CoStar Group Inc (CSGP) 2007 Q2 法說會逐字稿

Good morning. My name is Crystal and I will be your conference operator today. At this time, I would like to welcome everyone to the CoStar Group second quarter 2007 earnings results and financial outlook conference call. [Operator Instructions] Today, we have with us CoStar Group's President and CEO, Andrew Florance; Chief Financial Officer, Brian Radecki; and Communications Director, Tim Trainor. Mr. Trainor, please go ahead, sir.

Thank you, Crystal. Good morning everyone. Welcome to CoStar Group's second quarter 2007 conference call.

Before turning the call over to Andrew Florance, our President and CEO, let me state for the record that certain portions of this discussion include forward-looking statements which involve many risks and uncertainties that can cause actual results to differ materially. Important factors that can cause actual results to differ materially include, but aren't limited to, those stated in CoStar's second quarter 2007 press release and CoStar's filings with the SEC, including its Form 10-K for the year ending December 31, 2006, and Form 10-Q for the period ending March 31, 2007, under the heading "Risk Factors."

All forward-looking statements are based on information available to Co-Star on the day 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 conclusion of this call and remain available through midnight, August 3rd, 2007. The replay telephone number is 800-642-1687 within the United States, or 706-645-9291 outside the United States. Please refer to conference ID 6859325. The replay will also be available over the internet at www.costar.com/corporate/investor for a period of time following the call.

Thank you again for joining us this morning. I will now turn the call over to Andrew Florance.

Thank you, Tim. Tim, you can make that language sound interesting, I think you missed a career in radio broadcasting. I'm joined in today's call by Brian Radecki, our Chief Financial Officer. I believe many of you have now had the pleasure of meeting Brian. Brian has been a key player in our finance group for close to ten years now, and we are thrilled to now have him in a role as CFO.

Frank Carchedi, our CFO Emeritus, is also participating in today's call, his 36th and final call.

We'd like to welcome everyone to CoStar Group's second quarter 2007 earnings conference call. The company has completed another successful quarter during which our core subscription business generated strong revenue growth. In addition, as we announced in our release today, we have made substantial progress on the significant investments we have been making in our business. Over the past three quarters, we have focused on three major initiatives. First, we have dramatically grown the number of markets we research within the U.S. Second, we have significantly increased the quality of our service offerings in both the United States and Europe. And third, we increased the size and reach of our sales force.

We firmly believe that as a result of these investments, coupled with improving operational efficiencies across our organization, the company is well positioned for sustained earnings leverage through 2008. Having made substantial progress on our national market expansion and other investment objectives, we do not plan to initiate significant new investments in the latter half of 2007 or in 2008. The net result is that we now expect transition from a period of heavy investments in our business to one in which we generate solid earnings growth over the next two quarters and throughout 2008. Our primary focus in that timeframe will be pursuing operational excellence and working expeditiously towards a 30% EBITDA margin in our U.S. operations.

Revenues for the second quarter 2007 were $47.8 million, an increase of 22.7% over $38.9 million for the second quarter of 2006. Sequential quarterly revenue growth again accelerated, increasing 6.6% in the second quarter of 2007 over the first quarter of 2007.

Net income for the second quarter 2007 was $1.2 million, down from $2.3 million in the second quarter of 2006, due to strategic investments I mentioned earlier. EBITDA was $4.2 million in the second quarter of 2007, down from $5.3 million in the second quarter of 2006, also due to investment initiatives.

Revenues attributable to our European operations for the second quarter of 2007 were $5.9 million, an increase of 90.4% over $3.1 million for the second quarter of 2006.

During the second quarter of 2007, we continued to make significant progress in our research operations ahead of releasing our service in 81 new markets. In support of this major expansion of our U.S. geographical coverage, we have added 100,000 new listings, hundreds of thousands of additional images and hundreds of thousands of properties to our database.

In order to carry out this national research expansion, we have increased field and center-based research personnel, put more research vehicles into service and opened additional research centers. This was all part of a well-planned and well-executed expansion strategy we communicated to you at the end of last year.

We have substantially completed stepping up our research cost structure to research these markets and that we expect to see this cost structure stabilize. Our research team has done an outstanding job in researching these new markets and aggregating so many listings. The results are clearly evident in the growth of our database and very soon in the number of markets where we offer our service.

Total research and verified commercial real estate listings in U.S., CoStar's U.S. database, grew 46% year-over-year from approximately 528,000 in the second quarter of 2006, to 770,000 in the second quarter of 2007. As of today, we now have a record total of 822,000 listings in total across Europe and the United States in our database.

The total U.S. rentable square footage tracked and maintained by CoStar now exceeds 40 billion square feet, offering detailed information on more than 1.76 million individual properties across all types and classes of commercial real estate.

The largest year-over-year growth in listing type occurred in our for sale listings, which increased 74%. At the end of the second quarter of 2007, CoStar had over 281,000 for sale listings in the U.S., compared to approximately 161,000 listings at the end of the second quarter of 2006.

