CoStar Group Inc (CSGP) 2006 Q4 法說會逐字稿

Good morning. My name is Beverly, and I will be your conference operator today. At this time, I would like to welcome everyone to the CoStar quarter four year-end 2006 results and 2007 outlook conference call. [OPERATOR INSTRUCTIONS] Thank you. Ms. Capas, you may begin your conference.

Thank you, and good morning. I'm Audra Capas, Vice President of Communications for CoStar Group, and I would like to welcome you to our fourth quarter and year-end 2006 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 and year-end 2006 press release and in CoStar's filings with the SEC, including its Form 10-Q for the period ending September 30, 2006, under the heading, "Risk Factors." All forward-looking statements are based on information available to CoStar on the date of this call, and CoStar assumes no obligation to update these statements. Today's conference call is also being broadcast live over the Internet at www.costar.com/corporate/investor. An audio replay will be available two hours after the live call concludes through midnight on March 8, 2007. The replay telephone number is 800-642-1687 within the United States or 706-645-9291 outside the U.S. Refer to conference ID 6802221. 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 will now turn it over to Andy.

Thank you, Audra. Welcome, everyone, to our fourth quarter and year-end 2006 conference call. I'm pleased to report on a strong year and a fourth quarter that was very strong as well, during which we made significant investments in a number of exciting future revenue drivers while showing current strong revenue and earnings growth.

Revenues for the fourth quarter 2006 were $42.1 million, an increase of 17.6% over the same quarter a year ago. For 2006, revenues grew at 18.3% year-over-year-- to $158.9 million compared to $134.3 million in 2005.

Earnings per share for 2006 increased 91% over the previous year -- from $0.34 per share on net income of $6.5 million in 2005 to $0.65 per share on net income of $12.4 million in 2006.

Frank Carchedi, our CFO, will address the fourth quarter and year-end 2006 results in more detail at the end of this call.

Before he does, I would like to talk about recent investments we have made in the company and our plans to continue growing earnings and revenues.

Last quarter we initiated a significant investment to grow our field sales force in order to better capture the considerable revenue growth potential we believe this business has. I believe the primary limiter of sequential quarterly revenue growth is the effective size of our sales force -- not the size of the market opportunity we have.

The size of our field sales force remained largely constant at an average of 74 quota-carrying U.S. field subscription reps in 2005 and 70 reps for the first half of 2006. Given the massive opportunity the company has, management has set a goal of more than doubling the size of our field sales force by mid-2007 to 160 quota-carrying U.S. field sales reps. Many of these field sales reps will be placed in regions of the country that currently have no local sales coverage.

We have already made significant progress toward this goal. We now have 93 quota-carrying U.S. field sales reps -- that's a real tongue-twister there -- an increase of 33% over the average head count in the first half of 2006. In addition, we have 40 more representatives in training and another 20 who have accepted job offers to join CoStar. With these results, we are well-positioned to reach our goal of doubling the sales force by mid-2007.

This ambitious growth goal represents a significant investment in the cost of recruiting, training, travel, capital expenditures and cycle up-time. The typical account rep reaches 60% of normal productivity within six months of their hire date. We have varying expectations of productivity from our reps based upon the segment they focus on and the market they sell information into.

We are growing our sales management structure in advance of growing the field sales force. During 2005 we averaged 12 U.S. subscription field sales managers and, during the first half of 2006, we averaged ten. We now have 19 subscription field sales managers. In addition, year-over-year, we have grown our recruiting and training team from one to seven. Once we have achieved our goal of doubling the field sales force, we will evaluate the results and, potentially, contain the growth in sales headcount.

Despite the disruption caused by this hiring surge, we had a very good sales result in the fourth quarter of 2006. The U.S. subscription contract bookings rose 32%, from $5.1 million in the third quarter of 2006 to $6.8 million in the fourth quarter of 2006. $6.8 million in quarterly contract bookings in the fourth quarter is an all-time best for the company. Overall, the combined U.S. and UK sales results in December 2006 set a significant new record for us.

Our renewal rate increased from 92% in the third quarter of 2006 to 94% in the fourth quarter. That is the 11th consecutive quarter where our renewal rates have stayed above 90%.

The average new contract value increased a dramatic 45% -- from $8,300 in Q4 of 2005 to $12,002 in Q4 of 2006. Year-over-year, the average new contract value increased 31%, from $7,884 in 2005 to $10,317 in 2006. Typically, our new institutional buyers, such as REITs, pension funds and CMBS investors, purchase more expensive national access service from us, unlike the local access our traditional brokerage and appraiser firms pay less for. The number of these institutional purchases has continued to grow. In addition, most of the new retail clients we are signing are signing up for more services, typically for national or regional access at much higher price points. So, the average retail contract value is three times that of our 2005 average booking.

Given the fact that all 45 of our original markets are solidly profitable, and our 21 expansion markets from 2003 are profitable, we announced in mid-2006 that we intended to expand into an additional 100 United States MSAs. We believe that we can profitably sell our services in these smaller markets to our traditional target markets of local brokers, owners and appraisers. We also believe that this geographic expansion could further increase our ability to sell our services to retail and to the institutional segment. These MSAs include cities such as Buffalo; Albany; Rochester; Syracuse; New Orleans; Louisville; Fresno; Omaha; Alberquerque; Little Rock; Portland, Maine; Des Moines, Iowa; Knoxville and many others. Once we complete expanding our coverage in these additional 100 MSAs, we will essentially have completed geographical coverage of the significant U.S. commercial real estate market.

Our first priority in this final phase of U.S. geographic expansion is to photograph and collect information on the properties for lease and sale in these new markets. In markets like Boise, Idaho, we have already collected as many as 2,500 listings. In a market like Albuquerque, New Mexico, we have 2,400 listings. With listing counts like these, we believe we will be ready to successfully sell in these markets. Overall, across the U.S., we have had excellent results. The number of active sale and lease listings in our U.S. database has grown 100% -- from 349,000 in January 1 of 2006 to 694,000 as of February 21, 2007. This rate of growth is unprecedented in the history of our firm. It took us 19 years to get to 349,000 listings, and we basically matched that number in the last 14 months. Including UK listings, we today have an impressive 731,000 listings in our system. And that's on top of more than 2 million properties. The number of properties offered for sale in our U.S. database has increased 150%, from 99,000 on January 1, 2006 to 246,000 as of February 21 of this year.

