CoStar Group Inc (CSGP) 2005 Q3 法說會逐字稿

Welcome to CoStar Group’s Third Quarter 2005 Conference Call. Today we have with us Andrew Florance, President and CEO, Frank Carchedi, CFO, and Henry Stoever, VP of Marketing.

All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. If you would like to ask a question during this time, press star and the number 1 on your telephone keypad. Thank you.

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

Thank you. Before I begin, I want to introduce you to Henry Stoever, our Vice President of Marketing. Henry comes to us from Nextel, where he was Senior Director, Industry Marketing, and led a team of marketing professionals in support of Nextel’s $8 billion private sector business. His team developed and implemented targeted value propositions for nine industry marketing segments, including real estate and financial services among others.

Henry has a proven track record in senior marketing roles in three diverse industries - Blue Chip Consumer Packaged Goods at Kraft, Information Data Services at LexisNexis, and Rapid Growth Cell Communication Services at Nextel. Henry has a Bachelor of Science in Economics from the U.S. Naval Academy, an MBA in Marketing Strategy and Finance from Kelloggs School of Business at Northwestern University. I am very pleased to welcome Henry and now will turn the call over to him.

Thank you, Andy. Good morning to all of you on the call. As Andy mentioned, I’m the Vice President of Marketing and I joined the Company about three weeks ago. I’m actually thrilled to have been able to transition from one great company to another very dynamic, high-growth company.

Before I turn the call back over to Andy, I’d like to set the stage for the call that we’re going to cover this morning that includes a few forward-looking statements, which involve many risks and uncertainties that can cause actual results to differ materially from such statements. Important factors that can cause actual results to differ materially include, but are not limited to, those stated in CoStar’s Third Quarter 2005 Press Release and in CoStar’s filings with the SEC, including its Form 10-Q for the quarter ending June 30, 2005, 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 costar.com/Corporate/Investor for a webcast of this conference call. Now, back to Andy.

Thank you Henry. Welcome everyone to this third quarter 2005 conference call. We are pleased to report a quarter with solid revenue growth and stable earnings. Our revenues for the third quarter of 2005 were $34.3 million, an increase of 4.4% from the second quarter of 2005, and a 20% increase year-over-year. Core U.S. subscription revenues had very strong growth, with an increase of 5% for the third quarter over the second quarter of 2005.

The Company had EBITDA, Earnings before Interest, Taxes, Depreciation and Amortization, of $3.7 million and net income of $1.1 million or $0.06 per share for the third quarter of 2005. These earnings results include our one-time $2.2 million restructuring charge associated with cost savings from the closing of our Mason, Ohio research center.

We end the third quarter with $124.8 million cash, cash equivalents, and short-term investments for an increase of $11.4 million over the second quarter’s cash position of $113.4 million. We have no material debt. Frank Carchedi our Chief Financial Officer will address the third quarter 2005 results in more detail later in the call.

I would like to highlight some of the trends we are seeing in our business and update you on the progress we are making with the aggressive growth plan we are currently pursuing and have laid out for you in previous calls.

Our sales team set a new high mark in our core U.S. subscription-based sales in the third quarter. We sold $5.8 million in U.S. net new annualized subscription revenue in third quarter of 2005, for an increase of 53% over the $3.8 million sold in the third quarter of 2004. The $5.8 million sold in the third quarter is an increase of 7.6% over the $5.4 million sold in the second quarter of 2005.

Year-to-date we have sold $16 million in U.S. net new annualized subscription revenue, an increase of 49% over the $10.7 million sold in the same period of 2004. September 2005 was our highest U.S. subscription sales month ever, with net new annualized sales of $2,080,000. These are very strong increases driven by, among other things, a larger sales force, a lower sales force turnover rate resulting in a more experienced field sales force, new expansion market opportunities, and institutional sales opportunities for our national data.

The annualized value of the average new contract year-to-date is $7,757, up slightly over the average value of $7,698 in the same period of 2004. The average annualized value of a new contract rose again the third quarter of 2005 to $7,885. That is the new contract value. The average contract value would be significantly higher.

