CoStar Group Inc (CSGP) 2004 Q4 法說會逐字稿

Good morning. My name is Michelle and I will be your conference facilitator. At this time, I would like to welcome everyone to the CoStar Group's fourth-quarter and year-end earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you. Mr. Klionsky, you may begin your conference.

Good morning. I'm Mark Klionsky, Senior Vice President of Investor Relations. I would like to welcome you to CoStar Group's fourth-quarter and year-end 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 fourth-quarter and year-end press release and in CoStar's filing with the SEC, including its form 10-Q for the quarter ended September 30, 2004, under the heading Risk Factors. All forward-looking statements are based on information available to CoStar on the date of this call and CoStar assumes no obligation to update these statements. In addition, please visit our web site 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 this fourth-quarter and year-end 2004 conference call.

We're very pleased to report another quarter of strong revenue and earnings growth. Our revenues for the fourth quarter of 2004 were 29.7 million, an increase of 4 percent over the third quarter of 2004 and a 17.7 percent increase year-over-year. Our revenues for the year were 112.1 million, an increase of 17.9 percent over revenues of 95.1 million in 2003. CoStar's EBITDA -- earnings before interest, taxes, depreciation, amortization -- increased 50 percent to 19.8 million in 2004 compared to EBITDA of 13.2 million in 2003. For the quarter ended December 31, 2004, net income increased to 19.4 million, or $1.03 per share, compared to net income of 1 million, or 6 cents per share, for the fourth quarter of 2003. Net income for 2004 increased to 25 million, or $1.33 per share, versus net income of 100,000, or 1 penny per share in 2003. Net income in the fourth quarter of 2004 included a onetime income tax credit of approximately 16.1 million which Frank will discuss in more detail.

We grew our cash balances by 19.6 million in 2004 after the cash acquisitions of PeerMark, Scotch Property Network, and RealComp. The company ended 2004 with 117.1 million in cash, cash equivalents, and short-term investments; we have no material debt. Frank Carchedi, our Chief Financial Officer, will address the fourth-quarter and year-end result in more detail later in the call.

Before he does, I'd like to highlight some of the significant trends we're seeing in our business and update you on the aggressive growth agenda we have set for 2005. The commercial real estate markets continue to improve. In fact, the market now appears to be transitioning from recovery mode to a growth mode. Net absorption of office space totaled 92 million square feet in 2004, about 60 percent of what we experienced 5 years ago at the peak. But absorption in the second half of the year totaled 62 million square feet, accounting for more than two-thirds of the total absorption in 2004. The current pace of approximately 35 million square feet per quarter isn't very far off the 40 million square feet of net absorption per quarter we saw during the first half of 2000.

The industrial markets are gaining strength as well. We counted 124 million square feet of positive net absorption in 2004 with 100 million square feet of that coming in the second half of the year. With new industrial starts down dramatically, vacancy rates should soon return to historical levels.

The investment sales market continues to be strong, setting records in 2004 for both the total dollar volume of properties sold and the price per square foot paid.

We continue to enjoy outstanding levels of customer satisfaction. Usage of CoStar Property, our number-one revenue contributor, is strong and running approximately 5.3 million weekly page views. Over the past several years, the company has placed outstanding customer service as a top priority and as a result, our renewal rates have continued to improve, increasing 2 percentage points from approximately 91 percent in the fourth quarter of 2003 to approximately 93 percent in the fourth quarter of 2004. Given the fact that we will always have some percentage of firms going out of business or leaving commercial real estate, this is a truly remarkable renewal rate and we're really quite pleased with it.

During the fourth quarter of 2004, these renewals included long-term agreements with Cushman & Wakefield, Jones Lang La Salle, Advantis/GVA, Studley, Inc.; four of the industry's leading commercial real estate service providers. Earlier this week, we announced a long-term renewal agreement with Marcus & Millichap, the nation's largest brokerage firm, focused exclusively on investment sales. These five contracts have an aggregate future revenue value in excess of 26 million and are among the largest contract commitments we have received to date. These contracts demonstrate our ability to maintain and guard involvement with some of our oldest customer relationships.

By no means was this success limited to big deals. Selling conditions were favorable across the board, leading to our best-ever sales month in December 2004. Improving market conditions, the strength of our product offerings and our strong brand all contributed to a favorable selling environment in the quarter. We signed over 350 new customers in our existing markets in the fourth quarter of 2004, an increase of 25 percent compared to the same period in 2003. It's also important to note our average deal size increased approximately 7.8 percent in 2004 and the average contract value of new customers increased by approximately 20 percent.

December was also a record month for advertising sales, which turned in a very strong quarter as well. We had about 92,000 of electronic media advertising revenue in the fourth quarter of 2003 when Jim Black joined the CoStar Group to help us lead that business. With a modest investment in product development and staff in 2004, we released a new search-based advertising model similar to the advertising model on Google or Overture. Our advertising revenue in the fourth quarter of 2004 grew to 343,000, an increase of approximately 273 percent year-over-year. At the current pace, we believe we could have reached 2 million in electronic media advertising revenue in 2005.

We believe CoStar Group is in a strong position right now. The commercial real estate industry has recovered and appears to be moving into an expansion. We're experiencing the highest levels of customer satisfaction and renewal rates we've ever seen. Our sales organization is completely staffed, gaining experience; turnover is very low and we're achieving record sales levels. We believe we are in a superior competitive position. Our balance sheet is extremely strong and our fundamental business is showing higher margins and strong cash flow.