Finally, and very importantly, we believe the value of our retail real estate offering has climbed as the number of active retail listings in our database has increased a very impressive 185% -- from 98,000 on January 1, 2006 to 278,000 as of February 21, 2007. I am very encouraged by these numbers. I believe this is an indicator that the industry is clearly viewing CoStar Group as the most important clearinghouse for commercial real estate listings in the United States.

As most of you know, CoStar had historically built its flagship --product -- Property Professional -- on the basis of tracking the office and industrial markets. In May of 2006, we launched a major new aspect of Property Professional when we added robust retail real estate coverage and a range of retail features. The product launch has been well received throughout the retail industry. Since the launch, we have signed more than 130 new retail-related deals with leading national retailers, retail brokers, owners and developers with an annual value in excess of $3 million. This is the fastest revenue-growth trajectory we have experienced with a new product area. In the fourth quarter, we signed 33 new license agreements valued at $1.3 million annually with such major players as Quiznos, Hibbett Sports, Chick-fil-A and Weingarten Realty Investors. We continue to be very optimistic about the value of our retail offering in 2007 and well beyond.

During the course of the fourth quarter, we launched a major new upgrade to our CoStar COMPS product and the primary research software systems that support all of our products. With this new upgrade, our subscribers have even more fully verified comparables faster. They have better mapping capabilities and higher quality information -- all with a more user-friendly, integrated web interface and navigation that is now consistent across all of our products.

Frankly, the initial reaction from our customers to the new product was mixed. I spoke to one customer who had been using the COMPS product for 23 years. He was just getting over the fact that the books had been discontinued in favor of computerized systems a decade ago, and now we had changed the interface all over again. We have been listening very closely to these customers -- listening to their issues and resolving --them --and have released dozens of changes to the new software in response to this important customer feedback. While the transition was difficult for us and inconvenient for some of our customers, I remain convinced that, a year from now, our product suite will be a quantum leap better because we fully integrated all our systems.

On the back end, we merged our two disparate U.S. research systems into one more streamlined system, which should produce major efficiency gains for our researchers. We already have concrete evidence of a substantial productivity gain. In September through November of 2006 -- the last months of the old disparate research systems -- CoStar researchers produced, on average, 281 comparable sales per day. In January of 2007, using the new streamlined system, research production increased 81% to produce 510 comps per day. The numbers for February to date are even better. Research is now producing 849 comparable sales per day, for an increase of 200% over the old system.

This was a very complex and challenging software development deployment. The systems, methodology and data structures used by the COMPS systems, which CoStar acquired in 2000, were completely different than those used by CoStar's Property Professional system. We closed business on Friday and reopened Monday having integrated millions of disparate records collected over two decades into one fully matched, synchronized, integrated database. This is akin to changing out all the plumbing in a 1,000-room hotel over the weekend while guests are occupying the rooms and showering. This successful upgrade took years of development and planning. With this effort largely behind us, we are now focusing our effort on integrating the UK products.

Last night, CoStar Group announced that its wholly owned subsidiary in the UK -- CoStar Limited -- acquired Property Investment Exchange Limited, known as Propex, for approximately $22 million in cash and stock. Propex provides an online database of retail, office and industrial properties and matches buyers and sellers of institutional-grade investment properties in the UK using a unique electronic exchange platform. A majority of the UK's investment funds, institutions, property companies and brokers -- including all of the top 20 brokerage firms and all of the top 20 UK retailers -- rely on Propex as the UK's central exchange for a wide range of property investment transactions each year.

Property professionals in the UK with an investment-grade property they hope to sell to an institution typically enter all the particulars about that property into the Propex system, then digitally submit the information to select institutions. The Propex system has a database of active buyers in the UK and can help industry professionals select the right group of institutions to market the property to. The institutions tell us that they definitely prefer this system over the old, paper-based system because it helps them manage and track the large volume of introductions they get in any given week or month. When they receive an introduction on the Propex system, the system can tell them right off the bat whether or not they or anyone in their organization have already considered this particular property. If they have seen the property before, the system will automatically reject it. If they have not seen it, it can be tagged for consideration and perhaps rerouted to someone else in the organization who is better prepared to consider this particular property type. The property is tracked until an ultimate investment decision is made. Propex has even conducted actual property sales online with an auction component of the system.

In addition to leading the UK market for commercial property for-sale information, Propex's product, Shoppe Property, clearly leads the UK market for retail information solutions. We believe their database of 15,000 retail availabilities is the best in the UK and will provide the perfect starting point to launch the CoStar retail product in the UK.

Founded in 1999, Propex has approximately $5 million in annual revenues, 500 subscribers and many more advertising customers. It will be operated within CoStar Group's UK subsidiary, FOCUS Information Limited. I apologize for the sirens. We've got the loudest sirens in the United States here in Bethesda, Maryland.

Unlike the U.S., the market for commercial real estate information services in the UK has been highly fragmented. Our FOCUS subsidiary has strong information products in the office, industrial leasing and comparable lease deal segment, but is weak or absent in the retail and commercial property sales segment. Propex, which has a very strong product for retail real estate information as well as the leading investment sale-introduction platform, is the perfect complement to our UK operation, FOCUS. CoStar intends to invest significant systems resources in 2007 and 2008 to integrate FOCUS and Propex into a common software platform with its U.S. product offerings.

