CoStar Group Inc (CSGP) 2005 Q1 法說會逐字稿

Good morning. My name is Cynthia, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the CoStar first-quarter 2005 earnings conference call. (OPERATOR INSTRUCTIONS). Mr. Kilonsky, you may begin your conference.

Thank you. Good morning. I am Mark Kilonsky, Senior Vice President of Investor Relations. I would like to welcome you to CoStar Group's first-quarter 2005 conference call.

Before I turn the call over to Andrew Florance, President and CEO of CoStar Group, 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 from such statements. Important factors that can cause actual results to differ materially include but are not limited to those stated in CoStar's first-quarter press release and in CoStar's filings with the SEC, including its Form 10-K for the year ended December 31st, 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 website at www.costar.com/corporate/investor for a webcast of this conference call and for the reconciliation of all non-GAAP financial measures as discussed on this call to GAAP basis results. Andy?

Thank you, Mark. Welcome, everyone, to this first-quarter 2005 conference call. We're pleased to report another quarter of strong revenue growth and solid earnings. Our revenues for the first quarter of 2005 were 31.3 million, an increase of 5.4% over the fourth quarter of 2004 and a 19.3% increase year-over-year.

The Company had EBITDA, earnings before interest, taxes and depreciation and amortization, of 4.2 million and net income of approximately $947,000 or $0.05 per share for the first quarter of 2005. We ended the first quarter with 112.9 million in cash, cash equivalents and short-term investments. After the cash acquisition of NRB, we have no material debt. Frank Carchedi, our Chief Financial Officer, will address the first-quarter results in more detail later in the call.

First, I would like to update you on the progress we are making with the aggressive growth plan we're currently pursuing. The outlook for continued improvement in the commercial real estate markets is looking strong. We've now had seven consecutive quarters of positive net absorption on the office market, and nearly 138 million square feet of space has been taken up in that time. That's enough to bring the national vacancy rate for office space down a full percentage point to 13.6%. Competition from new deliveries should not be an immediate threat to declining vacancies and improving rental rates.

The industrial markets continue to show slow steady improvement as demand catches up with the 294 million square feet of new supply added over the past two and half years. The retail market also is showing strength. New shopping center completions increased 10% in 2004 versus 2003. This is the third year running for increased new center volume, and it represents the highest level in the past five years.

I would like to take a minute to discuss some encouraging trends we're seeing in our sales activity. As we discussed in previous calls, turnover in our sales force was a problem for us in 2003 in the first half of 2004, one that effectively kept our U.S. sales force, our U.S. information sales force below about 60 quota carrying AEs. We successfully implemented a number of initiatives in 2004 and introduced new leadership in the organization, and it has dramatically reduced that turnover. Now as our sales force matures and strengthens, we are beginning to see significant improvement in sales productivity.

The addition of our centralized inside sales team has enabled us to cost effectively grow our U.S. information sales force to 88 actively contributing sales professionals on our team in March 2005. That represents a 54% increase over the 57 quota carrying AEs on our roster in March 2004.

Not coincidentally we experienced our best quarter ever for both monthly gross sales and monthly net new sales in the first quarter of 2005. In fact, monthly net new sales in the first quarter of 2005, which is our gross sales minus any cancellations, increased 42% over the same period in 2004.

In addition, we signed over 460 new customers during the first quarter of 2005, a 35% increase over the same period in 2004 and a 29% increase over the fourth quarter of 2004. It is important to note that the sales productivity gains we experienced in the first quarter generally do not contribute to revenues in the first quarter, but are reflected in our higher revenue outlook for the balance of the year.

The satisfaction level among our existing customers as measured by renewal rates continues to grow. The renewal rate for CoStar's subscription services increased from approximately 89.8% in the first quarter of 2004 to approximately 93.6% in the first quarter of 2005. We are continuing to see strength in our electronic media advertising business. Building owners are finding that our search-based advertising model can deliver massive exposure for their building which is critically important in competitive leasing markets. This business produced approximately $827,000 in revenue in all of 2004, and we are currently on pace to match that number by the end of the second quarter of 2005. With office vacancy rates currently at 13.6%, we believe market conditions will remain very favorable for this product for the next several years, and we're making a modest investment in staff to maximize its revenue potential.

We believe CoStar Group is in a very strong position right now. The commercial real estate industry has recovered and appears to be moving into expansion. We're approaching the highest levels of customer satisfaction and renewal rates we have 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 high margins and strong cash flow.

We believe that the effort we have been making over the last 18 months to expand our database coverage is well leveraged over our existing software, distribution, research infrastructure and brand strengths. In total, we believe that there are a combination of ideal conditions within our business right now that support CoStar Group's current aggressive growth mode. We have a high degree of confidence in our business model and believe that our current efforts to reinvest our earnings growth into dramatically growing our database will position the Company for strong future revenue and earnings growth.

The Company has initiated 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.

