CoStar Group Inc (CSGP) 2006 Q2 法說會逐字稿

Welcome to the CoStar Group Second Quarter 2006 conference call. Today we have Andrew Florence, President and CEO; Frank Carchedi, CFO; and Audra Capas, Vice President of Communications. Thank you.

I would now like to turn the call over to Ms. Capas. Please, go ahead

Thank you and good morning. I’m Audra Capas, Vice President of Communications for CoStar, and I’d like to welcome you to our second quarter 2006 conference call. Before I turn the call over to Andy Florence, 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 to 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 second quarter 2006 press release and any of CoStar’s filings with the SEC including its 10-K for the period-ended December 31, 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 obligations to update these statements. Today’s conference call is also being broadcast live over the Internet at www.costar.com/corporate/investor/. And audio replay will be available 2 hours after the live call concludes through midnight on August 3, 2006. The replay telephone number is 800-642-1687 within the United States or 706-645-9291 outside the United States. Refer to conference call ID 2764427. The replay will also be available over the Internet at www.costar.com/corporate/investor/ for a period of time following the call. Thanks for joining us and I’ll turn it over to Andy.

Thank you, Audra.

Welcome everyone to our second quarter 2006 conference call. I am very pleased to report that environment where we are reinvesting into our future growth, we reported another quarter of solid earnings and strong revenue growth. We doubled earnings per share for the second quarter of 2006 from the same period a year ago. The Company for the second quarter this year had net income of 2.3 million, or $0.12 cents a share, versus 1.1 million or $0.06 cents a share in the second quarter of 2005. Our revenues for the second quarter of 2006 were 38.9 million, an increase of 18.5% from the second quarter of 2005. The acceleration of contract bookings grew 14.2% from 5.41 million in the second quarter of 2005 to 6.18 million in Q2 of 2006.

Our average contract value increased 23% from $6192 in Q2 of 2005 to $7644 in Q2 of 2006. Our average contract value grew quarter over quarter from $6672 in Q1 to $7644 in Q2 of 2006. Our renewal rate remains steady at approximately 93% for the second quarter. In fact, it has been above 90% for the past 9 consecutive quarters. Frank Carchedi, our Chief Financial Officer will address the second quarter results in more detail later in the call.

As stated in earlier conference call calls and communications that we hope to report before year-end 2006 that in aggregate our 21 market expansion effort had reached profitability. We are very pleased to report that in fact with a good 6 months to spare, our 21 expansion markets are now profitable and aggregate. This is especially impressive given that the last of these markets delivered just four months ago. Many of these expansions markets that delivered at least a year ago are showing very strong contribution in margins that are as strong as or stronger than those in our original 45 markets. This reinforces and supports our belief that the smaller North American cities can have even higher margin rates than do the larger cities.

At the end of 2004, CoStar’s information services covered 45 top commercial real estate markets in the United States and everyone of those markets was profitable on a contribution basis for CoStar. At that time, we felt there was a clear demand for our services in many of the U.S. markets that we did not yet cover. We also felt that by adding additional coverage, our national service offerings for institutions will be more comprehensive and therefore more valuable. In addition, we felt there was strong potential for CoStar in the retail space, but the retailers would demand more comprehensive coverage than we had at that time. Now our thinking has gone from plan to profitable reality. We have now reached research map, investigated and photographed 250,000 additional properties in the 21 expansion markets. Growing our core U.S. database by 30%. We had expense from [inaudible]. When we began this expansion, we identified 87 key brokerage firms in the 21 markets that were influential with our peers. Our goal was target these influencer, win their business, and set a foundation for long-term growth for our Company. As of to date, 66 of those 87 brokerages or 76% of them are already CoStar customers in this early phase. In many markets, all of the leading firms have now standardized on CoStar. Our early success in these markets is only a start. The product is obviously is delivering value to these folks and they’re responding to that. Legally, we have a fair amount of potential growth in the future in these markets. At a point of reference, we had a 100% of top firms in Washington, DC, 15 years ago, but our revenue in that market a decade and a half later is still growing at 15% year-over-year. On average, we are generating $20 of expansion market revenue annually for each property in our 21 new expansion markets database. So by comparison, we have $680 dollars of annual revenue for each building in our Washington, DC, database, or 3400% more per building. On average, we have $222 of annual revenue associated with each building in our original 45 market database for 1100% more. Obviously, based upon these benchmarks, we believe that in time our revenue per building in our expansion markets will move from the current $20 dollars per building towards the level of the $680 of revenue per building of the more mature markets, all the while showing strength in the margins. So they are already profitable. The expansion markets are still growing and sequential of 20% quarter over quarter. So they’ve got sequential quarter revenue growth of 20%.

As expected, our decision to expand our coverage from 45 markets to 66 markets has coincide with doubling of our sale of national subscription to our full U.S. database to institutions, banks, national players, and the like. We believe that our breadth of U.S. coverage help us gain a strong positive initial response from the retail real estate community when we launched our retail offering recently.

