CoStar Group Inc (CSGP) 2004 Q3 法說會逐字稿

Welcome to CoStar Group's Third Quarter 2004 Earnings Conference Call. Today we have with us Andrew Florance, President and CEO, Frank Carchedi, CFO, and Mark Kliosnky, SVP. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press star then the number two on your telephone keypad. I will now turn the call over to Mr. Klionsky.

Good morning. I'm Mark Klionsky, SVP of Investor Relations. I'd like to welcome you to CoStar Group's Third Quarter of 2004 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 can 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 third quarter press release and in CoStar's filings with the SEC, including it's form 10Q for the quarter ended June 30, 2004, under the heading Risk Factors.

All forward-looking statements are based on information available to Co-Star on the date of this call, and CoStar assumes no obligation 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 based results. Andy.

Thank you Mark. Welcome everyone to this Third Quarter 2004 Conference Call. We are very pleased to report another quarter of strong revenue earnings growth. Our revenues for the third quarter of 2004 were $28.6m, an increase of 4.2% over the second quarter of 2004, and an 18.7% increase year over year.

Net income for the third quarter increased to $2.4m or $0.13 per share, compared to net income of $281,000 or $0.02 per share in the third quarter of 2003. We ended the third quarter with $113.3m in cash/cash equivalents in short term investments, for a net increase of $6m over June 30, 2004. We have no material debt.

We believe we are very well positioned strategically, operationally and financially to pursue aggressive geographic and market share expansion in the United States and the United Kingdom. Frank Carchedi our CFO will address the third quarter results in more detail later in the call.

First I'd like to share with you some of the interesting things going on in our business and update you on the substantial progress we are making in our new market openings. We are seeing favorable signs in our business environment. The office market posted its best performance in four years in the second quarter of 2004, and that extremely positive trend continued into the third quarter. Net absorption increased to 30 million square feet in the third quarter, up 20% over the approximately 25 million square feet absorbed in the second quarter. We have not seen back-to-back quarters of that magnitude since the first two quarters of 2000.

The national vacancy rate for office space continued to decline, down another 3/10ths of a point to 14.1%. For the second quarter in a row the office market posted a decrease in the amount of direct vacant space. At this vacancy level we believe that renter stable transactions are plentiful but owners still need to market their space.

This improvement is widespread. 70% of the markets we're tracking improved in the third quarter and 85% had positive absorption. The industrial markets were strong as well. Net absorption of industrial space totaled 43 million square feet in the third quarter of 2004, topping absorption in the previous quarter by approximately 54%. At 10.4% the vacancy rate for industrial space is just a point or two above historical averages.

I'd like to take a moment to comment on a very positive trend we're seeing in the sales force retention. Historically the company has faced challenges in retaining quality sales professionals, who often working alone and are scattered far and wide across the United States. Sales turnover leaves potentially productive sales territories void, increases recruiting and training costs, and compromises customer relationships, and reduces the average experience level of our sales force. Improving sales force retention could have a significant positive impact on revenue growth and customer loyalty.

One of our top priorities this year has been to improve sales force retention. Historically our commission plan has been very focused in rewarding net new sales and territory. Our commission plans did not reward the account executive for increased tenure. To address this problem we have redesigned our commission plan, adding a significant component to reward existing subscription renewals. This new plan should increase and reward a salesperson as they add tenure and build a bigger book of renewing business. This ensures that as an account executive's customer relationships become more valuable to CoStar Group, that account executive will be rewarded accordingly.

This new comp plan effectively increased our sales compensation expense, but we believe that the added expense will be offset in the intermediate term by a reduction in recruiting and training expenses, higher renewal rates driven by greater customer loyalty, and higher net new sales driven by filled territories and more experienced sales people.

Earlier this year we commissioned an extensive independent review of our sales force, and based upon that study we have implemented or eliminated numerous policies to address some very specific feedback we received from both current and former account executives. For example, we reduced or eliminated most of the administrative burdens that were taking time away from selling and training activities, and we gave our sales managers and AE's more authority in the field.

Through newsletters and a new highly effective videoconference network, we have dramatically increased communications with our sales force in the field. Since putting these initiatives in place I'm happy to the say turnover in our sales force has dramatically declined. Year to date we have reduced our sales turnover by 44%. Our third quarter turnover rate dropped to a low of 4%.

