CoStar Group Inc (CSGP) 2003 Q4 法說會逐字稿

Welcome to CoStar Group's fourth quarter and year end results conference call. Today we have with us Andrew Florance; President and CEO, Frank Carchedi; CFO and Mark Klionsky; SVP of Marketing and Corporate Communications.

All lines have been placed on mute to prevent any back ground noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, press star then the number one on your telephone keypad. Thank you.

I will now turn the call over to Mr. Klionsky.

Thank you. Good morning. I'm Mark Klionsky and I'll like to welcome you to the CoStar Group's year end 2003 conference call.

Before I turn the call over to Andrew Florance, President and CEO of CoStar, let me state that certain portions of this discussion include forward-looking statements, which involve many risks and uncertainties that could cause actual results to differ materially from such statements. Important factors that can cause actual results to differ materially include but are not limited to those stated in CoStar's year end press release and in CoStar's filings with the SEC, including its Form 10 Q for the quarter ended September 30th, 2003 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 obligations to update these 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 to GAAP basis results. Andy?

Thank you, Mark. Welcome everyone to the year end 2003 conference call. We are very pleased to report accelerating revenue growth this quarter. Our revenues for the fourth quarter of 2003 were 25.3 million, an increase of 4.8% over the third quarter of 2003, and a 22% increase year-over-year.

Pro forma earnings tripled to 7.4 million or 44 cents per share for 2003 compared to pro forma earnings of 1.7 million or 11 cents per share in 2002. On a GAAP basis, our performance improved from GAAP basis net loss of 4.8 million or 30 cents per share in 2002 to GAAP basis net income of 100,000 or one penny per share in 2003. Our pro forma numbers represent net income before purchase amortization and cost of revenues and operating expenses. For the year end December 31, 2003, the company had revenues of 95 million.

We ended the year with 97.4 million in cash, cash equivalence and short-term investments. We have no long-term debt. We have an excellent balance sheet and are in an outstanding financial position as we move forward to pursue the growth opportunities that CoStar Group enjoys.

Last quarter and on our recent road show, we shared with you the six core growth drivers the company expects to develop over the next five to ten years. On this conference call I would like to sharpen the pencil and share with you more specifics on which growth drivers we are particularly focused on in the next 18 months and give you some highlights on these efforts. We believe the investments we are currently making will allow us not only to generate 80% pro forma earnings growth this year but will also position us to further accelerate our sequential quarterly revenue growth rates by 50% or more in 2005. After I've highlighted some growth drivers, Frank Carchedi, our CFO will address the fourth quarter and year end results in more detail.

First, I would like to update you on the market conditions we are currently observing and some recent successes CoStar Group has had. Our 4.8% revenue growth from the third quarter of 2003 to the fourth quarter of 2003 is the highest organic quarterly sequential revenue growth rate we have seen since the fourth quarter of 2000. Likewise, our renewal rates are close to the highest levels we have ever seen. The renewal rate for CoStar subscription products increases 2 percentage points from the fourth quarter of 2002 to reach 91% in the fourth quarter of 2003. The renewal rates would be even higher if you looked at pure cancellations and excluded companies that have gone out of business.

We are continuing to see signs of gradual but solid recovery in the commercial real estate markets. After three years of steep declines, most local markets have clearly stabilized and are starting to turn back up. The national vacancy rate for office space had increases for 10 consecutive quarters through mid 2003 and ended the year holding steady at 14.8% in both the third and fourth quarter.

A more meaningful indicator for us is absorption, the change in occupied space over time. We find positive absorption to be a good indicator of the general economic climate as well as overall transaction activity. Between the first quarter of 2001 and the second quarter of 2003, cumulative net absorption totalled a depressing negative 100 million square feet. Net absorption turned positive in the third quarter of 2003 and finished the year at positive 22 million square feet.

There's more positive news to be found in several other market measures. The amount of vacant sublease space in the market declined by about 30 million square feet during 2003 and rental rates took a slight upturn at the end of the year after nine consecutive quarters of declines.

I would like to update you on continuing successes we are having with a new product platform we released in December 2002. This platform continues to be a major factor contributing to our strong performance. We scored a huge technology win in 2003 with a new CoStar Property Professional System. Customers really seem to love the new platform. It's easier to learn, easier to use and provides a clear technology advantage over anything else in the market, including prior versions of our product.

Usage of the new CoStar Property System continues to increase at an amazing rate. The number of average weekly page views in CoStar Property Professional has soared from approximately 3.2 million weekly page views at the end of the third quarter to approximately 4.7 million weekly page views by the first week of January, an increase of 46% in one quarter. These usage statistics confirm our best hopes of adoption of this major new product.

