbers, it looks like sales headcount was relatively flat year-over-year.
So, why that sharp decline? Is there something negative about that?
Is it an indictment of sales productivity or commission payouts or are you cutting back somewhere we should be aware of?
Brian Radecki
Yes, I think I mentioned in my script that we had some yearend marketing campaigns that were going out, multiple direct mail pieces that were going out all through the quarter before the end of the year. So, those kind of dropped off from Q4 to Q1.
And then again, we expect an increase there, not just from ICSC, but also the release of Showcase in the second quarter. So, it's more timing and when the marketing and direct mail pieces went out.
A lot went out in Q4. Not as much went out in Q1.
And we'll expect to see an increase in Q2.
John Neff - William Blair
I meant more year-over-year. So, were there proportionately more of those kinds of marketing --?
Brian Radecki
Yes.
John Neff - William Blair
In the year-ago quarter, first quarter?
Andrew Florance
You also had higher sales training and recruiting costs in the first quarter of '07.
Brian Radecki
Correct. Higher sales training costs in the first quarter of '07 as we were ramping that up.
And again, we definitely had a difference in the marketing campaigns between the two years.
Andrew Florance
Now, I think as your seeing, both on the research side and on the sales side, again, first quarter last year we were still full on stepping up the cost structure. So, now you're seeing a lot of efficiencies coming in, and we've talked about a relatively fixed cost structure.
But obviously, excluding the one-time gain, you actually saw costs come down quarter-over-quarter. And again, that's because you're not in hiring phase.
Those groups are maturing. So, there is actually a lot less in training costs and those types of things.
John Neff - William Blair
Customer usage, how do you measure that?
Andrew Florance
We're looking at how many searches people are doing, whether or not they log on consistently. We look for at least 100 page views before we call you active, 100 requests from a logged-in state.
And we look for that in the course of a one-month time period, I believe, or else we don't call you active. And we watch it pretty closely, because it's one of the key metrics we use in compensating our sales people for growing the number of people using the product within their book of business.
And we think it's an important predictor of renewal rates. So, people that use our product heavily renew the service.
Some people that don't use the product heavily, renew the service too, but generally like them using the service. So, it's a measure of number of searches, number of pages viewed.
And right now, the numbers look very good, which is counter to probably general sentiment of a downcycle.
John Neff - William Blair
You gave some numbers. I was wondering if you could repeat what that total user count was at the end of the quarter?
But also, could you also describe from a standpoint of pricing scheme with contracts your revenue sensitivity to number of users? In other words, if we were to see more widespread industry layoffs in commercial real estate, more brokers being let go, et cetera, what kind of an impact or sensitivity does that present to your contract value?
Andrew Florance
Yes, so the total subscriber accounts, which the number we gave, is 90,822 currently. So, it's up 2,071 over the preceding quarter.
Now, so, we're seeing very strong growth in the number of subscribers with authorized IDs. As people, if a 10-person shop cuts two brokers or three brokers or loses two or three brokers, it really has no impact on the contract values.
It has no impact on the revenue side. Where it becomes more material is when somebody with five goes down to one.
Those people are going to be looking for a discount. And that's why I sort of mentioned earlier in the call and I have mentioned in previous calls is that's where you see a little bit more a friction on the renewal rate are those folks getting much smaller.
The folks who are mid-sized firms or big firms who are moving up and down slightly generally does not impact our revenue base. But right now the usage numbers and the subscriber growth is what you would normally associate with a strong market, not a weak market.
John Neff - William Blair
That's helpful. And then I was just a little confused when you said the average contract size for Showcase was $11,400.
Andrew Florance
Annually.
John Neff - William Blair
Annually. Okay.
So I'm just confused. My impression was that this was a per group of listing -- at per X number of listings per month kind of an offering.
Andrew Florance
What it is --
John Neff - William Blair
We get something more of a subscription kind of a thing.
Andrew Florance
It's much more of a subscription service, and many people are looking at this as a multi-year subscription. So what we're doing is we're going to a brokerage firm, and we have good intelligence and information as to what their volume and content of listings typically looks like.
We apparently have developed a formula that seems to resonate with them as a fair way to price marketing their entire basket of listings, based upon their historical activity we lock in a fixed rate, which will stay in place for the term of the contract regardless whether or not their listing count goes up or down. So if their listing count goes down, they're probably generating lot of commissions, and if the listing count goes up, they're going to be generating commissions in the future, hopefully.