While CoStar is the leading commercial real estate information provider, we believe we are currently addressing well less than half of the commercial real estate properties in the United States. We believe that any effort we make to expand our database coverage is very leveraged over our existing software, distribution, research infrastructure, and brand strength. We believe that there's real unmet demand in these untracked areas of commercial real estate. We hear that directly from customers and prospects and the formal research we conduct regularly to analyze opportunities.

The CoStar management team has initiated more than 50 prior market expansion and has succeeded in virtually every one. In total, we believe that there are a combination of ideal conditions within our business right now for CoStar Group to move opportunistically into an aggressive growth mode project.

We last initiated a major increase in our database and market coverage in 1998. In that expansion, we tripled the number of properties I just wanted to our database in a relatively short period. In the five-year period that followed, our revenues increased six fold. From that and 18 years of experience, we have come to believe database growth closely correlates with future revenue growth. In fact, revenue per tract building has historically increased as the number of tract buildings in our database has grown.

We believe that that is because the more comprehensive a solution we offer, the more prospects are reached by our solution. For example, when we provide office leasing data in Washington alone, we appeal primarily to Washington tenant rep brokers. As we add more markets, we continue to reach those Washington tenant rep brokers, but we also begin to reach multimarket investors; hence, our revenue per building tract grows. There's no question in our minds that we have not yet reached the optical optimal point in our database coverage. There are clear the significant investors that are active in multiple product types, like office, retail, multifamily and industrial, and in more markets than we currently cover. We believe these investors will be more likely to purchase our products at higher values as we become a more convenient and more comprehensive solution to their needs. We believe that over the next five years, our revenue per tract building will continue to increase, even as we expand our coverage.

We have a high degree of come confidence in our business model and believe that our reinvesting our significant earnings growth into dramatically growing our database will position the company for even stronger future revenue and earnings growth. Our economics are actually very simple and predictable. It costs approximately $45 to field research, photograph and initiate coverage of a building in our database. We expense that initial building addition and there's generally a 9- to 12-month lag before there's any associated revenue stream with that building. If we're producing only one service, be it CoStar property comps or tenant, then the cost to keep that building up to date averages out to approximately $25 annually. As we add all three services to a market that costs to maintain each building on average raises to approximately 50 to 60 annually.

Overall and on average, we currently generate $230 of revenue per tract building per year. In markets where we have all three core service offerings, we currently generate $357 of revenue annually per tract building on average. The revenue for a building when we first deliver to market has been around $20 to $30 per tract building and it has grown linearly to $230 on average over 5 to 7 years.

If you have noticed that the margin per building in the out years is very large, you've noticed correctly. We believe that the possible returns on the expanded database are very attractive and present CoStar with the highest opportunity for growth for the significant cash flow CoStar is generating. These revenue expense numbers per tract building are averages and there are fluctuations from market to market, but we believe the numbers are representative.

The company is initiating a number of aggressive growth initiatives for 2005. These include database coverage expansion, sales force growth, new product initiatives and increased marketing activities to support all of the above. We intend to research, add and sell information on an additional 500,000 properties over the course of the next two years, including the expansion markets. This will effectively double the number of markets properties we actively track in North America. We expect the majority of the 500,000 new properties will be retailed properties from across North American. We expect approximately 200,000 of these properties will come from our previously announced expansion markets, of which half of those are expected to be retail. These properties will range from properties as large as the Mall of America at 4 million square feet, the nation's largest shopping mall; to 5000-square-foot freestanding retail stores.

The NRB acquisition gives us a starting point on 40,000 retail properties. We're excited about the acquisition of NRB. National Research Bureau is the premier provider of property information to the shopping center industry. They've published the Shopping Center Directory for 45 years, providing us with a very strong brand to leverage our expansion in that zone. NRB generates approximately 2 million in annual revenue and is profitable with an estimated 20 percent operating margin. In addition to the 40,000 shopping centers in its database, NRB has information on over 70,000 property owners and leasing contacts and over 500,000 retail tenants throughout the U.S..

This acquisition brings a knowledgeable retail team and hundreds of prestigious new customers, such as Best Buy, Blockbuster, CVS, JC Penney, Payless Shoe Store, Saks, Target, and Toys R Us. Consider that a fast-growing retail chain like CVS currently has over 5300 locations, pays almost 1 billion in rent annually, and is looking to open 120 new stores in 2005. In addition to finding these new locations in a given month, CVS would have dozens of existing leases or disposition situations requiring attention. The real estate decisionmakers at these companies have had to make decisions that are critical to the success or failure of their business, and the revenue generation side of their business with significantly less information than their counterparts in office leasing industrial space have.

Our primary goal over the next three years will be to upsell these firms from NRB products to CoStar Property Professional product, which has images, mapping, aerials, availabilities, for-sale information, comparable sale data and much higher update frequencies. We believe these firms will find CoStar Property a very compelling alternatives (indiscernible) very limited amount of information in the current NRB products. Thus, our plans to integrate NRB's information into CoStar's subscription-based information services.

In addition, we've signed long-term license agreements with Claritas, the industry's leading divider of demographic data, enabling CoStar to integrate Claritas' demographic data into CoStar's services. By the end of 2005, we believe we will have the largest, most comprehensive retail database in North America and a very compelling offering for thousands of major retail players. Further, we believe the opportunity in retail will prove as large as the opportunity we are already pursuing in the office and industrial markets.

This week, the company released a 10,000 property database covering Richmond, Virginia. With 10,000 properties, Richmond's database would rank in the top 25 of our existing markets based upon building count. Richmond's building count is much higher than many of our existing markets because we made the decision to track comprehensively retail data in Richmond and our other expansion markets when we began building the databases last May. Richmond is about the middle of the size rank of the expansion markets we plan to enter this year.