On December 1, we successfully discontinued the desktop applications of CoStar Property and CoStar Tenant. And I'm happy to report the shut down achieved our highest expectations and that it was a complete nonevent. Our investment and customer service and training clearly paid off. Our account executives conducted over 11,000 trainings in 2003, the vast majority of them being one-on-one sessions at the customer's desk. There is no question that this intensive investment in customer service took time away from additional top line revenue growth in the short-term, but we are convinced it was a wise investment. The successful adoption of the new CoStar Property Professional System has already proven valuable both in attracting new business, confounding competitors an increasing renewals.

I would like to mention a recent article in the February 9th issue of the "Wall Street Journal" that cited the information revolution of one of the top ten trends in commercial real estate. CoStar is widely regarded as the industry leader in real estate information. Quoting briefly from the article, "Nowadays there's more information at your fingertips about the industry than ever before. You can find anything and everything from vacancy rates and rents to price comparisons from lease and sales information to market trends, as well as in depth analysis and forecasts." The article went on to credit data availability with helping prevent in the course of the recent downturn a real estate crash, like the painful one experienced in the early 1990s.

Last quarter and on the road show, we shared with our six core growth drivers that we believe could allow us to increase our revenues by orders of magnitude over time. They are, one: Growing our revenues through straightforward sales penetration in our existing markets with our existing products. Two: Cross selling additional existing products to our existing clients. Three: Broad geographical expansion opportunities. Four: Additional new product introductions. Five: Pricing leverage in our model. And finally, six: Additional acquisition opportunities.

I will begin by addressing the first growth driver; sales penetration potential allege. As Frank and I told you last quarter during our recent road show, we believe deeper sales penetration in our existing markets is our number one growth driver. We currently have 3800 brokerage firms as clients, which represents a penetration rate of approximately 9 - 12%. Even in our most penetrated market; Washington D.C., our penetration rate among brokers is only about 25%. With property owners, we're about 2% penetrated nationally and about 16% in Washington.

Our goal is to eventually increase penetration rates among brokerage firms in our existing markets to 50% and the penetration rate among owners to 30%. We're focused on about 100,000 prospects we're already tracking. We successfully demoed only about 58,000 prospects last year and we would like to dramatically increase that number this year. Of course other field sales force conducted the 11,000 trainings last year to facilitate an important conversion and they still produced our highest organic sequential quarterly revenue growth rate in three years.

We've been experimenting with an inside sales team at headquarters, that prospects and demos completely by phone and over the internet. A typical sales person has the capacity to do four times as many demos in a day as a person on our field sales team. We are expanding our inside sales force and are currently on pace to quadruple the number of people we reach in 2004.

We believe that Property Express, the light version of CoStar Property released in November 2003, will be a valuable penetration tool. The two primary reasons people don't buy from us are that they have never tried our product or they have tried it but are price sensitive and don't want to commit to an annual subscription for their entire firm. Property Express gives users the ability to use a credit card to access a scaled down version of our Professional product for 24 hour period without a subscription at the time they need it the most. More importantly, it gives us a project with much less friction in the sales channel. We can create awareness and drive revenues very cost efficiently with direct mail. Our inside sales people can demo it over the phone using WebEx.

We're seeing good traction on Property Express with only a minimal investment to date in marketing. We had approximately 1,500 unique user sessions in the first three months, and that's 1,500 people who otherwise would not have seen our product. At the current pace Express is developing, we believe that it could be become the equivalent of a 13th month of net new revenue. In addition, we believe it would be a valuable feeder for our higher end services. We already had a number of people who have used Property Express and liked it so much that they came back and subscribed to the Professional System.

In 2004, we intend to increase our marketing budget by 40% over 2003 to pursue this business more aggressively. I should note that even in light of this marketing budget increase, we still expect to grow earnings by more than 80% in 2004. We brought in about 1, 275 new customers for our subscription products last year. We believe we will eventually be able to at least triple our customer acquisition counts with Property Express.

We have also developed a subscription version of Express that we expect to release within the next few weeks. The cost advantages of our new technology enable us to offer this scaled down service at a lower entry point that will appeal to smaller brokers and owners. It is this smaller firm size that we have had traditionally our lowest penetration rates in. Our goal is to get these customers into our relative revenue base with Express and ultimately up sell them to the Professional System.

I will briefly address our second largest growth driver; cross selling. We are still seeing about 50% of our new business each month coming from up selling existing customers. Access to national data and access to the full suite of CoStar services; Property, Tenant, COMPS, Exchange and Connect are proven to be very popular cross selling upgrades. We've sold more than 500 suite package upgrades in 2003. And we're looking at different ways to package combinations like Property and Tenant for broker or COMPS and Exchange for appraiser, to increase the overall number of products a customer buys.

For 2004 we intend to move the third driver listed earlier; geographic expansion, to the forefront of our focus. At the high end, our fastest growing client segment is national consumers of data. I'm talking about financial institutions and fund managers whose investment, typically, is not bound by local geography. During the past year we sold national data to approximately 50 new institutional accounts and upsold existing accounts for just under 1 million in annual revenues.

