CoStar Group Inc (CSGP) 2005 Q4 法說會逐字稿

Good morning. My name is Cynthia and I will be your conference operator today. At this time, I would like to welcome everyone to the CoStar Group fourth-quarter 2005 earnings conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS).

I would now like to turn today's call over to Henry Stoever, Vice President of Marketing, CoStar Group. Please go ahead, sir.

Thank you, and good morning to all on the call. I'm Henry Stoever, Vice President of Marketing and I'd like to welcome all of you to CoStar Group's fourth-quarter and year-end 2005 conference call.

Before I turn the call over to Andy Florance, our President and CEO, let me state that certain portions of this discussion include forward-looking statements which involve many risks and uncertainties that can cause actual results to differ materially from such statements. Important factors that can cause actual results to differ materially include but are not limited to those stated in CoStar's fourth-quarter 2005 press release and in CoStar's filing with the SEC, including its Form 10-Q for the period ending September 30, 2005 under the heading "Risk Factors." All forward-looking statements are based on information currently available to CoStar on the date of this call and CoStar assumes no obligation to update these statements. In addition, please visit our Web site at CoStar.com/corporate/investor for a webcast of this conference call.

Now, I'd like to turn the call over to Andy.

Thank you, Henry. Welcome, everyone, to this fourth-quarter and year-end 2005 conference call.

We are pleased to report another quarter with solid revenue and earnings growth and more importantly, a really strong year. Our EBITDA, or earnings before interest, taxes, depreciation and amortization, increased significantly over the course of the year, up 66% from 4.2 million in the first quarter of 2005 to 7 million in the fourth quarter of 2005. We are seeing leverage in our business model now that we have completed the 21 new market openings we initiated in May of 2004. Frank Carchedi, our Chief Financial Officer, will address the fourth-quarter and year-end 2005 results in more detail later in the call.

I'd like to talk about recent investments we've made in the Company, how those investments are performing, and the investments we plan to make this year, 2006. Over the years, we've made a series of successful investments to build the Company and we plan to continue on that path of growth.

Our sales team turned in a very strong performance in the fourth quarter and 2005 overall. We produced a 48% year-over-year increase in sales growth, growing from 14.8 million in annualized net new U.S. sales in 2004 to 22 million in annualized net new sales in 2005. The fourth quarter represented our eighth consecutive quarter with a sequential increase in net new sales. Annual net new sales in the fourth quarter of 2005 rose to $6 million as compared to the third quarter of 2005's annual net new sales of 5.8 million. Each of the last two months' net new annualized sales numbers have set sequential record levels for CoStar Group. January 2006 was our highest sales month ever with 2 -- 2.260 million in net new annualized U.S. subscription revenue. These very strong increases are driven by, among other things, a larger sales force, a lower sales force turnover rate, new expansion market opportunities, institutional sales opportunities, and the strength of the CoStar brand in the marketplace.

Much of our sales force growth is currently coming from our telesales group rather than from our costlier field sales organization. The sales coming from outbound telesales efforts rose 22% from Q3 over Q2 and 24% from Q4 over Q3. We anticipate significant growth in the contribution from this cost efficient selling model in 2006. The average tenure of our field sales force continues to grow and is resulting in a more experienced and productive field sales force. Average net new U.S. subscription sales produced by each field sales rep grew 18% from $17,172 net new annualized sales each month in 2004 to 20,892 -- I'm sorry, $20,892 in 2005. The absolute dollar value of canceling contracts fell 8% in 2005 versus 2004, even as our revenue base grew significantly. So in real dollars, cancellations are coming down, not just on a percentage basis.

CoStar Group has experienced a steadily increasing average new contract value. Most recently, the average annual value of a new contract increased 5.5% from $7,872 in the third quarter 2005 to $8,304 in the fourth quarter of 2005. Similarly, the overall average contract value, including renewals and upsells, increased 5.4% from the third quarter of 2005 to the fourth quarter of 2005.

We established a dedicated institutional sales team in 2005 to focus on selling our products and services to large institutions, such as investment banks, rating agencies, CMBS investors, pension advisors, and other large financial organizations with multimarket commercial real estate information needs. This effort and strategy has paid off. Sales of larger institutional contracts with a value of 41,000 or more annually increased 108% from 1.2 million in 2004 to 2.5 million in 2005. Approximately half of our sales growth in the quarter results from selling additional products to existing customers, as opposed to signing new customers. We signed 508 new customers in the fourth quarter of 2005, up 42% from 358 new customers in the fourth quarter of 2004. We added 2,018 new U.S. paying subscription customers in the course of 2005, up 52% from the 1,326 new customers added in 2004.

Based upon our experience with product usage, renewal rates and cross-selling activity, we continue to enjoy high levels of customer satisfaction. This is evident in the increased usage we've seen of our subscription services. Average weekly subscriber page views in U.S. CoStar Web services climbed 48% in the preceding 12 months from 6.87 million weekly views in February of 2005 to 10.12 million last week. Our service with the biggest percentage gain is our commercial property for sale-related services. Our for-sale information services climbed from accounting for less than 1% of our service usage 12 months ago to being 14% of our service usage today.