In addition, CoStar Group intends to double the size of the UK research operations to ensure the same level of comprehensive coverage in the UK as we offer in the U.S. Right now in the UK, there's about one researcher per 2 to 3 million in population. In the United States, we have at least one researcher per million of population. With the integration of Propex personnel and the addition of new researchers, the CoStar Europe headcount will climb by --80 -- to approximately 205 personnel by year-end 2007. Some of CoStar's best managers and executives are in our FOCUS operation. I have been deeply impressed with the intellect, drive, vision and professionalism of Propex's CEO, Paul Marples, and the entire Propex team. With them on board, we have the best management team you could want to launch a successful Pan-European solution.

Our many global customers have told us that they would find a standardized, international information platform extremely valuable -- without qualification. And that is precisely what we plan to build. With our acquisition of Propex, we believe that CoStar will be well-positioned to offer the most comprehensive, one-stop retail, office, industrial, leasing and investment property information solution in the United Kingdom. We also believe this acquisition and the integration investment will consolidate and solidify CoStar's position as the leading commercial real estate information provider in the UK.

During 2006, our UK operations represented approximately 8% of total CoStar revenue and are expected to grow to 10% of total revenues for 2007. We anticipate that the integration and expansion of our U.S. and UK information systems will require an investment of approximately $4 million in operating costs during 2007.

Also during the fourth quarter, we were presented with a rare opportunity to acquire a well-regarded, Paris-based commercial real estate information company. Grecam, run by Hugues Kirichian and Claude Ogier, has a 28-year track record in Paris building a quality dataset similar to CoStar's. We believe that this historical dataset on 14,000 buildings is invaluable and can eventually be loaded into CoStar's Property Professional product. That depth of economic history would be impossible to rebuild without Grecam before the year 2035. With its in-depth knowledge of the property markets and their key players, Grecam has become an acknowledged research and consultancy partner to developers, investors, asset managers, planners, regional authorities and governments in France. The opportunity to buy Grecam at a good price resulted from a restructuring by one of our U.S. customers -- Capmark. While we remain in the very early stages of penetrating the vast European market for property information, we believe that the acquisition of this high-quality asset, coupled with our leading market position in the UK, positions CoStar to potentially dominate the European marketplace.

Before we turn to the Q&A period, I would like to turn the call over to Frank Carchedi, CoStar's CFO, to go into more detail about our fourth quarter and year-end 2006 results. Mr. Carchedi?

Thank you, Andy. Today I'm going to focus on the fourth quarter of 2006 results compared sequentially to third quarter of 2006, and our outlook for 2007.

Total revenues grew sequentially by 3.8% overall from Q3 to Q4, increasing from $40.6 million to $42.1 million. Although affected by the lower-than-expected third quarter contract bookings discussed on our previous call, the result for the fourth quarter continued to demonstrate consistent growth in core U.S.-based subscription revenue combined with continued high renewal rates. As Andy mentioned, the contract bookings amount rebounded significantly in Q4 and renewal rates returned to the 94% level.

Total subscription revenues for the company continued to account for approximately 96% of revenues during Q4, with our UK operations contributing 8.5% of total revenues.

On our previous call, we discussed the expansion of research for retail-building coverage and our national expansion. As a result of this expansion, gross margin decreased by $1.1 million, from $26.6 million in Q3 to $25.5 million in Q4 on a $1.5 million increase in revenues, as we ramped up all areas of field and centralized research. Margin percentages decreased, as expected, from 65.5% in Q3 to 60.6% in Q4.

Overall operating expenses increased, as planned, by $800,000 -- from $20.7 million in Q3 to $21.5 million in Q4, principally in the selling and marketing area as a result of sales force expansion that is already underway.

Principally as a result of our operating expansion, EBITDA decreased $1.6 million from $8.8 million in Q3 of 2006 to $7.2 million in Q4 of 2006. GAAP-basis net income decreased $1.2 million to $3.5 million or, $0.18 cents per share, in Q4 from $4.7 million, or $0.25 per share, in Q3.

Reconciliation to GAAP-basis results of all non-GAAP financial measures discussed, including EBITDA, is shown in detail in our press release issued yesterday, which is available on our website.

Capital expenditures for Q4 of 2006 were approximately $4 million, including $1.2 million related to field research expansion in the UK. For 2006, total capital expenditures were approximately $13 million compared to our plan of $14 million. We closed the year with approximately $158.1 million in cash, cash equivalents and short-term investments, an increase of $23.9 million over the beginning of 2006. In addition to cash flow from operations, we had an additional $5.6 million generated through proceeds from stock option exercises for approximately 270,000 shares during the year.

Now I'll discuss the outlook for the first quarter and 2007.

On February 16, 2007, our UK subsidiary, CoStar Limited, acquired Propex for approximately $22 million in cash and stock. Propex generates approximately $5 million in annual revenues and has approximately 500 subscribers. This acquisition, along with the fourth quarter acquisition of Grecam, is expected to result in inorganic revenue growth of about 3% for 2007 over 2006 and about 1.5% sequentially from Q4 of last year to Q1 of 2007.

As indicated in our press release, we expect overall growth in the 19% to 22% range, including organic revenue growth of approximately 16% to 19%. These growth rates will put expected revenue in the $190 million range for 2007. We continue to believe there is significant upside revenue growth potential. This is largely dependent on the successful growth of sales force size and productivity, particularly in view of opportunities resulting from momentum in established markets, ramp-up from newly released markets, the retail offering, our national expansion and new opportunities in the UK.

We expect fully diluted net income per share of approximately $0.50 to $0.60 for 2007. This estimate includes non-cash equity compensation charges totaling $6 million for 2007, the majority of which will be reported in G&A.

Additionally in 2007, we anticipate approximately $4 million in new pretax operating costs related to the expansion and integration of the UK.

Our effective tax rate is expected to be approximately 45% in 2007, higher than in 2006 due to our planned additional investment in the UK. The UK expansion is expected to generate tax losses in the UK, which will create a higher effective rate overall due to the lower tax rates in the UK.