Prior to opening in Richmond, we successfully presold enough monthly subscription revenue to cover the current monthly cost of maintaining and supporting the Richmond database. This marks one of the company's most successful market launches to date. In fact, this is the first time an organically built new market has opened in this strong of a financial position. Historically, for many markets, it has taken more than 12 months after opening a market to reach this financial milestone. We believe we were able to accelerate this turn point in Richmond because of our brand, our products and the quality of our preopening research is much stronger than it has ever been before.

We have not initiated presales activity in most of these expansion markets, but where we have -- Hampton Roads, Norfolk, Virginia, Greenville, Spartanburg, and San Antonio -- we have had similar pre-selling successes as Richmond. The company expects to open the remainder of the 18 new geographic markets throughout 2005.

We want to correct an inaccurate reference we have heard which stated that our current expansion into 21 markets will add as low as 14 percent to our inventory. We've already added more than that without being more than 60 percent away through the progress. That number is definitely inaccurate at 14 percent. We believe these 21 markets will increase our inventory of actively tracked U.S. properties by 43 percent or more. It is likely that anyone calculating those numbers is relying on CoStar-derived numbers for our existing markets. Those numbers are likely to be very complete. However, our expansion markets where complete data like CoStar doesn't exist, people might be relying on brokerage research numbers for a market or a listing service, which would likely dramatically understate the size of the market.

For example, if two months ago, you had been looking for the size of the market of Richmond, your best source would have been a brokerage firm tracking approximately 3000 buildings. Today, we track 10,000 properties for Richmond. So your numbers would have been about one-third the accurate number. It is also important for people to understand that our existing markets which have acknowledged strong earnings power are not all like New York City. 99 percent of the properties CoStar currently tracks are less than 12 stories, and hence, are not high-rise office properties. Only 1 percent of the properties we have historically tracked are high-rise. CoStar's business model has worked for years with smaller average property sizes.

CoStar believes that the first 240,000 properties of the 500,000 properties slated to be added to our database in the next two years consist of an estimated 200,000 expansion market properties in 40,000 NRB shopping center properties. That first half alone, we expect that will be adding approximately 9 billion square feet of GVA to our U.S. database of tract properties, for an increase of 43 percent. So a pretty dramatic increase in both number of buildings tract and gross building area.

The company has made a major investment over the course of the last 18 months in developing a next-generation Web-based sales contact management solution targeted at the commercial brokerage industry. A broker can use this product to track and manage contacts, properties, companies and sales opportunities. The product facilitates networking, teaming and sharing with other brokers who are also using the product. The unique value proposition for the product is that it integrates with CoStar data services. Many of the tenants, brokers, owners and properties that a broker enters into a contact management system already reside within CoStar data services. The user can save a tremendous amount of time by importing the data from CoStar, rather than typing it all in. Brokers typically develop lists of hundreds of prospects and properties and keeping them up-to-date can be challenging, if not impossible. A CoStar relationship manager can automatically update the user's contacts and properties as changes are made available from CoStar research. We expect the product will be sold to existing CoStar subscribers at a monthly subscription product on an individual user basis. We have presented the product to a number of potential prospects and have received very positive feedback. The product is expected to release this summer. This product will now upgrade to our area's desktop product, will replace that product.

We intend to expand our investment in both our sales and marketing operations. I'm pleased to report that we continue to gain momentum with our relatively new centralized inside sales model. As we discussed last quarter, most of our existing markets were opened before we released our Web-based products. The previous desktop versions of our products required face-to-face demonstrations to sell and multiple site visits to install and support. Today, all of our major services are Web-based. They can be demonstrated, sold and serviced over the phone and the Internet.

While the direct field sales force model remains crucial for maintaining strong relationships with top clients, the centralized inside sales model is proving to be a very viable, lower-cost model for reaching mass audiences for our products. This group currently represents only 5 percent of our personnel costs in the sales department, but it has been contributing approximately 13 percent of our gross new monthly revenue.

Our lower-end price competitors have proven that there are tens of thousands of smaller shops that have a need for information services in commercial real estate. We've conducted in-depth research into this target audience and believe that many of these brokers are great prospects for our services. Our brand awareness among the smaller firms is not as strong as it is with higher end prospects. We believe that the vast majority of these prospects have never even seen our products.

The inside sales groups we created in the second quarter of 2004 have had consistent success targeting these customers and so in the full range of CoStar's services. In fact, the inside sales group, coupled with the field sales group, has been able to close 33 percent of the prospects that were demoed last month that are coming from that smaller lower-end price competitor group. What's particularly interesting is that we're demo-ing prospects that have been using a low-end service costing $39 a month and signing them up to CoStar services with prices ranging from $165 to $900 a month. So we're able to get very significant value recognition beyond what they're paying these low-end services.

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

CoStar is selling a range of products to a number of very different prospect profiles. Our field sales force is organized by geographical territories for travel efficiency and local market knowledge benefit. In order to reach valuable prospects segment with unique needs, we're creating a new dimension in our sales force with segment specialists. For example, CMDS investors respond to a different set of CoStar value propositions than does a brokerage firm. The specialist that concentrates on CMBS players -- commercial mortgage-backed securities players -- is familiar with their needs and can team with and train generalist AEs -- account executives -- to find those value propositions. In 2005, we intend to invest in developing 5 specialists and an additional 5 traditional account executives.