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 93% in the third quarter of 2005 to approximately 94.4% in the fourth quarter of 2005. The 5.6% of nonrenewals include the dollar value of customers reducing their total purchase from CoStar but not canceling altogether, but also includes the value of customer contracts we discontinued on our own for bad debt or IFP violations. Those customers ending their involvement with the commercial real estate or discontinuing their operations completely, such as retirement, and our salespeople have been known to try to convince our customers not to retire. At this point, we believe that the nonrenewal rate for customers dissatisfied with our services or substituting a competing product is a remarkably small number.

We are pleased to announce that with the opening of Milwaukee on Tuesday, we have completed our 21-market expansion effort. Since the expansion program began in May of 2004, we have photographed approximately 246,000 properties and researched over 5 billion square feet of gross building area in the expansion markets. This is a huge accomplishment and I want to recognize our entire team for doing such an outstanding job. Not only are the numbers impressive, but in each of these markets, I believe we have delivered a vastly superior database and service than what was previously available in those markets. Now that all of these expansion markets have delivered, we expect all of them, in aggregate, will be profitable this year.

Of those expansion markets that have been opened for 12 months or more, 100% are now profitable, with an average four-wall EBITDA margin of 52%. Of those expansion markets that have been open for at least six months or longer, 63% overall are profitable with an overall aggregate four-wall EBITDA margin of 25% in that group. As you can see, these markets are maturing quickly and their trend to profitability is indeed measured in quarters, not years. 231 firms now subscribe to CoStar Property Professional in these expansion markets. 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 earnings growth drivers for CoStar Group.

I want to comment on an important trend in our research operations that I believe will have a significant positive impact on both the quality and cost-effectiveness of our research operations. Over the course of the last year, we've outsourced an offshored to India and the Philippines six discrete research functions that require about 80 personnel to perform on an ongoing basis. Currently, 12% of our research headcount is now outsourced. This has allowed us to avoid more than $1 million in annual costs. We're satisfied with the quality and the productivity levels of this outsourced research, and we intend to outsource more research functions that do not require extensive client contact, physical presence like photography or advanced training. Some of the savings we're capturing is being redeployed into better compensation packages for the research analysts who do have extensive client contact. We believe that enhanced domestic research compensation packages will reduce turnover, enable us to obtain higher client satisfaction levels, by giving them more continuity within their relationships with the CoStar team. We believe that, in 2006, we will have significant growth in outsourcing.

A little over a year ago, we learned from focus groups that our brand strength was leasing information, comparable sales data, market trends and analytics and tenant prospecting information. Commercial for-sale information was not considered our strength. In fact, our small -- other smaller information providers were more associated with for-sale listings than was CoStar. Since then, we have dramatically improved our for-sale information by increasing the distribution of our for-sale data and thereby increasing the value of listing for-sale properties on CoStar services. We've done this by giving national access to our information to all of our subscribers and customers, rather than just the information for their city. We have delivered a low-cost for-sale product distributed solely via the Internet called Commercial MLS. These initiatives are working well.

As a result of our now greater audience for for-sale listings, brokers are sending us even more listings. As of January 1, 2005, we had nearly 53,000 properties listed for sale in the United States. That number has now almost doubled to 103,000 properties listed for sale today. For the markets we cover, we believe we now have the most commercial real estate for-sale listings in aggregate of any information service and their verified listings. As a byproduct, we are now positioned to collect higher-quality comparable sale information faster, at a lower cost.

CoStar Commercial MLS is very significant in that it is the first subscription product we have produced that relies on a pure Internet customer acquisition model. We've always traditionally employed a sales force to secure new subscription customers. Neither our field nor our telesales groups handle sales for Commercial MLS. In November of 2005, we launched Commercial MLS and now customers can subscribe online and access details on over 100,000 verified commercial properties listed for sale. This service competes head-to-head with online listing services like LoopNet in an arena in which we did not previously compete directly. It opens up a whole new market segment for us -- hundreds of thousands of smaller brokerage firms, sole practitioners and residentially focused real estate professionals who may not have been great prospects for our higher end property professional system but are still interested in earning commissions from buying and selling commercial properties. Today, Commercial MLS is offered on a free trial basis at no cost, and once momentum builds, we will begin charging 19.95 per month. I've been amazed by the numbers and the take-up rate. In just the last 90 days, over 17,300 -- 17,232 people, representing over 10,000 different firms, have signed up to use CoStar Commercial MLS.

A point of reference -- it took us 18 years to sign up approximately 10,000 subscribing firms using the traditional sales force model, and we've doubled that number in 90 days. Obviously, it's on a free trial basis, so it's not apples-to-apples, but still the numbers are impressive.

Of the 16,000 users, approximately 22% are pure residential players and a full 53% do predominantly residential work. This service is resonating with a residentially oriented market, which is a huge market segment. There are currently 1.2 million members of the National Association of Realtors.

Usage of Commercial MLS is high. In the last 90 days alone, as many as 9,500 users have averaged 20 to 35 minutes per session researching for-sale listings.

We believe Commercial MLS will be a valuable customer acquisition tool going forward, providing us with upsell opportunities as these individuals use and learn more about CoStar. Already, our sales force has converted a number of Commercial MLS users into property and coms customers.