The integration of the company we recently acquired, NRB, is proceeding smoothly. National Research Bureau is a premier provider of property information for the shopping center industry. They have published a shopping center directory for 45 years, providing us with a very strong brand from which to leverage our expansion into the retail real estate information segment.

In addition to the 40,000 shopping centers in this database, NRB has information on over 70,000 property owners and leasing contacts and over 500,000 retail tenants throughout the U.S.

CoStar is in the process of integrating NRB's information into CoStar's subscription-based information services. In addition, the effort to integrate Claratosis' (ph) demographic data into CoStar services is on schedule and expected for delivery in 2005.

We believe that within 12 months we will have the largest most comprehensive retail database in the United States and a very compelling offering for thousands of major retail players. Further, we believe the opportunity in retail may ultimately prove as large as the opportunity we are already pursuing in the office and industrial markets.

As we reported in our recent year-end 2004 conference call, we have released a 10,000 property database covering the Richmond, VA market very recently. Richmond's building count is higher than many of our existing markets because we made the decision to track comprehensive retail data in Richmond and our other expansion markets when we began building the databases last May. We have sold enough monthly revenue in Richmond to cover the current monthly cost of maintaining and supporting the Richmond database.

I recently met with our top seven clients in Richmond after they had had a month to work with our new service. My goal was to gauge their satisfaction with CoStar's service offering. In particular, since we had used a new dramatically different and more thorough research process in launching the Richmond service, I wanted to gauge the effectiveness of this new market opening process. The feedback I received was without exception the most positive I have ever heard in the some 60, 70 markets I have seen opened. I heard comments to the effect that the new service we delivered far exceeded their expectations, that they loved the product, that our customer service was exceptional, and that many of them had already made money using our new service. I would encourage investors to pick up the phone and call people active in Richmond commercial real estate to hear it for yourself.

This marks one of the Company's most successful market launches to date. We expect to release four additional new markets during the course of the second quarter of 2005, this quarter. We expect to deliver eight new markets in the third quarter of 2005 and the majority in the remaining new geographic markets in the fourth quarter of 2005. In total, when this geographic expansion is complete, we believe these 21 new markets will increase our inventory of extensively researched and photographed U.S. properties by 40%.

On April 18, we successfully deployed the largest software release in the Company's history. This major release successfully replaced the 15-year-old back-end research systems that date many of the Company's services -- an upgraded CoStar Property, CoStar Tenant, CoStar's For Sale property offerings and CoStar Connect. We expect this new system to significantly increase productivity in our research operations and ultimately reduce our research cost on a unit basis. We expect that the enhancements we are making to our services will increase our sales and renewal rates.

New features enhancements made to the subscription services our clients use directly include a completely rebuild CoStar Tenant and CoStar Exchange, which makes them -- gives them the same look and feel that our customers already like and are accustomed to in our CoStar Property service. Our products have been optimized to run even faster and be more responsive. We have enhanced the tools for sharing proprietary information that clients store in our system. We have expanded the search capabilities in our services, including new highly detailed criteria options for property and ownership type searching. In addition, we have increased presentation, reporting and preview options to enhance an easier to use print wizard.

We have historically experienced our lowest renewal rates among vendors subscribing to our CoStar Tenant service. Many of them would subscribe, download thousands of sales leads of companies likely to move, and then once they had those leads, they would cancel our service. In our new CoStar Tenant service, we have added dynamic consistently changing Move Lead search that provides vendors with a way to identify those tenants with the highest likelihood of moving and identified those accounts who have moved within a specific timeframe. Since this Move Lead function is dynamic, it cannot be downloaded. Move Lead search could be valuable to a variety of vendors. Vendors such as catering companies, office supply stores and health clubs that serve tenants within a highly defined territory, and they can identify tenants that have moved into their area. Economic development agencies that track movement in and out of different areas can see those trends in the form of the latest moves and plan future moves in and out of their markets. Business that serve traditional real estate services such as construction companies involved in buildout, brokers, moving companies and interior furnishing companies can all target their services to those tenants on the move.

Along with these new software enhancements, we have radically changed the way we present For Sale properties to our customers. Under our previous model, the only people who had access to our For Sale inventory were subscribers to CoStar Property Professional and CoStar Exchange, and they only had access to listings in the markets to which they subscribed. While that local model works very well in the leasing business for us, the investment sales market is national if not international in scope. A potential buyer for a San Diego apartment complex is more likely to come from across the country than from across the street. For the brokers representing For Sale properties, broad exposures for their listings is critical.

In the new release deployed on Monday, we opened up the floodgates on our 60,000 plus For Sale listings. Now everyone who subscribes to CoStar Property Professional COMPS or Exchange has access to our entire national inventory of For Sale properties. That translates into a tenfold increase in exposure for our For Sale listings and dramatically enhances CoStar's competitive position in the For Sale zone.