I also want to take a moment to update you on the emerging strength of our centralized inside sales model. Most of our existing markets were open before we released our web-based products. Our prior desktop products required face-to-face demonstrations to sell and site visits to install. In addition, when we originally opened most of our markets our brand name was young and not yet established and we needed a strong local market presence to sell.

That dynamic has changed. Today all of our major products are Internet based and can be sold and serviced over the phone and Internet. While we believe that the direct field sales force model is critical for maintaining strong relationships with top clients, the centralized inside sales model is increasingly a very viable, low cost model for reaching broader mass audiences for our products.

Our lower-end priced competitors have proven that there are tens of thousands of smaller shops that have a need for marketing or information services in commercial real estate. We believe that a centralized outbound sales force is an important tool to cost effectively reach that mass audience.

The inside sales group we created earlier this year has had consistent success selling a full range of CoStar services from our call center in Bethesda. Typically, we are recruiting these inside sales people from the pool of hundreds of researchers in our large research centers, and these are people that are very familiar with our products and our data. This opportunity presents an exciting promotion path for our many researchers.

Though the group is new, small and represents only 5% of our salaries in the sales department, they are currently contributing approximately 10% of our gross new monthly revenue. The average deal size is relatively small, about $4800 annually, but the cost associated with that sale are dramatically lower than the traditional sale by one of our field AE's.

The inside sales team gives us tremendous flexibility and reach in penetrating these new markets, as well as more deeply penetrate our existing markets. We intend to very dramatically increase the size of this important group over the course of the next 12 months.

Improving market conditions, the strength of our product offerings, and our strong brand identity contribute to a favorable selling environment in the quarter. The CoStar Property platform has tremendous momentum in the market. It's strength is evident in our increasing sales to new customers, rising renewal rates, continued success up selling to existing customers. Overall we continue to receive very positive customer feedback on the strength, easy to use, and reliability of our product platform.

We signed over 300 new customers in our existing market in the third quarter of 2004. These new customers contribute to approximately half of our revenue growth and upsells to existing customers contribute to the rest. Of these new customers subscribing to one of our property products, almost 20% of the deals are subscriptions to Property Express, the live version of CoStar Property we introduced earlier this year. Property Express has proven to be very effective introducing smaller, more price sensitive customers to CoStar's services.

We hope in the future many of the customers subscribing to Express will choose to upgrade to our full professional system. I want to stress that we do not believe that we've seen any evidence that the Property Express is cannibalizing in any way our existing Property professional clients. Most of Property professional clients are higher end brokerage firms, who very much need the added features and capabilities of a higher end system.

As I noted in last quarter's conference call, in late summer we began to see a very favorable shift in the competitive landscape in San Diego and Atlanta, two of our most competitive markets. In San Diego, a number of the leading brokerage firms began contacting us and asking for proposals for very long-term license agreements. These firms had been customers of [Excellogent], a price competitor with a local MLS type business model. San Diego was this competitor's flagship market and some of these firms served as references and had possibly invested in [Excellogent] as they expanded into other markets.

When we spoke last quarter we had signed four of the leading brokerage firms in San Diego with terms ranging up to five years. Shortly after that call we signed additional significant players in the market. Most importantly including Burnham Real Estate Services. Burnham is one of the largest and oldest brokerage firms in San Diego. We are thrilled to, once again, count Burnham as a customer and to have this prestigious firm in our reference list for San Diego. A vast majority of significant firms in San Diego are now subscribing to CoStar Group.

Cleveland, another highly competitive Excellogent market, has decidedly shifted in our favor as well. In the third quarter CoStar signed license agreements with Grubb & Ellis, [Aniel] and Argos & Associates and Chartwell Group. Earlier this year in Cleveland we signed new agreements with [CRESTCo] International and Colliers International, another of Cleveland's leading players. CB Richard Ellis had been a CoStar customer all along for five years. We believe all these firms had been customers of Excellogent. With these latest signings all five of the top firms in Cleveland have chosen CoStar to provide their mission-critical market information. We hope to achieve similar wins in other competitive markets as well.