But it's a fixed number based upon their historical activity. And, again, we seem to have hit on something here because we have a short sale cycle on this product, it appears, and we have a high close rate --
Brian Radecki
John, it's much more similar to our subscription-based business in total. So it's very similar to kind of how we've been selling things in the past.
John Neff - William Blair
And if that --
Andrew Florance
We know you don't like the sort of annuity subscription revenue streams.
John Neff - William Blair
Yes. We hate that, but it's an interesting point because I guess there was some concern previously to what extent -- how do you avoid cannibalization with other products?
Is it even an issue if this is the average contract size?
Andrew Florance
I think that was a concern that we had 12 months ago or 18 months ago as we first began looking at the product. And given the average contract size we're looking at right now, it becomes less of a concern because the contract values almost have a comparative relationship to the information contracts.
The marketing contracts are looking like information contracts. But also if you look in our Scottish property network company, they actually do something where they have a Showcase like product and they have an information service, and I think something like 80% of their listing content is out for the public to see, yet they still have very strong subscriptions for information for kind of (inaudible) looking to get the extra 20% of the listings that aren't publicly disclosed.
And then when I look at the relative size of Glasgow and Edinburgh compared to the various US markets and I look at the revenue stream we're deriving from that Scottish property network, it's actually favorable. So I think that's a little empirical experience that we can look at on a potential cannibalization, it doesn't look like a concern.
John Neff - William Blair
All right. I can get back in the queue.
Thank you.
Operator
(Operator Instructions) The next question comes from Vance Edelson with Morgan Stanley.
Vance Edelson - Morgan Stanley
Hey, thanks for taking the questions. You mentioned some of the smaller customers who are undergoing a loss of confidence over the state of the industry, and if I heard you right, that may have contributed to the slight drop in the retention rate.
Just wondering if you could elaborate a little on the increase in bad debt and the cause of that which might suggest more than just concern on the part of customers?
Andrew Florance
Sure. So let's segment that appropriately.
I would say that, you look at CB Richard Ellis's reported revenue growth and earnings growth and Richard Elli's sales reported revenue growth, earnings growth, and there's no sign of any issues that I see as I look at that. And so if you have a delay in a buying cycle from our mid-size to larger firms, it is more related to them spending too much time reading the FT or The Wall Street Journal and the bad news, not the actual reality in their business.
When I talk about loss of confidence, that would not apply to the one, two, three-person brokerage firm in California, Phoenix, or Southern Florida. Some of them are in bad straits.
It's actually real there. Leasing volume in some markets in California not San Francisco, but say Orange County, leasing volume is down sharply.
And so some of the small firms are going bankrupt, which would be a loss of confidence. So we're seeing bad debt in some of those guys.
And that's what you're looking at in that cancellation rate being a little higher in this quarter. And when you look at those guys anecdotally, what you see is some people who entered the marketplace.
Generally I'm seeing people that entered the marketplace in the last one to three years, like went out on their own from some bigger firm and now they're going back into a bigger firm or going into something different.
Vance Edelson - Morgan Stanley
Okay. That's very helpful.
And you would explain the slight international sequential drop in revenues, but the international EBITDA was down quite a bit more. Was that primarily due to the heavy investment upfront, or were there any other factors at work there?
Andrew Florance
We had a one-time transaction in the fourth quarter that probably should be written up in the real estate textbooks for the all-time most lucrative lease termination deal in the history of real estate globally. So we were paid $800 per square foot to terminate a 10,000 square foot lease in London early in the fourth quarter and took a large one-time gain, so what you're seeing is just the elimination of that one-time gain.
And the UK is probably six months behind the US in sort of filling out the geographic coverage, and so they are a little bit behind the US in the margin expansion phase of the business.
Brian Radecki
I think we discussed that the international is running a few quarters behind, and that's why, obviously, we're targeting the 30% in the US and then breakeven by the end of the year internationally.
Vance Edelson - Morgan Stanley
All right. And then, lastly, could you provide some color on the legal expense related to the competitors, what effect that had on the quarterly numbers and then whether that should trend down significantly from here and thanks?
Brian Radecki
We haven't disclosed that amount. Obviously, if you take a look at the G&A line, it's not up significantly quarter-over-quarter.
So I believe it was $9.743 in Q4 and $9.805 in Q1. So it's not a significant change.
I don't think it's anything that we're going to discuss.