For the first quarter of 2007, we expect fully diluted net income per share of approximately $0.05 to $0.10 cents. This result is somewhat lower sequentially from Q4 due to the completion of the ramp-up in U.S. research operations, further sales force expansion and seasonality of our operating costs, which are generally higher in Q1 than in Q4. Also note that, in Q2, we expect a $1 million to $2 million incremental expense for our annual ICSC trade show in May.

Purchase amortization and depreciation are expected to increase to an aggregate of approximately $4 to $5 million per quarter by Q4 of 2007 as a result of acquisitions and recent higher levels of capital expenditures.

Based on these estimates, EBITDA for 2007 is expected to reach approximately $25 million to $30 million, which, again, includes the estimated $6 million of non-cash charges for equity compensation.

Finally, we expect capital expenditures for 2007 of approximately $12 million, including investment of $2 million to $3 million for UK expansion. The remaining expenditures are related to the continued expansion of our U.S. platform, including facilities, communications servers and software requirements, and support of existing operations, consistent with the past several years.

In conclusion, revenue growth remains solid and we expect significant margins in the core U.S. business even as we continue to invest aggressively in the expansion of U.S. building coverage and operations. Additionally, significant investment will go to the UK market for its long-term development. We expect to report the separate U.S. and UK results to you, and we look forward to reporting our progress. With that, I'll open the call for questions.

Can we open up the question and answer period?

Yes, sir. [OPERATOR INSTRUCTIONS] Your first question comes from the line of Dalton Chandler of Needham & Company.

Good morning.

Good morning, Dalton.

Let me just ask about the start with the sales force expansion. You say you now have 93 -- I'm sorry -- quota-carrying sales reps and 40 already in training. Was that part of the fourth quarter expense or has that happened since the fourth quarter? I'm just trying to judge how much further that should ramp up from the $9.9 million sales and marketing expense you reported.

There was a lot of that in the fourth quarter. There were 20 who began last week and 20 began in January and -- maybe December, January. And then the 93 would have all been in the company in the fourth quarter. And then the 20, obviously, that have been offered jobs and have accepted have not yet started. So there's a fair amount of expense, significant amount of expense. And of the manager growth we mentioned, and the training recruiter growth we mentioned, the majority of that occurred in the fourth quarter.

Okay. And then if I understood correctly in your prepared remarks, you were talking about potentially adding beyond the 160 target. When would you make that kind of decision?

Actually, those weren't prepared remarks -- those were just off-the-cuff. That was a joke. What would drive that decision is if we ramped up to the 160 level, we were getting excellent production from the whole group and we could demonstrate that to the shareholders, we would. We don't believe our investors would want us to stop there, and we would continue to ramp it up. So, it would be at the point that we actually saw an acceleration in sequential quarterly growth -- significant acceleration -- and could demonstrate the return on the investment.

Okay. And that's the sort of thing that could happen maybe at the end of '07?

Yes. That would most likely not occur prior to the third or fourth quarter. And, sort of anecdotally, I think you have enough of an opportunity here to support, over the longer term, a 300-person sales force.

Okay. And, then to shift gears for a minute, in your impromptu remarks [laughter], you mentioned during the quarter your average new contract was worth about $12,000 per year, if you just do the straight math on the retail contracts you announced, 33 in the quarter at $1.3 million, that works out to $39,000 a year. So, I'm assuming retail, you're saying retail is -- customers are worth a lot more. Did I do that math right and, if so, can you talk about why you're getting so much more from retail?

Yes, you did the math right. I'm sure it's plus or minus a little bit, but the math is generally correct. And there are a couple of reasons why we're getting significantly larger numbers. When you're selling one of our information products to a mid-size brokerage firm in Dallas, they're going to be buying Dallas information. When you sell a product to a major national retailer, they're buying information for every U.S. city. So, they're going to be buying a much bigger menu of items from us than the local brokerage firm.

Our pricing is related to the number of stores they have, the number of geographies they purchase. If they're a developer, it's related to the number of assets they own and the size of those assets. So, this is all brand new turf for us. These are all brand-new customers and we're able to go after very large firms that are brand new to us, that have a significant demand for our product. So we're going right to these high dollar-value numbers. There are some contracts that come in that are a retailer buying only local access, and their pricing is similar to a local broker. But, by and large, we have a huge opportunity to go after very large firms here for quite some time at higher numbers.

Okay. It also looks like that number has been trending up since you introduced the product, is that correct?

That is probably correct. We now have the first customers on board to show to other customers that we're starting to build up a little bit of a client list to show to people. So we're moving through that very early-adopter phase now.

And we look forward to going to the large industry conference in May of '07 with a tombstone, with being able to say we launched this last year, here's some of the quality names that have signed up for the product and are using it quite extensively. We will also be at ICSC in May of this year with this new, very robust and extensive listing coverage. So, when we were at ICSC the prior year, we had under 100,000 listings. We will be moving toward the 300,000 listing mark at the next ICSC, which means when someone comes up to our booth and looks at the product at ICSC, they will be looking at a tombstone of successful users, and whenever they look something up, they will find a large supply of listings wherever they go.

Okay. And a final question on the acquisition. I assume its impact was included in your EPS guidance for the year. Could you tell us, was that accretive, dilutive? What sort of impact that had?

Dalton, both of the acquisitions on their own probably have margins in the 10% kind of range -- 10% to 20%. So, not significant dollars. And, I think the more significant point is, that when you roll all this together, the net effect is we're going to make a significant investment in the UK. So that, when I talk about that $4 million, that's pulling all these pieces together, whatever margins the various companies have. And then, on a net basis, we're going to add about $4 million to that.

Okay. I'll put that down as a no comment. [laughter] All right, thanks a lot, guys.

Thank you, Dalton.

Your next question comes from the line of Brandt Sakakeeny of Deutsche Bank.

Good morning, Brandt.

How you doing? It's Chris Amony for Brandt.

Hi, Chris.

Frank, can you quickly first just give me the sequential growth rate of the core subscription business in the quarter?

It was actually slightly higher than that overall. It's 3.9%.