52% of our sales growth in the quarter came from signing new customers in contrast to selling additional products to existing customers or price increases. We signed 511 new customers in the third quarter, up 51% from the 338 new customers in the third quarter of 2004. Year-to-date we added 1,510 new customers, up 56% from the 968 new customers added in the same period of 2004. The 511 new customers added in the third quarter is down slightly from the 538 new customers added in the second quarter of 2005. We believe we are well positioned to increase well beyond the 538 new customer level in the coming fourth quarter and there is a reason behind that, and I would like to give you a little color on that.

In the beginning of the third quarter, we initiated an aggressive marketing campaign offering 18,000 prospective new buyers of CoStar Property a 90-day free trial offer. We offered trials to prospects within our core existing markets only. We did not offer trials to prospects in any of the expansion markets. We were very pleased to experience a nearly 20% response rate on those 18,000 offers. More than 3,500 people responded to and accepted the offer.

As you can imagine, delivering even basic training to that many respondents in such a short time period was challenging, but at this point we have more than 700 prospects in the trial categorized as “heavy” product users. These 700 prospects represent 573 different firms. These pre-trial users will lose access to CoStar Property November 1st, and we believe that many of them will want to continue accessing our service and represent excellent prospects to become new clients in 2006, if not, in the fourth quarter of 2005.

The sales force devoted very significant time and effort to initiate these 3,500 trials, leaving less time to sign new business during the third quarter, despite the fact they had a record quarter in the third quarter. But it is our belief that their efforts in the third quarter will pay off and yield a much heavier than normal pipeline in the fourth quarter, positioning CoStar Group for strong sales in the fourth quarter of 2005 and high new customer counts.

We believe we are continuing to enjoy some of the highest levels of customer satisfaction we’ve ever experienced. This is evident in the increased usage we have seen of our subscription services. Average weekly page views in U.S. CoStar web services surpassed 8.4 million in September. Usage at the end of September was up approximately 40% from the same period in 2004, and up 31% over the first week of January 2005.

Usage of our for-sale products in third quarter 2005 has increased by an astounding 300 to 500% over January 2005 -- the first week of January 2005. We have enhanced this for-sale product for our customers by upgrading the for-sale software and switching from licensing only local data subscribers to licensing national for-sale data to all of our customers.

As a result of our greater audience for for-sale listings, brokers are sending us an ever increasing number of listings. The Company has seen unprecedented growth in the number of commercial properties listed for sale on the Company’s website this year. As of January 1, 2005, the Company had approximately 53,000 properties listed for sale in the United States. That number soared 61% year-to-date, with 85,200 properties listed for sale currently. For the markets CoStar covers, the Company believes it now has the most comprehensive real estate for-sale listings database in aggregate of any information service.

The satisfaction level among our existing customers as measured by renewal rates also continues to grow. The renewal rate for CoStar subscription services increased from approximately 91.2% in the third quarter of 2004 to approximately 93.2% in the third quarter of 2005.

With the acquisition of the retail customer-- with the retail/commercial real estate information service NRB earlier in January of this year, CoStar Group has initiated a major product expansion into retail real estate. We have begun the process of integrating the acquired NRB information into the CoStar database and expect to complete the basic integration into CoStar Property within the next three to four weeks. That milestone alone will represent a significant upgrade for our existing customers.

A significant percentage of our software development teams are now working on a number of important initiatives to produce a very compelling retail real estate product offering through our CoStar Property product line. We hope to report more on these initiatives in our year-end conference call. We expect to complete a high-end retail real estate offering that truly meets the needs of major retail players by the May 2006 ICSC conference. The ICSC, being the International Conference Shopping Center, honors a 40,000-person attendant conference in Las Vegas in May of 2006.

Approximately 18 months ago, CoStar Group field researchers began photographing, measuring, and detailing thousands of new buildings as part of our plan to aggressively expand our geographic coverage of commercial real estate in the United States into 21 new markets. Since the expansion program began in May of 2004, we have visited and photographed approximately 227,000 properties in those 21 expansion markets. We are now in the home stretch of our expansion market canvassing. We believe we have completed in excess of 90% of the canvassing in these new markets to facilitate strong product delivery.

When we began the process in the last year -- last year we produced 4 x 4-foot aerials for each of these 21 new markets, and on those aerials we plotted out hundreds of thousands of red dots indicating potential buildings we needed to inspect. We wallpapered an entire hallway, about a 100-foot hallway just outside my office, with these aerials with a sea of red dots. Each month we have updated those aerials, and as we inspected buildings, we would turn the inspected buildings from red to green. Today, a million miles later of driving through those markets, those aerials down that hallway are a sea of green dots indicating completed inspections. To see it is really to understand what an impressive task it is. My hat is off to our field researchers and the field management team who have turned in an outstanding performance.