Andrew Florance
And our legal and anti-piracy team is actually having significant success with out-of-court settlements with smaller password stealers so that they're probably actually almost operating as a profit center, which is highly unusual in a general counsel's office.
Vance Edelson - Morgan Stanley
Got it. Okay.
Thanks a lot, guys.
Brian Radecki
Thank you.
Operator
Your next question comes from Christopher Mammone with Deutsche Bank.
Christopher Mammone - Deutsche Bank
Sitting in for Chris. Just a housekeeping question first.
The $300,000 lease termination charge that you mentioned, is that included in the guidance for second quarter?
Brian Radecki
Yes, it is. It is included in the second quarter guidance.
Christopher Mammone - Deutsche Bank
Okay. Thank you.
And the other question, with respect to the strong subscriber growth that you saw this quarter, would you characterize that as purely ramp up on the sales force productivity, or do you think that you are seeing some early success in the 80 new markets that you have in the US now?
Andrew Florance
I'll sort of go between those two options, and I'll say that it's probably the maturation of the sales force. We had a lot of newer sales people now they are with us for six months, nine months, and they're beginning to become productive.
And this has probably been a somewhat challenging exercise for our sales force because they are pursuing strategic initiatives, as opposed to the maximum revenue initiative. So they're getting a lot of high subscriber growth that will pay off over the next several quarters to come.
And I think it's a mix, these subscribers are coming from both older and new markets, probably more of the mid-aged markets is the biggest driver.
Christopher Mammone - Deutsche Bank
Okay. And one last question.
Did I hear you correct that you said you might be starting to see revenues from Showcase in the third quarter?
Brian Radecki
I would expect minor revenues from Showcase in the third quarter. I would believe that most of the revenues will show up in the fourth quarter.
As Andy mentioned, there will be some free trial periods for a few months so we would expect to start to see Q4 seeing revenue come in from that. We'll obviously discuss that more on calls to come.
Christopher Mammone - Deutsche Bank
Okay, but is that included in your annual revenue growth guidance?
Brian Radecki
Yes, it is.
Christopher Mammone - Deutsche Bank
Okay. Thank you.
Brian Radecki
Great. Thank you.
Operator
Your next question comes from Brett Huff with Stephens Incorporated.
Andrew Florance
Hey, Brett.
Brett Huff - Stephens Incorporated
Good morning. How are you?
Andrew Florance
Doing fine and a couple of technical difficulties this morning.
Brett Huff - Stephens Incorporated
Okay, I had two quick questions. Number one, I wanted to make sure I understood how the pricing on your product works generally.
I know you described it a little bit, but I want to make sure that I understand it. Is it that, if a substantial decline in the number of people at a brokerage has to occur in order for repricing to occur.
But isn't that also limited by the length of contract? Like that issue wouldn't even come up if it were an annual contract until renewal; is that right?
Andrew Florance
You've got that correct.
Brian Radecki
That's correct, Brett.
Brett Huff - Stephens Incorporated
Okay. So that's one thing.
And then the second thing is can you talk just a little bit about the exposure of your business generally to weakness in sales versus weakness in leasing in the commercial market?
Andrew Florance
Sure. Our property professional business, which is the largest component of our business, is not very exposed to the sales marketplace.
I mean, I think it's got very light exposure. Our commercial multiple listing service, which generates probably around $1 million a year, or half a percentage point of our revenue, would be exposed to a sales downturn.
So if volumes came down, sales came down, our sales in that product, which again was half a percentage point of our revenue, would have a lot of exposure. And I see some softness in that product.
So that product was growing steadily up until the fourth quarter, and then it began to level and that's a low-end product that we set up to be more competitive with like LoopNet. Our comps product is -- from the people that have worked with the product for 25 years is generally not very cyclical, because as volumes in the sales side go down or problems occur or bankruptcies occur, the banks themselves need the product more in order to try to understand their asset exposure and what's going on in their loan-to-asset ratios.
So we don't, the more cowboy brokers who are riding the upward trend are not the guys who are doing that, not the men and women who are doing a lot of careful analysis with our comps product. It's the appraisers and valuation folks that do more work with our comps product, and they remain employed when things get dicey.
Brett Huff - Stephens Incorporated
Okay. Those are the only two questions I had.
Thanks for your time.
Operator
At this time there are no further questions. Are there any closing remarks?
Andrew Florance
Yes. I'd like to thank everybody for joining us on the call.
I think we had a great quarter, and I'm sorry that we had to make you wait ten minutes to hear about the good news. Thank you very much.