Okay. Okay. And just on the $4 million that will be spent on consolidation of the UK, how will that be spread throughout the year?

In my model it is probably more weighted to the second half of the year. But it's going to--essentially it's, in a sense it's already standard. As I mentioned, we had fourth quarter capex, which isn't part of that $4 million. It's a different area. We had capex in the fourth quarter to ramp up the field research effort in the UK. So, the operating expenses related to that are already underway. I would say the significant ramp-up to that $4 million rate is going to be more in the mid-2007s.

Okay. And then, on the 100 new markets, have any been delivered to date? What's sort of your thinking on how those will roll into the available database over '07?

We have not delivered those local markets. I think we have delivered a couple. A couple of people signed up in some of those markets in advance of us officially releasing them -- people that know the company well and are located in some of these markets and have used CoStar in some other cities. We made some exceptions. By and large, it's still too early to formally roll those products out. However, national customers for our product have been picking up these Boise; Albuquerque and Portland, Maine; listings as soon as they go into the system. So, the national retail customers and institutional customers are getting that product right now.

That's all I have for now, thanks.

Thanks, Chris.

Your next question comes from the line of John Neff of William Blair.

Good morning, guys.

Good morning, John.

Morning, John.

Okay, you answered the sales rep question. You have given in the past what the quarterly revenue has been in the 21 new markets. Do you have that for the fourth quarter?

It's, I believe, between $1.4 and $1.5 million, John.

Okay, great. I'm just wondering if you could explain the revenue growth -- what seems to be, to an outsider's perspective, a paradox, which is the deceleration because it seems that the retail product traction is very strong. It's actually helping your average selling prices. Bookings growth in the quarter was strong, the 21 new markets are growing nicely sequentially, you're growing the sales force, you're monetizing Commercial MLS. How do we explain the deceleration in the growth? In the third quarter you described the sales force restructuring, which made a lot of sense because you took 30 people out of telesales capacity. Is there something comparable in the fourth quarter to explain it?

John, part of that, part of what we need to talk about, is in my impromptu comments. I'm talking about, I'm analyzing the --revenue -- actual revenue recognition in Q4. When Andy is discussing the sales force and the bookings, the results he's talking about sales activity in Q4. And when we talked in the third quarter, we talked about this quite a bit. The third quarter bookings, which we discussed at length in terms of some things that affected that lower number of sales bookings in the third quarter, actually mostly affects the Q4 recognized revenue.

So, that's why I started my remarks by saying that recognizing that that $3.8 is ever so slightly down from Q3 recognized revenue. It's really because of that bookings number we talked about in Q3. I think, the point being, that Q4 bookings number has rebounded. In fact, it was, I believe, a record number for the company. And so, some of the actions we had already taken and discussed on the Q3 call were starting to bear some fruit there as well. In Q4 you had a return to a 94% renewal rate. I know that was another thing discussed on the last call that everybody was -- although we were not concerned -- everybody was concerned about the slight decline in renewal rates. And that has bounced back up to 94%. So, it's really a timing issue. What you're looking at in recognized revenue for Q4 is all about the stuff we talked about last quarter.

Okay. So the removal of 30 people from the telesales capacity in the third quarter affected the fourth quarter recognized revenue?

That's correct.

Part of it, yes.

There's that delay between sales and recognized revenue. So, what we're selling in any given quarter is not materially impacting that quarter's revenue recognition. It's impacting the next quarter's revenue recognition. So, we're sort of rehashing third quarter news.

Okay. Great. And then a question for you -- it was actually at the bottom of one of the press releases you put out with some retail contracts signings. And you have been putting out press releases when you're signing up retailers or a retail-oriented customer to the Property Professional product. At the bottom of that recent press release you gave a very impressive list of retailers -- I think it included Walgreens, Target, Yum brands, 7-11 -- that were subscribers to the CoStar COMPS product. My question is, are these retailers new to CoStar, and what is the significance of their signing up for the COMPS product? Is that a migration path to Property Professional? Is that a migration path other Property Professional retailers have traveled?

Well, probably half of them are new to CoStar COMPS. So we are -- the sales force is -- spending more time looking at that retail audience. So they're delivering whatever solution that retail audience wants. In some instances we went in to sell a retailer Property Professional and, during the course of the meeting, they said that what they would rather do --- that they were much more interested in our CoStar COMPS product. Sort of whatever they want, we will sell them. The migration path I'm sure exists, but we're only six months into this, so it's a little early.

Very often the people buying the COMPS product from us on the retail side are appealing their appraisals for taxes or they're trying to just value their assets, which is a little different from the people who are opening new stores. In some instances, the people opening new stores are acquiring sites, and then they want the COMPS product and the Property product because they use COMPS to figure out what a fair price would be. They use Property to find out what's for sale.

So, we anticipate that we will get the same sort of interest in our traditional business. Fifty percent of our business each month is cross-selling additional modules, and 50% is new customer acquisition. We anticipate exactly the same thing in the retailer segment. So, we might offer Property Professional, come back and later sell COMPS and vice versa.

Great. I was wondering if you could quantify -- you talked back in the second quarter -- about the incremental spend associated with the accelerated retail development and the 100 MSA expansion. I think you talked about it being $4 million in the fourth quarter. I was wondering if you could just quantify that spending in the fourth quarter, and what you're expecting it to be on an incremental basis on a quarterly basis in 2007. In other words, I'm trying to look for a spending number associated with these efforts that, if we were to back out, we could look at what the core business --

Yes, it happened as predicted.

Let me try to give some more color around that, John. First of all, let me say that there's a lot of research and other activities going on across the whole platform, so in some ways it is difficult to precisely say that this is a retail research action versus a 100 MSA action. But, in analyzing the numbers, I'm very confident that there is a net amount of at least $4 million in the fourth quarter. When I say net amount, I'm actually now looking at the ramp-up of retail-related revenues associated with at least the retail side.