Our field research teams are now transitioning towards our goal of broadly expanding our coverage of U.S. retail real estate. Within the last two quarters, our field research teams have already photographed more than 21,000 shopping centers from our acquired NRB database. These will be added to the 35,000 shopping centers we already have in our databases. Our total retail database is actually much higher than these numbers if you include standalone retail properties.

Returning to the expansion markets, we have delivered service to 6 of the 21 new markets since the beginning of the third quarter of 2005. The most recent expansion markets we have opened are Greensboro/Winston Salem, Greenville/Spartanburg, Providence, Salt Lake City, Toledo, and Tulsa. CoStar is reporting on 66,000 properties in these 6 new markets, with 1.26 billion square feet of building area and with 109 million square feet of space available or for sale. In total, CoStar has delivered 14 new markets within the past year with more than 122,700 properties combined and more than 2.6 billion square feet of building area. Those 122,000 properties have approximately 0.25 billion feet of availability.

The Company is focused on insuring that each market delivered meets the highest standards of quality, even if that should mean slightly more pre-release research work. As a result, 2 of the markets slated for delivery in the third quarter of 2005 have been pushed back into the fourth quarter. We are very pleased with our results and the reception we have received in these expansion markets to date and we are determined to make the best first impressions possible, even if it is at the expense of a few weeks’ shift in timing. We have compared our databases to alternative sources in each of these new markets, and we believe that by a very wide margin CoStar’s databases are the most comprehensive databases available in each of these new markets.

At this point, we still expect to open 3 to 5 new markets in the fourth quarter of 2005. In total, we have signed 175 new companies in the course of the last 15 months in the 21 expansion markets. Since the start of the third quarter, the Company signed 63 leading commercial real estate firms in the expansion markets.

Expansion market customers include such top firms as Advantis/GVA, Carlson, CB Richard Ellis, Coldwell Banker NRT, Colliers Arnold, Cross & Company, Commerce CRG, NAI/Rhode Ottmers & Siegel, Staubach, Trammell Crow, and Transwestern Commercial Real Estate Services, and many others too numerous to name. Overall, we are very pleased with the acceptance and adoption of our products in these new markets. At this point, we believe that the vast majority of the new markets will be a financial success.

While the majority of our revenue growth and revenues are still coming from our original core markets, we believe that these 21 new markets will be long-term growth drivers for CoStar Group. In the aggregate, we expect the 21 new markets will be cash flow positive by the second quarter of 2006. We very much look forward to updating you on our progress towards that goal at our year-end conference call.

At this point, I’ll turn the call over to Frank Carchedi, CoStar’s Chief Financial Officer.

Thank you Andy. Today I’m going to focus principally on a discussion of the sequential comparison of the third quarter of 2005 results to the second quarter of 2005 and our outlook for the fourth quarter of 2005.

Total revenues grew sequentially by 4.4% overall from Q2 to Q3, increasing by over $1.4 million from $32.9 million to $34.3 million. The growth for the third quarter was principally the result of continued solid growth in our core U.S.-based subscription revenue combined with our continued high renewal rate of approximately 93% for the quarter. We reached a 5% sequential growth rate in the core U.S. subscription revenue area. This growth rate has been accelerating slightly each quarter throughout 2005.

However, non-subscription areas such as ad hoc survey fees and advertising, which account for only 5% of the total revenues, came in lower than expected, affected in part by slower summer activity. Volatility in this area reduced our overall growth rate.

Additionally, we lost some ground to exchange rates as U.K. revenue, which continued to grow sequentially in pounds although slower than at the U.S. rate, actually declined as measured in dollars. Total subscription revenues for the Company continue to account for approximately 95% of revenues during Q3, with our U.K. operations contributing 7.9% of total revenues. We continue to believe we have significant revenue opportunity in new markets, which have not yet begun to significantly accelerate overall revenue growth.

Gross margin increased by $1.3 million on the $1.4 million increase in revenues. Margin percentages increased from 67% in Q2 to approximately 68% in Q3, while some individual markets continue to experience gross margins in the 80%-plus range. Some of the increase in margins is attributable to immediate savings from the closing of the Mason, Ohio research center.

