CoStar Group Inc (CSGP) 2003 Q3 法說會逐字稿

Welcome to CoStar Group's third-quarter 2003 earnings conference call. Today we have with us Andrew Florance, President and CEO, Frank Carchedi, Chief Financial Officer, and Mark Klionsky, Senior Vice President of Marketing and Corporate Communications. All lines have been placed on mute to prevent any background noise. After these speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) Thank you. I will now turn the call over to Mr. Klionsky.

Thank you. Good morning, I'm Mark Klionsky, Senior Vice President of Investor Relations. I would like to welcome you to CoStar Group's third-quarter 2003 conference call. Before I turn the call over to Andrew Florance, President and CEO of CoStar, let me state the certain portions of this discussion include forward-looking statements which involve many risks and uncertainties that can cause the 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 third-quarter press release and in CoStar's filings with the SEC, including its form 10-Q for the quarter ended June 30th 2003, under the heading risk factors. All forward-looking statements are based on information available to CoStar at the date of this call and CoStar assumes no obligation to update the statements. In addition, please visit our website at www.CoStar.com/corporate/investor for a webcast of this conference call and for the reconciliation of all non-GAAP financial measures discussed on this call -- the GAAP basis results. Andy?

Thank you Mark. Welcome to this third-quarter 2003 conference call. We are again very pleased to report continued strong earnings growth, accelerating revenue growth and overall GAAP profitability. Our EBITDA increased by 140 percent year-over-year from $1.6 million in the third quarter of 2002 to $3.7 million in the second quarter of this year. Our net sales have now increased month after month for four consecutive months, contributing to a clear acceleration of revenue growth rates. Revenues increased sequentially by 4 percent for the third quarter of 2003 over the second quarter 2003. That was an increase of 45 percent over the 2.75 percent sequential quoted growth rate we reported in the last earnings call. We had a strong quarter. Frank Carchedi, our Chief Financial Officer, will address the third-quarter financials in more detail later in the call.

If there's a theme running through our business right now, its momentum. And we're seeing it in almost all aspects of our business. Market conditions are improving, usage of our products is soaring, our monthly net sales are increasing and our revenue and earnings growth rates are clearly accelerating. For the first time in nearly three years, we are beginning to see solid signs of recovery in the commercial real estate markets. The national vacancy rate for office space dipped slightly to 14.8 percent in the third quarter. All of the change was just 1/10th of a point in the previous quarter. It was the first downward move after rising for twelve straight quarters.

If you have been following our calls for some time, you have heard me talk a lot about absorption as a key indicator of overall market conditions, as well as our clientele. Absorption represents the change in occupied space over time or the net of companies expanding or contracting. And with the exception of the occasional blips, absorption of office has been decidedly negative since the first quarter of 2001. In fact, dating back to the first quarter of 2001, cumulative net absorption has been -100 million square feet. You can imagine that figure is roughly the equivalent of all the tenants in a city of the size of Pittsburgh vacating their space all at once. Net absorption of office space totaled 14 million square feet in the third quarter of 2003, and is now positive 9 million square feet year-to-date.

There's even more positive news to be found in the sublease vacancy statistics -- as much of the surplus space being marketed by corporate America either has burned off, been leased or taken off the market. The amount of available sublease space -- once as high as 148 million square feet or roughly the equivalent of all the office space in Denver -- has now declined for six consecutive quarters and is now at its lowest level since the second quarter of 2001. Along with the positive absorption trend, deliveries of new office space declined to 13 million square feet in the third quarter -- the lowest amount since CoStar began tracking national statistics. And the amount of office space under construction dropped to 66 million square feet -- also the lowest it has been since we began keeping track.

While it will take some time for supply and demand balances to stabilize, these trends bode well for commercial real estate service providers that depend on leasing and sales commissions as their primary revenue source. With the industry rebounding, we find ourselves well-positioned for growth. The new product platform we introduced in December 2002, has been extremely well-received by our customers. It has been a deciding factor in winning new business from reluctant purchasers such as Cars International, in Seattle and Cleveland, as well as important renewal agreements from major players like Henry S. Miller and the Bradford Companies in Texas.