Our acquisition of NRB in January of 2005 initiated a major product expansion into the U.S. retail real estate sector. We completed the integration of NRB information into the CoStar database at the end of December, 2005. We have now photographed and databased 230,000 retail properties. That is a 225% increase from the 70,000 retail properties we had four quarters earlier.

Now, we are currently in the process of building a much more robust offering, one that packages traditional CoStar property professional services with geographic and retailer-specific tenant information and Claritas demographic details, one that includes a new powerful proximity search capability with on-the-fly mapping and customize retail reporting capability. We believe our retail offering will revolutionize the retail industry and completely change the way retailers, owners and retail brokers conduct their jobs. Imagine you are responsible for opening all the West Coast stores for an emerging coffee chain. Your firm is probably managing and renegotiating a lease every week; you're opening and closing stores weekly. Your success in opening stores in an effective location on a timely basis would be critical to your firm making overall earnings targets. We believe that currently there is no service that integrates the three vital pieces of information you would need -- where your consumers are, where your competitors are, and where the available properties are.

Let me describe what our retail offering will allow this coffee chain to do by walking you through a search I ran just this morning. I searched for 150,000 square feet or larger retail properties in Orange County, California with between 1000 and 4000 square feet available. I added that I wanted a population of at least 5000 people within a one-mile radius of the potential store with a minimum household income of $40,000. I then stipulated that I wanted to be within a half a mile of a traffic-generating business like a grocery store or a drugstore, but I did not want to be within a half-mile of a competing coffee chain like, say, Starbucks. In 20 seconds, I had list with photographs and details on 31 properties in Orange County. With a click or two, I could see maps showing the location of the properties and exactly where the competitors were in relation to those properties. Just as easily, I could see extensive demographics and the nearby traffic counts for each of these potential properties. What I did in a matter of seconds or minutes would have taken weeks in the traditional method.

We believe our investment in this arena is a good one. As you know, the retail market is huge and we see a clear need for our service. Retailers are trying to open or close stores more effectively. Developers are searching for the right mix of retail tenants to maximize profitability, and brokers are trying to make a living on this information-starved business. There are multiple opportunities and we are uniquely positioned to capitalize on them. Our core business is turning in high margins and strong cash flow. We have the unique scale, experience and infrastructure to build the kind of information service the retail market needs, and we have the capital support and long-term retail strategy. We believe we are currently the only real estate information provider in a position to cover such a large and diverse market segment, which is why we believe no other competitor is currently adequately serving the retail industry today.

We also believe that there's a unique situation where the interest of the parties in the retail industry are aligned with our own. In the last few weeks, we've shown our retail offerings to owners, brokers and select retailers in apparel, consumer electronics, foodservice, discount store, dollar variety, grocery and drugstore categories. They all expressed great enthusiasm and strong demand for a service that they called revolutionary, innovative and long overdue. We are excited to introduce our retail offering this May at the ICSC conference, where it will pursue our first sales to retail customers.

At this point, I'm going to turn the conference call over to Frank Carchedi, CoStar Group's Chief Financial Officer.

Thank you, Andy.

Today, I'm going to focus principally on a discussion of the fourth quarter of 2005 results, compared sequentially to the third quarter of 2005, and also our outlook for 2006.

Total revenues grew sequentially by 4.3% overall from Q3 to Q4, increasing from 34.3 million to 35.8 million. The result for the fourth quarter was principally due to continued solid growth in our core U.S.-based subscription revenue, combined with our continued high renewal rate of approximately 94% for the quarter. We reached a 5.2% sequential growth rate in the core U.S. subscription revenue areas. The growth rate in that area has been accelerating slightly each quarter throughout 2005. Nonsubscription areas, such as ad hoc survey fees and advertising, which account for only 5% of the total revenues, were basically flat overall, reducing our overall growth rate. Total subscription revenues for the Company continued to account for approximately 95% of revenues during Q4, our UK operations contributing 7.8% of total revenues. We continue to believe we have significant revenue opportunity in the group of 21 newly opened markets, which accounted for only 2% of our overall revenue in Q4 of 2005.

Gross margin increased by $500,000 from 23.3 million in Q3 to 23.8 million in Q4 on a 1.5 million increase in revenues. Margin percentages decreased from approximately 68% in Q3 to 66.6% in Q4, as planned. We continue to ramp up research operations related to new market and retail expansion. Overall, operating expenses decreased 2.6 million from 22.3 million in Q3 to 19.7 million in Q4, primarily due to the $2.2 million restructuring charge associated with the closing of our Mason, Ohio operation during Q3. The remaining decrease can be attributed to our continued success in controlling and leveraging overhead costs and the seasonally lower cost structure during Q3 and Q4.

As a result of sales growth, lower seasonal cost structure in Q3 and Q4 and lack of the Q3 restructuring charge, our EBITDA improved 3.3 million from 3.7 million in Q3 to 7 million in Q4 of 2005.

In addition, EBITDA increased 2.8 million or 66% from 4.2 million in the first quarter of 2005. On a GAAP basis, net income improved from 1.1 million or $0.06 per fully diluted share in Q3 of 2005 to 3.2 million or $0.17 per share in Q4 of 2005. 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 Web site.