I have good news to report on the major client front as well. In October we signed Studley, a leading national commercial real estate firm specializing in tenant representation, to a five-year multi-market deal. Studley first began subscribing to multi-market CoStar services in New York City in 1995. This current renewal is their third successive multi-year multi-market license agreement with CoStar, and represents one of the largest contract commitments we have ever received. This new agreement increases the number markets and services that Studley subscribes to and provides options for Dudley to add additional markets with our mutual expansion market to come online. In addition, we recently signed a multi-year multi-market agreement with Advantis GVA, a leading brokerage firm throughout the southeast, which is affiliated with the Saint Joe companies. This renewal binds the existing separate agreements for 11 Advantis GVA offices in Atlanta, Florida, North Carolina, Washington D.C., and added three offices in Richmond and Hampton Roads, where CoStar expects to soon be offering service.

One of our primary reasons for launching the 21-market expansion earlier this year, was our belief that we could provide more value to growing regional and national customers by increasing our market coverage. We believe Advantis GVA's willingness to commit to CoStar months before we're ready to begin delivering a service is a very good indication that they agree with us.

We are making very solid progress in our goal of expanding the 21 new U.S. markets. I want to reiterate several points on this market expansion. First, we believe that as we add these new markets we are not only going to gain the opportunity to sell products to the companies operating in the new markets, but we believe we will also strengthen our ability to sell multi-market product coverage to customers in our existing markets. We believe that some of the markets we're expanding into are as large as or larger than some of the markets we are already operating very profitably in.

Year to date we have invested approximately $4m in capital expenditures to purchase equipment and technology to support our data collection photography efforts in these new markets. We designed, purchased and deployed a new fleet of 32 field research vehicles. We've hired, trained and deployed approximately 65 new field researchers into our 21 expansion cities, taking our total field research operations to about 160 personnel in the field.

The CoStar team as been hard at work this year. This year our U.S. expansion fields teams have photographed, mapped and measured and gathered data on more than 70,000 new properties, totally over 1.7 billion square feet of commercial space. We are rapidly approaching the halfway mark in completing the total number of properties we estimate that are in these markets. I think the last time I updated you we were at about 20% complete. So you can see we are rapidly gaining momentum in the field.

In May we acquired TeerMark, a company that was providing commercial real estate information services in two of our targeted expansion cities, Nashville and Memphis. We believed correctly that through the acquisition we could accelerate our delivery of product in those two markets. Since acquiring TeerMark we have already photographed 6,900 buildings in these two cities and have added close to 90 million square feet, compared to what TeerMark was tracking in these markets in their database.

In addition, we found an astounding, close to 1,000 active listings that were not available in the TeerMark system. Last month we discontinued the TeerMark platform, and now have approximately 50 customer sites in these markets using CoStar Services. We have recently held grand opening events in Nashville and Memphis to introduce our services and the people there seem to be very excited about our being there. Our data and our software represent a major upgrade over the commercial real estate information services previously available to the participants in those markets.

With the acquisition of TeerMark, Memphis and Nashville were the first of our 21 expansion markets to come online. We expect other markets to begin delivering as early as December of this year. We expect that we will be completing the time consuming field research phase of expansion markets on a rolling schedule, with one or two markets delivering each month throughout 2005.

As a market nears field research completion, we expect to have an advance team go into the market for pre-sell activities to the influential brokerage firms in each market. When the field research phase of a market is complete, we anticipate that our research teams in Bethesda and San Diego will need about a month or two to begin calling on the properties in the market to updated the listings, load floor plans and building notes.

I've been spending a lot of time visiting with prospective customers and a number of the expansion markets, and the reception we are getting is very encouraging. Our products seem to exceed their broadest expectations of what a company can do with commercial real estate information systems. The real estate firms in these cities view CoStar as an economic catalyst that will make their local opportunities more visible to all of the important national and international lenders and investors, and will help them bring more value to their relationships with clients as they grow outside their market.

Our pre-sales activities in a number of expansion markets have yielded very promising results. In Richmond we'll be opening with support of at least five of the city's top real estate brokerage firms. In addition to our Advantis contract, our Washington D.C. account executives already assigned multi-year license agreements with Thalhimer, a member of the Cushman and Wakefield Alliance and the largest in Richmond, Grubb and Ellis, Harrison and Bates, the market's second largest brokerage firm, Commonwealth Commercial Partners and Porter Realty. Avantis and Thalhimer also have signed subscription agreements for the Hampton Roads, Virginia locations.