With regard to operating expenses, overall operating expenses increased by $1.5 million from $20.8 million in Q2 of 2005 to $22.3 million in Q3 of 2005 due to a $2.2 million restructuring charge associated with the closing of the Mason, Ohio operation during Q3, which was somewhat offset by lower selling and marketing expenses.

Selling and marketing expenses decreased during the third quarter of 2005, compared to the second quarter when we had costs relating to the seasonal ICSC trade show participation discussed on our previous call. Software development costs were relatively flat, and G&A was up slightly but did not vary significantly as a percent of sales.

Our EBITDA, which is Earnings before Interest, Taxes, Depreciation, and Amortization, decreased $500,000 from $4.2 million in Q2 of 2005 to $3.7 million in Q3 of 2005. This result included the $2.2 million restructuring charge from the Mason, Ohio closing. Without that charge, EBITDA would have increased 40% in a single quarter to almost $6 million.

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 Q3 of 2005 were significantly lower than expected at approximately $1.7 million, of which $1.1 million was related to our market expansion efforts and the remaining $600,000 to the support of our existing platform.

We closed the quarter with approximately $124.8 million in cash, cash equivalents, and short-term investments. We continue to maintain a strong balance sheet and financial position as we enter the fourth quarter.

Now I’ll discuss the outlook for the fourth quarter. As we indicated in our press release, we expect quarterly sequential revenue growth of approximately 4.5% for the fourth quarter of 2005. During the fourth quarter, we continue to expect accelerating sequential growth in core U.S. subscription-based revenue of over 5% from the third quarter of 2005, while we anticipate non-core revenue to remain flat or possibly decrease slightly.

We continue to believe there is significant upside revenue growth potential from growth in sales force size and productivity, particularly in view of opportunities resulting from momentum in established markets, continued new market openings, and in 2006 from the retail product offering.

For the fourth quarter 2005, we expect fully diluted net income per share of approximately $0.15, slightly higher than our original expectation.

Overall gross margin is expected to decrease slightly in the fourth quarter of 2005, based on our continued ramp up of our research operations related to our retail and market expansion and replacement of Mason, Ohio capacity. We continue to expect a 10% total increase over two quarters in the cost of sales amount to support the planned platform. We previously expected that ramp up to be completed by the end of 2005, but now believe that it will be completed during Q1 of 2006. Also, we expect operating expenses, including selling and marketing, software development, and G&A expenses to remain relatively flat over all in Q4 of 2005.

Finally, we expect capital expenditures to continue to include investments in assets required to support our planned market and retail expansion, including additional field research equipment and building photography, totaling approximately $1 to $1.5 million for the fourth quarter of 2005. In addition, as third quarter 2005 capital expenditures were somewhat light, we expect approximately $1 to $1.5 million of capital expenditures for the fourth quarter to support existing operations, slightly higher than usual.

In conclusion, organic growth remains solid and we believe substantial upside exists in growth at high incremental margins for both existing and new markets. Investments in new markets and retail continue, growing the cost structure as planned as we move toward full coverage of the platform. We continue to experience earnings growth even with the ramp up of operations, and in the longer term we expect more leverage on earnings as our cost structure stabilizes. We look forward to reporting our progress to you.

With that, I’ll open the call up for questions.

[OPERATOR INSTRUCTIONS]. Your first question comes from Brandt Sakakeeny with Deutsche Bank.

Thanks. Good morning Frank and Andy. Question for you. I guess in looking at some of the larger clients who have signed for the new market, is there any way to give us a sense for say a percentage that they’re paying on top of existing contract values? So if CB Richard Ellis were paying let’s say $5 million or something, how much are these new guys paying for these new markets and is it generally in line with your expectations?

I would say the majority of the selling activity in these new markets or a significant percentage of selling activity in these new markets is actually to new firms. They may be affiliated with some big names, but they are often separate equity structures. But to give you a general feel for it, I would say that a major national that has an affiliation in let’s say Richmond, Virginia or Salt Lake City or the like, they’re going to be paying a comparable additional number in that market to what they’re paying on a per market level already. So it’s very much in line with what they’ve been paying per unit in the past, and we’re fairly pleased with that and we’re being very consistent in our pricing on these new markets. We are very carefully researching the firms ahead of time and making sure, and we’re not really engaging in a lot of negotiation. We’re doing the [Saturn] sort of negotiation.