At this time last quarter, you may recall we were on the verge of launching the retail component of CoStar Property Professional at the International Council Shopping Centers Convention in Las Vegas. We said we expected an enthusiastic response from national retailers, shopping center owners and commercial brokers based upon their reaction we had already received during the 6 months of market testing prior to the event. What we didn’t at ICSC was an overwhelming crush of traffic in our business. In three days, we had more than 6000 retailers, owners, developers, and brokers knee deep at our demo station, wanting to know how they cut their time, expense, and risk of making retail real estate decisions using our technology. Never in our Company’s history have we’ve seen such an immediate stunning response of a product launch. I believe it would be an understatement to say that anyone who was there other than possibly a direct competitor wouldn’t agree with me that the new product was a buzz of ICSC.

Let me read you an e-mail I got on my trio from an SVP at one of our top 10 clients at the end of the show. I think it sums it up nicely. He wrote, Congratulations on a wild ICSC. To say you knocked it out of the park is an understatement. I’d call it a grand slam. Buzz on the [cab line] was very favorable. I didn’t really know what the cab line meant -- I guess the long -- really long cab line to Vegas. But it basically conveys the tone of the convention.

Since May 22, overall usage of CoStar property professionals took a sudden jump up 25% as subscribers logged on to use the new retail features. Users were able to retrieve details on some $450,000 retail properties and more than $1 million retail candidate locations, including those of America’s top 3000 retailers. They also have access to [inaudible] demographic data with building level precision, data metrics, traffic count data, and a powerful new proximity search capability with on the fly mapping and reporting function. As we all know, the proof is in the results. Since the show, we have signed 71 related contracts with an annualized value of more than 1.2 million. These contracts are retail oriented brokerage firms, owners and leading retailers such as Sbarro Inc., Pathmark, Spencer Gifts, Mattress Discounters, [inaudible] and others.

The sales cycle for the largest retailers appears to be in the 90-day range as we expected. More deals are in the pipeline and we expect to see continued strong demand for our retail offering in the future.

Even though CoStar already actively tracks almost a million commercial properties in the U.S. there are far more than a million that are not in our databases. Before launching the retail product, the Company decided to expand its coverage to conventionally cover every -- to cover the majority of U.S. retail properties and we expected it would take 3 to 4 years. Given the triad successes of our retail launch, our 21 market expansion and our institutional national data sales, the Company has decided to accelerate the expansion of our North American database growth. A primary focus of this accelerated investment in database growth will be increasing the likelihood of broaden option of our retail real estate listing service as a primary platform for finding and marketing retail properties in the U.S.

CoStar intends to expand its fleet of 52 field research vehicles by acquiring and equipping an additional 100 research vehicles. Rather than [Dodge Brenner] the Company has been using, CoStar intends to add less costly and more environmentally friendly hybrid cars [inaudible] vehicles and the support of the expanded research efforts, CoStar also plans to add an additional 250 researchers during the third quarter of 2006. Those researchers not operating in vehicles will based either in the United States or off shore in order to achieve the highest possible quality at the lowest overall cost. The primary goal of this expanded research team is to add retail listings and properties to our database from both markets we are already servicing and from smaller markets we do not yet actively cover.

In addition to collecting retail information, research teams operating in markets that we do not currently cover will while there collect information on office properties, industrial properties, and land for sale. We believe that this effort will increase the size of our U.S. database by 50% in the course of the next 12 months. We expect to add approximately 100 new MSAs to our coverage, the majority of which will be tertiary or smaller. This effort should cover the total number of MSAs CoStar covers -- Buffalo, Albany, Rochester, Syracuse, New Orleans, Louisville, Fresno, Omaha, Albuquerque, Little Rock, Portland Maine, and Knoxville are examples of the assorted of markets we plan to cover. Obviously, these new MSAs cost a fraction to initiate or maintain when compared to the likes of Los Angeles, Las Vegas, or Minneapolis.

One important dynamic of our business model I want to highlight is that while in the short term adding more property to our database may suppress our earnings growth, we believe that in the intermediate and long term, not only does it enhance our earnings through high margin revenue growth but it also reduces our per unit research cost and should drive even greater margin expansion intermediate and long term.

At one extreme, when we were operating in Washington, DC only many years ago, our research costs for our basic product was an inflation adjusted $243 per building annually. At the other extremes, we anticipate that our per building research cost can drop to as low as $6 per building as we approach 3.5 million properties in the future.

We believe that we will be able to enhance our retail and our institutional surface sales through this enhanced national coverage. In addition, we believe that we can sell our databases for markets such as Albany, to brokerage firms and owners in Albany as well as to brokers, banks, owners and vendors that operate in New York State generally. Of course, we believe that growing with the brokerage firms investors that subscribe to all of our markets and use it for national coverage would find even more value in our surface with this expanded coverage.