When we open in San Antonio earlier next year, we'll be launching service with the support of the leading brokerage firms in that market as well. During July and August, our Austin based account executives signed multi-year license agreements with Trammel Crow, Transwestern Property Services, [NIA Rhodes], [Hunters and Segal], Cross and Company, Travis Commercial and others. We are currently initiating efforts in Iowa and several other markets.

We hope to be in a position to disclose additional successful pre-selling activity from several of these markets in the next conference call. In total we expect to deliver at least five new markets by the end of the first quarter of 2005. While we will not realize revenue from these customers until we deliver our service in these markets, we believe we can open some of these new markets with enough monthly revenue from pre-sales to cover the monthly baseline operating costs of these markets. Perhaps more importantly, we think that this initial success confirms our belief that we can successfully drive sales without having a physical office presence in a market.

Before I turn the call over to Frank, I'd like to share with you some promising news from our London operation. This summer we released Focus Agency, an upgrade to our core product in the U.K. This upgrade has been very well-received by U.K. brokerage customers. Focus Agency utilizes CoStar's sophisticated map searching and display software and incorporates over 25,000 high-resolution photographs taken, using CoStar's experience with high grade building photography.

With the help from these upgrades we've signed 67 customer firms in the third quarter in the U.K. We believe this demonstrates that CoStar's leadership in developing software for commercial real estate professionals can be leveraged in other countries to create exciting growth opportunities.

Additionally, in October, Focus carried out a major upgrade of its existing product in Manchester. Outside of London, Manchester represents the second largest market in England and Wales. Over 140 senior brokers and commercial real estate professionals attended the Manchester rollout presentation at the Radisson Edwardian Hotel. Focus managing directors, Jonathan [Brigg], Jeremy [Carr] Smith, Matthew Hopkinson, then presented individually to more than 40 companies during the week, and hosted a less formal meeting for 200 Manchester professionals at the end of the week. I imagine that was at a pub.

These efforts in Manchester, coupled with our recent acquisition of the Scottish property network, show the U.K. marketplace our serious commitment to creating the first U.K. wide professional commercial real estate information system. I understand that we expect to sign approximately half a dozen firms this month from these efforts in Manchester. For further strength in our U.K. product offerings we intend to offer essentially our CoStar Property professional product in Scotland possibly as early as the second quarter of 2005.

Returning to the U.S., our software development group has been hard at work on a number of exciting software initiatives. The teams are working late evenings typically. They're the first people I see in the morning and the last people I see at night here at CoStar. I hope to be able to share the results of their efforts in one of our upcoming conference calls with you.

At this point I'll turn the call over to Frank Carchedi, CoStar's CFO.

Thank you Andy. As reported in our press release yesterday and as Andy indicated, the year-over-year financial progress we have made is substantial. I'm going to move directly to a discussion of the third quarter results as they compare to the second quarter of 2004.

The sequential results of Q3 and Q2 of 2004, are important in understanding the company's progress and why we believe we will be able to continue to balance our investment in 21 new markets, with continued revenue and earnings growth during 2004.

Total revenues grew sequentially by 4.2% overall from Q2 to Q3, increasing from $27.5m to $28.6m. The growth of the third quarter was principally the result of further penetration and successful cross-selling of products, combined with a renewal rate of approximately 90% for the quarter.

Organic growth was approximately 3.6%. Subscription revenues for the company continue to account for approximately 94% of revenues during Q3. Our U.K. operations contributed approximately 80% of the revenue in Q3 as expected. First margin increased by $800,000 from $18.6m in Q2, to $19.4 in Q3 on a $1.1m increase in revenues. Increased cost of revenues from Q2 to Q3 of approximately $350,000 was related to the expansion into the new markets, and the additional of a Scottish property network cost structure. The increase in expansion related costs results principally from the full affect of staffing the field research efforts in the new markets, as well as substantial travel, training, depreciation and other operating costs. All of this is occurring as expected in advance of product release and there are no current revenues recognized in association with these costs.

Margin percentages increased slightly from 67.8% in Q2 to 67.9% in Q3. This was not the increase I expected but it was held down somewhat by aggressive field research efforts both in the U.S. and more recently in the U.K. Without the charges for expansion markets, which I estimate at approximately $800,000 to $900,000 in Q3, margins in the core business would be over 70%. With some individual markets continuing to experience margins in the 75% to 80% range.