With the company pursuing so many valuable sales opportunities in 2005 and 2006, we feel it is prudent to support these initiatives with a proportionate increase in our 2005 marketing budget. We intend to increase our marketing budget and personnel in the marketing department by approximately 50 percent in 2005 over 2004. We expect that a significant piece of that increase will focus on our emerging retail opportunity.

The Company believes that it is uniquely positioned to take advantage of an expected billion-dollar-plus market opportunity, and given CoStar's strengths and improving market conditions, we believe that this is an ideal time to aggressively pursue this growth opportunity. The Company expects to aggressively accelerate its investments in sales, marketing and product development and specially growth in database coverage. We believe that the Company is making very leveraged investments to further enhance future earnings potential while we expect to maintain positive earnings.

At this point, I'd like to turn the call over to Frank Carchedi, CoStar's Chief Financial Officer.

Thank you, Andy. As reported in our press release yesterday, our year-over-year financial progress has been substantial. But today, I'm going to focus on a discussion of the fourth quarter of 2004 results as they compare to the third quarter of 2004, our outlook for 2005 and some of the accounting and presentation issues that are important as we head into the year.

Total revenues grew sequentially by 4 percent overall from Q3 to Q4, increasing from 28.6 million to 29.7 million. Growth for the fourth quarter was principally a result of further penetration and successful cross-selling of products, combined with a renewal rate of approximately 93 percent for the quarter. Subscription revenues for the Company accounted for approximately 95 percent of revenues during Q4. Our UK operations contributed approximately 8.7 percent of the revenue in Q4, as expected.

Gross margin increased by 900,000 from 19.4 million in Q3 to 20.3 million in Q4 on a $1.1 million increase in revenues. Margin percentages increased about a half percent from 67.9 percent in Q3 to 68.4 percent in Q4. Without charges for expansion markets, which I estimate at 1.1 million in Q4, gross margins in the core business would be 72 percent with some individual markets continuing to experience gross margins in the 80-percent range. There are no revenues recognized in the fourth quarter from the current market expansion, except for the two acquired markets.

With regard to operating expenses, overall operating expenses increased from 17.5 million in Q3 to 18.1 million in Q4. These costs on the whole were lower than expected as we continue to control and leverage our overhead, even with the market expansion underway. As a result of sales and margin growth, our EBITDA, which is earnings before interest, taxes, depreciation, and amortization, improved from 5.1 million in Q3 of 2004 to 5.5 million in Q4 of 2004.

Based on our track record of profitability and the expectation of continued future profitability, in the fourth quarter, we recorded a onetime non-cash income tax benefit of 16.7 million resulting primarily from the reversal of our previously recorded valuation allowance against deferred tax assets arising from our net loss carryforwards, which we expect to utilize to reduce future amounts of income taxes we would otherwise be required to pay.

As a result of this tax accounting and our continued earnings growth, our GAAP basis net income improved from 2.4 million, or 13 cents per fully diluted share in Q3 of 2004, to 19.4 million, $1.03 for fully-diluted share in Q4 of 2004.

Reconciliation to GAAP basis results of all non-GAAP financial measures discussed on this call, including EBITDA, is shown in detail in 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 purchased amortization on net income has become less significant. Therefore, beginning with the results for the first quarter of 2005, the Company expects to no longer report pro forma earnings. The Company expects to continue to report EBITDA and reconciled EBITDA to net income.

Capital expenditures for Q4 of 2004 were approximately 2.8 million, of which 1.2 million was related to our market expansion efforts and the remaining 1.6 million for the support of our existing platform. For 2004, total capital expenditures were approximately 9 million, as planned. We closed the year with approximately 117.1 million in cash, cash equivalents and short-term investments, an increase of 19.6 million over the beginning of 2004. The cash generated was principally from growing EBITDA results with an additional 6.3 million generated through proceeds from stock option exercises for approximately 425,000 shares during the year. In January, we used 4.1 million of our cash to purchase NRB.

Now, I will discuss the outlook for the first quarter and 2005. We expect to reach approximately 135 million in revenue for 2005, representing approximately 20 percent overall growth, 18 to 19 percent of which is organic. Sequential quarterly organic growth rates are expected to grow from their current levels to reach 5-1/2 to 6 percent by the fourth quarter. We expect the majority of 2005 growth to continue to come from the existing core markets with the expansion markets adding to growth rates in the back half of the year.

Gross margin percentage is expected to grow in the core markets and we also expect about a $1 million reduction in purchased amortization in cost of sales, but overall, we expect gross margin to come under pressure from our geographic and retail expansion, which requires significant ramp-up of staffing and other costs in the research area. As a result, overall gross margins are expected to be in the 67 percent range throughout 2005. We expect operating expenses, including selling and marketing, software development, and G&A expenses, to increase by approximately 5 percent per quarter on average for 2005 as we expect to expand sales, telesales, and marketing generally and move more directly into a selling and marketing phase of planned new market expansion. Additionally, we continue with major development initiatives in both the product and infrastructure areas. We expect purchased amortization and operating expenses to remain relatively flat from the fourth quarter of 2004 levels during 2005.

Beginning in the third quarter of 2005, we are anticipating equity compensation charges related principally to the required expensing of granted but unvested stock options in the amount of approximately 1.8 million per quarter. EBITDA for 2005 is expected to reach approximately 17.5 million, which includes the estimated $3.7 million charge for stock option and other equity compensation expense principally occurring in the third and fourth quarters. It's important to note that 2004 EBITDA of 19.8 million has no such compensation charge.