Capital expenditures for Q4 of 2005 were approximately 1 million, of which 500,000 was related to our market expansion efforts and the remainder was in support of our existing platform. For 2005, total capital expenditures were approximately 8/4 million compared to our plan of 12 million. Capital expenditures for 2005 were far less than expected due to lower contract building photography during the year, some of which is now essentially rolling forward into 2006, resulting in higher than normal estimates for capital expenditures.

We closed the year with approximately 134.2 million in cash, cash equivalents and short-term investments, an increase of 17.1 million over the beginning of 2005. In addition to cash flow from operations, we had an additional 7.4 million generated through proceeds from stock option exercises for approximately 292,000 shares during the year.

Now, I will discuss the outlook for the first quarter and 2006. As indicated in our press release, we expect organic revenue growth of approximately 18 to 22%, putting revenue in the $160 million range for 2006. We expect a sequential quarterly increase in revenue from the fourth quarter of 2005 to the first quarter of 2006 of approximately 3.5 to 5% and quarterly organic growth rates to reach up to 6.5% per quarter by the fourth quarter. We continue to believe that there's significant upside revenue growth potential and growth in sales force size and productivity, particularly in view of the opportunities resulting from momentum in established markets and ramp-up from newly released market openings, with potential upside from the retail offering later in 2006. We anticipate noncore revenue to remain flat or possibly decrease slightly, and there is virtually no new retail revenue in my 2006 guidance.

Overall gross margins are expected to be in the 66 to 68% range throughout 2006. Gross margin percentage is expected to remain fairly steady in the first half of 2006 as we continue to ramp up research staffing to support our retail and geographic expansions. Gross margins could increase in the back half of the year as a result of sequential revenue growth and stabilizing research costs.

Beginning in the first quarter of 2006, we are anticipating non-cash equity compensation charges principally for the required expensing of unvested stock options and restricted stock grants totaling approximately 1.25 to $1.5 million per quarter. The majority of the expenses will be recorded in G&A and sales and marketing. By comparison, during 2005, we had approximately 350,000 of total equity compensation charges. We expect operating expenses to increase from Q4 of 2005 to Q1 of 2006 by 15 to 25%, including equity compensation charges as we boost our sales force and marketing groups to meet our growing marketing and sales initiatives. In Q2, we expect a 2.5 to $3.5 million incremental expense for our retail launch, including the ICSC trade show in May. We expect operating expenses for the back half of the year to be fairly steady.

As stated in the press release last night, embedded in our 2006 cost structure guidance is an estimated $12 million of pre-tax expenses related to our expansion of retail coverage, which includes current and future personnel, marketing and overhead costs. Personnel costs are principally in development, sales, and research. These costs are not one-time launch expenses or capital expenditures, but part of the overall ramp-up of our cost structure to support the retail building coverage. Because of the ramp-up during 2006, it's likely that 2007 would have even greater costs associated with the retail project. The retail launch is a multi-year investment, supported by the strength of the core business.

Purchase amortization and operating expenses is expected to remain relatively flat from fourth quarter of 2005 levels, while depreciation is expected to increase by 7 to 10% during 2006. Interest income is expected to be in the 5 to 6 million range, based on higher average cash balances and interest rates. We expect fully diluted net income per share of approximately $0.45 to $0.60 for 2006, which would be fully taxed at approximately a 42.5 to 43.5% effective rate.

For the first quarter of 2006, we expect fully diluted net income per share of approximately $0.05 to $0.10.

Based on these estimates, EBITDA for 2006 is expected to reach approximately 21 to 25 million, including the estimated 5 to $6 million charge for stock option and other equity compensation expense.

Finally, we expect capital expenditures for 2006 to range from 12 to 15 million, including significant investments in building photography for our planned retail and market expansion of 8 to 10 million, as well as 4 to 5 million to support existing operations, consistent with the past several years.

In conclusion, organic growth remains solid and we believe substantial upside exists in revenue growth at high incremental margins for both established and new markets. Even with significant investments in retail, we continue to balance earnings growth with long-term investments as the core business generates high incremental margins and the new markets move steadily to profitability.

As always, we look forward to reporting our progress to you. With that, I will open the call for questions.

(OPERATOR INSTRUCTIONS). Brandt Sakakeeny, Deutsche Bank.

A quick question for you -- first, on the renewal rate, Andy and Frank, is possible that the renewal rate is too high? Meaning, are you not putting as much pricing upside as you theoretically could and sort of not optimizing potentially the absolute revenue rate that's generatable from the client base?

I think you've got a valid observation. Economics 101 says that if your renewal rate is that high, you've got pricing leverage.

I think, at this point, we believe that we have really just begun to penetrate the potential opportunity for our products and services and that we're probably less than 15% to 20% penetrated to the number of customers, potential customers we want to reach. We are trying to keep the balance more towards penetration rather than individual contract realization. But you do see us in those average contract values, those new average contract values, you do see us moving the lever at a pretty quick pace. It seems to be running at about 5% sequential quarterly growth in average contract value right now. We're working that dial but we're not working it aggressively right now.