AS CoStar business and market opportunities continue to grow rapidly, so is our focus on accelerating world-class operational excellence across the Company. Earlier this month, we announced the appointment of Brian Radecki to Vice President of Research Operations. Brian has played a major role in every aspect of the Company’s global and domestic science functions for much of the nine years he has been with CoStar. In his newly created management role, Brian is responsible for making our outsourcing operations oversees and here at home more efficient by streamlining redundant procedures and cutting unit costs. At the same time, he is looking for ways to expand the skill of our databases upon increasing the quality of our product. It’s an exciting opportunity, and with Brian’s help, I think CoStar will reach higher levels of performance and growth we enjoy today.

In June 2006, CoStar began charging for its CoStar commercial MLS product, a high-value, low-cost online database that contains the nation’s largest collection of research commercial for sale property listings. In just over a month, more than 1000 free trial subscribers were converted to paying customers. They are brokerages, sole practitioners, and residential agents who buy and sell the occasional commercial property. Another 30 signed up because I checked that number last night. It is our first subscription product that relies on a pure Internet customer acquisition model.

We acquired Comps.com in 2000. We had a comparable sales property database at the time but the deal made sense because Comps was the clear market leader with 22 years of experience in the very complex product area. So building by building integration of their data into our database across hundreds of thousands of properties pose significant challenges. In addition, the integration of the two research software systems, software products, billing systems, etc., pose a real challenge. Since that acquisition, we have made steady progress towards total seamless integration. CoStar has a strong track record of integrating more than a dozen acquisitions. In the upcoming quarter, we will complete all aspects of the Comps integration when we deploy a major product in back office software release that has been two years in the making.

Our last major upgrade of the Comps product was completed just after we acquired Comps in 2000 when we made the look and feel of their product similar to that of CoStar software. Since that release, our Comps revenues have grown more than 300%. Our Comps product renewal rate is in the mid 90% range, mid 90s, and it has one of the highest renewal rate of any of our products. We have not been taking that success for granted, and we have been working hard in what we think is a terrific product upgrade. The new product has more than 50 feature enhancements. We are keeping those features confidential until closer to the product release. I’ve been working with the bait of the new product and can already see fast improvement. As is the case with any good software upgrade when I find myself back in the system our clients are still using today, it feels like slowing down from 75 miles an hour down to 15 miles per hour and you really start to understand how strong the new product release might just be.

We’ve spent countless hours in focus groups on this product and we feel confident when we release it our clients will love it.

The improvements we are making to our back office research software that feeds the Comps product are possibly even more valuable. We know that the quality of the data we produce is more important to our customers than is the quality of our software. Both are important but the data in the product is the most important. We expect our streamline and fully integrated research system to enable use to produce more comps, more accurate comps, higher value comps, and more timely comps all at a lower cost per unit. We anticipate yet another significant productivity gain in our research operations.

Before we take any questions, I’d like to turn the call over to Frank Carchedi to talk a little bit more about our second quarter results.

Frank?

Thanks, Andy.

You’re welcome.

As stated in the press release night, net income doubled from 1.1 million, or $0.06 per share in Q2 in 2005, to 2.3 million, or $0.12 per share in Q2 2006. In addition, EBITDA increased 1.1 million from 4.2 million in Q2 2005 to 5.3 million in Q2 of 2006 on year-over-year revenue growth of 18.5%.

Today I’m going to focus principally on a sequential result for the second quarter of 2006 compared to the first quarter of 2006 and also on our outlook for Q3 and the remainder of 2006.

Total revenues grew sequentially by 4.5% overall from Q1 2006 to Q2 of 2006, increasing from 37.3 million to 38.9 million. The results in the second quarter was primarily due to continued solid growth in our four U.S. based subscription revenues combined with a continued high renewal rate of approximately 93% for the quarter. We had a 4.3% sequential growth rate in the core U.S. subscription revenue areas with stronger overall growth in the nonsubscription areas and in the U.K. Total subscription revenues for the Company including the U.K. accounted for approximately 96% of Q2 revenue. A group of a 21 newly opened markets, which has reached revenue of approximately 1.2 million quarterly, or 3.1% of our overall revenue in Q2 2006 continue to present a significant opportunity. In aggregate, the [inaudible] was profitable on a direct basis [inaudible] allocation and we continue to expect rapid growth at high margins in these markets. The group of 21 markets grew 20% sequentially in Q1 to Q2 of 2006.

Gross margin increased by approximately 2 million from 24.3 million in Q1 to 26.3 million in Q2 or $1.7 million increase in revenue. Margin percentages increased from 65.3% to 67.5% in Q2, primarily as a result of organic revenue growth and short-term reduction in field research costs as we redeploy field research from the 21 market expansion to the resell practice.