We expect EBITDA for the existing core platform to continue to grow and I believe that in 2005, that EBITDA margin percentage related to the core platform will be in the 20 to 25 percent range. Individual market performances are currently reaching higher levels than that with fully-loaded market EBITDA margins of up to 40 percent. We expect net income of approximately 23 cents per share for 2005, which is shown on our press release, will include equity compensation expense, investment earnings, depreciation and amortization of approximately 12.5 million and will be fully tax effected at approximately a 40 percent rate.

For the fourth quarter of 2005, we expect quarterly sequential revenue growth of 5 percent, of which approximately 1 percent is related to the recent acquisition of NRB. We expect diluted net income per share of approximately 5 cents per share for the first quarter of 2005.

Finally, we expect capital expenditures in 2005 to continue to include investments and assets required to support our planned market and retail expansion, including additional field research equipment, building photography, communications, photographic and computer equipment and leasehold improvements and workstations totaling approximately $2 million per quarter. In addition, we expect approximately $1 million of capital expenditures per quarter in 2005 to support existing operations, which is consistent with expenditures for the past several years.

In conclusion, we recognize that this is a challenging year on the financial side due to the many growth initiatives underway, combined with a number of new accounting and presentation issues. However, we remain focused on our solid organic growth, high margins and creation of future opportunities for growth in revenue and earnings. As always, we look forward to reporting our progress to you. And with that, I'll open the call for questions.

Brandt Sakakeeny, Deutsche Bank.

A question just about the pricing environment. Given the strong sort of absorption activity in the real estate market, and I think your big contract signings -- I guess I would've thought I would might have had a little more upside on the revenue line. Is that a function of the pricing environment, or is there anything else going on there? Is the advertising business may be a little weaker?

Well, the advertising business is up 270 percent year-over-year -- 273 percent year-over-year -- and is continuing to grow at a very good clip. It could be 5 percent growth over a 2-year quarter over quarter, so it's not that. The major contract renewals -- actually, before I hit that, the average new contract is coming into the Company at 20 percent higher than the same quarter year prior. The major contracts we're renewing with firms like Jones Lang LaSalle or Cushman & Wakefield do not include major price increases, nor major price reductions and they don't include bundling of additional new major products. Those contracts are generally single-digit increases.

Okay.

And that's sort of in conformance with many of the long-term contracts we've set up with those players that govern that rate of price increases. Now, those major players probably represent -- they represent a relatively small piece of our overall revenue, but they are important customers and we have long-term agreements with them.

Okay. So I guess, just were you surprised on the -- I guess again, given your original guidance, granted I think we're at the slightly higher end, but still, it does appear that you were surprised on the upside by the renewal rates that tweaked up 2 percentage points and things like that. So I'm still just trying to figure out why you might not have come at the high end of the range.

Brandt, I don't think we're particularly surprised on the renewal rates. They've been high. They've been well into the 90s. Keep in mind that in our model, and as I mentioned earlier, we actually climbed in terms of the overall percentage of subscription revenue, which is a very steady -- not a volatile revenue stream. So keep in mind in our model that it takes time to move the dial in terms of sequential quarterly growth rates. A lot of what you're seeing in Q4 revenue production is actually from the summer months in terms of selling; in other words, July, August, September is where we're selling to essentially build up an entry point for Q4. Those are typically not as strong selling months as you might see, for example, in the fourth quarter production. So there are some factors. I think the revenue momentum continues to be good and we're pleased with the organic growth. We think it can go higher in 2005.

We saw consistent growth in monthly sales progress each month from the summer throughout the end of the year culminating in our best-ever sales month in December.

Okay, and what should we think about as a normalized sort of CapEx number from sort of an '06 to '08 timeframe as a percentage of sales?

Let me just try to answer that generally. If you look at 2005, we continue to be in what I think is a heavy CapEx period because of retail and geographic expansion of both, as well as technology advancements. The normal ongoing platform appears to be requiring in $1 millions to $1.5 million range per quarter, and that's just replacement of workstations, furniture and fixtures, just sort of the replacement of ongoing equipment. It's not particularly a capital-insensitive business. So that 1 million to 1.5 million has been what we've been seeing for the past several years in the core platform, and it's 1 million to 1.5 million a quarter. So really, when we have these aggressive expansions, you do see significant dollars going out in a short period of time for research vehicles, or expanding the research group, or building out new space, leasehold improvements, workstations, et cetera. So that is just kind of the period we're in now. So I do think that '04, '05 -- and we said that at the beginning of '04, that we thought that this current drive would cause some additional CapEx.

Okay. And just a final quick question on the EPS impact of option expensing in the fourth quarters -- do have that, Frank?

The numbers I gave are estimates and let me elaborate on that a little bit. Those calculations, obviously, as you know have a lot of moving parts in terms of the valuation of options. We put a placeholder in the guidance at essentially about at 1.8 million a quarter, and you see that in the press release where I put that in the reconciliation between EBITDA -- the footnote to the reconciliation for EBITDA. So we're looking in the 1.8 million a quarter, 2 million a quarter range, and frankly, I'm going to have to fine-tune that as we get closer down to the adoption of 123 in the third quarter.

Okay. Thank you.

Dalton Chandler, Needham & Co.

I just wanted to confirm some of the numbers that you went through in your prepared remarks. I think, Andy, you said it cost $55 to add a building, 25 a year to maintain it, and you can generate -- or you're generating an average of $230 per building per year?