The strength of the analytics and forecasting capabilities in the Property Professional System in combination with the seamless multi market access is very valuable to this client segment. Our customer list now includes large financial players like [Agone], [INAUDIBLE] Investments, CS First Boston, Cohen & Steers, Deutsche Bank,Dreyfus Louis, ING, Friedman, Billings, Ramsey and Prudential Investment Management, to name just a few. We feel it is important to expand our market coverage to bring even greater value to this lucrative customer segment, as well as to our traditional consumers of national data, large brokerage firms and REITs.

In addition, I would argue that our most effective competitors are those who compete in markets where we do not offer any product at all. Where we do offer a product that goes head to head with a competitor; our depth of data, quality imagery, superior service and breadth of product offerings, compete very favorably.

In order no maintain our leading market position, we feel it is important and worthwhile to offer a product in the vast majority of significant U.S. markets. Most of the smallest markets that we currently are in generate very solid earnings and we believe that many of the hundred or so cities in North America and the UK that we do not currently service could contribute meaningfully to our future earnings growth. We have begun aggressive advance work in preparation for our expected expansion in 21 new U.S. market areas in 2004 and 2005.

This is the first major organic geographical expansion CoStar has made in four years. We intend to begin photographing and researching properties in the first of these expansion markets by April 2004 and expect to have research personnel working in all 21 markets by June of 2004. We expect to begin advanced selling in the first of these markets in the fourth quarter of 2004 and we expect to complete and deliver two markets on average each month from late 2004 until late 2005. We believe that we can enter these markets with unprecedented financially efficiency, delivering the highest quality databases yet delivered and there by positioning us to further accelerate our sequential quarterly growth rates in 2005 by as much as 50%. Furthermore, we believe it is possible to achieve internal rates of return from 30 to 70% on our investments in these new markets.

In addition to adding and expect 21 new markets, we intend to expand the geographic boundaries in many of the markets that we currently cover. We believe that some of the markets we cover would be better served if we expanded the list of counties we proactively covered for a given market. We think that in order for our product to be an ideal solution for our clients, it should cover all the properties within a 30 to 60 minute drive time from a majority of client sites in a given market. For example, our Charlotte, North Carolina coverage includes Mecklenburg, Iredell and Union Counties, which in total have, approximately, 275 million square feet of commercial space. At very little cost we intend to add the counties of Gaston, Catawba and York counties, which in total contain 130 million square feet of commercial space. That is almost a 50% increase in the amount of inventory we can offer existing and potential clients in the Charlotte market.

We believe that this expansion will leverage our existing investment in the Charlotte and similar markets and help us win new business. In total, we expect to add approximately 80 new counties to 20 of our existing markets in the 2004-2005 time frame. We expect to commence work on these counties in mid 2004. This effort is in addition to the 21 completely new markets we expect to add.

I'd like it refocus now on those 21 completely new market areas we intend to enter in 2004. We have selected and prioritized these expansion markets from a potential universe of approximately 50 significant North America markets. We made our final selections based upon a client requests, size, proximity to existing infrastructure, competitive considerations, complexity and perceived risks. For competitive reasons we are not going to disclose a complete list of the new markets, but they include cities such as Las Vegas, Minneapolis, Milwaukee, Richmond, Memphis, Nashville and others. Many of these expansion markets are larger than markets we are already operating profitably in today. In total we expect that these markets could add more than 4 billion feet of commercial space to our databases and hundreds of thousands of valuable properties to our active database inventory.

We are very excited about the what the addition of these new marketings will do for our clients and business. We are confident that we can execute this expansion with unprecedented efficiency. CoStar has been repeatedly recognized for the sophisticated technology and processes we use doing the sort of field research required to open new markets. CoStar personnel and contractors have driven millions of miles and photographed hundreds of thousands of buildings over the past decade. Field operations are one of CoStar's core competencies.

In preparation for this significant market expansion, we have revisited every aspect of the technology and process we use to collect comprehensive information on new marketings. As a result, we have dramatically improved the technology and process we will use in the field on this expansion effort.

In the last major expansion four years ago, limitations on digital photography led us to use film in collecting imagery and paper to collect data. Field research managers would Federal Express research assignments the out to personnel out in the field who would then photograph properties on film and collect data on clip boards. The photographers would then express ship the film and notebooks back to our headquarters where personnel would key the data into our system and arrange to have the film developed. Once the film was developed, additional personnel would scan the film into our databases and file the slides away. Other personnel would call in the collected data in an effort to gather additional information. The entire process was necessary, but cumbersome, expensive and inefficient.

Today, we have dramatically streamlined and reduced the cost of this process. Our field researchers receive their assignments electronically and can view them in their vehicles on board routing computers. We have licensed digital content from a number of third party data providers to refine our property targeting and collection process. As our vehicles move from property to property, guided by GPS systems, all the information they collect is collected digitally. Our new vehicles will be equipped with a retractable roof and a 25 foot neumatic mass with a remote controlled, high resolution, wide angle digital camera.