The power of CoStar's new platform came across loud and clear in a series of focus groups conducted on our behalf by Market Connections, an independent market research firm. Sixteen focus groups were held in eight cities across the country during August and September and included approximately 150 commercial real estate professionals -- both heavy CoStar users and people using competitive services. An overwhelming majority of participants rated CoStar as vastly superior to anything else on the market and almost unanimously named CoStar as their go-to source -- the first place they turn to for commercial real estate information. In addition, they raved about many of the features in the new system. They described things like the ability to search on a map or an aerial -- breakthrough features that are only available on our new Web-based platform -- as features they can't live without. The new Property 8.0 platform is also driving additional sales to existing customers. Our average customer buys just one and a half out of the five to six potential services we could offer them in a given market. So we see a lot of up-sell potential there. Deep integration of comparable sales and tenant data within the new system makes CoStar Property 8.0 an excellent showcase for CoStar COMPS and CoStar Tenant. As a result, we have had good success in our initial efforts to upgrade heavy users to a full suite of CoStar services -- CoStar Property, Tenant, COMPS, Exchange, and Connect. In addition, we find that many firms that principally operate in one or two markets would gladly pay a reasonable premium for access to national data. As a result, the average value of new contracts and our existing contracts is increasing.

As I have mentioned on previous calls, our entire organization -- our sales force in particular -- has been focused on driving higher usage of all of our products and CoStar Property 8.0, in particular. Our sales force has done a tremendous job maintaining strong net sales while serving as a front-line in this massive usage drive effort. During the first nine months of 2003, our account executives conducted over 8,000 training sessions -- many of these one-on-one sessions going desk to desk at customer sites driving usage. We believe this significant effort and accomplishment represents a positive shift in our sales forces' culture toward a more intensely customer-oriented focus. We believe this product -- productive new culture will solidify our customer relationships, win new customers, and drive long-term earnings' growth and shareholder value.

A proof point of this came during the recent focus groups when customers talked about proactive customer service as a major, positive differentiator for CoStar Group over competitive services. Our customers know our account executives are compensated based upon their customers' usage. They understand that the interests of the AE -- or our account executives -- servicing their account are aligned with theirs and they love it. I know I have shared this with you before but it bears repeating. With the desktop version of CoStar Property, it was difficult for us to analyze who was using the product and how often they used it. With the new Web-based system, we can precisely track successful usage and can proactively direct additional training to those who are not logging on with regularity. This proactive customer service manifests itself in higher usage rates for our product and deeper penetration of the potential users within our customer sites. In addition, and very importantly, we have seen a clear decline in cancellations in 2003, and we expect this trend to continue. Reversals in September 2003 were at their lowest point since November of 2000. Usage of the new CoStar Property System continues to increase at an amazing rate. Just ten months into the roll-out, 97 percent of our customer sites have accessed the new system. Usage of CoStar Property 8.0 has soared from approximately 2.5 million weekly page views at the end of the second quarter to approximately 3.2 million page -- weekly pages views at the end of the third quarter. These usage statistics confirm our best hopes for the smooth and successful deployment and adoption of this major new product. In fact, earlier this month, we informed our customers that we intend to discontinue the desktop application -- the older versions of CoStar Property and CoStar Tenant in the next quarter.

Just as the enhanced features in CoStar Property 8.0 augment our offering to new customer segments, we believe the technology advantages of our new product platform have the potential to open up great new avenues for growth for CoStar within our core customer segments. In the fourth quarter, we've planned to launch the first such product. For a fee, CoStar Property Express will provide commercial real estate professionals with access to a light version of CoStar Property for a 24-hour period without requiring the normal one-year subscription. We believe this exciting new product will appeal to a broad base of current customers -- CoStar users who need access to high-quality commercial real estate data outside of their home market, as well as to those who have an occasional need for our information.

While those property products draw on the same database and image library, the differences between the two services are significant. Property Profession -- Property Professional has all of the tools a power user would need -- advanced search capabilities, ownership information, historical data, analytics, forecasting, and integration with our other subscription services. Property Express is primarily a tool to identify leasing and sale opportunities. The cost advantages of our new technology enable us to offer the scaled-down service in an affordable, consumption-based price to small brokers, owners, and corporate users who don't need the full Professional system. Our similar COMPS Express or on-demand service continues to generate revenue increases year-over-year and has proven a valuable incubator for subscription sales. We currently generate in excess of $3 million in COMPS Express sales. CoStar Property -- the Professional System -- generates about twice as much subscription revenue as our COMPS Professional System and the usage of the Property product is three times as high as the usage of the COMPS System. Based on our experience selling COMPS-on-Demand Service, we believe Property Express will become a significant revenue driver and potential penetration tool.