It seems like if just a small fraction of those-- I think you said it is maybe 3,000 folks who have expressed an interest and are doing the free access right now. If you can converge just a fraction of those, it looks like the fourth quarter growth could be substantially better than maybe the 4.5% that you’re forecasting. Is that a fair assessment or are we more likely to see that in the first quarter of ’06?

Well, there you get a chance to split up Frank and myself.

We’ll give you two answers.

There is no question that the third quarter we did some investing beyond the third quarter with our sales force, and we feel good about that. We could have offered a 30- or 60-day trial and tried to capture some of the benefit of that effort in the third quarter, but we decided it was really better for the marketing program to go with 90 days, which put the turn-off date into the fourth quarter, which is where you would expect to see the benefit of the trial in new customer sign-ups.

Again, the number of people in play at this point according to our sales force is in excess of 500 firms, and I would hope to see a number of that additional-- amount of that additional business come into the fourth quarter, but I really think it should be viewed as a 6-month benefit not just a 2-month benefit. So, people may have been using the product every other day for the last 90 days, and when it turns off November 1st, they may sign up immediately. But I think a larger number of them will come to miss the service over 6 weeks later, 8 weeks later, 3 months later.

But overall we are very pleased with the program and it actually exceeded our expectations. You don’t normally look for a 20% response rate to a direct mailing campaign. So, in the future, we would like to use the tool some more, but we’ll probably run smaller trial sets just because of the high response rates.

Okay. Great. Thank you. Do you want to add anything or is that sort of a reconciliation of the opinion?

Well, just to reconcile about your question about the guidance versus what Andy is saying so you don’t think that we’re fighting, a lot of the numbers that Andy gave-- and when he is talking about the sales force activity, he is talking about productivity and looking at new contracts that are gained on a month-to-month basis. So as we sit here in October as that productivity kicks in, from my perspective and the numbers I’m talking about being recognized revenue, as those new contract dollars filter into the contract base, they ultimately have to be installed and we begin billing. So as we’ve spoken many times on the call, there is a delay in seeing those numbers in recognized revenue versus sales productivity for a quarter or a month.

Okay. No, that’s a fair point. I guess just a final question is on the for-sale listing properties, it looks like you saw some good growth there. How do you monetize that? Do you get paid on a per listing or when the sale is completed, and how should we think about that business going forward?

Well, the product is bundled with our CoStar Property and CoStar Comps subscription services. So as that product improves and as the number of for-sale listings grows dramatically-- it’s an area where we have historically not been viewed as the absolute market leader-- and as we move into a leadership position in that market, it should drive overall sales numbers and drive, if it’s possible, a slight increase in our renewal rates off the 92% renewal rate level.

The other thing is it is an important product to support our very strong comparable sale product. If we know all about a building well before it sells, if we are able to photograph it, visit it, capture income information, map it out, and do a lot of research on the building before it sells, that means that at the point it sells we can produce the comparable sale report on that building much quicker at a much lower cost. So it has the very important benefit of strengthening the quality of our comparable sale product while reducing the cost of producing the comparable sale.

Okay. Great. Thanks so much.

Your next question comes from [John Nash] with William Blair.

Hey guys. A question I’ve got, sort of, I was going to ask the monetization question of the for-sale listings, but is there any chance that those listings are in some way cannibalizing or affecting the faction of the ad sales?

No. It would be fairly different. The ad sale numbers, traditionally, it’s very difficult to-- it’s a little more difficult in the second, later part of December and August to sell ads. No one wants to sign a contract in August when they perceive, generally incorrectly, that the whole market is gone in August. So I think that’s what you’re seeing there. The for-sale listings, people normally do not purchase advertisements on for-sale listings. They purchase advertisements for for-lease listings. This is the way the industry works. It’s tradition to aggressively market lease space and you keep for-sale space close to the [vest], and a building would be viewed as tainted if you advertised it if it were for sale. You would look too desperate if you had to run an ad for it if it were for sale.

So I think really what it is is just reflecting this growth-- because we’ve got a much bigger distribution now, and I would say it is completely separate from the advertisement area. One benefit is if you get a lot more people coming to your website and a lot more usage, then you have more eyeballs. In the long term it should increase ad sales not decrease it.