I want to emphasize that this impressive listing and inventory growth of our database is a direct result of our successful investment in additional research personnel and equipment over the past two years. We are confident that these investments will result in increased sales of our services to new clients within the 81 new markets we are planning to open and to many existing and present clients in our current markets who are eager to add expanded coverage to their service offering.

By adding all these markets, we are in a very real sense filling in a lot of geography and adding a great deal more nodes to our network, making our coverage even more comprehensive and robust than it was before, which we believe enhances overall value.

As mentioned, most of our national research expansion has been focused on prepping for the release of CoStar property professional service offering in these 81 markets in the third and fourth quarters of 2007. These 81 new markets, or core-based statistical areas, CBSAs, will be in additional to the 121 CBSAs in which we currently offer CoStar property professionals. The 81 new CBSAs where we plan to release property professional includes such cities as Des Moines, Buffalo, Albany, Rochester, Syracuse, New Orleans, Louisville, Fresno, Omaha, Albuquerque, Little Rock, Portland, Maine, Knoxville and many others. Our researchers have been busy canvassing these markets, adding buildings, confirming listings and building our digital image libraries, in preparation for launching our services in these markets.

If you are familiar with our history and our business model, you know this is how we have executed and successfully pursued geographic expansion as a company in the past. CoStar has an established track record of making the necessary investment to analyze, aggregate, verify and add the entire commercial property inventory in new markets to our database, and then capitalize on that opportunity in terms of increased sales and revenue.

And in line with that previous experience, we are confident the same will hold true for this expansion phase, as well. Our experience has demonstrated that after making the necessary investment to add the entire market inventory to our database, the markets we enter become profitable and aggregate within about 18 months of product release. Earlier last year, we completed a similar geographic expansion covering 21 markets. That expansion phase was completed with the launch of our service in Milwaukee in February of 2006. Today, those 21 markets are profitable in aggregate, generating a 40% EBITDA market level margin.

Following the expected product release in 81 new markets we are entering, the company believes it will begin generating revenues, offsetting the expenses that occurred in researching these markets. Furthermore, we believe this expansion will contribute to future revenue growth for more than two decades.

Our sales force has been eagerly looking forward to opening these new markets. We have begun pre-release marketing and we fully expect that commercial real estate professionals within those markets will embrace the productivity gains and enhance property marketing opportunities that CoStar offers. With this latest expansion phase nearing completion, I can say we are well on our way to achieving our goals, being the only real estate information provider with a research organization, proprietary software infrastructure to offer truly comprehensive national U.S. coverage for commercial real estate.

Being in a position to offer truly national information on a market-by-market and building-by-building basis will enable us to offer our service to more markets and strengthen the value of our existing product offerings for current subscribers who already rely on our information. By making our proactive research and verified commercial property information available in more markets, we appeal to a much wider audience of potential subscribers.

Many of these secondary and tertiary U.S. markets have become increasingly attractive to real estate investors as a result of the intense competition for prime real estate assets in core markets, such as New York, Los Angeles, Washington and Chicago. Even some of the most active traditional real estate investors are finding themselves effectively priced out of the traditional core real estate market by aggressive pricing offered by private equity firms and other deep-pocketed investors.

As a result, a number of our existing subscribers have expressed interest in adding these new markets as they come on line. One recent example is a long term license renewal CoStar negotiated with one such client in the second quarter, Marcus and Millichap Real Estate Investment Services. Under its new agreement, this major national real estate firm significantly added to its product subscriptions and upgraded to national data. We are currently in negotiations with other major subscribers involving similar terms and we fully expect to finalize additional contract agreements in the coming months.

CoStar has also reached an agreement with another national real estate entity, CCIM Institute, an affiliate of the National Association of Realtors, which most likely would not have been possible without our new nationwide coverage. Under the agreement, CoStar will provide CCIM members with access through our entry level product, Listings Express, for a limited time in each respective CCIM member's home market.

CoStar also believes the agreement with the CCIM Institute will accelerate the expansion market opening process, by introducing the company and its product offerings to a large group of commercial real estate professionals and prospective subscribers through a well-regarded organization like CCIM.

The agreement with CCIM is in essence a trial period. It is possible that the agreement may delay the date on which we achieve revenue from some accounts, but we believe that overall, the market agreement will increase awareness and sales in the intermediate term.

During the agreement period, our marketing department and sales force will be communicating with prospective CCIM subscribers who are using this entry level product, Listings Express, to build awareness of the enhanced service available from our high end property professional service.

CCIM has also provided CoStar with tens of thousands of lease and sale listings and comps from its CCIM membership base that we can use in our research process.

CoStar continues to attract a growing who's who of leading retail and commercial industry players to subscribe to our retail information service. As you know, we launched our retail real estate information product offering in May of 2006 at the retail real estate industry's major conference, ICSC.