Using this equipment the operator can take the photograph from a superior advantage point and then move it directly into a computer and photo shop right in the vehicle. From there they can enhance the photograph and store it directly in our database without any further human intervention. While at the property the researchers can use a laser to measure the property and store it's location size and shape in an electric map. A process that used to take a minimum of two weeks is completed in 25 minutes.

In our last major expansion we had significant competitive pressures and financing pressures driving us to deliver new markets as quickly as possible. This rush forced us to spend more money and deliver less than optimal quality initial databases. This meant that our researches and headquarters were trying to build databases on new markets before the field researchers had finished photographing half of the new market. This environment required dramatically more research personnel at headquarters and decreased the quality of initial product.

Today we are not experiencing a comparable competitive or financing pressure, so we can allow our field research operations to finish a market before the more expensive headquarters researchers begin their work, which we expect will dramatically reduce the time and effort required to initiate coverage in total. We believe this will result in higher quality initial product delivery at lower costs.

Our last major expansion phase represented at least a tripling of our then coverage in a short period of time. And that put a significant strain on our smaller less experienced research operations. This expansion phase represents less than a 40% increase in property coverage and will be handled by a much larger, 550 strong, much more experienced research team.

In addition, we believe that a major rewrite in integration of our back office data collection systems will be completed by the time our centralized teams go to work on the expansion markets. This means that as the increased workload from the expansion markets phase in, we expect to to somewhat offsetting efficiency gain from our systems improvements.

We believe that the strength of our product offering, brand positioning, infrastructure, sales channels, national client basis, orders of magnitude is greater than what we had when we initiated or last major expansion years ago. We think this superior positioning will allow to us enter these markets at a much lower cost and reach broke even much faster. We used to talk about reaching cash flow positive in a now market within 18 months of delivery. Now we believe that for most of these marketings we can reach break even within a quarter to a product delivery. Many of the planned, expansion markets are readably accessible to our existing 30 field sales offices across the country.

We expect major account sales will be handled by our existing experienced regional sales staff. This coupled with the fact that our products are no longer desk top base and no longer require extensive on site technical support, means we believe we can avoid the significant expense of expanding our network of field offices. In addition, to our direct sales force in the field, our sales efforts in the new markets will be driven by our cost effective outbound sales channel and by direct mail and on demand purchase channels, such as Property Express and COMPS Express.

The fourth core revenue driver I listed earlier is our ability to produce new high margin products. I want to briefly highlight several new products recently released or in development. In our call last quarter I spoke briefly about our plans to enhance the advertising opportunities within our subscription services. Jim Black joined us in the September 2003 to lead our efforts in this area. You may recall Jim is the founder and former CEO of Black Skies, Inc., the nation's largest publisher of office leasing directories. Jim, in fact, invented the office building directory and has over 30 years of experience selling property marketing products.

Until the late 1980s, when electronic data services like CoStar began to emerge, brokers relied on printed office directories like Black Sky to keep track of available space in their market. At one time we published our own office directory called Corner Stone. Today, while these office directories still exist and carry tens of millions of dollars in property based advertising, they no longer serve and meaningful purpose in the leasing and sales process. CoStar is significantly more exposer than the office directory and has become the primary vehicle for marketing buildings and space listings. Our customers perform, approximately, 1.5 million space surveys for our products each quarter.

This week we released a new advertising product that can give property owners a highly targeted and cost effective way to market a space directly to the brokers looking for that type of space. Our advertising model is very similar to the [Google ad] model where ads can be targeted as narrowly or broadly as you like you can buy up greater levels of exposer within the product.

For example, for about $750 a month, an owner with 20,000 square feet of space in Bethesda can target ads so that anytime someone searches for 20,000 square feet in Bethesda, her ad will appear. When our listings appear in a result set, they receive priority positioning and are enhanced to stand out. The owner can then buy exposer in additional sub markets or the entire market area. That way, when a broker searches for 20000 square feet in the Washington central business district or Tyson's Corner, the Bethesda listing may not appear in the search results, but the banner ads for the property and availability would appear and give her a chance to attract brokers in the similar market areas that could have an interest in her space in Bethesda. We believe that with a modest investment in expanding our electronic media sales force we can develop a multi million dollar revenue stream.

In the fourth quarter, we also released the first on-line version of CoStar Professional Directory, a service available exclusively to property professional subscribers. On the surface Profession Directory is a rich electronic Roll 'a' Dex with detailed contact information for over 300,000 commercial real estate professionals. But the real value is that the Professional Directory provides the kind of information only CoStar compiles; done deals, current landlord rep assignment,, sublet, major tenants and owners represented, local and national associate and so on.

We believe CoStar Profession Directory is the only electronic directory where can you review a broker's resume of current assignments and past deals. Brokers can even plug in their biographical information and credentials and upload their photo to create personal profiles. This enables a tenant rep to gauge the experience for broker in another city before handing off a tenant or another to see if the leasing agent he is considering has any assignments that might conflict with his property.