In addition to moving from the desktop to the Web, we have dramatically enhanced the advertising opportunities within our subscription service and have hired Jim Black to lead our efforts in this area. If Jim's name is familiar to you, it's because he is the founder and former CEO of Black's Guide Inc., the nation's largest publisher of office-leasing directories. The Washington Post referred to Black's Guide as the Bible to the industry. Jim invented the office-building directory and has over thirty years of experience selling property-marketing products. Jim will be responsible for leading and expanding CoStar's electronic media sales force, as well as developing new products and tools to help owners and brokers market their properties more efficiently. Until the late 1980s, when electronic data services like CoStar began to emerge, brokers relied on biannual, printed, office directories like Black's Guide to keep track of available space in their market. At one time, we published our own office -- Washington D.C. office directory called Cornerstone. Today, while these office directories still exist and carry millions of dollars in property-based advertising, they no longer serve a purpose in the leasing and sales process. CoStar has significantly more exposure than the office directories and has become the primary vehicle for marketing buildings and space listings.

We have offered advertising within the desktop versions of CoStar Property and the new Web products since 1995. And at one point, we generated approximately $2 million in annual revenue from ad sales. In 1999, when vacancy rates dropped to a twenty-year low across the country and as we reached the end of the product life cycle of Desktop Property, we encountered a difficult market in which to sell advertising space. In late 1999, early 2000, with vacancy rates in the very low single digits, if an owner had a 25,000 square foot vacancy -- chances were it was the only 25,000 square-foot vacancy in the submarket -- there would be a line to lease that space. So there was no need for the owner to advertise it. Today, an owner with 25,000 square feet of space available is probably competing with 10 to 20 similar spaces in their market. We can give that owner a cost effective way to market that space directly to the brokers looking for that type of space. We can target as locally and nationally, and are developing the ability to match ads to very specific search criteria. We were also doing some exciting things creatively -- essentially serving as the creative team to assist our customers in electronic media.

In July and August, Equity Office was one of a dozen advertisers in our site. They ran a national ad on the CoStar web site offering an incentive for brokers who lease one of the hundreds of small spaces that Equity has available across its portfolio. And we linked the ads to our database to show real-time inventory of those small spaces. That ad was viewed more than 2.4 million times during its eight-week run -- which we believe is about 75 times the exposure of the real estate industry's most widely-read trade magazines. We currently have two account executives dedicated exclusively to electronic media. Sales year-to-date are well ahead of planned and the margins are high. We believe that with a modest investment in expanding our electronic media sales force in select cities, we can develop a multimillion dollar revenue stream.

Our Focus brand in the UK is enjoying strong momentum as well. Jonathan Bray, the Managing Director of our London operation, recently recruited five new people for Focus -- his business development team. Together, they bring over 23 years of online, property information sales experience. Most importantly, they represent the very best sales and account management specialists in the UK property information sector. Three of the five were previously strong performers with our main competitor in the UK. These new hires will add experience and depth to what was already a strong sales and customer service organization. In Stanley, we recently completed our first international sale -- a license agreement to provide property data on New York, Los Angeles, Boston and London to 19 professionals at Investment Bank Bear Stearns in New York and London. The deal was negotiated on both sides of the Atlantic by Jeremy Carr-Smith from our London team and Devin Pauley (ph) on our New York team. We believe that there are many more large opportunities like this and potentially thousands of smaller ones that will be enabled and facilitated by a single, common, international information platform.

I want to take a moment to comment on half a dozen significant growth drivers that may be possible for CoStar to drive over the next five years. Our highest priority is sales penetration to new accounts in our existing markets. We believe it is possible to increase our brokerage and owner client base by over 400 percent in our existing markets. Today, of all the active brokerage firms we tracked in our existing markets, 9 percent subscribe to one of our products. In more established markets like Washington D.C. that we have been in for more than a decade, 25 percent of the active brokerage firms subscribe to one of our products -- almost three times as many people -- almost three times the penetration rate. We continue to consistently add new brokerage firms to our client base in Washington. And we believe we can reach penetration levels of over 35 percent over time in the broker segment. Reaching that penetration level on a national basis would add over 14,000 new brokerage clients. On a national level, 2 percent of the active office industrial owners subscribe to one of our services. In sharp contrast, in Washington D.C. -- again a more established markets -- 16 percent of the active owners we tracked subscribe to one of our products and 40 percent subscribe where they own at least 250,000 square feet of rental building area in that market. That suggests a potential eight-fold increase in ownership clients on a national basis.

In addition to focusing on reaching new accounts, we are pursuing growth through suite sales of our various products. We have had good success lately selling a package of five of our services in one suite at a discount price over purchasing each service separately. We're also upselling a number of our clients from local-only data to national data. Over the five-year horizon, we believe that within North America and the United Kingdom, there are close to 50 additional markets we can profitably enter at a relatively much lower cost than we have historically experienced with new market entries. The lower cost base is being based upon our strengthening brand-name, our established national customer base and a lower cost of selling and distributing our new Internet products.