We believe we will benefit from this stronger For Sale offering a number of ways. First, it will enhance the value we have to offer thousands of smaller brokerage firms. For brokerage firms that do both leasing and sales, CoStar Property Professional and Property Express can now offer them the comprehensive leasing information they really need for the local market and broad national coverage of For Sale opportunities.

For brokerage firms that focus predominately on investment sales, the addition of our entire For Sale inventory to CoStar COMPS greatly enhances the value we offer these professionals. COMPS can now provide them with the two essential pieces of the valuation puzzle. The asking prices on properties currently being offered for sale and verified transaction details on properties that have recently sold. Basically many of these customers previously had to go to several information sources to get these different pieces of information. We believe we can offer them a superior value as a single source provider.

Our new back-end research software system, CoStar Enterprise, is completely integrated with and replaces both our former customer relationship management system and our primary research system. These software systems are used hours everyday by 80% of our 1000 employees. So efficiency gains made in these software systems are very highly leveraged. A large portion of our development team has worked on this system for close to three years, and we have been expensed millions of dollars that the system cost to develop.

The system deployed without a hitch in a 96 hour round-the-clock operation this last weekend. We believe that based upon the strength of this system and other factors our single biggest cost, the cost to maintain each building in our database, will ultimately drop at the same time that our research quality can improve. If our researchers were carpenters, it is as if they are switching from handsaws to power saws. We anticipate that despite the fact that the number of billings we track in 2006 over 2005 will continue to grow sharply, our cost to track them will remain relatively fixed. This creates the ideal situation of potential revenue growth without significant expense growth. In short, we believe that this new system will support CoStar's demonstration of a strong leverage in our earnings model in 2006.

CoStar Enterprise offers at least dozens of advantages over the system it replaces. I know firsthand 15 years ago I personally wrote the software for the first version of the system now being replaced, so I know how much better this new system is.

For starters, the new system reduces the overall time required to train a new researcher. The system has clearer layouts, is more intuitive, and is based upon a number of wizards that closely guide our research through the more common tasks and scenarios. Instead of learning three or four new software systems, the new researcher only has to learn one integrated system.

The new Enterprise system works on a double monitor system similar to a Bloomberg terminal given the researcher an eightfold increase in viewable screen area. In the old system, if a researcher was entering available space on the 11th floor of an office building, the software would only have room to display the information relative to that one specific suite.

In the new system, there is room to show the suite they are working on, while also showing of photograph of the building, a visual color-coded stacking map of the building showing where all the tenants are, a typical floor plan, information on the broker they are updating with and on and on. With all this information immediately and constantly viewable, the process becomes much more intuitive. A researcher can use their minds and really try to figure out what is going on in the building. They could easily spot that the building did not have an 11th floor if that was the case or if there was a tenant that just moved into the same space, thereby making it easier for them to avoid potential errors in the database.

The new Enterprise system transmits data to the user through http, so it is easily accessed from anywhere. Our researchers working in the field or satellite offices report a night and day improvement in system response times and performance for the new system.

In the old system, most of the research assignments were done manually by managers using spreadsheets and handing out reams of paper. In the new system, workflow is completely automated by a color-coded research dashboard and electronic inbox system customized to each researcher and rolling up through the management levels. The new Enterprise system allows for sophistication and efficiency and tasking that would have been inconceivable in the old system. A field researcher operating out in the field in Nashville might enter a piece of information they discover, and it will be automatically tasked to a researcher in Bethesda, Maryland.

Based upon what that researcher finds out and what they do to manipulate that data, the Enterprise system can create intelligently generated follow-up implied research tasks for a researcher in San Diego or, say, Mason, Ohio, research centers that the first researcher may have never seen firsthand.

This opens up the possibility of sending select sub tasks of our research process to the lowest cost research center no matter where it is geographically located.

The number of quality control tasks that used to be handled manually or simply impossible are now automatically and easily integrated into the system. The new system is fully integrated with CTI, our automated intelligent telephone dialing, making it possible for our researchers to make and receive more calls in less time.

In addition, the new system will enable our managers to get critical real-time performance metrics. The system provides the researcher with a host of contact sensitive one click automatic Internet search options. One building in Enterprise can have 100 different Internet links or prepopulated potential searches a researcher could draw on to find valuable data on the property and its tenants on the Internet. This feature alone could dramatically enhance our database quality.

The new Enterprise system has a powerful and easy to use set of tools for handling the millions of building photographs, floor plans, aerials and marketing shots, site plans and other images we must process. We used to rely on a dedicated team of imaging specialists to load images into our databases. With the new system, we have eliminated the need for imaging specialists, and the researchers can directly enter their images into the database in less time than it used to take for them to pass the image off to the imaging specialist. The net impact is that we expect the timeliness of our services to improve, while our unit research costs ultimately decline.

We believe that this new Enterprise system operates more securely with less server cost as well. With this successful deployment, we expect we will be able to eliminate dozens of servers in our data center.