All right. I guess a second question is, you talked to -- and I know you've been active in terms of consolidating some of the databases and doing a lot more in the back office. How much more room do you have to go with that? Is there a lot of offshoring and sort of more cost leverage that you all can get out of those activities?

I think it's actually a continuous process over five years. I think there will be a lot of opportunities to offshore and a lot of efficiency gains from the integration of our back-end databases. We are committed to continuing to invest in building research software systems that allow us to more efficiently break some of these research tasks down to smaller subsegment tasks and move them to the most efficient or cost efficient place to actually do them -- always focusing first on the quality of what the customer is seeing. But, we're probably running three or four offshoring experiments right now that, if we like the results, we can actually scale it and grow it. As we add 1 million properties over the next several years, being able to keep our cost of research per building dropping is very important to us, and we think we can do it. (multiple speakers) -- why you are still getting the revenue opportunity of those buildings.

Okay, thank you. Just I guess a final question for you, Frank -- in terms of the guidance ranges, I guess they seem a little wider to us, given the predictability. I guess what are the factors that could bring you to the low end? What are the factors that could generate the high end of the guidance?

Well, I think part of the reasons for wide ranges is that we do have this significant retail investment and ramp-up of the cost structure. In other words -- and I've discussed this before, that I think the cost structure is relatively volatile, relative to the revenue, which is highly visible.

Yes, I guess, Frank, I was commenting more on the revenue guidance rather than the EPS guidance.

Yes. In terms of the topline guidance, you know, I don't think the ranges are extremely wide. I mean, if you break them down into actual absolute dollars, you know, it's a matter of $100,000 here or there, so it's probably not as wide when I say 3.5 to 5%; it's probably not really as big a number as it sounds like. So, but I do want to give room -- for example with these noncore areas, that for example flattened out in Q4, and that was not unexpected but you know, they're going to tend to be more volatile and move the dial, small amounts on revenue, which will affect those percentages.

Okay, great. Thanks so much.

What I was saying on the cost structure is that a lot of the cost structure variability has to do with timing of ramping up and changing the cost structure over time. If you look out and say, well, you know we're going to get to 12 months from now, you might not know exactly at which pace quarter-by-quarter, so there may be some volatility there.

Okay, thank you very much.

Dalton Chandler, Needham & Company.

Good morning. I guess, to stay with the retail expense for a minute, I think most people had already tried to build that in, and it looks like it's going to be little higher for '06 at least than was most of us had modeled. I mean, is it exceeding what you thought it would be a little bit, or are we just wrong again?

Well, you gave me the easy answer. I don't think it actually exceeds -- I think a lot of this -- and I've talked about it in past quarters -- is the timing of it has been probably less than perfectly predictable. As we said, I think, in the last two quarters, the cost to ramp up probably has been pushed back a little bit as we got into the 21-market expansion and focused on that. So I think what you're seeing now is a concentrated effort occurring in 2006 where the 21-market expansion is wrapping up, looking very successful and basically in the rear view mirror, and we will be focusing on the cost structure and the building of the platform for retail.

Okay. I heard you say -- I didn't catch all this but you said something about the retail-related costs being up again in '07. Were you talking about absolute dollars or percentage of revenue?

I'm talking about absolute dollars. One thing to keep in mind is when I talk about 12 million landing in '06 as part of the expense structure and investment, that's not all incremental, for example, to '05. I mean '05 had significant retail work in it as well, particularly on the development side. But if you think about just the mechanics of a cost structure ramp-up, as we ramp up from Q4 -- or Q1 to Q4 of '06, naturally, as you go forward, you are already at that higher cost level in Q4. So almost by definition you would start out '07 at a higher annual level, and then it could potentially grow from there.

What I'm trying to avoid is anybody thinking that the $12 million is some kind of launch expense that disappears all of a sudden as we enter into the next year or the back-end of '06.

Your marketing costs could come down in '07, but it's replaced by a larger research cost as the number of listings that come into you grow. As we look at this retail opportunity, I mean this is one area where everyone can appreciate the scale of the tasks we're taking on, documenting major swaps with the retail real estate in the United States. It's sort of a question of how aggressively we're going at that. We've always talked about it being a multiyear effort and it's much we're trying to bring into focus in '06. So there's a little bit of slightly more aggressive stance on it in '06 and that's what you're seeing.

So when you anticipate moving out of the aggressive expansion mode and into the normalized maintenance mode on retail?

Well, I think it's probably a two-year, three-year ramp-up to be where you really want to be in terms of having the whole inventory in there. Again, we are anticipating having well more than 1 million retail properties in the United States in our system, and those will come in on a rolling basis over multiple years.

Okay, so we're talking 2008/2009 timeframe?

Yes, later '07, '08 but you know, at a relative level. I mean, you should see revenues come in associated with it in '07 and possibly some revenues in '06 but we're not relying on those heavily just because we'd like to see the first contract come in before we report past the second contract.

Then related to that, you mentioned that you've already been calling on some retail prospects. Are you doing that with a sales force that you are already building out, or is that more of a high-level executive contact?