Overall operating expenses increased 1.4 million to 22.5 million in Q1 to 23.9 million in Q2. Selling and marketing expense increased to 1.2 million from 10.9 million in Q1 to 12.1 million in Q2, principally due to a seasonally increase in spending related to the annual ICSC ratio and retail launch.

Offer development, G&A, and first standardization expense remained relatively flat from Q1 to Q2. As a result of sales growth and modest overall increases in cost structure, EBITDA increased $600,000 from $4.7 million in Q1 to 5.3 million in Q2 in 2006. GAAP basis net income increasing 1.9 million or $0.10 per share in Q1 to 2.3 million, or $0.12 per share in Q2 of 2006. Reconciliation of EBITDA and GAAP basis result is shown in detail in our press release issued yesterday which is available on our web site.

Capital expenditures for Q2 of 2006 were approximately 2.7 million of which 1.5 million was related to our research photography and retail expansion effort and the remainder was for the support of our existing platform.

We closed the quarter with approximately 150 million in cash, cash equivalents, and short-term investments, an increase of 8 million during the quarter. In addition, the cash flow from operations we generated an additional 1.7 million for proceeds for stock options exercises for approximately 73,000 shares during the quarter.

Now I look at the outlook for the third quarter of 2006. As indicated in our press release, for 2006, we are now expecting organic revenue growth of approximately 18 to 20%, bringing revenue in the 160 million range for the year. We expect a sequential quarterly increase in revenue from the second quarter of 2006 to the third quarter of 2006 of approximately 3.5 to 5%. We continue to believe that there is significant upside revenue growth potential in growth and sales force size and productivity, particularly in view of opportunities resulting from momentum in established markets, ramp up from newly released marketing openings and the retail offering.

For the third quarter of 2006, we expect fully diluted net income per share of approximately $0.16 to $0.20. Gross margin percentage is expected to remain fairly steadily in Q2 to Q3 as we continue to ramp up research staffing to support our continued expansion and retail building coverage. Sales and marketing is expected to return to the Q1 level due to the reduction in seasonal market costs. By the fourth quarter, we expect to ramp up research activity significantly as described in yesterday’s earnings release and in Andy’s discussion this morning. The majority of this expansion will affect cost of sales, and we expect that this will result in incremental ongoing cost structure of approximately $4 million per quarter beginning with the fourth quarter of 2006. We expect 2006 fully diluted net income per share of approximately $0.50 to $0.60 cents EBITDA including equity compensation charges that are expected to reach 22 to 26 million for the year.

Capital expenditures are expected to be in the 5 to 7 million range in the third quarter which included the planned purchase of 100 additional field research vehicle.

In conclusion, organic growth remained solid and we believe substantial upside exists in revenue growth at high incremental margins for both established and new markets and surfaces. Even with the significant investments in retail, the strength of our core business and business model is apparent. Continuing to make long term investments with an emphasis on growth. We look forward to reporting our progress to you.

And with that, I’ll open the call for questions.

[OPERATOR INSTRUCTIONS]

John Neff, William Blair & Company.

Hey, guys. Can you go into a little bit more detail as to the nonacceleration in third quarter revenue? Sales count is increasing. You got the 21 new markets growing 20% sequentially. You’ve got the commercial MLS product which you’re now charging for and a retail product. So really you’re looking for sort of a 5 to 6.5% sequential growth range in the back half of the year, now 3.5% to 5%, but Frank, can you just kind of indicate the upside potential for that? Are you just being conservative?

Well, John, I think there is upside and continue to believe there is upside in every upcoming quarter and next year because of these opportunities, but as you know, we have a great degree of visibility on revenue from month to month, and certainly from quarter to quarter as well. So, you know, when you look at Q2 revenues for Q3 we’re still optimistic, but it’s where it’s at and, you know, that’s where I want to keep you guided towards.

And the reality is, we’re getting a strong response for the retail product. It is a fairly major shift to the sales force. They’re dealing with a new sale cycle. On the larger retailers it is longer than the sale cycle for brokerage firms. We have taken them into off-site meetings for training, things like that. So there’s a little bit of a shift taking a turn here which doesn’t let you see an acceleration right away associated with retail.

Probably a distraction as well from the other sales efforts as well, I would think.

Well, we take the whole sales force up to Chicago for a couple days to teach them the product or take them to ICSC for a half a week. It definitely changes things up a little bit. But we feel good about we’re doing and why we’re doing it and feel optimistic about the product.

Can you talk a little bit more about what kind of feedback or new information is driving the retail acceleration? You mentioned in the press release that it was, I guess originally a 4-year development plan. Now how long do you envision it being?