With regard to operating expenses, overall operating expenses, excluding purchased amortization, increased slightly from $16.2m in Q2 to $16.4m in Q3. These costs on a whole were lower than expected. We continue to control and leverage our overhead, even with the market expansion.

On a more detailed level, selling and marketing expenses increased from $6.9m in the second quarter of 2004, to $7.5m in third quarter of 2004. This increase resulted principally from increases in sales commissions implemented in Q3, coupled with marketing and pre-selling efforts in expansion markets.

Software development and general and administrative expenses both decreased slightly from the second quarter of 2004, to the third quarter of 2004. And no additional income tax expense was recorded in Q3 due to increased deductions for stock options exercised and lower than anticipated state taxes and federal alternative minimum taxes.

Income tax benefit of $100,000 resulted from the deferred income tax as we recorded related to the U.K. acquisitions. We expect that this benefit will continue to be recorded in each quarter and is excluded from the calculation of pro-forma earnings.

Pro-forma earnings per share, which is based on our net income before purchased amortization, and the related income tax benefit, $0.21 for the third quarter, an increase of $0.03 per share from the second quarter of 2004. The company continues to experience growth in current earnings, while also investing in future growth. Our earnings before interest, taxes, depreciation and amortization improved from $4.6m in Q2 of 2004, to $5.1m in Q3 of 2004. Our GAAP basis net income improved from $1.7m or $0.09 per share in Q2, to $2.4m or $0.13 per share in Q3 of 2004. Reconciliation of GAAP basis results of all non-GAAP financial measures discussed on this call, including EBITDA and pro-forma earnings shown in detail on our press release issued yesterday, which is available on our website.

In addition, as reported in our press release yesterday, the company announced that due to substantial year-over-year earnings growth, the impact of purchase amortization on net income has diminished. Therefore, beginning in the first quarter of 2005, the company expects to no longer report pro-forma earnings. The company expects to continue to report EBITDA and to reconcile EBITDA to net income in 2005.

Capital expenditures for Q3 of 2004 were approximately $1m, of which $400,000 was related to field research, and the remaining $600,000 from the support of our existing platform. We closed the quarter with approximately $113.3m in cash, cash equivalents, and short-term investments, an increase of $6m over the second quarter of 2004. Cash generated was principally from growing EBITDA results, with an additional $1.5m generated through proceeds from stock option exercises, or approximately 66,000 shares during the third quarter.

Now I'll discuss the outlook for the fourth quarter and 2004 annual results. We have discussed for the last couple of quarters, and as Andy has just described, during the third quarter we experienced the full impact of the field research phase of our planned 21-market expansion. We generally have not experienced this type of expansion over the last few years. And as in our past expansion plans, we expect our cost structure to continue to escalate in advance of revenue in these markets, as we invest in future growth opportunities for 2005 and beyond. This is consistent with our plan to balance earnings growth with continued expansion of a business platform focused on long-term opportunities. As we indicated in our press release, we expect quarterly sequential organic revenue growth of 3.5% to 4% for the fourth quarter. Also, we expect pro-forma earnings of approximately $0.22 per share for the fourth quarter. We now expect approximately $0.78 of pro-forma earnings per share for the year, which is up from our original expectations. In addition, we expect diluted net income per share of approximately $0.14 for the fourth quarter. And we now expect approximately $0.44 of diluted net income per share for the year.

Gross margin is expected to continue to increase by up to 1% from Q3 of 2004, to Q4 of 2004, based our assumed Q4 revenue growth in existing markets- I'm sorry, based on our assumed Q4 revenue growth in existing markets, outpacing additional research operation expense levels in new markets during Q4.

We expect operating expenses, including selling and marketing, software development and G&A expenses, to increase by approximately 4% overall in Q4 of 2004, as we expect to move more directly into the selling and marketing phase of planned new market expansion. We believe that these increases include escalation in the underlying cost structure of the existing core business of approximately 1%, due to normal salary and cost escalations.

We expect purchase amortization in the fourth quarter to continue at approximately $1.7m. We also do not expect to incur significant tax expense in Q4. We expect to have an income tax benefit of approximately $120,000 relating to deferred income taxes from our U.K. acquisitions.