The Company continues to track close to two dozen potential acquisition targets throughout the U.S., Canada and the UK. This year we deployed a very powerful customer relationship management system that gives us excellent visibility into our customers' usage activity and their pricing. This system is revealing a number of cases of significant underpricing -- which when corrected over time, we believe will drive revenue growth. Again, we're very pleased to report continuing-strong earnings growth, accelerating revenue growth this quarter, and overall GAAP profitability. At this point, I would like to turn call over to Frank Carchedi, CoStar Group's Chief Financial Officer, to discuss the numbers for the third quarter in detail.

Thank you, Andy. As reported in our press release yesterday, revenues increased 20.1 percent from $20.1 million in the third quarter of 2002 to $24.1 million for the third quarter of 2003, due to the addition of our London operations earlier in 2003 and consistent, continued organic growth of the core business. Gross margin has improved from $13.1 million in the third quarter of 2002 to $16.5 million in the third quarter of 2003. And margin percentages have improved to 65.2 percent to 68.4 percent over the same period.

Pro-forma earnings -- which is our net loss before purchase amortization -- improved significantly from $418,000 or 3 cents per share in the third quarter of 2002 to $2.1 million or 13 cents per share in the third quarter of 2003. Meanwhile, as Andy mentioned, we reached an important financial milestone in the third quarter of 2003. Our GAAP basis results improved from a net loss of $1.1 million or 7 cents per share for the third quarter of 2002 to GAAP basis net income of $281,000 or 2 cents per share in the third quarter of 2003. The year-over-year progress we have made is substantial but I'm going to focus on a discussion of the third-quarter 2003 results as they compare to the second quarter of 2003.

Sequential results of Q3 and Q2 of 2003 are important in understanding the Company's progress and why we believe we're positioned for continued revenue and earnings growth. Total revenue grew sequentially by 4 percent overall from Q2 to Q3 -- increasing from $23.2 million to $24.1 million. The growth for the quarter was principally the result of further penetration of our subscription-based information services in our potential customer base across our national platform, the successful cross-selling of services into our existing customer base and improved renewal rates during the quarter. The UK operation contributed approximately 8 percent of the revenue in Q3, as expected. Organic growth was achieved in U.S. subscription-based information services, including CoStar Property, Tenant, COMPS, Exchange, and Connect, of 3.8 percent in Q3, versus 2.4 percent in Q2. With the addition of the London-based Focus services, subscription revenues for the Company account for approximately 94 percent of revenues during Q3.

Gross margin increased from $15.5 million in Q2 to $16.5 million in Q3 -- as margin percentages increased nearly 2 percent -- from 66.7 percent to 68.4 percent. Cost of sales decreased slightly from $7.7 million in Q2 to $7.6 million in Q3. With regard to operating expenses, overall operating expenses -- excluding purchase amortization -- increased slightly from $14.8 million in Q2 to $14.9 million in Q3. On a more detailed level, selling and marketing expenses increased from $6.4 million in the second quarter of 2003 to $6.7 million in the third quarter of 2003. This was due to increased marketing expenditures related to the Sweepstakes Campaign, as well as direct mailing campaigns. Software development remained constant at $1.7 million in the second quarter of 2003 to the third quarter of 2003. General and administrative expenses decreased from $6.7 million in the second quarter of 2003 to $6.5 million in the third quarter of 2003. This is due to reduced headcount and wage expense during the quarter in our U.S. operations. Income tax expense of $158,000 -- related to state taxes and federal alternative minimum taxes -- was recorded in Q3. Pro forma earnings per share was 13 cents for the quarter -- an increase of 4 cents per share from the second quarter of 2003. The continued improvement in pro forma earnings results from sequential revenue growth, growth in gross margin percentages -- which increased nearly 2 percent in a single quarter -- and relatively stable operating expenses. Our earnings before interest, taxes, depreciation and amortization improved from $2.9 million in Q2 to $3.7 million in Q3 of 2003. Our GAAP basis results improved from a net loss of $367,000 or 2 cents per share for Q2 to GAAP basis net income of $281,000 or 2 cents per share in Q3. Reconciliation to GAAP basis results of all non-GAAP financial measures discussed on this call, including EBITDA and pro forma earnings, is shown in detail on our press release issued yesterday, which is available our website.

Capital expenditures for Q3 of 2003 were approximately $1.5 million, as planned -- somewhat higher than usual due to the office relocation and equipment upgrade for the London office. Days sales outstanding and receivables were under 20 days. We closed the third quarter of 2003 with approximately $35.9 million in cash, cash equivalents and short-term investments -- a $4.3 million increase over the second quarter of 2003. Our favorable operating results, combined with strong collections and receivables, leave us in a very strong financial position coming out of this quarter.