The preprocessing of data we do each night used to take 12 servers 12 hours to complete. Now one server can complete the task in four hours for a 3600% processing improvement.

We designed the old research software system back when we are operating in one city with about a dozen researchers based upon what we knew about commercial real estate back in the early '90s. Now that we have successfully completely reengineered and rebuilt our software systems for where we are today and what we know today, we are just starting out a journey of discovering significant potential quality and efficiency gains. In this new software development environment, we expect our team will be able to evolve and develop our new system at a much faster pace than was possible in the old arcane environment. We hope to fully integrate the COMPS research process into Enterprise by the end of this year and capture those significant potential efficiency gains as well.

In addition, we hope to automate a lot more of the research outreach functions, automated our system so we can reach more potential sources of data, and in the not too distant future, allow our better clients to directly enter their information into our database and thereby potentially reduce our research costs further.

Though this research engineering process has been time and resource consuming, we're very pleased with the final result. The bottom line is we believe that this system will enable us to do a lot more research with fewer resources.

CoStar's aggressive investment into 21 new U.S. markets, Scotland, Manchester, retail real estate, a larger sales force, product enhancements are all now well underway. At this point, we have good visibility into the cost structure associated with these investments. We believe these initiatives will drive new additional revenue growth for years to come. We also believe that with this expanded geography and product type coverage we will reach a much more optimal service level for our best potential clients and create a more defensible scale of operation.

I have highlighted our new Enterprise research system as an example of some of the significant efficiency gains we are continuing to make in this business. At this point in the year, we are comfortable with the cost structure guidance we have given for 2005. Furthermore, outside of equity compensation charges and inflation and acquisitions, we are now comfortable saying that we expect our cost structure for 2006 to stay in-line with the annualized cost structure we expect to reach in the fourth quarter of 2005.

In other words, we saw significant cost structure increases in 2005 over 2004, and in 2004 over 2003, we saw significant cost structure increases. At this point we do not expect to see material increase in cost structure in 2006 over the level we reach in 2005. We believe we will be able to show strong revenue growth in 2006 over a relatively fixed cost structure. Accordingly, we believe we are positioned for enhanced earnings growth in 2006. That is the recognized and proven strength of CoStar's business model.

Over the last two years, CoStar's management team has been focused on expanding the scale of our operations. We believe that by the end of 2005 we will have completed significant progress towards that very important goal. At this point, CoStar's management team is preparing to shift our primary focus from platform expansion to realizing significant cost savings in this business.

At this point, I am going 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 I am going to focus on a discussion of the first quarter of 2005 results as they compare to the fourth quarter of 2004 and also our outlook for Q2 and 2005.

Total revenues grew sequentially by 5.4% overall from Q4 to Q1, increasing from 29.7 million to 31.3 million. Growth for the first quarter was principally the result of further penetration and cross-selling of products coupled with overall renewal rates of 93.6% and the addition of NRB revenue of approximately 475,000 for the quarter.

Subscription revenues for the Company continued to account for approximately 95% of revenues during Q1, and our UK operations contributed approximately 8.7% of the revenue in Q1 as expected. Gross margin increased by approximately $525,000 from 20.3 million in Q4 to 20.9 million in Q1 by a 1.6 million increase in revenues. Margin percentages decreased about 2% from 68.4 in Q4 to 66.5% in Q1 as planned.

Without charges for expansion markets and NRB, which I estimate at approximately 1.4 million in Q1, gross revenue -- I'm sorry, gross margins on the core business revenue would be approximately 72% with some individual markets continuing to experience gross margins in the 80% plus range.

With regard to operating expenses, overall operating expenses increased from 18.1 million in Q4 to 19.8 million in Q1, mainly due to increased sales and marketing expenses. These costs on the whole were consistent with what we expected during the first quarter as we launched full sales and marketing efforts for our expansion plan and held our annual sales training event. We continued to control and leverage our G&A and other operating expenses even with the expansion underway.

As a result of the impact of our expansion cost on margin percentage and higher sales and marketing expenses, our EBITDA, which is earnings before interest, taxes, depreciation and amortization, decreased as expected from 5.5 million in Q4 of 2004 to 4.2 million in Q1 of 2005. Our net income also declined, but principally as a result of the Q4 tax benefit that was recorded.

In the first quarter of 2005, we also reported a net income tax expense of 644,000 which approximates a 40% effective tax rate. This tax charge is essentially a non-cash item due to our loss carryforwards.

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.

Capital expenditures for Q1 of 2005 were approximately 2.4 million, of which 1.5 million was related to our market expansion efforts and the remaining 900,000 for the support of our existing platform. We closed the quarter with approximately 112.9 million in cash, cash equivalents and short-term investments, a decrease of 4.2 million from the end of 2004. The cash generated during the quarter from our EBITDA was largely offset by capital expenditures and changes in working capital accounts.

The overall decline in cash resulted from the purchase of NRB in January for approximately 4.1 million. We continue to believe we have adequate resources to operate under our current business plan, including our current major expansion, and we're in a very strong financial position coming out of the quarter.