It's about -- it's approximate -- and the numbers change as we gain additional efficiencies in the research process, or as we add additional data fields. And we're talking about the actively tracked buildings which are generally the buildings that we recurringly (ph) visit in Property Professional. So the number actually to correct the first number you gave me, it's closer to $45 to add a building, $10 less than the 55. It is about $25 on average to maintain a building during the course of the year. Now that's if we're doing just the leasing module, the Property Professional module, as you add in a tenant module on a city or a comparable sale module, you get a nearly linear increase in cost to maintain the building, so it rises. As you add all three products, it rises to $50 to $60 per building to maintain annually.

Then, on the revenue per building annually, we're seeing across the whole U.S. system right now approximately $230 per building annually. It ranges as high as $2100 per building annually in New York City; that's an anomaly. The next one down might be Washington D.C. at $725-ish per building. And then when a new market bursts open, obviously, it opens at a fairly small number which is much closer to what it cost to maintain the building during the course of the year.

Okay. When I look at the building count that you publish in your K every year and just do the simple math of dividing revenue by buildings, I don't get anywhere near $230. So --.

Well, one of the things we're trying to focus on here is we're trying to clarify what building number we're using, because buildings are all over our databases. In the United Kingdom, they use government data on properties, and they may report on a million-some buildings in our United Kingdom operation. And in fact, they're only actively tracking possibly 100,000 properties. In the United States, we may have -- in the United States, we might have hundreds of thousands of buildings in the comparable sale products that are going back 20-some years, but no one has touched them in 15 or 20 years.

So what we're now focusing on is a more reliable metric for the company, is those properties that are actively tracked commercial real estate properties that our researchers are coming back on month after month or year after year and keeping them up to date, hunting for the availabilities, hunting for the for-sale. So we're focusing on the actively tracked properties in CoStar Property Professional as a key metric.

Okay.

And we also have a million-plus buildings in -- gosh, we have probably 20 million some buildings in our assessor data feeds and things that we're not actively keeping on top of all the time.

Okay, so just doing the math on that, you have about 580,000 actively tracked buildings?

Approximately.

Okay. And then, Frank, you mentioned the million-dollar reduction in the depreciation and in the gross margin. Could you just give us the actual number that's in there?

Dalton, it's actually the purchase amortization that's up there, and that's what -- everybody's been tracking that, somewhat because that was one of the reconciling items for specifically for the pro forma. I'll keep giving that number, and it also helps to understand margins to little bit. But the actual number is in the 3 to 400 range per quarter -- 3 to 400,000 per quarter going out in 2005.

And then, just finally on the revenue growth for the year, it was up about 18 percent, and I think the acquisitions really didn't have any impact on that; is that right?

You're talking about the growth for '04?

Yes, '04 over '03.

Yes, and that's correct. The acquisitions we did, did not move the dial significantly on revenue growth.

So then looking to the guidance you gave for the coming year, you're essentially saying the organic growth isn't going to increase, but you are bringing on all these new markets. And as you do that, your revenue per customer is going to increase because you already have customers who have agreed to take those 21 new markets.

Yes. I think there -- I think if you drill into it, there is some overall increase in the organic revenue. Let's say it's a percent or 2, but I think the important thing in my comments, and then I'll note it again, is that we've sort of been clicking along here at 4 percent sequential quarterly growth and we're starting out the year continuing that, plus we got the NRB acquisition in the first quarter. But the important thing is that we believe that the organic sequential growth climbs into the 5-1/2 to 6 percent range by the fourth quarter because of the new markets. So what you're getting with that is -- that's important -- is that the accelerating sequential rate may not contribute dramatically to the year-to-year organic rate, but if you think about -- as you build your model out into '06, you have a Q4 sequential rate in '05 that's substantially higher than what you have in Q4 of '04.

Okay. Can I -- I'm sorry, just one last question. I missed your gross margin guidance for '05.

I think we're looking at about 67 percent. And a combination of -- you mentioned the purchase amortization, which is sort of a mechanical effect, and then I think that's a combination of continued growth in margins in our business model for the core markets, offset by the margin pressure as we build the research group for retail and new market expansion.

Okay. Thanks a lot.

Jim Wilson, JMP Securities.

Good morning, guys. Well I guess my bigger question obviously you've got great detail on '05, but I'll make you look out and try to make you talk about '06 and so all these investments which are obviously -- well at least even more in dollars than I would've expected. I would assume you probably expect some -- you have great opportunities and expect some good things out of it for '06. SO I don't know if you could color either sort of per market in the new markets, what the revenue potential you think could be, if it's 500,000, 1 million, whatever you might want to color it. And also, in retail or anything else that might help suggest how good revenue growth opportunities could be as you look into '06.

Jim, let me just first give some general -- I mean we obviously, we did not give guidance out at '06. But I think the way -- I think there were some pieces of information to consider if you model that out. And one was one we just talked about, which is that we believe the organic growth rates per quarter can be higher, so -- and we believe that would continue out into '06 from Q4 of '05 obviously. That's the way our model works. So as you model goes into '06, you can think about that.

On the cost side, again, the way our model works, without giving specific guidance for '06, the cost side is going to ramp up because of these investments. And you think about what that is, it's the hiring of researchers, it's salespeople -- those kind of costs which once we ramp up to the next level or platform again tend to become stabilized and nonvolatile. So you can sort of I think launch forward off of the '05 data and see how leveraged those '06 will be.

Right. So you can take the investments in '05 and in a stable building count model, that cost structure would stay the same, and in fact, in the field operations could decline into '06 while the revenues continue to move at that higher accelerated pace. So it's very similar to our historic new market opening sort of fixed cost and then expanding revenues over that. And another way to look at it is to again take that per building add, when the markets delivers, we see somewhere around $20 per building in revenue, and then it linearly appears to grow to approximately $230 per building over a 5- to 7-year period.