Now I will discuss the outlook for the fourth quarter and the year 2003. For the fourth quarter, as we indicated in our press release, we expect quarterly sequential revenue growth of approximately 3.5-4 percent and GAAP basis net income of approximately 4 cents per share -- which would put us at nearly break even on GAAP basis earnings per share for the year. In addition, for the fourth quarter, we expect pro forma earnings of approximately 15 cents per share -- which would allow us to reach approximately 44 cents of pro forma earnings per share for 2003. This would be a significant increase from last year's 11 cents of pro forma earnings per share. The per share amounts from Q4 and 2003 are fully diluted for the effect of outstanding options and also assume the issuance of 1.25 million shares of common stock during the fourth quarter of 2003 from our public offering.

We continue to believe that in the longer term, higher revenue growth rates are possible. We're are seeing sequential quarterly growth rates of 5 percent or more in many of our markets during the quarter -- while operating in adverse economic conditions. Some of those market performances include San Francisco, Houston, Denver, Portland, Raleigh, Philadelphia, Indianapolis, and Kansas City -- which all grew between 5 and 12 percent. Gross margin percentage is expected to increase by approximately another 1 percent in Q4, based on assumed revenue growth and a relatively fixed-cost structure. Operating expenses -- including selling and marketing software development and G&A -- are expected to increase by approximately 1-2 percent overall in the fourth quarter, primarily due to salary and cost escalations and increased marketing initiatives. Purchase amortization of $700,000 included in cost of sales and $1.2 million in operating expenses, is expected to remain consistent during the next quarter.

Due to our progress on earnings, we expect to continue to have growing taxable income. Although our net-operating-loss carry-forwards are substantial, we may be subject to some limitations on their use. In addition, we may be subject to alternative minimum taxes in state and local tax jurisdictions that may not recognize portions of these loss carry-forwards. As a result, we incurred $158,000 of income tax expenses in Q3 and expect to incur approximately $160,000 in Q4 of 2003.

As reported in our press release last night, in connection with CoStar's planned public offering of 1,250,000 shares of common stock, the company's registration statement on form S3 filed on July 2nd, 2003, as amended, was selected for review by the Securities and Exchange Commission. The review did not result in any changes to CoStar's previously-reported financial results. CoStar filed Amendment Number Three to its registration statement last week, and expects to begin its road show later this week. In response to comments received from the SEC, CoStar will file an amended annual report on form 10-K for the year ended December 31, 2002 and an amended quarterly report on form 10-Q for the quarter ended June 30, 2003, to conform the disclosure on certain items in these reports to the disclosure in the registration statement. Certain areas affected are disclosures surrounding pro forma earnings in the company's MD&A and the acceleration of amortization expense for the customer-based asset of our London acquisition -- which does not materially affect reported 2003 results or future expenses for amortization.

In conclusion, we believe we have and will continue to demonstrate the strength of our business model and our ability to execute our plan. We believe we are well-positioned to continue to achieve revenue and earnings growth moving forward -- much as we have in a difficult business environment throughout the past two years. We look forward to reporting our progress to you. And with that, I will open the call for questions and answers.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster. Dalton Chandler, Needham & Company.

Congratulations on another good quarter. I wanted to ask you, first, about the margins. There was such a dramatic improvement. And based on your comments in giving guidance for the next quarter, I am assuming there is really nothing unusual in that. It was all just pure leverage?

Yes, Dalton. Obviously, the revenues are up and that contributed to margins. And on the cost side, you know generally the cost structure is stable. As I usually mention in my guidance or as I described, there are salary escalations and other cost escalations -- they don't necessarily occur 1 percent every quarter. They can tend to increase or even decrease from time to time. So, generally, we think the cost of sales line will increase due to salary escalations and other cost escalations. But it so happened in the third quarter that that cost was very stable, so we have a lot of leverage on margins in that particular quarter.

Okay. You did mention that there are as many as 50 new markets that look attractive to you. Would you -- how do you intend to approach that? And could that potentially have a negative impact on margins in some future quarters?