Finally, we expect capital expenditures in Q4 of 2004 to continue to include investments and assets required to support our planned market expansion, including additional field research equipment, building photography, communications equipment, initial databases and measuring, photographic and computer equipment, totaling approximately $1m to $1.5m for the quarter. In addition, we expect approximately $500,000 to $1m of capital expenditures in Q4 of 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 we will continue to grow earnings and revenue, while balancing our investment into new markets and prepare for expected future growth during 2005. We look forward to reporting our progress to you. And with that I'll open the call for questions and answers.

[operator instructions] Your first question comes from Dalton Chandler with Needham & Company.

Good morning.

Good morning Dalton.

I understand you have the expenses from the new market roll out in cost of goods. But I thought that last quarter you said you were expecting a sequential improvement in the margin and it really didn't happen. Were you surprised by expenses or what happened there?

Well, as I said, we didn't get the margin. Margins increased slightly but we did not get the 1% margin increase that I expected. Keep in mind that 1% margin improvement is in a couple $100,000 range and a significant number. So, yes, we did not get that improvement because of continued aggressive expansion, and as Andy said, we've gone out and we've captured 70,000 buildings. So the field research operation continues to work very aggressively. And additionally, as I mentioned, the U.K. as well is experiencing market expansion. So we did not get what I expected but I do expect margins to continue to improve over time.

Okay, and sort of along the same lines, how do you account for the sales and marketing expense associated with pre-selling in markets where you're not generating revenue yet? Is that also depressing the operating margin?

Yeah, if you're looking at the operating margin. Any sales and marketing expenses that are coming through associated with new markets, whether it's marketing events or whether it's operating expense or sales activity. All of that is being expense. So if you go below the margin line and look at operating expenses, there are operating expenses as well related to new markets that are not, you know, for which no revenue is reflected.

Okay. When do you expect to start paying taxes again or to start showing taxes on your GAAP income statement?

The presentation of tax effected numbers is dependent on a very judgmental accounting issue, which I think we've talked about in the past, which is the recognition of the significant operating loss carry forward as an asset on our balance sheet. That decision has not been made yet. So from an accounting presentation standpoint we'll have to update you on that next quarter. In terms of the actual cash payment for taxes, I think it's safe to say we are years away from actually having any significant in cash tax payments based on NOL that we have.

Okay. All right, thanks very much.

Thank you, Dalton.

Your next question comes from Brandt Sakakeeny with Deutsche Bank.

Thanks. Good morning Andy and Frank. Frank do you happen to have the dollars in revenues that came about from the Scottish property network acquisition as well as the TeerMark acquisition in the quarter?

The Scottish property, just rough numbers, Scottish property is running about $60,000 a month. And TeerMark acquisition had a baseline of perhaps $25,000 or $30,000 a month.

Okay, so relatively minor.

Relatively minor. We did have some, probably the biggest impact for this quarter was the SPN and it was relatively minor.

Okay, great. I guess the next question is just on the head of sales, any uptake there on your progress? It sounds like you've been making some changes to the sales force compensation. Do you expect more when you settle on someone or have you already settled on someone?

We hope to have signed a report very shortly on that but it's to early to disclose anything. But it's been a very productive process and very successful. We've met a lot of very good candidates so we're picking from a very good pool. We're aligning the talents of these different people with where we think our sales force is going over the next couple years. So I hope to be able to announce something shortly.

Right, thank you very much.

Your next question comes from Jim Wilson with JNP Securities.

Good morning Jim.

Oh, sorry, just a couple questions. I guess Frank on the guidance for Q4 with the renewal rate and obviously the success you've had in new signups as well as taking business away. How come that sequential revenue growth guidance of at least as good as you just experienced in Q3?

There's a couple things Jim, as I mentioned, as you look at Q3, I mentioned that the organic revenue growth was about 3.6% there about, so that may help you a little bit. The other issue is in Q4 and considering the expansion plan being-- I'm staying on the conservative side here for guidance in Q4 and there's a couple reasons. One, sales energy is being used in new markets, again, for which there will be little to no revenue actually recognized in Q4. So we are using some sales energy in that effort. Then additionally, as we head into Q4 we do hit the holiday season and typically slower selling months, as well as typically a small loss in non-subscription revenue. In other words, the ad hoc revenue, like ad hoc comps purchases, just simply because of the loss of business days. Hopefully that helps you.