Okay. Right. And then the other question, it looked like the field sales had kind of dropped a little bit sequentially, continuing to see that ramp in telesales growth. Can you talk about the relative productivity between the two groups?

Sure. The field sales force at this point is-- as you know, the turnover rate has come down to a pretty low number in the field sales force, which means-- and we’ve been holding that low turnover rate for more than a year now-- which means that the field sales force now is a very strong group. They are much more experienced than we’ve ever seen before. So they know what they’re doing. It is a strong group with high productivity and very few low performers. So we’re very happy with that number and what they’re doing out there.

The inside sales group is growing rapidly, as you know, going from 2 two years ago to today somewhere around 34 people, so that’s pretty rapid growth. That group is much more junior and is climbing the productivity curve. The people who have been in the inside sales group for more than a year are at comparable productivity with people in the field, but overall the productivity in the inside group is lower just because they are rookies, generally speaking on average.

We’ve got a good blend now. We have a disproportionate number of our new customers coming from our inside sales group and we have our bigger contract numbers coming from our field sales group. So it is settling into a nice blend, and we’re going to continue to grow the inside group and we have no intention of really reducing the field sales group at this point.

Okay. Great. Then I guess just sort of the big, sort of broad question for the quarter I guess would be when you talked earlier in the year about expecting, and I think this applied more to the total revenue line, a little bit of a pick-up in the sequential rate of revenue growth as we moved into the back half of this year. It has been fine and fairly steady, but why--? Looking back now, why hasn’t that acceleration in sequential growth in total revenue materialized the way you maybe thought it might at the beginning of the year?

I think the acceleration in U.S. subscription revenues is occurring. We are seeing a very consistent, strong trend in growth in what’s coming in each month and new subscription contracts. You still have the noise factors and you have some delays when we’re delivering to some markets and seeing recognized revenue and expansion. The noise factors include when we’re actually seeing the recognized revenue. U.K. exchange rates in real, in U.S. dollar terms are revenue in the U.K. declined over the quarter even though they had positive sales and were growing.

So you’ve got that working against you and, again, more seasonality than expected in the advertising sales at the end of the summer, and also some noise in our one-off purchases on our website. As we have strong, comparable sales, subscription sales in our comps product, we’re seeing a little bit of leveling in the one-off purchasing of comps on our website. As well as, if you have a decline in the number of properties being sold, any one month or every other month you’ll have less appraisals and you can get some fluctuation there.

So it is a story of a very positive trend of what’s going on here in these 21 new markets and it’s a very positive trend of what’s happening in productivity in our sales force. We’re very happy with it. We wish that the noise factors didn’t align in the quarter to tweak it down a half a point, but it did, but big picture the trends are going the right direction. The things that mean something, which is the trending in the U.S. core subscription revenue, that’s going in the right direction.

Yes. John, that core U.S. subscription base is about-- it’s so important because it’s about 86% of the total revenue. It’s also where basically the vast majority of the growth focus is. And so it’s critical that that is the part that is accelerating, that the productivity and the numbers are going to get higher there, and that we’re having successes there. These other volatile areas, they can also go the other way. They will flip back and forth in terms of their contributions, their revenue, and their contribution to growth rates.

So if you want to talk about keeping your eye on the ball, I mean the U.S. core subscription area is the critical one that we’re looking at. And I think there is continued opportunity for the new markets, many of which have been recently released, they continue to be released, to contribute in a bigger way to that U.S. core and then, of course, all the other opportunities. As you and I have talked before, regardless of those opportunities, we still have to look to the sales force in terms of size and productivity, and I think there is continued significant capacity for opportunity to grow the size and the productivity of that sales force.

Thanks. Frank, if you’ve got them handy could you give us the year-to-date sequential growth rate of the core U.S. subscription revenue growth?

I don’t know if I have it quarter by quarter, but if you go back to Q4, I was just looking at that this morning. Q4 of 2004, the growth rate there was 3.7% and it has increased steadily quarter by quarter and was 5% in Q3 of 2005.

4.9%

My expectation for Q4 is that it will be north of 5% in that area.

And it is a steady sequential increase in each quarter.