Now I will discuss the outlook for the second quarter and 2005. As I mentioned last quarter and as Andy has just described, during the first quarter we continue to ramp up our field and market research in addition to significant investments in sales, telesales and marketing as we move directly into the selling and marketing phase of a planned new market expansion.

As we indicated in our press release, we expect quarterly sequential revenue growth of approximately 4 to 4.5% or approximately 1.3 million of organic revenue growth for the second quarter of 2005. We continue to expect to reach approximately 135 million in revenue for 2005, representing approximately 20% overall growth from 2004 with approximately 19% organic growth.

Sequential quarterly organic growth rates are expected to grow each quarter in 2005 from their current levels as we release new markets and expect to reach approximately 5.5% or more by the fourth quarter. We expect the majority of 2005 growth to continue to come from the existing core markets with the expansion markets expected to add to growth rates in the back half of the year.

We expect fully diluted net income per share of approximately $0.06 for the second quarter of 2005. Our expected results throughout 2005 will be fully taxed at an effective rate of approximately 40%.

As announced last night in our press release, the Company now expects to begin expensing stock options in January 2006 under new guidance from the SEC. Therefore, the Company is raising its previously reported 2005 guidance for net income and EBITDA by approximately 2 million and 3.3 million respectively. We now expect 2005 net income of approximately 6.5 million and fully diluted net income per share of $0.34, which includes approximately 500,000 for estimated equity compensation charges for risked stock grants.

In addition, we now expect 2005 EBITDA of approximately 20.8 million. This implies that we expect sequential growth in EBITDA and net income throughout 2005 despite the continued cost structure increases due to the expansion.

Overall gross margin percentage is expected to remain relatively flat into the second quarter of 2005 based on our assumed revenue growth being partially offset by expected continued investment expansion, which requires a significant ramp-up of staffing and other cost in the research area. Overall gross margins are expected to be in the 66 to 67% range throughout 2005.

We expect operating expenses, including selling and marketing, software development and G&A expenses, to increase by approximately 3 to 4% in Q2 and each quarter for the remainder of 2005 as we expect to continue to invest in sales, telesales and marketing during the rollout phase of planned new market -- new expansion markets. We expect purchased amortization and operating expenses to remain relatively flat over the remaining quarters of 2005.

Finally, we expect capital expenditures in 2005 to continue to include investments in 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 in 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.

Our goal is to complete the ramp-up of the cost structure required to support the planned platform by the end of 2005, and then we expect to return to a relatively fixed cost model at the beginning of 2006. In this model we would expect compensation and benefit cost escalations to be the principal cost pressure in addition to accounting for equity compensation expense. Based on this model, we believe that we will experience gross margin expansion and significant earnings leverage in 2006.

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. We remain focused on our solid organic growth, investment in new markets, retail 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 will open the call for questions.

(OPERATOR INSTRUCTIONS). Brandt Sakakeeny, Deutsche Bank.

A couple of questions. Just as you look at the new markets, what is the timing I guess in terms of any chance that they get pushed a little further back because there is more potential buildings there, or are you pretty comfortable with that timetable as set forth?

The numbers that we just gave for the second, third and fourth quarter this year, which I guess was for (inaudible) and then the remainder in that fourth quarter, those numbers should be very good. Because at this point, we are more than halfway through with these markets. We have actually some number of months ago increased the staff in those markets to accelerate the pace of building adds. So now we are actually getting acceleration in the delivery schedules, not delays. So we feel very good about that.

Great. And how is the pre-selling coming?

Pre-selling is going well. There are really about four markets that we have been pre-selling in. We are just about to launch another wave of preselling into some of the markets they will be releasing in the third quarter. As an example, I think the next market in the queue would be Hampton Roads Norfolk area, and I believe that that market could open with enough presells to cover the cost of operating the market. So it could open at breakeven, which again is a big win.

Okay. And it sounds like, Frank, from your comments that you expect this quarter to be the trough organic quarter as these markets pickup. And I just sort of reconcile we have obviously seen great growth in the renewal rates and a pretty robust market. What is behind the deceleration in organic growth in the past couple of quarters? Is that just the legacy of the salesforce productivity issues in the beginning part of the year?

Well, first I just want to clear a couple of things. One is that we have no or very little revenue from any of the expansion efforts that we have been talking about for probably a year or so just to make sure that everybody does not get confused in terms of when all these new opportunities arise, when this revenue hits. So there is -- what you are seeing in Q1 is almost strictly the core platform producing.

We actually had a little bit of improvement in the total dollars or organic revenue contributed, but of course, as we go from quarter to quarter as a percentage rate, you are on an ever expanding base. So we are working to accelerate the growth rate, as well as the dollar level of revenues added. And if you look at my guidance for Q2, I do expect both an increase in growth rate as well as dollars contributed.