This is a significant acceleration, obviously. As [inaudible] with market expansion, it’s difficult to -- there is no source for how many buildings are out there in the United States, so it’s a little difficult for us to engage precisely how long it will take. This definitely shaves at least a year or 18 months off that 4-year mark. One of the -- you know, one of the consistent core feedback we got again and again from everybody was they absolutely love what we’re doing in this product. For the brokerage firms is something that are prepared to adopt this new retail product nearly instantly. That shows up in the 25% surge and usage in the data release [inaudible] and the number of our [inaudible] signing up. But the biggest and most demanding customers and highest selling contracts that we feel that they are going to want us to ultimately want us to have coverage of Albuquerque and Buffalo and the like and we won’t be doing, it’s the cost involved in cycling up coverage in those markets. They are not nearly as great as going into Richmond or Minneapolis or Las Vegas, but we do sense that they love the product and what we’re talking about doing but they want us to give them -- they are going to want many properties as possible. So we’re just trying to respond to that ahead of the curve.

Right.

And also I should go back to the fact that your old school traditional revenue drivers still exist for every building we have in the database. They can still expect to sell that Albany New York building to an Albany broker and still expect some sell that information to your city broker and you still expect to sell that information to a GMAC or some other large national institution. So you’re doing it for multiple customer bases and we’re fairly confident of what that surging looks like and we think it’s very good.

Can you talk a little bit about if you’re started charging for commercial MLS, the conversion rate that you’ve experienced and ultimately has there been any impact at all on listing growth?

Well, it’s a little early to tell since a lot of people come in. This -- the MLS product is geared to the lower end of the commercial real estate community. It’s folks who are not looking for a full inventory comprehensive information solution for commercial real estate. They are those people who are not doing commercial real estate day in and day out everyday. People who are maybe buying maybe a residential realtor who does three or four transactions a year and the like. So a lot of the people that came in during the free trial, they might be showing up once every 6 weeks to use the product. So until -- we’ve only been charging now for a month, almost a little more than a month, so we need to be able to look for a quarter or so before we can figure out how many of those people are signing up. The people that did the free trial are moving over. What we’re seeing anecdotally is that about half of the sign-ups are people that are brand new, never used the system before and half the people that used it during the free trial. The [inaudible] is pretty good. It appears to be getting some good traction. We got a big surge listing growth when we first rolled the product out in the trial base several months ago and I think the next surging listing growth will be driven by as much as anything by this whole retail expansion and by putting more people out in the field in these markets we’ve never been to before and we’re fairly pleased with it. I mean, it has a sales force of nine and it’s contributing to our growth.

One more question, and then I’ll get back in the queue. It looks like the retail contracts that you signed are averaging a little under $17,000 versus your average subscription size of about I believe around $11,000 for the other products. Anything we can infer from that?

Well, I would actually go back to that $7,000 average new contract as many of the contracts you're talking about there. [Inaudible] $7000 and $17,000. So it’s more than twice the average new contracts value. Yes, I mean, this is something where the type of people that we’re meeting they’re very large consumers of real estate information. They are just very new to us and so we’re going after to some much larger companies and some much larger players on average and to date the folks who have been signing tend to be the mid or smaller players and the bigger contracts have a longer sale cycle so we do expect to see these retail contracts being bigger than what are current new sales look like today. We got some larger numbers in the sale cycle right now.

Great. Thank you, guys.

Jim Wilson, Jolson Merchant Partners

I was wondering -- that was sort of my question on the retail, but I know you don’t know until you get the people signed up and sign the contracts. But I was wondering on the commercial MLS, unless I had missed it one by here, what – kind of what dollar value or how would you characterize the pricing you’re getting on those new [inaudible] the thousand people that have converted, or the thousand subscribers that have converted?

Well, Jim, we’re simultaneously going two completely different directions. On the retail side, we’re dealing with a much larger average contract side and then on the PMLS side, the listing service side, we’re dealing with a much smaller contract side. So we’re at 17,000 I guess, per John’s calculation, on the new signups with the retail we’re at $240 dollars a year. The absolutely opposite on the CLMS side. So there’s still very small numbers. So the success in this product will be measured as we sign up thousands more, thousands of additional clients, which that is what we will be pursuing. We’ll be pursuing the 10s of thousands of customers.

Okay. And then, I guess, I just wanted to look forward then with, you know, kind of revenue potential. [Inaudible] cost increases will ultimately researchers, you’re talking about in the neighborhood of $4 million a quarter. So or’07, I mean, what do you expect that initiative and out of the [inaudible] retail? Can you give us any thoughts on sequential kind of revenue growth that you hope this might drive or [inaudible] because it would keep up the [inaudible] flat earning here but you’re obviously [inaudible] accelerations of revenues. Can you characterize any way you can think of to color how ’07 might look for you guys?