We've got the leader -- we've got an individual in the sales group who is the leader of that sales effort. The way we established that institutional specialists sales force last year and the way they grew the institutional sales 100% year-over-year, or the rate of institutional sales 100% year-over-year, we're doing the same model for the retail where we will have a handful of retail specialists who just focus on those high-end retailers. The leader of that group as well as other people have been (indiscernible) to meet with some other major retailers, lining up some of the beta users and getting initial feedback. I do have to say that, in my two decades of doing this, this definitely -- the reaction to what we're showing people in this product is one of the more positive reactions I've seen from potential customers since we added pictures, the ability to see photographs of buildings, into our products. So, we're liking the reaction we're getting. But we're still very aware of the scale of effort required to actually deliver the right product.

Okay. We couldn't have a conference call without accusing Frank of sandbagging us on the revenue numbers. So given that you are already out calling on these retailers -- (multiple speakers) -- expect to be selling at the end of May, but Frank, you are saying you don't have any retail revenue in '06. (multiple speakers).

Frank, I will turn that question over to you!

Well, as Andy said, he wanted to see the first contract before he forecasted the second one. I'm just taking my cues from him, so I think that some of that is selling into -- and when I say no retail, I'm talking about specifically in the retail customer, the retail sector, not brokers interested in retail, which is embedded in our ongoing sales. But in terms of new sector sales, you know, part of it is we want to start see it unfolding, we've seen the pricing unfolding. Part of it is timing, how long will that sales cycle be? When you get out to ICSC, after that half the year is over, so you know, we will see when we get there.

Brad Eichler, Stephens, Inc.

This is actually Trey Grooms for Brad. Just a couple of questions -- you were good enough to give us your expense numbers for retail in '06 that you're expecting. Can you refresh my memory on what was the expense related to the 21 new markets in '05?

The -- (multiple speakers) -- expense.

the incremental expense on the expansion?

Yes, let me describe it this way. I believe that the total investment -- in other words incremental P&L effect, probably from mid-'04 to the end of '05, was in the 5 to 7 million range. So that includes amounts that are being offset by revenue because that revenue started in actually the end of '04, early '05. Then there was capital expenditure as well. So I look at that entire 21-market project as probably a 10 to $13 million total investment.

As we move into '06, if you look at the entire year of '06, there probably is no net investment running through the P&L, but if you looked at it quarter-to-quarter, there's probably a small amount of investment in the first two quarters, balanced out by profitability in the second two quarters. So, calendar year '06, I'm not expecting a big net investment. As I said, I think that's in the rearview mirror. Quarter-by-quarter, we believe we will move from, in aggregate, a slight burn rate to some profitability, again on the aggregate project. Individual markets are looking profitable.

Okay, fair enough. On the offshoring, you guys said that you plan on continuing this effort and up until now, you've had redeployed those savings bank into the business. Is your plan to continue that, you know, putting those savings back into the business, or do you expect any of that to go to the bottom line?

I actually think we probably have a voice in cost growth because we haven't redeployed it all back into the business. Remember that, when closing the Mason office, we actually generated some savings, some of which we redeployed. But we are definitely actually recognizing some savings, and I think we are in the very early phases of this effort. This is -- as I mentioned, we are trialing about three initiatives that, if they are successful, could have a more dramatic impact on the bottom line. So I would see this actually moving more towards absolute savings as we move through '06 and '07.

Okay. Then one final question -- the new product that you rolled out, I think you said in November, the Commercial MLS product -- when do you expect the free trial to end on that product? Is it a first-half of '06 or is it further along than that? What kind of opportunity is out there for this product?

We wouldn't want to anticipate any material revenue in '06 associated with the Commercial MLS product. We think it's much more important to get significant momentum in this segment where we've traditionally not been a strong player, and we want to emerge as a leader in that sector. So we want to -- we are seeing tremendous momentum and pickup, and we are seeing a very clear acceleration at the rate at which for-sale property information is being volunteered into us. We want to see that trend continue because, if we have good information and detail about a building that's for sale prior to it selling, it enables us to produce the very profitable comparable sale information much quicker, much more accurately, at a lower cost. So we're going to let momentum build on that product for an indeterminate amount of time this year until we feel very comfortable that we are number one in that space.

Then, from that point, you know, this is a pretty big market we are addressing here because, again, half of the people using this service right now appear to be residential agents. If you look at commercial real estate as the whole -spectrum, 99.9% of the properties in our database are under ten stories in size. A lot of the commercial properties in our database are relatively small commercial properties; they could be less than the value of a house. This is a segment that could really go after that million-plus residential realtors in the United States. So I see this as being potentially a product that could cross into the north of 10 million annual revenue area, eventually. But first, we want to get a clear momentum.

Okay, thanks a lot, guys.

John Neff, William Blair.

A question for you -- does your guidance imply that 2006 EPS in the core business -- and by that, I mean excluding the retail initiative -- does the guidance imply that the '06 EPS in the core business would be $0.80 or $0.95? I know, Frank, you said in your comments that not all the 12 million in '06 retail spending is incremental. But what is the guidance saying about the profitability in the core -- (multiple speakers)?