And, again, keep in mind that even in Q2 we are still seeing very little, almost negligible, new revenue from market openings. That does not begin to move the dial substantially until Q3.

Okay and just one final question on the EBITDA guidance. Last quarter you had a slightly different number adjusted for the, I think it was about a $.5 million difference adjusted for the option expense. Any commentary on that figure? I think it was 21 and change versus your number now of 20 and change.

Let me clarify that. There is no change in the EBITDA without equity compensation expense as we presented it in the first quarter. So if you go back to the original outlook, you saw the adjustment in the footnotes for the equity compensation charges.

Embedded in that equity compensation charge was this $500,000 number for restricted stock charges, which, of course, will be accounted for currently. They are not part of this stock option expensing area.

So there has been no change. The revised 2005 outlook reconciles in total to what we presented before. It is just that the $500,000 restricted stock charge remains, and that number of 20 million 750 has a charge against that. And, again, apples-to-apples in 2004 there were no such equity charges either of stock option or restricted stock.

Right. Perfect. Thanks for clearing that up.

Dalton Chandler, Needham & Co.

They got my name right this quarter.

That is exciting.

Yes, it is, the first. I just wanted to verify you do expect now to get all of these new markets open d before the end of this year, is that right?

That is correct. I would say that of the 21 markets it is possible that one or -- I don't know which one -- but I would not say that everyone will deliver to the day by December 31. One could go into January, but we anticipate -- we would say it is more likely that it will all be done by January -- by December of '05.

Okay because I thought last quarter you expected 2 or 3 to be in next year, so this is a bit of an acceleration.

Yes. We successfully deployed a number of additional field researchers in those markets, some earlier in the quarter, and that is picking things up. The pace of building adds is accelerating.

Okay. And then you said that on a net basis your new sales were up 42% year-over-year. Could you try to give us some sense of how that translates into the subsequent quarters, the year-over-year growth?

Sure. I will let Frank do that.

There has been -- what Andy is talking about is sales productivity, and if you drill down into basically how we build the revenue base and look at the net monthly annuity number that gets brought in each month, as Andy described there, there has been a substantial improvement in that number. That number I believe you will start seeing filtering into recognized revenue. There are a number of reasons why you just cannot pick up the financials and say, "We, okay, there is a 42% year-over-year increase."

There are many other factors affecting revenue many things moving the dial. There are other parts of revenue that are not subscription-based. There are advertising revenues, for example. There is foreign currency exchange, fluctuations that move the UK numbers from quarter to quarter.

And additionally, a lot of that sales productivity, and this was actually relevant to Brandt's question earlier, what Andy is talking about is sales productivity not recognized revenue. And a lot of that productivity is being directed toward the new market, so those contracts are being backlogged, and that is part of what we expect will move the dial as we get out into Q3, Q4.

So we're encouraged that we're seeing the sales numbers hit the board from a recognized revenue standpoint. We can only bill for the markets that are open, and that is to some degree putting a muffler on the recognized revenue versus the productivity.

Right. So a salesperson could sign up a $50,000 annual contract with Hampton Roads, but it could be six months before we actually are able to install that product and recognize the revenue, and that is what's going on in '05.

Okay and a final question. In your K, you said you had about 700 researchers. Given that you are going into new markets, but at the same time you deployed this more efficient software platform, how should we expect to see that number change over the course of 2005?

I believe that number will continue to grow on plan through to the fourth quarter of '05 as we bring on more markets and bring on more retail and more For Sale. We are seeing a dramatic increase in the number of buildings in the system.

Where you start to see it level off is we think we don't expect, even though the number of buildings in the database will increase again in '06 dramatically, we do not expect to see a corresponding increase in researchers as you go into '06. So --

So where do you expect to end this year?

I believe it is somewhere around 800, about 800. And you know our goal is to bring -- the wish list is to bring the number down in '06, but right now we're saying we don't anticipate it to growth.

Just to give you an overall idea of what is driving the expense ramp-up, the overall headcount in the plan is rough numbers going from the beginning of the year around 1000 to the end of the year, December of '05 where we are between 12 and 1300. So that headcount ramp-up, largely in research and field research, is what is driving the cost ramp-up. Obviously a large part of that is in cost of sales.

So getting back to the issue of ramping up costs and then getting back to our fixed cost model, we are ramping up that headcount to service the platform, and then we expect that headcount level will stabilize. And as you know, when we hit that cycle, that is the biggest cost driver, the headcount number. We feel pretty good about getting to a point of 1200 to 1300 people in the organization.

Brandon Dobell, Credit Suisse First Boston.

(multiple speakers). I mostly want to focus on the cost side of the business from two perspectives. One, as you roll into new markets looking at adding the buildings in retail and commercial, how have the costs gone relative to your expectations, and can you give us some color on how to think about cost to now add a building versus where you were a year or two ago perhaps?

I kind of want to get a better feel for as we look out towards the end of the year and maybe, Frank, to your comments for '06, how we should think about the new platform impacting that cost structure for either retail or commercial?