Yeah, okay. Is there, I guess at this point, any markets where somebody like [Excellegent] actually has equal or kind of more presence than you do? I'm not thinking of any but maybe there's something out there?

Des Moines, Iowa.

Des Moines, Iowa. Okay, I hadn't thought of that one. But no major city?

Milwaukee, they operate in Milwaukee and I'm uncertain if any other cities. Difficult to tell if they're really there, or talking about going there. But Milwaukee would be a major one and Minneapolis as well. So those line our future and we look forward to them.

Got it, okay. Then I guess Frank, as far as '05, the whole combination of when you make your guidance will be after with the Q4 release as far EPS tax rates and the whole works. And as well as even just some thoughts on revenue growth.

Yeah, I mean, we'll have to update you on that. I wanted to let everybody know about the change in presentation. The tax affected issue, obviously at some point if we continue on this business plan that tax NOL will get recognized and we will be tax-affecting numbers. So obviously the conservative answer is to tax affect the numbers.

But I would presume it would look more like kind of an AMT without, but not a full tax rate?

No, I mean, at the point that we recognize that NOL, what happens in the accounting is that we actually will have a normalized tax affect on the pre-tax earnings number. Obviously that will not change or affect operating cash flow. But we would, at the point we make that accounting decision, we would be tax affecting the numbers.

If you look out into '05 the only other issue that I'll remind you of and what we've talked in the past, and I think everybody is well aware of it, is the stock option expensing issue. The FASB came out this week and updated everybody in terms of they're providing for a slight delay in that, which would require stock option expensing by Q3 of next year. And obviously they're providing for early adoption that kind of thing. So we've talked about that before and we'll have to update you on that as we head into '05.

Okay, so you haven't decided whether you would start recording that in Q1 or not?

I have not decided if would early adopt. But, again, and the numbers news in terms of outstanding options and, well, actual valuation, but, again, if you're on the conservative side, and if you assume option expensing, you could look at our pro-forma disclosures and footnotes that we made and give you a sense of the order of magnitude for that expense item.

Okay, just one final thing. Anything new on sort of sales success in non-brokerage verticals, Andy, rgional state owners, commercial lenders, anything new to add there?

Only that the trend we've been seeing that-- that segment represents less than 10% of our existing revenues. But it is approximately 30% of our monthly ongoing sales. So it remains a very strong component of our revenue growth and it's going very well. An exciting segment for us and we'll be releasing, hopefully we'll be releasing software upgrades in 2005 that appeal to that market even more than the current product offerings.

Got it. Okay, great. Thanks.

Thank you.

Your next question comes from John Neff with William Blair.

Hey guys.

Hey John.

Just a couple of quick questions here, just housekeeping. Could you give a little bit more of a description as to what is engendering the income tax benefit with the Scottish properties acquisition?

Yeah, John, it's kind of a technical accounting area. What's happened is when you do the purchase accounting for those acquisitions we're setting up deferred taxes on the balance sheet and you'll see that if you look at a balance sheet, of $3m to $4m. It's an accounting process where we're accounting for the non-deductible values of the intangible assets in those acquisitions.

Again, it has to with- it theoretically has to do with getting proper tax affected rates as you move forward, if you had a normal tax situation; obviously we don't. So that benefit is coming through on it's own, not blended together in a tax provision. So it's basically the unraveling of that deferred tax amount in connection with both write-offs of non-deductible intangibles from the U.K. and the benefit results from that.

I'm sorry, I was just writing as fast as I could. You mentioned what the CAPEX number was in the third quarter and also what you expected it to be in the fourth quarter. Could you repeat those?

The third quarter was approximately $1m and it breaks down between $400,000 on the expansion side, field research equipment, that kind of stuff, and $600,000 on just the normal headquarters and existing platform. For the fourth quarter the field research, the expansion side, I've pegged it $1m to $1.5m. And, again, it's field research equipment, communications, photographic equipment, et cetera, so $1m to $1.5m there, and another $500,000 to $1m, again, on the normal headquarters and operating platform. So $1.5 to $2.5m.

Okay, great. Thank you.

Thank you.

At this time there are no further questions. Are there any closing remarks?

I'd just like to thank everyone for joining us on this conference call and we look forward to reporting positive news in the next quarter. Thank you very much.

This concludes today's CoStar Conference Call. You may now disconnect.