Dalton, there are approximately 50 markets. They include some large-scale markets such as a Toronto or a Minneapolis, and they include smaller markets such as a Hartford, Connecticut or a Richmond, Norfolk. In general, they are largely smaller markets like Richmond, Norfolk -- and the Hampton Roads area. We have seen that our smallest markets have good revenues and very strong margins, so we believe that that carries down to an awful lot of additional markets across the United States that at some point over the next five years, are attractive to us. Now, I do not believe -- you know, we are in a very different situations than we were in 1999 - 2000, when we expand our number of markets dramatically. Then, you know we had a much smaller footprint, a smaller brand-name, a desktop technology that was more expensive to deploy, a very small field sales organization. And so it was a dramatic investment compared to our established revenue base.

Now, as we go forward to look at -- you know, in the future when we look at markets like a Richmond, Norfolk, Hampton Roads, sort of thing, we would not anticipate opening an office in that market because the new desktop platform, we're having good success selling them -- I mean, the new Web platform -- we're having good success selling through tele-sales. We can tap the major accounts from our Washington-based sales force. We no longer maintain large field-support organizations just for installation and technical purposes. We actually train from a centralized call center. All in all, we think that these sorts of changes dramatically decrease the cost of opening new geography -- taking it from what historically might have been two years of negative cash flow down to two quarters of negative cash flow and at a small fraction of the historical negative cash flow. So, all told over the next five years, we do not -- we expect -- we are in control of that level of investment. And we're actually pretty excited about the IRR -- that, you know, the kind of returns we're seeing on these small market entries. And you know, where we bring in additional (indiscernible) try to establish market or the whole Portland experience, where we recently entered. So we would like to tap those over time but we don't see it significantly eroding our margins.

Okay. Thanks very much. I will let somebody else go.

Jim Wilson, JMP Securities.

Good morning, guys. Just one question. Andy, you laid out very nicely the -- your percentage caps, if you will, of the brokerage firm market and of the ownership market so far. Can you give any similar thoughts or describe opportunities and where you see it currently with commercial-lending space -- tools they would be interested in -- and sort of where you stand and where you see the potential for that area of potential customer base?

Certainly. The numbers we are able to give you on the brokerage and ownership side of business are actually fairly precise -- as precise those things can get. As you know, we are tracking that brokerage and ownership data as part of our product so we have good visibility there. We don't have that same universal coverage of the lending community, but my feeling is, is that while we are see while we're seeing overall national penetration rates in brokerage and ownership, ranging from 2-9 percent, the penetration rates in our potential lender markets is in that range and to the lower side of that range -- probably in the 2-5 percent range. And that's a relatively new market for us in the growth cycle. So we can only really address that market effectively, I feel, in the last year or so as we came up with a national integrative platform for all of our products -- as opposed to the local markets. So, I think, we have equally-promising growth prospects in that zone over the next five years.

Okay. Thanks. That's all I have.

William Drewry, Credit Suisse First Boston.

Hi. Thanks. Two questions. First off, just on the smaller-market expansion -- so, Andy, basically are you saying that over a period of time -- maybe three years when you can get it to a new smaller-markets and established level, that you can have the same sort of margin -- that you could have in a top-30, top-40 kind of market?

Actually, our feeling is that we can have actually achieve as good or better margins in these smaller markets. And, obviously, the numbers are not as big as the bigger markets. But they are actually not linear-related to the size of the markets. So we're seeing some small markets -- you know, our very smallest markets, population centers of a million people or less -- that's doing some of our best margins and approaching a half -- 3/4 of a million to $1 million of revenue. And with the established brand-name -- the established national consumer base for our data -- we think we can actually get to those margins reasonably quickly. The other thing to look at, Will, is that the -- not only as we enter a Richmond or a Hampton Roads or Norfolk, not only are we reaching that market, we're also strengthening our product offering to lenders to the CMBS investors and to the overall national market. And we're even reaching -- doing a better job of reaching deeper penetration to brokers and owners in Washington D.C. who do occasionally have a need for that data and will buy it one off. So we think overall it has a very positive margin effect throughout the system.

Are there generally less dollars though available -- revenue dollars available in like a Norfolk than there would be in, say, a Dallas?

Absolutely. Probably -- it's only a guess but I would say probably 1/4 to 1/5th of that number in that zone -- you know, 1/3rd to a 1/5th.

So is the margin leverage then on the -- you know, just on the cost structure now versus where you were three or four years ago or is it also just the cost structure that you can operate in a market like Norfolk versus the cost structure it takes to operate in Dallas?

The cost structure of operating in a market like Norfolk and also the taking advantage of the fact that we have an operating platform 90 miles to the north.

Got it. I just have one other question. I don't think you have given anything in the way of real guidance for '04 yet. But just wondering -- looking sequentially beyond Q4 into Q1 and Q2, do you think that sequential revenue increase of three - four, I think it was, that you're looking for Q4 -- that kind of number or even better into a strengthening -- you know, just general marketing dynamic -- is achievable into Q1, Q2, first half of next year?