I mean, John, clearly we believe that the earnings leverage and the profitability in the core is dramatically higher than what you're seeing as an aggregate result. When we look at this 12 million, you know, I've got a schedule right in front of me. It's actual people; it's marketing budget; I mean it's hard dollars. That is -- it's very real and very incremental to the retail effort. So, we absolutely believe that the core business is a great, steady leverage business with high incremental cash flows. I don't want to step into the trap of answering your precise question, which is can you add all these numbers together and get to a different answer on the guidance, but I think, clearly, we think that these costs are diluting the margins of the other part.

Can you give us a rough estimate as to how much of the $12 million spend is incremental to '05 levels?

Yes, I believe that half of it is incremental to the '05 level.

Okay, that's very helpful.

We've been saying that. I mean, we've been in conversations each quarter and as we've traveled around, we've been saying that. I don't know if we put specific dollar amounts on it but we have been basically saying, look, these quarterly numbers already include retail. For example, the development team, that substantial team working on retail, has been working on that project for quite a while -- I mean, certainly in '05. As well, there have been marketing efforts surrounding it, some research ramp-up relative to that, and obviously the early-stage is of building and establishing that platform.

Okay.

John, I'm not permitted to answer the question you just asked, it if I had to permit it, I would have been more direct! (LAUGHTER)

You guys mentioned, in the press release, several additional expansion markets in '06. Any sense of how many are in the United States?

Yes. We are thinking, in the United States, and it would be a fraction, a small fraction of what we did in the 21 expansion markets. By necessity, we don't have cities left there as big as Minneapolis or Las Vegas or Salt Lake City, so you're moving down to clear-cut tertiary cities now. We'd be doing half a dozen or less of cities that you would recognize, but for competitive reasons, we're going to not discuss the specific cities. But for modeling, these are not barnburners.

Can you comment on the ad sales component of the nonsubscription portion of revenue? I know you said last quarter December tends to be seasonally weak. But generally speaking, is that stream performing as you hope?

Well, if you look at -- I mean, there's different ways to look at it. If you look at 2005, the ad sales area actually exceeded plan. I think a lot of that had to do with it got off to a quicker start early in '05 than we expected. So in total dollars, for '05, it exceeded plan. It has tended to flatten out a little bit from a growth perspective in the last quarter or so, but if I look at that one single component as part of that 5% that you're talking about, or that we talked about, we do expect more growth in that area, on an isolated basis, during '06. So, what I was talking about in terms of that 5% being flat is just the aggregate of that whole group, which includes, as you know, a hodgepodge of different revenue streams.

Great. Last question -- can you give us a little update on the success of the free trial that you detailed on the last call?

We believe that we picked up -- and we don't have hard data on this at this point -- but we believe we picked up somewhere in the neighborhood of 100-some firms from that trial. We think really that the ultimate answer from that comes sometime in the second quarter, when you look back at that point and say, okay, when you begin the trial to when you stop the trial and six months after, what did you pick up? We will be able to give you a better answer on that. But we know we did pick up what I think is probably nearly 100 customers from it. It's sort of been eclipsed, in our minds, by the Commercial MLS because the free trial, with a lot of effort, brought onboard 750 consistent users in a product in which we are already very strong. This Commercial MLS has brought on nearly 10,000 users with no drain on the sales force in a 90-day period. So we're sort of now focusing more towards that Internet customer acquisition trial basis, which is a lot cheaper.

Thank you.

Brandon Dobell, Credit Suisse.

I will make it quick for you. We are three months away from the retail launch. How specific have you gotten in terms of thinking about the pricing model and prioritizing where you might add buildings over the next 6 or 12 months, based on the feedback you've gotten from people? And also trying to figure, looking at the ongoing costs of the retail model from a research perspective, relative to the commercial side of the business.

Internally, we're being very specific. Right before I got on the conference call, I was e-mailing back and forth to the product manager and we were shaving dollars back and forth on proposed pricings for different retailers. But we are -- we will continue to develop that pricing right up to 30 days prior to ICSC, trialing it, exploring it with some of the retailers. We also might do multi-year contracts where the pricing steps up in the contract each year, related to how many retail properties we bring online, so we know on Day One -- or we know that. in June of 2006, we will not have 1.5 million retail properties, though eventually we would like to get there. So we may have the pricing step up to some of these retailers in each year as we add hundreds of thousands of retail properties.

In terms of -- so we are developing a pricing model that we're getting comfortable with, and we would like to be able to see a clear, 100 million-plus revenue opportunity in that, in the retailer-specific zone, as opposed to owners and brokers, so we're keeping that in mind as we do that pricing.

In terms of where we are prioritizing our efforts, we've already solidified that. We have a clear view of that. We have selected about a four or five-point methodology on which regions of the country and which types of properties we will prioritize first and how to do that most cost effectively. That plan is well in the works, and we're pretty comfortable with that plan. We've done a lot of fly-overs of different regions of the country. We have a lot of information now on where the retailers are located and what concentrations of listings we anticipate getting from which states, and we are optimizing to that.

The ongoing cost structure, as with any of our products, it costs more to initiate the coverage than it does to maintain it ongoing. But we think the cost structure is similar to the per-listing cost structure in the office and industrial. So you know, you're dealing with an ongoing demand for very rough numbers, 100 to 200 incremental researchers ongoing, which is not a huge nut when you consider the revenue opportunity here over time.