Perhaps most importantly, many of our clients have an important need to maintain accurate mailing lists of other industry professionals that are often direct mail marketing efforts. Often this poses a significant challenge because the brokerage industry is very large and is in a constant state of change. We believe CoStar Professional Directory can meet this need for many of our clients.

We also have two major new products under development. We expect the first one will be ready in about six months and the other is delayed for the fourth quarter. I hope to be able to give you more details on these projects next quarter.

The fifth core revenue driver I mentioned is the potential price leverage in our business. We believe that CoStar Group will experience revenue growth through pricing leverage in 2004. This will occur as we focus on pricing rationalization. In other words, making sure like firms pay like prices.

Now that we have dramatically improved the back end systems we use it manage customer relationships, we have found some broad variances in what similar sized firms pay us for data. In some cases it is a result of an acquisition where the customer was never brought up to market pricing. In other cases it may stem from a special promotion, a pricing mistake or competitive situation . Most of the time it's just that the licensing agreement hasn't kept up with the clients growth.

For instance, a company licensed for three brokers in 2001 may have now grown to six or seven brokers. That firm may be paying us 400 a month under the old agreement, while other six person shops are paying us about 850 for the same service. We don't think it's fair to our customers that identical firms who is compete for the same business gain a competitive advantage in having a lower cost for the same information and product. In the past it was difficult to see inside our customers' shops short of walking in and counting desks. Today we have much greater transparency into our customer base and believe we can price more fairly than before. Some of those who are paying below our minimum prices may see increases in their monthly license fee of approximately 15 - 20%. We believe that these increases will seem small compared to the numerous additional features and benefits we have added to our products in consideration of the outstanding service levels we have been providing.

Again, we believe right pricing is important and we feel comfortable exercising this price rationalization knowing that Property Express is a strong option for anyone who objects to paying higher prices for the Professional System. With the expected release of a subscription offering of CoStar Express, CoStar effectively has a true first class and coach option for our clients for the first time ever. Clients who do not wish to pay a fair price for Property Professional System can opt to continue their same price service with Property Express. Our goal is to protect the low end while bringing up prices for those who are under acceptable or normal minimums.

Finally, I want to very briefly touch on the last revenue growth driver I mentioned, strategic acquisition opportunities. In total, we've acquired 15 companies and we continue to view acquisitions as a significant growth revenue growth driver. While there is nothing imminent on this front we continue to monitor 20 to 30 potential targets. The kinds of companies we are looking at include complimentary information services, commercial real estate software and commercial real estate media. There are a number of local property information service companies that could help us by bringing in new geography. But we have to weigh those opportunities against the 30 - 70% IRRs we think we can get right now on organic expansion of the new cities I've mentioned.

In summary, our management team, the board of directors and the entire team here at CoStar are excited about the six core growth opportunities we are tackling as we head into 2004. We believe that these growth drivers position the company to grow our revenues by orders of magnitude over time and realize very impressive earnings leverage.

At this point, I'd like to turn the call over to Frank Carchedi, CoStar's CFO and he will go into the fourth quarter and year end numbers in more detail with you.

Thank you, Andy. As reported in our press release yesterday and as Andy indicated, the year-over-year progress we have made is substantial, but to save time I'm going to move directly to focus on a discussion of the fourth quarter results as they compare to the third quarter of 2003. The sequential results of Q4 and Q3 of 2003 are important in understanding the company's progress and why we believe we will be able to balance our planned investment in 21 new markets with continued revenue and earnings growth during 2004.

Total revenues grew by 4.8% overall from Q3 to Q4, increasing from 24.1 million to 25.3 million. The growth for the quarter was principally the result of further penetration of our services an our potential customer base across our current platform, a successful cross selling of our services into our existing customer base, a renewal rate of over 90% in Q4, and favorable foreign currency exchange rates. The UK operation contributed approximately 8% of the revenue in Q4 as expected.

Organic growth of approximately 4% was achieved in U.S. subscription based information services, including CoStar Property, Tenant, COMPS, Exchange and Connect. With the addition of the London based Focus Services subscription revenues for the company accounted for 94% of revenues during Q4.

Gross margin increased from 16.5 million in Q3 to 17.5 million in Q4, as margin percentages increased from 68.4% to 69.1%. Cost of sales increased slightly from 7.6 million in Q3 to 7.8 million in Q4.

With regard to operating expenses, overall operating expenses excluding purchasing amortization increased from 14.9 million in Q3 to 15.4 million in Q4. On a more detailed level, marketing expenses increased from 6.7 million in the third quarter of 2003 to 6.9 million in the fourth quarter of 2003. This was due to increased trade show costs and direct mail campaigns as well as additional sales personnel costs in the UK operations.

Software development increased slightly from 1.7 million in the third quarter of 2003 to 1.8 million in the fourth quarter of 2003. Company continues its focus on service enhancements an development as well as the support of internal information systems to manage our growth.