And you can see that number happening. I mean, if you look at the ramp-up of really all cost categories, but particularly cost of sales from Q4 of last year or Q4 of 05 to Q4 of 06, you will see that. You will also see a dramatic ramp-up, as we discussed, at the Q3 timeframe going from Q3 to Q4. I think that ramp-up of overall operating expenses from Q3 to Q4 is about $3.2 or $3.3 million. So, we did not quite ramp up as hard as I had expected --meaning ramp up as hard as I had expected, meaning the $4 million. And some of that is reflected in the fact that our Q4 earnings came out somewhat ahead of the range.

So we had a good quarter. But, that also goes to my comments that, in Q1, what you're basically going to see is the wrap-up of that ramp -- the sort of mechanical effect of getting a full quarter out of that expanded research group. You're going to have continued sales hiring, so that's why you see, going from Q4 to Q1 sequentially, a slight further decline in the EPS range.

Great, I'll ask one more and I can get back in the queue. But, Andy in particular, I just want to try to gauge your appetite or sense of the timing before we see an assault on continental Europe from the UK. Thank you very much.

Ground wars in Europe never go that well. We have no near-term plans to aggressively do anything outside of the vast majority of our efforts in the United Kingdom. We acquired the French company because it was a target of opportunity. I think, over the years, we have actually used that company as an example of why we would jump out of the UK before it was a very profitable market. So, that company in France came up -- great data set, great historical record, very similar to CoStar's data set. Some good managers there, a customer of ours was selling it, we picked it up at a 1.8 multiple.

Yes, 1.8 times revenue.

Yes, 1.8 of revenue. So it was a very good deal. It won't be a major distraction for us in 07. So we're going to be focusing our efforts on really solidifying our position in the United Kingdom, building the first integrated international system between the U.S. and the UK. That will take all of our efforts for 2007. And we wouldn't expect to be looking outside of the UK aggressively until '08, '09 -- sometime in that time period.

Thanks very much.

You're welcome.

Your next question comes from Brandon Dobell of Credit Suisse.

Thanks, hi guys.

Good morning.

Afternoon almost.

A couple housekeeping ones first. Frank, I may have missed the split between cash and stock for the UK deal. Did you guys talk about that?

It is mostly cash. I believe it is about 95% cash.

Okay. So, in terms of an expected share count for '07 guidance, there shouldn't be a whole lot of impact there.

No, and I believe the shares are disclosed in the 8-K.

Okay.

There's a share number in there -- 21,000 shares, rounded.

That mostly went to the principal of the firm.

Okay. From a pricing perspective, Andy, anything that's changed recently with the customer set changing? Or more national products? Do you see more or less leverage, from your perspective, on price? Have you started to think about what you might do with pricing going forward?

Well, we anticipate that, throughout '07, you're going to see the higher price point levels that we're seeing hold. These bigger purchase blocks hold, where the customers are typically buying more from us or they're entering at higher -- buying more modules from us in their first acquisition. So, overall, it's going to be a story of higher average contracts.

There is a dynamic that will be introduced in '07 that is a little bit different. And that dynamic is, we are launching a product -- I think I've mentioned -- called Listings Express. And that is a product, again, where the company has historically done very well at the mid-size brokerage firms and owners, larger brokerage firms and owners, and the higher-end institutions. Very good at the high-quality upper end of the market. There is, again, this massive market at the base that's looking for a low-end product, so we're rolling out this listing information-only product, which will be at a lower price point than our Property Professional product or our Property Express product.

So, you will see the upper end going higher up, and the lower end going lower down, in pursuit of the lower end, in pursuit of greater penetration in that market segment. I think our penetration rate at that one-person brokerage shop -- one-, two-person brokerage shop -- is 5%. We would like to see that penetration -- that one-person, sole proprietor number -- move into the double digits as soon as we can.

Okay. In a similar way then, if you could, you looked at the '06 mix of customers, separating out commercial brokerages from pensions, investors from REITs, the bigger buckets of customers. How much different is it from the '05 metrics, and where are you guys seeing the biggest variance here in terms of real strong growth or no growth in a certain category?

The financial services -- the institutional customers through the later part of '05 into '06 and today -- still are the most aggressive buyers. Our products, the value of our products to them, is relatively new as we completed national coverage and integrated. So, that is the fastest-growing segment. And now the retail side is vying with it to take the lead.

So, while the brokerage firms remain nearly half of our customer base, the financial institutions and retail-oriented customers are beginning to push them down. But it's going to take a lot, as you can imagine. It's going to take a lot of sales to actually push them down, because they continue to purchase at a good clip as well. So, the overall trend we've been seeing over the last three years continues, where the brokers become a smaller and smaller percentage of our revenue, though still the majority. But barely the majority.

Final question leverages on an earlier question about contract size. With the growth in retail, growth in institutional investors or institutions relative to brokerage firms, I'm guessing that the brokerage firms are that $7,000/$8,000/$9,000 customer, and if those are growing but not as fast, there should be a natural uplift that, over time, should continue as the institutions and guys like us are buying bigger deals. Is that a fair assessment?

That is a fair assessment, with the only offset that, should the company succeed in delivering a lower-end product to the one-person residential shop in Des Moines, Iowa -- if it happens in scale, a mathematical game -- you will be seeing an unprecedented number of $1,500-a-year contracts being offset by $100,00 contracts. So, the two ends of the spectrum will be fighting against each other. But, I think the bigger picture, the thing we know is happening,-- is the higher-end customers are the predominant trend right now.

Listings Express product -- do you expect that to be sold by the direct sales force? Is that more tailored toward the inside sales force? Do you see an opportunity to go back to an inside sales force when you launch this product?

I think that it is a worthwhile product for the field sales force to sell. I look at what we have seen with our Property Express product, which was our first limited-feature product that we brought out in the leasing area.

Right.