In adding a new building, there was a major upgrade of technology we used to add new buildings, that we built in the later part -- in the middle of '04, beginning the summer of '04. That took the cost of adding a building from what had been two or three years prior somewhere around $75 per building to somewhere around $45 per building. So it was a pretty dramatic decrease in the cost to add each building.

The cost I think is continuing to decline just because our field people are becoming more experienced and are just moving at a slightly faster rate.

But the big change now should be the cost to maintaining a building should begin to start declining again with the deployment of a new Enterprise system. So where we had been seeing it cost about $25 per building per year to maintain a building for one core product, we think that number will be coming down. And the good news is the number of buildings are going up dramatically. You know we control our cost but grow buildings, which appears to historically be associated with revenue growth. So we like the mix there.

The new Enterprise system we have just deployed is step one of a major cost-saving initiative. And I would anticipate five additional major efforts that you see in the next two years. So we are very focused on looking at every single keystroke in maintaining building information and building adds and every single process and trying to engineer a higher quality out of the process while squeezing those costs down. And so that is really going to be a primary focus for us over the next two years, and I hope to be able to report real results there, if not every quarter, every other quarter, over the next two years.

Okay.

Did I answer your question at all?

Yes. Shifting gears a bit, in the past you guys have talked about the DC market as being a pretty good boogie for what you think the rest of -- not the rest of the markets, but some markets could look like from a penetration perspective or customer mix. I wonder if you could give us any other markets that are either getting to that point that feel like they have the opportunity that you have seen good growth from where we might think, hey, they have been around for five or six or seven years and should have kind of topped out.

Just to get -- I think you guys focus so much on New York and Washington. Is there other places that we can look to try and get a better feel for how things are turning from a same customer growth perspective?

Absolutely. Frank, you've got the numbers right there in front of you.

I've got numbers market by market. First on the revenue side, DC, which we think of as you said, you know that is the model, and that is a very mature market. I look at trailing 12-months growth for this quarter in the 15% range. So, you know, it is a very solid performance for what you think of as a very mature market.

But then I moved to New York, equally as mature, and for trailing 12 months, I'm looking at 21%. And, of course, it is lumpy from quarter to quarter. It depends on the productivity (multiple speakers).

If you go to a market like Atlanta, maybe not quite as mature as those two maybe but clearly what we would consider a mature market, they are in the 25% range for trailing 12-months growth. So it has just been an astounding market, again, for one that has been considered mature for quite some time.

You can look at markets of all different shapes and sizes. Philadelphia was historically a market that took a long time to get going, but now most recently had 22% trailing 12, Denver 25, and you know there are some lower ones because it is lumpy from quarter to quarter, and each market produces whatever it does and kind of inches along.

But the cost structure in the Philadelphia, even with that growth rate, is relatively fixed or declining while the revenues are growing.

So you look at it -- you move it to the profitability side, you're looking at many of those more mature markets that are on a four-wall basis throwing off in the 60, 70% plus range in terms of four-wall EBITDA before corporate allocations. And then even after allocations, many of the markets 30 to 40% range.

In fact, one of the things that is happening is we leveraged the overhead against all these new markets, is that the drag in fully loaded profitability on mature markets is diminishing. Just a natural mechanical phenomenon. I mean we are going to open 20 new markets, leverage the overhead so the share that Denver or Dallas or San Diego is getting starts to reduce.

And at the same time, you have probably noticed that the G&A actually was relatively constant, while the profitability in the existing markets is continuing to increase.

And that G&A -- we would look to try to keep that G&A pretty stable. We get a lot of leverage there. Selling and marketing obviously we're in a very aggressive time period in terms of marketing programs, salesforce and expansion and activity. So that is where we are spending more of the operating expenses.

Kind of implicit in those comments I guess, guys, would be that there's a decent number of markets that are growing at well below the overall average seeing '05 is 10% or something like that? You mentioned Philadelphia it took a while to get going. It is now showing a better growth rate.

What kinds of things keep markets from growing at the corporate average or better? Is it a timing issue? Is it the types of customers in that market? Is it a salesforce issue? I'm trying to get a feel for how those -- I could drag those up to the average or better.

Well, historically I think -- Frank is looking at it, but I'm unaware of any markets that are, frankly, real dogs.

I think what it is is that it jumps around. I mean if you look at Houston, for example, was pretty flat last quarter, which is not -- that happens from quarter to quarter. It can be based on where the customer cancellations are occurring. It can be based on sales staffing. Those are some of the factors as you mentioned that could happen in a market.

Particularly in a smaller market, I mean your sales staffing is critical. If you have two salespeople and you lose one, you know you cut the potential productivity in half. So it makes a big difference in the short-term. But if I go back to Houston, I mean historically it has been a phenomenal grower. I think we bought it in -- I think we bought it in '99 through acquisition, and it was doing (multiple speakers). So Houston is now doing between 8 and 900,000 a quarter. So it has been a phenomenal grower. But again this is the way when you look at our overall growth rate it is made up of many granular (multiple speakers) that are moving sort of moving (multiple speakers).