Okay, that's helpful. Thank you. Then, a different perspective -- Andy, in your opening remark, you talked a lot about the strength of the inside sales force and the productivity there. Maybe an update on where we are numbers-wise in both inside and field, and your expectations for how that looks as we move through '06. Then, is there a point at which you don't need to add any more direct or you start to cut back the direct if the inside guys are working well? Where does that balance start to shape out for you?

Well, in rough numbers, we are approaching about 40 people in the inside, the telesales group. We just opened a telesales group in our Columbia Research Center, led by one of our seasoned sales managers, Karen Karmilowicz, so we now have a telesales group in Bethesda, San Diego, and Columbia, so we can create a curve path to researchers and recruit from researchers in each of those three centers, and it's reached 40. Now, that's a very green group at this point because the rate of growth is pretty fast. Remember, this group didn't exist 18 months ago, and it's now doing 20-some% of our revenue.

The field is -- in U.S. subscription sales is constant producers at about 72. In '06 at this point, we anticipate taking the telesales group up to approximately 80 to 90 people and the field increasing that to by about anywhere from 8 to 15 with a lot of those increases being specialists for things like institutional sales, retail. We think it's important to have a blend of higher-end field sales reps than can do face-to-face meetings with high-valued customers, as well as a telesales group with a lot of firepower to do broad telemarketing. To wit, the field sales force is not ever going anywhere permanently because, yesterday, I met with field sales reps from Polycom from their headquarters, and it is the videoconferencing leader sending salespeople out to go meet in person -- (technical difficulty) -- still a role there.

Fair enough, a fair point. Then final question, as you think about the breadth of content you will have when commercial combined with retail, where do you see your role in the whole idea of local search, visual bay search, that kind of thing as all the big guys on the Internet start to role out these interesting products?

Well, it's an interesting point. I think we've got an amazing depth of local content growing here, where you want to see a picture of Starbucks in a [year or so], we should have pictures of every Starbucks in the United States, every Target, every Burger King -- high-quality pictures tied in with a lot of content on each one of those locations. So, the discussion does come up with people who are involved in those areas and local search content. It's still very early, and we are balancing -- we're focused first and foremost on what's going to create revenue for us, intermediate term. We don't want to make any long-term commitments too quickly until we have a better idea how it's all shaping up. But there is some potential there in that area.

Great, I will turn it over. Thanks.

Jim Wilson, JMP Securities.

Good morning, guys. I was wondering I guess two things on the (indiscernible) the retail buildout. I know that we've gone down through in that -- in the new 21 markets, a lot of what you put in place is retail, but did you in terms of the data information and pictures, but can you kind of I don't know color how buildout towards retail, the new 21 markets are and then where that stands for the historical base?

Jim, the new 21 expansion markets are on a very solid footing for the retail. There are more than approximately 100,000 retail properties in those 21 expansion markets that we've databased, photographed, and we've got a disproportionate number of our listing counts inside those 21 expansion markets. So that area is very strong, and so that one is in the pocket.

We think that there are more than 0.5 million retail properties that we will add from our existing market areas over the next several years, and in fact, what we're going to do is we are going to first in our existing market areas to find that retail content, because it's the most cost-effective thing to do. So, there's an awful lot of growth in the existing markets from the retail.

I guess that was sort of what -- sorry?

Yes, do you want to redirect that?

Well, no, what I was thinking -- yes, that's kind of what I was thinking, is that as your incremental spend here, I guess a lot of it is now going back to -- you rolled it out and spent a lot on the new markets, and now you're kind of incrementally rolling in back to the existing marketplace.

Yes. The reality is the process we used to launch the existing markets occurred years before the expansion margins. The technology is radically different; the Company is radically different. So we like what happening in these expansion markets. You know, it appears to be 12-month, 50% four-wall EBITDA margins. So, we're trying to bring some of that back to the existing markets.

Okay. Then my other question is maybe, Frank, could you break apart, in '05 and '06, what amount of the incremental revenue growth came from new markets versus, again, original existing markets?

You mean '05 -- (multiple speakers)?

'05 versus '04, and then what you're thinking for '06 versus '05. You know, kind of ballpark numbers.

I don't know if I have that off the top of my head. One way to look at it is, earlier I said, that if you think about Q4 of '05, not all of the markets were opened but everything we had generated incrementally was 2% of the Company's revenue. So as we go forward, I think the best way to say it is, in '06, I continue to think that the 21 markets supply a relatively small percentage of the total '06 revenue guidance, but they can be a very meaningful part of the sequential growth.

As you know, when you start -- when we look at our sequential growth from one quarter to the next, you know, it does not take that much to move the dial on those numbers, so good performance in a 21-market expansion can -- I continue to believe it can substantially move the dial on sequential growth rates. But in the final analysis, you're still going to have '06 revenue that's principally on that established market platform.

Okay, that makes sense. Thanks a lot.

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

At this point, we are watching our participant list dwindle a little bit as we reach the 1:12 mark, so we're going to wrap this conference call up. I want to thank all of you who are with us at this point for joining us and staying with us for this year-end conference call, and we look forward to reporting our progress to you at the next quarterly conference call. Thank you very much.

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