That was a major migration opportunity. So, people would look at our products, choose the less-expensive Property Professional, then come back six months later and upgrade. So, I believe that we have an opportunity here to bring a one-person brokerage shop in the door at $100 a month, then eventually migrate them up to several hundred dollars per month. Potentially we see one-person shops at $1,000 a month. So, I would like to see the field sales force establish a relationship with these people, then try to move them along, adding modules over time. And you also look at the value of a sole proprietor paying us $500 -- maybe $6,000 -- a year, but with a 94% renewal rate, you can multiply it by 19 and it becomes a pretty substantial number.

Okay. Makes sense, great, thanks.

Thank you very much.

Your next question comes from the line of Jim Wilson of JMP securities.

Oh, great, thanks, good morning, guys.

Morning, Jim.

I was wondering -- just to kind of follow-up on the last set of questions, because I think we're all trying to work through the various mix client issues etc. -- so, for the very slight deceleration in organic growth that you're forecasting, can you give, maybe even -- Andy used to give a lot of regional color on how different markets were doing -- maybe that would help also in differentiating the organic growth rate that you're operating '07 versus '06.

Jim, I'm always watching and looking out for regional variances in growth rates or sales caused by some sort of phenomena, unlike local competitors. In fact, I have not discerned any material variance by geography or age of market in our sales rates. It's very consistent across the board. The primary driver for variances in various regions is the number of account executives we have in that region. So, we just explained to you what's going on.

We now have at least 7,580 markets that should have an account executive, and we don't have that many account executives. So, a market where an account executive is flying into that city to sell into that city does not perform as well as a market where there is an account executive based in that city. So, from '07 to '08, we anticipate more consistent production across the board as we successfully put sales executives into all of our material geography. So, we're looking for greater consistency. We see no signs of certain external variance in in sales -- in organic sales -- based upon geography or regions. It's more a question of our internal. Where do we have people staffed? The numbers of sales people coming in the door right now, the recruiters are doing their job. They're delivering high-quality sales people to us at an alarming pace.

Okay. That mix of brokerage versus the higher-end -- both retail and institutional. What was that a year ago? Frame of reference?

I think a year ago it would actually have been skewed a little bit to the institutional side. It's probably shifted a little bit back to the brokerage side -- just slightly -- only because the retail product brought in some large retail brokerage firms. So, now it's brought some big brokerage firms back to the table that we haven't historically been able to reach. So, there's some retail, some firms that have half of their business in retail that before were not interested in buying our product. They have hundreds of employees, and now they are very interested in our product. So, that's sort of blending it back a little bit.

Okay. Then, finally, I guess -- any change or any impact from the CB Trammell Crow merger? Obviously, two of your, I would guess, three- or four-largest customers?

CB and Trammell Crow, combined, would be our largest customer, but as companies go, actually a single-digit percentage of our revenue. So, both of those companies use our product extensively. So, as we're talking, there are hundreds and hundreds of high-end rainmakers for those firms logged into our system doing deals. So, we do not anticipate that a very successful organization like CB Trammell Crow would be reducing the amount of information service they're providing to their high-end producers. And we're always in conversation with CB. We have been doing business with CB for 20 some years and Trammell Crow for nearly as long.

So, we're always talking to them -- talking about what the future looks like. They're very interested in what we're doing in terms of international growth. So, we're always discussing things. But, I would say relations are very good with that new organization.

Okay, good, thanks.

Your next question comes from the line of Rick Leggott of Arbor Capital.

Morning, guys.

Hello, Rick.

A couple questions here. Have you done anything in the last 6 to 12 months to restructure sales force compensation in any way?

We have. In the last, the '07 plan would be different than the '06 plan. As we anticipate high growth in head count, we are trying to orient the commission plan such that, if I'm the only sales person in Minneapolis, I am better off if there is another sales person in Minneapolis who's also making quota. So I might get 20% more commission per sale if I've got another sales person with me in Minneapolis who is also making their targets. So, there's a new team component. And that's because -- historically, realistically -- if CoStar Group only had one sales person in the United States of America, that sales person would not want to see the second sales person walk in the door. So, we're trying to align the company and the shareholders' interest with the sales persons' interest. So, that's the biggest change.

So, what conflicts, if any, exist today that will be addressed with the change in '07?

Well, it's now in place, but in '06, honestly, a sales person in a given city, subconsciously or consciously, would see the new person walk in the door that we had hired and trained, and would begin working on making sure that that new person found a new career in the next six months, because they wouldn't want a new person answering the phone when someone called in to subscribe. This new program resolves that conflict. We have long-term sales people who have been the only person in a particular market calling up saying, "I think my market is ready for another account executive." So it seems to be working.

Was there conflict with your telesales group?

Oh, yes. Up until the third quarter of '06 -- second, third quarter of '06 -- a channel conflict had been growing, where -- real or, more likely, imagined-- the sales people felt they were competing for the same dollars. It was definitely more imagined. So, they were less than cooperative. That has been completely resolved because we have de-emphasized the telesales group, reduced the size to less than half of what it was. And all the selling activities are now partner-selling activities. So, they actually are closely aligned now and getting along famously.

Okay, thanks. What are you hearing from your sales force with your integration of your COMPS database and your core database? Is that affecting sales cycles in any way?

I don't think it's affecting -- I do not believe it's affecting -- sales cycles. I think it's possible that it could have caused a minute, barely perceptible blip in cancellations. And I would encourage all the investors not to look at $400 of contract cancellation and react. Again, our renewal rate is as high as it's ever been. Probably a little bit of distraction as the rollout occurred. It's one of these things where you do a major product upgrade like that. No customer likes change. If I change the way your Microsoft Excel works, you don't like that, even though there's a very powerful reason why we're doing it, and it resets the baseline so you have faster software development going forward and lower user-training cost going forward. So, there was a little bit of noise, but all good. And, as you know, as I mentioned, the research productivity and the overall data quality will go through the roof.

Okay. Another question. Financial institutions -- as we think about folks monitoring assets, evaluating assets, risks -- is that a category of customer that can become material for you?

Oh, absolutely. Can become very material. Is very material.

Have you broken out FI's as a percentage of rep -- financial institutions?