Okay. And I guess maybe going, putting the longer-term thought process back in the context of -- like some of your presentations in the past of a longer-term opportunity to get to 30 percent-ish or so type operating margins. So I guess what's called excluding, which is I think where it was excluding that stock option expensing and everything else that has been adjusted -- has that changed materially where you think you would have to get to in revenues in order to leverage up to that kind of margin?

Well, I think the core business in '05, if you strip out all the growth initiatives, would be approaching that 30 percent target margin. So as you lay these additional investments in, you're setting another higher number that you're moving to to reach for the business to reach that 30 percent margin level. But the existing platform is probably approaching that 30 percent right now.

On an EBITDA basis?

Yes, on an EBITDA margin -- what I said was I think it has already as we head into '05, you're looking at 20 to 25 percent EBITDA margins. And that continues -- the core business continues to lever -- the important thing to think about here is, even in Q1 of '05, Q2 of '05, the new revenue that you see, we're talking a lot about retail in new markets, but the new revenue you see continues to come from the core platform. And you see once again in Q4 on the actual data how leveraged that production can be. In Q4 of 2004, as I mentioned, we grew $900,000 of gross margin on a $1.1 million revenue increase. The reason for that is because in Q4, we hit a little bit of a lull in the investment pattern. We haven't really launched into the retail full-scale and we're sort of between the field research and the centralized research effort for new markets. So you had kind of a stabilization of the cost line. And you see how dramatically it can be leveraged when that happens. Now, of course as we get out into Q1 of '05, we will be adding research headcount, aggressively turning toward ramping up. And you'll see margin pressure.

Okay. Great. Thanks.

John Neff, William Blair.

A couple of questions. 95 percent of revenue in the quarter was from subscription revenue. It had been 94 percent for the prior 7 quarters, and yet advertising revenue grew dramatically in the fourth quarter. What accounted for the uptick in subscription percentage?

John, advertising revenue continues to grow dramatically on a percentage basis, but it's still a very, very small part of the total revenue. So keep in mind that the vast majority of everything you see on the topline growth line is coming from subscription-based revenue. And adjust mathematically over it, that keeps happening, that 94 going to 95, that number is going to push up. It's happening very slowly. It doesn't happen dramatically, but it just sort of probably kicked in the rounding up to 95 in that quarter. But that definitely is what's happening in the model. It is definitely becoming more subscription-based.

Okay. And what was total ad revenue in 2004?

The total for ads was total -- I don't have that number right in front of me.

What was the research headcount at the end of the year?

I believe the research account approached 700 by the end of the year.

Great. And your assumption of a 40 percent effective tax rate -- where does that come from? It seemed a little high, given the base federal rate.

John, first of all on the marketplace, the ads -- the 2004 revenue was about 800,000 in total. On the tax rate, just to be candid with you, we're heading into a new accounting area there; the 40 percent is an estimate. It obviously could be slightly lower. But I think the best thing, in terms of guidance, is to put in 40 percent as a placeholder and we'll have to see as we go forward. There are, to my knowledge, no unusual items in the tax accounting that would drive the effective rate dramatically higher or lower.

Okay.

And we expect that advertising number to double going into '05.

I think you said around 2 million?

Yes. At the current rate, it would be just under 2 million.

And lastly, I just missed it when you said it. What was European revenue for the quarter and for the year?

It was about 8.7 percent of total revenue for the quarter and it has been running about 8 percent for the year, overall. So that's about what we've expected. They've grown -- they've kept up growth rate generally with the core business.

18, 19 percent?

Yes. And some of that is -- keep in mind, you've got acquired, you've got SPN in there, which ramped it up little bit in the fourth quarter.

And then there's some advantage in exchange rates, right, driving that?

Yes, a little bit of it is exchange rates going in the early part of the year. In the last couple of quarters, it has been fairly stable but at a high level on exchange rates. But if you go back to when we did the deal, I think they were doing about 7 percent, 7.5 percent of revenue. So this new higher level in part is the exchange rate. We did the deal when the exchange rate was about $1.58, and it's now routinely $1.88, or in that range.

Thank you.

Gary Steinrow (ph), JP Morgan.

Just a follow-up on one of the last questions. Do you have a number for the nonsubscription revenue that are kind of onetime sales you do?

You mean, the other 5 percent?

Yes. Well I guess the other 5 percent is part advertising, part --

It's a variety of different things. It's advertising. It's -- probably the biggest part of it is ad hoc comps revenue where people go into the comp system and by one piece of information off a credit card. That's the biggest piece of that other 5 percent that occurs.

And about five minutes after that happen, a salesperson calls you and asks if you'd like to subscribe.

Okay. In terms of the -- your revenue forecast for '05, in terms of organic growth, it seems to be -- you have the same of what you did for '04, and yet you're adding the properties -- you are going to have more sales force, you are going to have more product. It's just a little bit of a disconnect for me.

Gary, first of all, keep in mind that, as I was saying, none of -- nothing that you see in revenue growth currently -- and actually very little for the first two quarters of '05 -- is going to relate to any expansion plans. It's going to continue to be off the core platform. But really starting in Q3, you'll start to, I think, see the dial moving because of revenue in expansion markets.