Well, Jim, I think you have [inaudible] right. This expansion, this wave of expansion on addressing retail as well as specific MSAs will add for an ongoing $4 million quarterly cost structure, principally in labor upping the cost of sales lie and obviously will enhance the retail offering and provide greater revenue opportunity, it will also create offerings within [inaudible] which granted our smaller than -- you know, for example, 21 market expansion but and were pretty new revenue opportunities there. So I don’t know if I can give you any quantification. We haven’t given any notice out of the guidance. I don’t know if I can quantify it but I think it’s, as Andy described, the more buildings we cover, the more [inaudible] we cover the greater the opportunity on the top-line side.

And the CLMS, I don’t really feel has a big material cost to it. It’s really a piece of software. It’s a reconfiguration of data. It’s another parts of our product offering and a lot of that is expensed out behind us, other than direct marketing costs we put into it which are measurable but they are generally [paper click] and the like. They’re very measurable.

Maybe I’ll just ask one last one. There maybe another way [inaudible] top line would be but [inaudible] did you think of going forward on either the gross margins or the SG&A level that might otherwise further change will be better or worse other than simply leverage of revenue growth?

I mean, at this time, Jim, I can’t -- I don’t know if I can give you anymore specific guidance on the other captions. You know, what I usually talk about in terms of modeling is to, obviously, consider salary escalations across the board [inaudible] and at this point some seasonality in terms of some of the specific events or marketing events we described, but I don’t know if I can give you any other granular data or clarity on each [inaudible] going forward.

[Inaudible] Jim, is that this sort of expansion or acceleration of our effort in retail and some of the coverage is a bit different than the 21 market expansion. In the 21 market expansion there were incidences where we were going into a Milwaukee where the first research vehicle hit the street for when we actually had material revenue or were approaching profitability or a profitable market it was two years. A pretty long time between start of expense and revenue or meaningful revenue. As we go into Des Moines, IA, it’s a much faster ramp-up and we’ll be launching the product there without trying to get full inventory. We’ll be launching the product as soon as we have complete availability for Des Moines, IA, and then fill in the full inventory over time. So we do expect to see the revenues come in faster on the investment than we have historically seen.

No. That makes sense.

And the same thing is true with what we’re doing with retail. So if we can add -- I’d like to add another 100,000 retail listed as soon as possible and it’s basically supporting the product we’ve already got out there that we’re selling so it should – you know, you should see a faster translation from dollar invested to revenue coming in.

Okay. Thanks.

Brandt Sakakeeny, Deutsche Bank

Thanks. If I can add the quick question. Frank, just do you have the FAS 123 costs where exactly they were in the P&L?

I don’t have a specific breakdown. They are mostly in G&A and sales and marketing line predominantly. I’d say off the top of my head about 60% of the costs which is described in the earnings release is in the G&A line.

Okay. Great. With the remainder in sales and marketing 40ish?

All of which of about 10% of it which is distributed up in the other line.

Right. And then a question for you, Andy. On the sales force head-count. Do you have that a quarter and then maybe could you give us just an update on some of the initiatives of the sales force in terms of retention and compensation and get your view on how the sales force is operating right now. Thanks.

I can give you some head-count numbers on the sales force. We’ve got roughly 78 quota carriers in the field sales force. About 52, 50, 52 inside sales quota carriers. 9 quota carriers on the ad sales force and there are another approximately 18 over in the U.K. quota carriers.

Okay.

And the retention in that group is stable right now. We are -- the group is increasing. We are putting -- as we get some good revenue traction from the expansion markets we are doing some geographic reconfiguring putting some people out into some of these market areas like Salt Lake City or Nashville and the like and -- or Milwaukee and Lass Vegas. More people in Minneapolis as revenue picks up there. And we are working towards some fairly significant streamlining in terms of building up larger regional offices -- six or seven larger regional offices that people can travel shorter distances for face-to-face meetings in this growing number of MSA that we’re covering. So we think we’ll get some better productivity by having a larger group of sales people based in Chicago who are traveling out to several cities around Chicago. So we’re doing some shifting of the organization [inaudible] there’s been a lot of work there and I think it’s fairly straightforward blocking and tackling stuff is fine to where we are right now but again we’d like to see that number keep growing and we are seeing higher average contract buys and decent productivity.

Right. And do you think -- should that grow in line with revenues or just slightly below that do you think sales force head-count?

It should lead it by a bit, but if we get the head count up you should see revenue acceleration pick up six months later.

Okay. Great. Thank you.

[OPERATOR INSTRUCTIONS]

Brandon Dobell, Credit Suisse First Boston

That question has been withdrawn.

Your next question comes from Brad Eichler with Stephens, Inc.

A couple of questions. First, you know, to go back to an earlier question that was asked. You talked about the GAAP from the beginning of your research process to recognizing revenues in some of the larger territories being two years. You said this was going to be faster. Can you just try to quantify that at all as to how much quicker the potential is here?