I don't think we have done it formally. I mean, we examine and look at it, but I think in any given sales month now it's probably 30%.

Gross.

The gross sales number coming in are 30% plus.

And where would that have been a year ago? Two years ago?

Two years ago it would have been 1%.

Okay. Good. I'll take my last shot here, as it relates to guidance. You've narrowed your organic range. It used to be 3.5 to 5, which implied 15 to 22. Now we're at 16 to 19, so 3.8 to 4.4. So, we have basically taken a little off the top. As we look at all the new MSAs, the sales force hiring, the productivity associated with those sales force additions, it would seem to me we're set up now to possibly exceed the top end of the guidance range, assuming the economy doesn't go to [expletive] in a hand basket. Should that happen, what should we expect in terms of spending next year?

Well, Rick, I'm not sure I totally agree with your assessment of that guidance range, but ---

What did I miss? Help me understand that, first of all.

You have to look at the guidance range. Basically, we're starting out 3.5% to 5%. If you roll that forward, compounded across the year, I think you will have a view as to why I'm saying 16% to 19% and narrowing that a bit. I mean, everybody wants to hear about acceleration of top line growth, but from where we are right now, as we head into the first quarter -- and we will report that to you pretty soon here-- first, we have to accelerate from 4% to the top of the range that we keep giving you.

So, we're going to get there, and then we will come back and reassess or talk about further acceleration. As far as the spending, I'm not sure what you're saying. I think what you're saying is, if we do accelerate it, will we go hire more sales people and go even harder? The answer, I think, is yes. And Andy already, I think, said that earlier.

We will be able to clearly communicate the value there. I think the shareholders will be with us on that. The other thing to keep in mind -- the important thing to keep in mind -- is those 60 recent additions to the sales force for the first six months they're with us is they are absolutely more of a distraction than a benefit. They consume enormous resources of management time, training time, coordination time. They're not allowed to sell product for the first two months or so.

So, keep in mind, as they do begin to sell product, there's a lag between when they get a contract and when we recognize revenue. So, you perhaps are seeing some evidence of acceleration from the sales numbers we mentioned for the fourth quarter because of new bodies, but the full effect of it lags six months. And----

Didn't you mention, though, that at the six-month point these folks are at about 60% of mature productivity?

Right. But there's zero in the first couple months.

I understand, I get that.

They actually distract the existing sales people. So, an existing sales person brings a new person along for meetings, points out things, shows them things and helps them figure out how to prospect. Whenever you add a lot of bodies, there is a distraction factor. But it's going the right trend. We're seeing what we want to see, what you want to see. But don't believe that, because we extend an offer, that that quarter will have any impact on revenue. It's actually the reverse.

All right. Thanks, guys.

Yes.

Thanks, Rick.

Your next question comes from the line of Jennifer Pinnick of Morgan Stanley.

Good morning.

Good morning.

I had a question regarding the guidance. Does that include the sales people ramping up to 60% productivity within six months?

Yes, I mean the people that we have already talked about hiring?

Yes.

And doubling. And we don't have them all yet. So, the answer is yes. The model includes the people that we have already hired and haven't yet hired, ramping up in that timeframe. To add to what Andy was saying, today they may be producing nothing. They may be even distracting the existing sales force. You can see how it's going to take time. If it takes six months to get to 60%, then keep in mind there are always two different discussions happening here. There's the bookings that occur in a quarter. Then there's effect on revenue. So, the bookings impact actually tends to affect revenue even another quarter out. So it's going to take some time.

Okay.

By the way, what's been missed here is, that doesn't mean that the existing sales force does not also have an opportunity to increase their productivity. I believe they do.

Okay. And can you just talk about retention trends within the field sales force?

I think it's relatively constant with what we have been seeing the last 18 months or so. So it's fairly decent.

Okay. And then, can you quantify the pricing impact quarter over quarter for Q4?

The product pricing impact?

The pricing impact on revenues, yes.

Are you talking about the pricing escalation of existing contracts or are you talking about the price growth for new customers?

Just --

Maybe Andy can address one and I'll address the first one. The pricing impact from the existing customer base -- in other words, the overall growth in revenue as we renew --contracts -- is minimal, I would say. It's basically on par with the inflation rate. So, there's not a very aggressive pricing program built in to move the current customers on that. That's by design, and maybe Andy can comment on what's happening for pricing of new customers.

So, to clarify, with existing customers -- we are pretty much keeping them on line with inflation because we perceive that the most important growth opportunity for us right now is acquiring new customers and selling additional modules to existing customers. We are not in a phase where we think we need to try to milk existing customers. So then, we are not -- other than what we have --discussed -- where we are offering this new Express Listings product with limited, very limited functionality at a lower price point. We are not dramatically changing our pricing schedule.

We have, in the past year or two, done pretty significant price increases -- double-digit price increases for new customers on a price schedule. But we're feeling that we're more in a penetration mode or additional customer acquisition mode, so we're trying to keep the pricing fairly constant. Again, if you think of our products as a menu in a restaurant, it's not that we have raised the price of the surf and turf, or changed the price of the tuna sandwich -- we just have more customers coming into our restaurant and ordering surf and turf right now. So it's changing the mix, and that would impact revenue a little bit.

Okay, I see. I'm hungry now. [laughter] Just a little bit about the acquisition. That $4 million-- does that include the headcount increase in the UK, or is that just for systems integration?

I would say it's primarily labor-based, headcount related.

Okay.

Yes, it's labor. And the systems effort is really a reallocation of our constant level of software development. So, significant resources will shift from doing integration of the COMPS product to doing integration of the UK operation.

Okay. That's it.

Thank you very much.

Thanks.

You have a follow-up question from the line of John Neff of William Blair.

I'll follow up with you off-line in the interest of your getting off the call, thanks.

Okay.

Thanks, John.

With that we will go ahead and wrap up this earnings call. I want to thank all of you for joining us. Look forward to getting together with you again for the first quarter earnings call.

Thank you.

This concludes today's conference call. You may now disconnect.