Secondly, keep in mind that we talk about sales force growth, but that also takes time during '05 to grow, train, and ramp that sales force up. And additionally, our subscription revenue production grows, but if we keep doing -- if we're moving from, say, 17 to 18 or 19 percent organic, those are all bigger dollar production numbers, and we're continually working sequential growth rates off a higher base. So we're producing more in new revenue every quarter to achieve the same growth rate. So I think if we go from where we've been at 4 percent, up into the 5-1/2, approaching 6 percent a quarter range, it's fairly dramatic. And we would be pretty excited about that.

And with the results really that dramatic in showing itself in the '06, '07.

Right. I mean, you wouldn't see anything dramatic until Q4, but it would give you a substantially higher revenue platform for '06.

Okay. And in terms of the spans in your cost of goods sold and your sales and marketing, is that going to be pretty linear throughout the year, or is it going to be a big chunk early on?

I think the -- there's going to be a bigger chunk early on. In other words, you're going to see gross margin pressure I think from Q1 on, and the -- what's called a 2-point drop in gross margins -- I think you'll see that virtually from the beginning in Q1, and then throughout the year, giving you a 67 percent margin.

We have next to no sales turnover right now.

Then on the operating expense side, I think same thing -- I think Q1 is probably, because we're really gearing up on expansion as well as Q1 is typically a quarter that has higher costs for a number of reasons. Benefit costs are higher. Typically in the first quarter, we have our annual sales training, development meetings. That drives Q1 sales and marketing costs up. We're launching into some marketing campaigns. So I think you'll see -- and if you work through the model to my guidance, which was 5 cents of GAAP for the first quarter, you'll see that there's some pretty significant pressure out of the box here on the first quarter.

Okay. And how should we think of '06, in terms of your spend? Is it going to revert to kind of '04 numbers? Is it going to be a continuation of '05? And don't say something in the middle.

Well, as I described before, and of course it's hard to say. We haven't given guidance on '06. All I can really do is talk about how the model works. But what I can tell you, and as I said before, is that once we ramp up to the level we need to be in retail and new markets where we are now servicing that bigger platform, the cost once again stabilize and we would be back to normal cost escalations on the spending side, and hopefully driving higher revenue opportunities. So the model continues to behave in the same way that it's behaved for years, which is we ramp costs up to support a bigger platform, the costs become stable again, and we expect to drive continued revenue growth off that platform and leverage the earnings.

And the '06 plan is obviously sensitive to '05 results. If every investment initiative in '05 is a success and is generating cash, we'd probably look to make additional investments in '06. But we have total control of what rate you do that and the ability to fall back to '04 cost structure if we weren't satisfied with '05 results.

But we could expect your '06 incremental gross margin to look more like your -- what you just reported in the first quarter -- 80 percent, rather than what we're going to see in '05?

Well, again, without getting specific, what's going to happen is margins will be under pressure throughout '05 because of the expansion of the research cost structure. Then what happens is, when that stabilizes, as we saw in this Q4 where you get a little bit of stabilization there, you're growing -- you're continuing to grow revenue over a very stable cost structure and it's going to be highly leveraged to the margin line. So you see margins grow over time with the exception of periods where we've ramped up the research group. See how that happens.

In Q4, as I gave in my guidance at the end of Q3, Q4 is just a bit of an anomaly here, as I said, because we hit of a lull in the ramp-up of spending as we transition from field research to centralized research and we haven't yet really gotten into the retail side yet. But when that happens, you see what happens and you see how leveraged it can be.

Thanks, guys.

Rick Leggett, Arbor (ph) Capital.

You might have mentioned this already. If I missed it, I apologize. You've mentioned in your press release that your sales force turnover was down 50 percent. What was it previously, and how are you measuring that?

It probably -- in '03, it probably ranged as high across the year as 70 percent.

And is that -- I mean -- .

We've had two changes in the organization. One is, we restructured the commission plan to give the account executives a small consideration for their renewal activity the contracts they keep re-signing each year which give them the ability to grow a long-term annuity like more similar to the life insurance sales model.

We also have made a change in the leadership of the sales force.

When was that done?

That occurred about nine months ago or so, and so we have a new head of sales -- a gentleman named Chris Tulley -- who formally a vice president of sales with Dell and Xerox before that and GTSI. So a very seasoned veteran at a different experience level than the prior head of sales.

And when was the restructuring of the payout done?

That would have been in --

The third quarter of '04, I believe.

Yes, so --

So Mr. Tulley directed that?

No, that was just prior to his coming onboard. And the net cost of that restructuring, when you factor the result of lower turnover, the -- it was June. So the net cost -- the commission rates went up. The overall compensation of the sales force went up somewhat. The cost associated with hiring and recruiting went down dramatically, and it was about a wash. And obviously, that's a much better situation because you've got a stable, experienced sales force with good relationships with a customer base. So our turnover rate in the fourth quarter was measured in the -- one or two bodies.

And what are the total bodies now?

It's -- let me actually give you an actual number.

Let me try to -- the easiest way is to summarize -- sort of summarize the entire sales force. This excludes marketing, the marketing group. The sales force today I believe includes about 122 people -- 79 quota-carrying account executives, 12 in the telesales, the outbound sales who are also quota-carrying -- 7 ad sales personnel, and then 8 additional people in the UK. And the rest of that group would be the regional management and the top management.

Okay, thanks.

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

We'd just like to thank everyone for joining us on this year-end conference call and we are looking forward to the opportunity to grow this business aggressively in '05 and beyond and show very positive strong results in '05 and '06. Thank you for joining us.

Thank you, ladies and gentleman. This concludes today's CoStar Group fourth quarter and year-end earnings conference call. You may now disconnect. It's about ding-dang time!!!