Yeah, from the last year. Actually, if you go from Q4 of 2004 to-- I was just looking at this this morning. I don’t have the numbers in front of me, but if you go Q1, Q2, Q3, it’s a steady acceleration of growth. So more absolute dollars and a higher growth rate leading up to Q3 were just recently 5%, and I think it can be north of 5% in Q4, but again, it would have the other 15-16% of revenue that I’m being cautious on, particularly based on what happened in Q3.

Great. Thanks guys.

[OPERATOR INSTRUCTIONS]. Your next question comes from [James Wilson] with [JM Security].

Thanks. Good morning guys. I was wondering a couple things. Do you have any thoughts-- now I know of the unity option expense issue-- of any strategic changes or stock-based strategy that you might go to deferred or any you can update us on there?

Yeah, Jim, I think we have nearly abandoned the granting of stock options. We’re still able to grant them. I wouldn’t say we would never do it, but we have nearly abandoned that, in part because of the measurement difficulties and the issue surrounding that. We have moved the executive group as well as the senior management group to restricted stock, which I think has worked out very well and has been received very well.

And we’re in kind of an interesting period, because at this point we still have vesting stock options to compensate people as well as new restricted stock grants, so that people generally have a blend of options and stock. And, additionally, for other managers, key people, we’re looking at cash compensation, deferred compensation. We’re looking at other things, the entire benefits package, the 401(k), potentially an employee stock purchase plan, things that would augment the total compensation package across the board.

Okay. So your option expense that you might-- or that you might report ’06 and ’07 compared to what you’re posting in your Q’s could or should be lower then?

The option [piece] I expect to gradually fall off as we stop granting new options and they vest out. I put a marker out there, and, as you know, these measurements and all are a moving target. I’ll have better information as we get closer to ’06, or into ’06. But I put a marker out there probably more for modeling purposes than anything to say that you could expect $2 million a quarter in total stock compensation charges.

So while the option number will start at some point in Q1 presumably of ’06, based on the accounting that’s out there today, and will decline, you’re going to probably have some rationing up of pure equity compensation to offset that. I would say at this point I probably to keep everybody on the same page put a marker out there of $2 million a quarter, and as we get closer I’ll have some hopefully better information on that.

All right. That sounds good. And then, secondly, just on the two I guess vertical market opportunities you have coming forward-- obviously, most significantly retail. Andy, kind of your thoughts on when you might start to see a real customer base developed so we can get a sense of what you’re able to price them at and things of that nature.

Then, secondly, you already have a number of financial services clients, but the product rollout of a newer version of CoStar Property that might [apprise] more banks to sign up with you?

Okay. We would be targeting the-- our core target point for the retail product is the ICSC convention in May of ’06. So it is our goal to really roll out and begin trying to sign major players at that point. You will see some limited pick up of retail business prior to that from December of this year through April of ’06, but the real-- the [realness] begins at the end of second quarter of ’06, which means we would be in a position to give very preliminary information in the third quarter-- in the second quarter call of ’06, but more meaningful information in the third quarter call of ’06.

We’ve got a lot of things going on there that we’re working on and it all looks pretty good. We’re not talking a lot about it today because it’s some interesting stuff and we don’t want to be telegraphing everything until we’re ready to market it. In terms of enhancing the institutional product, we should remember that the biggest thing happening to enhance our institutional product offering right now is the 21 market expansion.

So if I am a bank and I am considering buying CoStar services, the fact that CoStar Group now has much more comprehensive in the U.S.-- much more comprehensive coverage in the United States with adding in markets like Las Vegas and Minneapolis and Milwaukee, these are all important markets to banks and institutional investors, CNBS investors, REIT, and the like, and as we close this year and have where maybe some [MSA] is covered, it will be a much stronger product to that audience.

In addition, those banks loan as much money or more money into retail as they do into office and industrial. So the parallel efforts of growing our retail products will be strengthening our product offering to institutions and to banks. In ’06, we will probably begin focusing on more software-oriented initiatives to enhance revenues in that zone, but right now this massive add of building inventory to support them is really what we’re focusing on and the software is going in there as well.

All right. Thanks.

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

I would like to thank everyone for joining us for the third quarter ’05 conference call. Again, I would like to welcome Henry to our team, and we look forward to reporting our year-end numbers with you at the next call. Thank you very much for joining us.

This concludes CoStar Group’s Third Quarter 2005 Conference Call. You may now disconnect.