Yes. In a 21 market expansion, we really wanted to go into Minneapolis or Las Vegas and have virtually every single building photographed measured and detailed from the Burger King on up to the 55 story skyscraper before we launched product one. Before we gave the first client access to system. We perceive a little bit of a shift here where we actually think there is an interest in buying our product in some of these tertiary markets at the point at which we have all the availabilities in the system, the for sale properties and the major properties in the market. So you might have -- and these number will not be entirely accurate but they’re representative of what I’m talking about. You know, in Milwaukee it might be 20,000 buildings our researchers have to visit. In Buffalo it could be 6,000 properties that we need to visit. We can loosen the market on hunting for listing in Buffalo 10 times faster than we move through hunting for every single building to full inventory. So you could be cycling up in Buffalo three months after you start research. You would not get -- your sales would start coming in. They would not be fast or [inaudible] as your sales from the market where you have full inventory which you’re bringing in a lot faster and you’re also able to turnaround and there’s clearly going to be somebody in New York City whose operating throughout New York State who would buy that buffalo data the second we availability data in there. And then also it’s just sort of incremental support to that effort to sell our product to the biggest retailers in America. So at least we have gotten all the right meetings, post ICSC with the absolute biggest name in retail. So we’ve been in the headquarters of the top 20 retailers in America. They are absolutely operating out of Buffalo and they’re operating in Albany and [inaudible] effort the second we have those availabilities cycles out to a higher degree it’ll help us close some incremental higher ratio to those deals.

Just to continue on that for one second. When you look at the in aggregate – look at the size of the 21 new markets that you brought on and the revenue opportunity associated with those, relative to the revenue opportunity associated with this hundred market expansion, how would you compared --I mean, I’m talking revenue opportunity over time -- how would you compare the opportunity sets there?

Well, a lot of this growth in our database from this expansion is actually going to come from our existing markets so there are retail properties in Miami and Washington and New York also very attractive we do not yet have in our system. So this will be broadening out the existing databases and then also adding additional MSAs. I think that on any measure I think that this effort has more overall revenue opportunity associated with it than the 21 market expansion just because you’re going to be dealing, I mean, a team of vehicles and people I think ultimately could add a 1.5 million buildings in the next three years or so. And I go back to -- [inaudible] I go back to the fact that, you know, our revenue is correlated with a number of buildings and listings in our database and our efficiency at scales, we get bigger and bigger, our per unit cost of collecting these buildings comes down and the value of each of building in our database to some number of customers grows the more buildings we’ve got. So both those two trends are the right long-term or intermediate trend, even though it depresses our real live margin in the short term.

Understood. On the spending on retail in the quarter, I think everyone was expecting and you got it to 2.5 to 3.5 million of incremental marketing expense, and in the press release you said you spent 5 million on retail. What was the breakout for the incremental marketing expense?

Yes. Brad, the $5 million includes the baseline, you know, ongoing research, development, you know, other elements and as all those numbers hang together. In other words, there was 2.5 million spent approximately on the ICSC and retail launch and the focus effort. But then on top of that there has been such ongoing operating costs going to retail. So the 5 million was a pretty extraordinary second quarter number devoted to retail.

Understood. Was sales and marketing in other areas cut back a little bit, or was that at a relatively normal level in the quarter?

I think everything else was at a relatively normal level. In other words, there weren’t cutbacks to compensate for the ICSC or the retail launch. I’ll give you a couple specifics. One I think I already mentioned which was there was a short-term lull in the field research cost that we transitioned out of the 21 market expansion which basically dropped up in the first quarter. So that caused some retraction of costs in Q2 open the cost of sales line and then the other thing that happened is seasonally the first quarter is an expensive quarter on sales and marketing because of sales training and annual conferences and that kind of stuff which usually I talk about as being seasonal relative to Q1. So that dropped off as we head into Q2 which offset a little bit.

And just so I’m clear on the 21 expansion market, the thought is not to terminate those researchers but your redeploying those, is that correct?

Only in field research there was a movement of -- because the field research is done comprehensively for the 21 market, the vehicles and field researchers were largely moved away from those and into retail and other projects in other parts of the country. .

Right. But there’s no longer term cut or offset to expenses for -- when you finish up the 21 market?

If you look at the 21 market as a [inaudible] unit you have [inaudible] as you remove --

For the 21 market.

The 21 market if you had four vehicles in Milwaukee and once you visit virtually every property there you no longer need more vehicles. You need one remaining.

But for CoStar in aggregate, you don’t add a vehicle to just somewhere else?

[inaudible] shifted into markets doing new things.

Okay. And then just two final quick questions. Of the top 20 retailers, you said you’ve been able to talk to, have you gotten any no’s or this isn’t a product for us at this time.

I’m sure we have gotten no’s. It’s not a product for us at this time. I’m unaware of anybody saying this is not a product for us. I think some people may have said I want to see Albany in there or I want to see Portland, Maine in there but by enlarge, I’m quite impressed as you go into some of these mega, mega organizations you do get the opportunity to meet 15 to 20 people on 5 different occasions before you move to an actual contract.