General and administrative expenses increased from 6.5 million in the third quarter of 2003 to 6.8 million in the fourth quarter of 2003. This was due to one-time move costs and higher occupancy expenses related to substantial upgrade of our London office, which we believe is already leading to higher productivity in the UK. Income tax expense of 124,000 related to state taxes and federal alternative minimum taxes was recorded in Q4.

Pro forma earnings per share was 16 cents for the quarter an increase of 3 cents per share from the third quarter of 2003, a continued improvement in pro forma earnings resulted from sequential revenue growth, growth in margin percentages, which over the last year increased approximately 3 percentage points and relatively stable operating expenses. Our earnings before interest taxes, depreciation and amortization improved from 3.7 million in Q3 to 4.2 million in Q4 of 2003. Our GAAP basis net income improved from 281,000 or 2 cents per share for Q3 to 1 million or 6 cents per share for Q4. Reconciliation to GAAP basis results of all nonGAAP financial measures discussed on this call including EBITDA and pro forma earnings is shown in detail in our press release issued yesterday, which is available on our website.

Capital expenditures for Q4 of 3 were approximately 1.2 million as planned, due to the relocation and upgrade of our London office and totalled approximately 3.9 million for the year, as expected.

We closed the quarter with approximately 97.4 million in cash, cash equivalence and short-term investments, an increase of 61.5 million over the third quarter of 2003. This substantial increase resulted from 53.5 million of net proceeds raised in the company's follow on public offering, which closed in November 2003, in addition to growing EBITDA, improved cash collections and 4.6 million of proceeds from stock option exercises of approximately 200,000 shares of common stock during the fourth quarter.

Day sales outstanding in receivables were under 20 days. We continue to believe we have adequate resources to operate under our current business plan, including our expansion plan and that we are in a very strong financial position coming out of the quarter.

Now I'll discuss the outlook for the first quarter and the year 2004. Beginning in 2004, the company plans to further expand its operating regions into 21 new markets throughout the U.S.. The field research phase o this expansion is expected to start in Q2. We generally have not experienced this type of expansion over the last few years and as in our past expansion plans, our cost structure will escalate in advance of revenue in these markets as we invest in future revenue growth opportunities for 2005. This is consistent with our plan to balance earnings growth with continued expansion of the business platform and focus on long-term opportunities.

As we indicated in our press release, we expect quarterly sequential organic growth of approximately 4% for the first quarter of 2004 and organic revenue growth of approximately 16% for the year. In addition, we expect GAAP basis net income of approximately 6 cents per share for the first quarter of 2004 and 35 -37 cents per share for the year. Also we expect pro forma earnings of approximately 16 cents per share for the first quarter of 2004 and 71 - 73 cents per share for the year. This would be a significant increase over last year's 44 cents of pro forma earnings per share.

The estimated per share amounts for 2004 are fully diluted for the shares issued in our recent follow on offering and the estimated diluted effect of outstanding stock options. We estimate 18.6 million in fully diluted weighted average outstanding shares for the first quarter of 2004 and 18.8 million for the year.

We continue to believe that in the longer term higher revenue growth rates are possible. We experienced sequential quarterly revenue growth rates of 5% or more in many of our markets during the fourth quarter while operating in least than favorable economic conditions. Some of those market performances include Washington, Atlanta, Phoenix, Seattle, Miami, Tampa, Cincinnati, Charlotte, Austin and Raleigh, which all grew sequentially between 5 and 11%.

Gross margin percentage is expected to continue to trend upward by approximately 1.5% quarterly, moving forward through 2004 based on assumed revenue growth, combined with a gradual ramp up of direct expenses related to additional vehicle and research operating costs for our expansion plan.

We expect operating expenses including selling and marketing, software development and G&A expenses to increase by approximately 2.5 - 3.5% overall per quarter in 2004. In the first quarter, this is due principally to annual sales training costs and there after to increases in personnel, marketing, outside services and communications, primarily as a result of our expansion. We believe that the underlying cost structure of the existing core business will continue to escalate at approximately 1 - 1.5% sequentially each quarter in 2004 due to normal salary and cost escalations, with the expansion plan generally responsible for a significant portion of the new cost levels.

We expect purchasing amortization in the first quarter to be approximately 1.8 million, consistent with the fourth quarter of 2003 and we expect purchasing amortization to trend downward to 1.6 million per quarter for the remainder of the year. We expect to continue to grow our overall cash, cash equivalence and short-term investments and anticipate approximately 900,000 in investment income in 2004. We expect to continue to have growing taxable income and 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 and state and local tax jurisdictions may not recognize portions of these loss carry forwards. As a result we expect to incur tax expense of approximately 500 to 600,000 in total for 2004.

Finally, we expect capital expenditures for 2004 to include investments in assets required to support our plan market expansion, including 35 additional field research vehicles,substantial building photography, communications equipment, initial databases and measuring, photographic and computer equipment, all totaling approximately 5.5 million. In addition, we expect 3.5 to 4 million of capital expenditures in 2004 to support existing operations, which is consistent with the past several years.