Anecdotally looking over Frank's shoulder, there are basically about three markets that are just below 10% growth rate. And then most of the markets are hovering around the 20% number. And those three that are hovering just below the 10%, it is more a timing anomaly.

So a market like Houston or Pittsburgh are great markets for us, and all it takes is one contract, one major company to merge in a given quarter, and then you can get your growth rate pushed down. So there are a lot of external factors that can cause noise. But long-term those are all great markets.

I'm actually quite happy with the fact that there is no market out there that is a real underperforming problem at this point. Probably Atlanta two years ago was an underperforming market. Now it is one of our strongest markets.

Jim Wilson, JMP Securities.

Two questions and just a follow-up. On the gross margin side, as you look forward over the next couple of years and I know we have been talking a lot about revenue per city or revenue growth rates per city, but I don't know maybe Frank or Andy your thoughts on how margins of the newer markets might or could compare, and over what period of time to some of your strongest, most mature or large markets at this point?

I think that many of the markets will open with breakeven or positive to the margin line. We expect acceleration to be dramatic because in those new markets generally day one they open with the cost that they are required to have to run that market. So you are going to see in the smaller markets an extreme version of leverage. Any newer market is going to have dramatic leverage, of course, because you're going to start with a very small base of revenue, and everything you grow is going to have extremely high incremental profitability.

So I think the gross margin market by market continues to expand for the core markets. I think it is going to be rapid in the newly opened markets. But again you know we watch and we look for three or four quarters to see if they are making great progress, and I expect they can.

On an overall basis, as you saw and as we put out there last quarter, we had margin pressure, and that is the result of rapid ramp-up, particularly with headcount in the research group to service this new platform. So you saw a couple hundred basis points decline. It is going to stabilize I think for the rest of the year because although we continue to ramp up, we're also growing revenue from principally the core markets, so you get a stabilizing on margin.

When we get into 2006, I believe we will get into a zone where you will have a tremendous leverage again on that margin line, and you're looking at more mature markets with gross margins in the 80% plus range. So I think there is a lot of room to grow margins as we get out into 2006.

Only one other question. Any further thoughts or maybe you will defer this to later this year as to changes you might make to stock compensation strategy as you go into '06?

Well, I think that you probably have seen some changes already in terms of restricted stock grants that were made, and you know you are seeing the accounting for that. Those are obviously from an accounting perspective much easier to value and to deal with than what has been put out there in terms of a stock option accounting in those models. So I think that we are doing some things, and also it's an ongoing discussion in terms of what -- not only the accounting issue, but what the appropriate compensation strategies are for people throughout the Company.

John Neff, William Blair.

Two questions for you. First, can you give me -- give us a sense of how much you have been spending internally over the last three years in developing the new Enterprise software system, and what might be the order of magnitude of the drop-off now that it is in place?

And the second question actually refers to the nonsubscription revenues just are actually slightly down year-over-year. It does not sound like from the numbers you gave earlier that it has to do with advertising sales revenues. But what is going on with ad hoc revenue?

I will answer the second question first. I think in January there was a decline in ad hoc COMPS revenue, which from time to time you see some volatility there. So basically less buildings sold in December or less buildings were For Sale in January around the United States. And often it is geographically seasonal. So there was a little bit of a decline there. We can tweak our pricing around there and try to re-energize that, but it is relatively stable.

Also, we have talked about the fact that we -- in the last conference call, we talked about a major new product that we might be able to talk about in the next conference call, which is that customer relationship management software system that overlays over our data products. That is a successor product to the old desktop shrink-wrapped Arie (ph) software program we used to sell.

We made the decision to completely stop selling the old shrink-wrapped system maybe a quarter or two ago. So that revenue disappeared completely, and that is just trying to good faith for the customers not be selling the old system right before the new system comes out. So that is what that is.

Now to answer the question on Exchange, I would think that the investment in Exchange over the last several years and the related back-end or the related data structure changes in our products, the cost on that is in excess of $10 million or somewhere in that neighborhood. I really do not anticipate our software development cost structure going down after the release, and that is because at this point those dollars invested in the software initiatives are highly leveraged over the size of our operations now. So getting a 10% efficiency gain over our research department can basically equate to creating 80 bodies of cost savings with a 10% -- and, John, it is permanent.

So we actually have a number of things we think we can still do in our products and our back-end software that can continue to create cost savings. So you will see a relatively constant software development line there.

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

Well, we would like to just thank everyone for joining us for the first quarter of 2005 conference call, and we very much look forward to reporting progress on our market opening initiatives and the retail initiatives as we come into the second quarter of 2005 conference call and hope you will join us there.

Thank you for participating in today's conference call. You may now disconnect.