Okay. And then the final question is, on the visibility comment you made earlier, Frank, about the sequential growth rates for the third quarter, when you look out, you have pretty good visibility that one quarter out, is it two quarters out, three -- what’s the?

You know, we’re 96% subscription based and when we say subscription based we mean long-term contract. So a contract of at least a year. So I have quite a bit of visibility going out beyond the next quarter for the next year and really beyond if you think about our experience [inaudible]. But obviously for months and months and for quarter to quarter the visibility is quite good because you enter the quarter with that 94 – 94, 94% renewing in customer base.

Right.

And you’re dealing with – what you’re dealing with from one quarter to the next is the productivity of the sales force, you know, what the sales force is producing as it layers on to that quarter and impacts that next quarter.

Okay. Thanks again.

Brandon Dobell, Credit Suisse First Boston

This is actually [Rob Rigg] calling for Brandon. I had a quick question, are you doing any customized products for your smaller customers? I understand that you’re doing it for some of the lower brokers.

I’m not really aware of any sort of customization at the lower end. I mean, there are products that are designed to have self-customizable features -- like you can load up your logos and [inaudible] reports and your firm name shows up against the place. So you do some of your own customization. Is there anything in particular that you’re thinking about there that I’m missing?

No. Not really at this point.

We generally are looking for -- I mean, we do data extracts and some customization for the contract that are north of a quarter million dollars, 100,000 and like and so if general growth wants the numbers to be in base 9, we’ll give them to them in base 9. But other than that, we try to stay very privatized.

Okay. Great.

John Neff, William Blair & Company.

Hi, guys. You guys -- I just want to get a sense for where you are in some of the expense initiatives that you talked about over the last few quarters, including things like offshoring. Have you undertake the new acceleration of the retail strategy -- an example I guess of that would be, I’m wondering if [inaudible] just have to catch up to the new acceleration because I was under the impression that you guys were looking at ways of eliminating the trucks and going to a more of an independent contractor with a proprietary software workflow.

Well the workload profit is becoming much more sophisticated. So you could have a person photographing and measuring and geocoding a property in the center of Albany at 3 o’clock today and then someone at 6 o’clock Eastern time arrives at work in India and then does -- adds an additional 20 or 30 fields to that property from India and then somebody in the Philippines might pick that property up in the morning and make some phone call on it during the daytime in the U.S. So we are absolutely pursuing initiatives to drive our per unit costs way down as we drive the number of units we’re doing up to try to pursue the revenue associated with them. But the specific decision to put -- to not rely on the contractors. The contractors are not the right tool to use when you’re trying to move faster because a lot of these contractors have part-time jobs or something where they might be doing some wedding photography on Saturday and Sunday and they might go to the rehearsal dinner on Friday night and they work on more flexible schedules. When you really move into a zone where you’re trying to -- you know do 10,000 buildings a day, you want to have staff who are consistently 100% devoted to doing it and the field researcher is the one thing we can’t really – ultimately you got to have somebody there that initiates something that then feeds the broader machine to enhance the research and get it out there. But the cost of the vehicles are going to be dramatically different this next phase. The first round of vehicles we used were -- I think they were somewhere around $200,000 each because they had the booms for very high quality photography. The boom came 30 feet out of the vehicle and you get some great images with that. Now that we have 45 of those vehicles out there, we don’t need another 100 of those higher end vehicles. Ultimately, what we’ll do long term is we’ll use these vehicles that probably cost about $35,000, not $200,000, spread those around the country and then evenly spread out these high-end photography platforms for an overall lower cost per same quality. And then also we do drive around the world. I believe it’s twice a week we drive around the world in miles and as we move that drive around the world to five or six times a week, we are going to save [inaudible] amount of money by getting a vehicle that gets 50 miles to the gallon, as long as it doesn’t fall apart.

Right.

So we’re chasing the revenue and I think we’re getting some cost savings, so the aggressiveness of the expansion, you know, short term we’re adding more buildings, otherwise suppresses earnings short term.

Frank, full-year CapEx expectation?

I think we’re probably in the same range we started out at. It was probably about 12 to 14 million range. The timing did a little bit – you know it’s a little more lumpy than what I thought and you’re going to see probably possibly 5 to 7 million in Q3 alone because we’ll buy [120] vehicles and put them all at once. So the ongoing demand for CapEx just for the existing MSA, for the core platform, workstations and that kind of thing hasn’t really changed much for years, but the field research and the vehicles are obviously more costly.

I think we’ve -- I’m not sure if we were disconnected there, but at any rate, I think that would definitively be the end of the conference call. Thank you joining us for the second quarter 2006 earnings call and we look forward to [inaudible] progress next quarter.

Thank you. This concludes today’s conference call. You may now disconnect.