In conclusion, we believe we have and will continue to demonstrate the strength of our business model and our ability to execute our plan. As we have in the past, we believe that during 2004 we will continue to grow earnings and revenue while balancing our investment into new markets. We look forward to reporting our progress to you.

With that I will open the call for questions and answers.

Ladies an gentlemen, at this time if do you have a question, please press star then the number one on your telephone keypad. Star, then the number one.

Your first question comes from John Neff with William Blair.

A couple of questions here for you.

Hi, John.

The 21 new markets in 2004, that's a little more than we expected in the course of one year. I was just wondering if the increased pace of that was reflective of the current lack of, sort of, actionable acquisition targets at this point or would that have been the pace regard - - would that be the pace even if acquisition targets presented themselves?

No, the 21 additional new markets have absolutely nothing to do with any acquisition targets, their presence or lack of presence. We feel as a management team that these markets are very valuable to us right now, present a very high IRR. We actually explored larger numbers of market entries and decided to scale back a little bit, be a bit more conservative. This will occur over the time period 2004-2005.

So it's really based upon our very high levels of optimism about what entering these additional markets will do for our overall business and really balancing it against what we see as probably continuing in similar acquisition opportunity environment that we've had for the last five years. We just want to put our focuses in investing in our core business because we think that's where our highest returns are right now at this very moment. That's sort of an answer that covers a period of a quarter or two of focus.

Right. And I was just wondering the 30 to 70% IRRs, what period of time do those returns apply to and what accounts for that fairly wide range? In other words, what's the 30% IRR market versus a 70% IRR market?

I'll let Frank answer that.

John - -

And if I don't like his answer, I'll jump in.

John, we normally look at three to five year scenarios and keep in mind that there's a build period, so as Andy said, we're going to be building these markets for the next year to 18 months. So we're looking at that kind of time cycle.

The reason for the variation is the markets have all different kinds of dynamics, including their size and also their proximity to currently operating markets. So for example, a certain size market like a medium size market that has close proximity to another major market will obviously move quicker on the sales front and the operating front. Things like the are dynamics that change that IRR. I think 30 to 75% is a good range that we use from time to time. I think there could be cases where the IRR is higher than that. We've had higher IRRs in the past. But I think that's a good general range.

Right. And could you give us a sense of what the current size of the sales force is and what you expect that number to be say in a year from now? And same with the research staffing.

I can answer on the current size of the sales force. We currently have approximately 83 quota carrying executives, including 7 of those in the UK office.

Does that number include the tele sales?

Yes, that number does include tele sales. They are quota carrying and they close business.

Okay.

And we expect to increase that by probably about 20% during the course of this year. On the research front, I believe we have somewhere around 550 researchers today and we anticipate adding about 100 researchers over the course of the year, including those field personnel.

Okay. Great. Thank you.

Your next question comes from Jim Wilson with JMP Securities.

Good morning, Frank and Andy. I guess Andy, could you maybe give your thoughts a little color as you look at competitors out there, and I'll ask in two ways, one: Do you think any of them are getting more or less competitive in any given markets? And two: Sort of wrapping that in it, are they becoming more or less attract to potential acquisition candidates, sort of forgetting price, than you might have thought three or four months ago?

Well, I'm sure they're sitting on the edges of their seat to hear what I'm going to say, but I think there have been some changes out there in the last six months months to a year. I think one of our competitors that operates on more of a marketing method through boards of realtors and as a regional competitor in probably 8 or 9 cities has, we believe, based on with a we can tell, has declined pretty significantly in the last two quarters. They seem to be slipping fairly quickly. That would make them unattractive as an acquisition target, as well as the nature of the contracts that they have got in place would make them unattractive.

We've seen another one of our indirect competitors become a little more attractive as they have a more disciplined financial model and are break even. But I think that a lot of interesting things will play out in our business over the next 18 months as we add these 21 additional markets. We think it will continue to shift the competitive front in our favor. That's fairly veiled there.

But, bottom line is we've seen one of the competitors that relies on broker input, board oriented systems we think decline significantly and the lighter internet national listing system stabilized and actually become a good sort of lighter competitor. We don't perceive we compete directly against that company for information dollars, but we think it makes them probably more attractive target.

Okay. Does that maybe potentially increase the likelihood that if next incremental acquisition may even be in continental Europe as opposed to domestically or should I say even elsewhere outside of the U.S.?

We have a number of very small, you know, sort of footnote acquisitions we are keeping our eye on and are in discussions with. You could see some footnote acquisitions occur in the United Kingdom, and by footnote I mean along the size of our new market systems acquisition in San Francisco or core data in Houston so that sort of single or dual city small acquisitions. We again remain very focused on the opportunity that we have in North America and the United Kingdom. We are going to continue, for the foreseeable future, to go after what we see as just a huge earnings leverage opportunity in North America and the Unit Kingdom and we're going to try to avoid getting distracted outside of of that sphere. We think there's a lot of interesting things to look at, may not be direct competitors that are obvious by we think there are a lot of interesting things to look at in North America.