Well, you're right -- we haven't given anything on '04. But clearly, Q3 represented a pretty significant acceleration over Q2. We have always stated that we believe throughout this difficult economic period we have always stated that we believe that growth rates could inherently be higher so we're optimistic that we're reaching higher levels now. And, of course, we're optimistic that we can improve on those levels going forward.

Okay. Great. Thanks a lot. Great quarter.

Jennifer Foster, Chilten Investment.

Hi, guys, I just wanted to ask about the advertising revenue that you spoke of. I think you said it could be a multimillion-dollar revenue contributor at some point. Is there a chance you could give us a timeframe of your expectations there?

It has been a multimillion-dollar revenue contributor in the past. We scaled it way back. I think those sorts of numbers are achievable inside of a two-year timeframe.

Okay. Great. Thank you.

Tom Farron (ph), Cove Partners.

Hi, guys. I just wanted to try to get some insight on current pricing trends.

In general, we -- as we've mentioned in the past, we have increase the -- we have created an installation fee for new customers which effectively is a minor one-time increase. And we also -- with the new customer relationship management system -- we've got better pricing controls and less discounting. So the average new contract coming in is actually entering at a higher number, as well as people are buying larger blocks. So in all indicators the -- there is some pricing leverage in the business and we are -- it's an upward trend.

Okay. And what are you guys seeing for renewal rates? That was roughly 90 percent in the past and 87 percent in '02.

It is -- has been -- in the last quarter approaching that 90 percent number. And it has been a -- renewal rates have been increasing as a general trend during the year. It obviously goes up and down one month to the next. But a clear trend towards higher renewal rates. And, again, last month was a -- was one of our lowest cancellation or one of our highest renewal rates months we've seen in -- since 2000. And the revenue obviously is at a much higher base. So that was a dramatic -- you know, was a number we double-checked to make sure it was right.

Do you guys want to put a number on that?

No. For competitive reasons we do not really talk about that.

Okay. Thanks.

Hirsch Barber (ph), Compass Point.

Hey, there. Do you all breakout the organic growth rate versus acquired revenue such as property intelligence? Thanks.

Yes. Yes, we do. We have reported that in the past. I did not mention that. But the property intelligence when it came on board in the first quarter of this year, contributed approximately $1.5 million per quarter basically. Something along those lines in terms of the inorganic run rate that they brought into the business.

Alright. Would you just remind me again when that acquisition -- when do you lap (ph) that?

It actually closed the first week of January for 2003, so we have a full calendar year going here.

Okay. Thank you.

Thank you.

Steve Lapper (ph), Darby Partners.

Hi, guys. I'm just trying to understand something that intuitively doesn't work for me -- which is if you're so highly penetrated at the top players and you're going to expand your penetration level -- which would be all well and good -- and you're minimally if not transactionally based a little bit, where does the rebound that you're looking at and so prominently forecasting help CoStar? Your rebound in the commercial market.

Well, one of the great misnomers in the commercial real estate industry is when you ask a practitioner how many firms they believe there are in a market. They generally dramatically underestimate the number of brokerage firms active in the market. And they dramatically underestimate the number of practitioners. So despite the fact that CoStar has successfully sold to a number of the very visible players in the industry, the typical market -- the top 10 visible names are only one one-hundredth of the actual firms in the market. As the market improves, generally brokerages become more optimistic and are a little more confident in their future and the direction where things are going and more likely to adopt a new technology or invest in their future with our products. In addition, we are -- with the Property Express product, we're taking some of those mid- or smaller-size firms that may have historically been reluctant in uncertain market conditions to invest in a one-year committed contract -- a pretty significant number -- and sell them more consumption-based pricing. So it's more -- (multiple speakers)

Do you think, though -- is there a chance that that would then find it -- migrate its way to the larger firms? The consumption-based contract? Why would they renew if they knew that was available on the market?

Well, for a couple reasons. One, there is a dramatic -- the bigger firms tend to really demand and need things like analytic capabilities, exporting capabilities, integrated data in the COMPS and Tenant and the like. Often the very smallest firms and mid-size firms just want to know where the availabilities are and what the listings are. The major firms could not function off of our Property Express System. In addition, the pricing is such that if -- you know, it's cheaper to buy it in a case than buy it individually. We have very good visibility into what a large firm would pay if they switched from the subscription base to the time-billing method and it would send their rates up dramatically. Once again, unlikely they would want to do it. And actually what we've seen is -- with the COMPS Express or COMPS-on-Demand product over the last, I guess, four years now, we've been able to maintain a very good balance between the two and we constantly farm out the leads of who is buying too much on the On-demand or the Express System to our salespeople. And they go approach those people and convert them to subscription-based services.

Okay. Thank you.

Hirsch Barber, Compass Point.

Yes. I just wanted asked a little about use proceeds for this deal coming up. You currently have -- what about $35 million cash here -- cash-flow positive and planning on this deal raising about 45 more. Is this kind of just get it while the getting is good? Is there anything that you all have stated that you'll be using this additional cash for? Thanks.

Well, we had a lot of growth drivers in the business. So what we stated the use is for the whole range of growth drivers in the scale of opportunity we are addressing over the next five years. We -- in addition one of the things I have mentioned as a growth driver is we are tracking probably two dozen companies that are potential acquisition targets. The Company, historically, has done approximately 14 acquisitions, all of which we believe have been very successful. And we want to have cash balances such that we have some flexibility in future acquisitions to blend equity and cash as need be in key strategic acquisitions. And we have always pursued accretive acquisitions in the past. We do not at this point have any specific or firm acquisition target in the very short-term in mind. Does that answer it to some degree?

Your next question comes from Michael Grossman, Essex Investment Management.

Hi, Frank and Andy. My apologies if these questions have already been answered. I just jumped on in the Q&A. The first one is the percent of sales that have come from new clients per quarter versus ancillary sales. And the second question is, the rate of conversion to the Web for your clients -- has this met or exceeded expectations or missed expectations in the quarter?

Michael, let me comment on the make-up of the new clients. Roughly half of the new business -- or the revenue growth -- results from new clients and generally the other half results from principally cross-selling into those clients, as well as some price increases -- although that's a much smaller part of the total revenue growth for a quarter. Hopefully, that's what you are looking for.

Yes. I was wondering if that mix is changed. I believe that last quarter you said that ancillary sales accounted for 60 percent of new revenues.

My feeling is that that trend -- that trend on the ancillary sales is probably continuing but I think we're actually moving -- we're probably transitioning into a little bit more new client acquisition as well because I think the word is out that the Property product is pretty successful -- the new product. And on that question -- adoption of transition to the Property 8.0 from the old desktop system -- that has exceeded our expectations. We used -- you know, we monitor what percentage of the customer base is active at any given time in a given platform. We're already exceeding what we think was the old usage level of the product before we completely converted everyone over. I think we're at 97 percent of customer base -- accessing the new -- having accessed the new Web system. And the usage trends are basically showing strong growth in usage of the new Web product such that we're at the point that we are down to the only people who are using the desktop product are people have been just too busy to attend a training session or just old habits die hard. But even those people, as we talk to them -- a lot of them are expressing that, yes, they know the Web product is dramatically better and that when we turn off the desktop product, they will start learning the new system. So, it has exceeded expectations and we are really quite happy with it. Actually, our sales force has done a tremendous job with that and are really quite pleased with that.

Okay. And lastly, I was little surprised that you increased your revenue growth expectations but held the earnings constant given the incredible leverage in your business model. So, are you using the additional cash -- you know, reinvesting in SG&A and marketing or -- why is the discrepancy there?

I guess the easy answer, Michael, is that there is some -- there actually is some dilution in the fourth quarter as a result of the offering that is in process. So that is affecting -- if you're looking at the third quarter's pro forma earnings versus the fourth-quarter guidance -- (multiple speakers)

Okay, and that's all in the dilution of the share count?

There is some minimal dilution which probably accounts for the difference you're looking for. Again, we do think that it's highly-leveraged, and we think that the operating expenses are very stable. But obviously as you saw this quarter, there is just varying ranges of stability. I mean they were extremely stable in this quarter. And that's good news. We are working hard to do that. So we will hope for the best.

Okay. Thank you very much.

Tom Farron, Cove Partners.

I have a different question. What do you guys have for a year-over-year and sequential net headcount change?

The headcount has been fairly stable year-over-year, except for the addition of the London acquisition which added approximately 60 to 65 people. So generally pretty stable, and if you look at the cost structure -- if you track the cost structure quarter-by-quarter for the last four or five quarters, and you figure in the London cost structure -- which steps it up in Q1 of '03 -- I think you'll find a lot of stability there in that cost structure. That is largely evident of the headcount being pretty stable.

Okay.

At this time, there are no further questions. Do you have any closing remarks?

We would just like to thank everyone for joining us on this third-quarter conference call. And we look forward to speaking to you for the year-end conference call. Thank you very much.

Thank you.

Thank you for attending today's conference. You may now disconnect.