Okay. Great. And final thing is just you had mentioned your penetration targets for brokerage and property owners. Any thoughts today on the real estate lender market?

That's a very important space for us and one we will pursue aggressively and the fact that we've got tighter and tighter integration between the comparable sale product and the statistical aspects of the leasing product and also a greater national platform, we think will have an even stronger product offering for them. And I think we are less than - - I would be very confident that we're less than 20% penetrated that opportunity. Those are often some higher dollar opportunities for us. We will be very focused on that over the next two years.

Okay. Great. Thanks.

Thank you, Jim.

Your next question comes from Dalton Chandler with Needham & Co..

Good morning.

Hi, Dalton. Perfect pronunciation. Congratulations.

You don't know how long that took. First of all, I was wondering, you talked a little bit about the net absorption for the year but could you just give us if you have the numbers for the third quarter and the fourth quarter?

I don't have that right here but it was - -actually, I do have it. It looks like it was - - I mean, it was basically negative in the first two quarters and then positive in the second and - - I mean, in the third and fourth quarter. So we were up in the 15 million - - approximately 15 million absorption each of the last two quarters. There were a number of very large transactions that occurred in the fourth quarter. They're probably half a dozen transactions in the 500,000 square foot to 800,000 square foot range that occurred. So we're seeing some mega leases occurring in the market which is really driving that positive absorption.

Okay. I guess what I was really wondering was did it accelerate in the fourth quarter? It sounds like you're sg the third and fourth quarter were about the same.

The third and fourth quarter were about the same and I think the truth is that it accelerated and sort of was flat from Q3 to Q4. So I think it's not a straight line sequential acceleration from Q2 to 3 to 4, it's more acceleration from Q1, 2 and 3 and then flat in 4.

Okay. On the market expansion, you talked about the potential for those to accelerate the sequential quarterly growth rate by 50%. Could you just tell us a little bit more about how you arrived at that 50% number, what the underlying assumptions are.

Well, as you know, our sequential quarterly growth rates have been accelerating over the last year or two and that fourth quarter was - - the third and fourth quarter of 2003 were strong numbers for us. And we would like to see that organic sequential quarterly growth rate continue to accelerate as we pursue a number of different initiatives; the advertising product, working the additional sales channels harder, hopefully consuming market improvement and on the pricing leverage opportunity. But when you then look at what impact these 21 additional markets would have on our business as you went to the fourth quarter of 2004, first, second, third of 2005, based on, you know, not assuming anything dramatic happens in the sequential [INAUDIBLE] assuming nothing dramatic happens in the sequential quarterly growth rate in the base moderate model, we just think the nature of what we normally see in opening these new markets would take you up two points or more in the sequential quarterly growth rate numbers.

I guess what I'm asking is, you did mention specially the financial and investor customers being the fastest growth segment. So are you expecting that to accelerate with the addition of these new markets or would it be - -

We are expecting the product offering to be stronger to that group and there by over a longer term period accelerate the revenue growth in that zone, but actually, when we talk about accelerating the revenue growth, in 2005, I'm actually in my mind thinking more about the opportunity to reach just hundreds of brokerage firms that are in these secondary and [INAUDIBLE] markets that are today and actually one or two primary that don't subscribe to our products. When I pick up an association magazine that covers the commercial real estate industry and I take my Post It notes and I mark 50 advertisements from brokerage firms and put a green one on every client and a red one on every nonclient, there are more nonclients, and the number one reason is because they're in these 21 markets that we don't yet cover. So as we get in there and provide a product to them, that's why I'm thinking the 2005 short-term additional revenue growth comes from and that is one of our most basic blocking and tackling sales for CoStar.

Okay. Thanks. That helps. Now, just simplistically, if you're going to grow 16% this year and you think that could accelerate 50% to '05, would that be 24%?

Mathematically that's right. Was that a math test? Andy pointed to me only because I'm sitting here with a calculator. Realistically, when you think about the market roll out, you're looking at 12 months or so of a building phase so you're looking at market releases that start, perhaps, in Q1 of '05, so I'm reluctant to concede on your math problem there.

Well, actually - -

If you assume the 16% holds constant, which you get as a ramp up effect on sequential growth from the roll out out of those markets through the year.

Since it's on a quarterly basis, you actually get it a geometric growth rate and it comes out to more than 24%, but I was trying to cut you some slack. All right.

I thought you said you were trying to keep it simple.

Either way. All right. Thanks, guys.

Thanks.

Ladies and gentlemen, we are reached the time for the allotted time for questions and answers. I will now turn the call back to Andy.

I would like to thank you all for joining us for the year end 2003 conference call. We look forward to speaking with you at the first quarter 2004 conference call or sooner. Thank you very much for joining us.

This concludes today's CoStar Group's fourth quarter and year end results conference call. You may now disconnect.