This year we returned to ICSC with an even stronger product and stronger client roster, leading retailers, retail developers and retail brokers. We signed new retail-related deals with 81 retailers and retail owners, developers and brokers, including two of the largest publicly traded retail property owners in the country. However, because of non-disclosure agreements, we cannot identify those companies.

Also, during the quarter, CoStar Group filed copyright infringement and other legal claims against Centers and Malls LLC, a company providing a service that competes with CoStar's retail offering. As a result, the United States District Court of Maryland issued a temporary restraining order directing Centers and Malls to stop all sales distribution and use of its competing service, which includes shopping center data the court found had been printed, pirated, from CoStar. The court also affirmed that CoStar's proprietary method of compiling and classifying information in its database is protected under federal copyright law.

CoStar now has approximately 320,000 retail listings, 71% more than we had in our product last year at this time. We believe that our success in significantly increasing the depth and breadth of our retail database will enable us to further drive sales of our retail information offering. We also believe that the tremendous growth is evidence that the retail owners and brokers have recognized the value of marketing their listings through CoStar.

Having the largest, and we believe the best, research organization and commercial real estate affords us a unique perspective on the industry. In terms of overall performance, the declining vacancy rates, increased investment activity and overall improving conditions seen in most U.S. commercial real estate markets over the last few years, appears to be slowing. We're seeing lower net absorption levels occurring at the same time as an up tick in new construction activity, which is resulting in slower occupancy growth.

While commercial real estate conditions are softening somewhat, we believe the market should remain solid for our products and services into 2008. Vacancy rates declined slightly in the office sector this past quarter. The national average dipped from 11.4% to 11.3%, while industrial and retail vacancies rose slightly. Industrial vacancy rates inched from 8.7 to 8.8% and retail vacancy rates went from 6.6 to 6.8%.

We are forecasting that vacancy rates for all product types will inch up over the next six quarters. One factor behind these vacancy rate trends is a decrease in the level of net leasing activity. In the first two quarters of this year, office absorption is off 37% from the levels it saw in the first two quarters of last year. This year's office net absorption number is 35 million square feet versus [66] million for the same time last year. Similarly, the industrial absorption activity is off 39% from last year.

But vacancy rates are still relatively low in most markets, compared to historical standards, which is helping owners to continue to achieving rental rate growth, a critical factor for investor concern over how they're going to service their debt. The office sector has seen rents rise 6.1% over the past year, while industrial rents are 4.5% up.

Currently, levels of new construction activity, they're relatively high in each of the asset classes. The office market is 155 million square feet of office space under construction. The industrial market is 157 million square feet. And the retail market is 209 million square feet. The relatively high construction levels and lower leasing activity will likely result in these vacancy increases over the next year.

Of course, there is a broad range of market conditions found in various markets in different regions in the country and certainly between the United States and the United Kingdom and France. New York City, for example, is experiencing record rent increases and overall vacancy rates are dropping from down to about 5.3%, the lowest in the country. As a result, New York City rental rates have spiked 23% over the past year to almost $56 per square foot, which is a level that's never been seen before, even in the late '90s dotcom frenzy.

Similarly, San Francisco's office market is seeing solid improvement. Formerly one of the hardest hit markets in the dotcom downturn, San Francisco has steadily improved since 2004 and vacancy rates now sit at a comfortable 10.6%. Over the past year, the market has seen the vacancy rate drop 2.1 percentage points and rental rates rose 19%.

Some markets have not faired as well. Over the past year San Diego's vacancy rate is up, Phoenix is up and Orange County's is up, generally a point to two points.

Given the huge scope of the likely base of prospective customers for our services, we recognize the need to significantly grow our field sales force in order to capture the enormous potential revenue addressed for buyer business. I believe the size and effectiveness of our sales force is the primary regulator of sequential quarterly revenue growth. And as we previously disclosed, restructuring and expanding our sales force to take advantage of this opportunity has been and remains one of our top priorities.

In 2005, and for the first half of 2006, the size of our field sales force remained largely constant, an average of 70 quota-carrying field U.S. subscription reps. However, given the enormous opportunity we believe the company has before it, management set a goal to more than double the size of our field sales force to 165 field reps by mid-2007. These sales reps are and will be located both in regions of the country where we currently have local sales coverage and areas where we have reps, but need more. So, it's in areas where we don't have local sales coverage and it's an additive to markets where we do have sales coverage.

We have made significant progress towards this goal, but we have not yet met it. Certainly, an increase of that size for this industry was ambitious and involved hiring in dozens of states, more than 120 recruiters, trainers, manages and reps in a relatively short period of time.

It is also a bit challenging, because the type of people we are looking for not only have to have the skills and experience to sell our services, but also have to possess the acumen to actively manage the e of existing clients and users within their territory. These individuals need to have strong commercial real estate knowledge and sales skills, as well as solid time management and very strong customer service focuses.

Our initial goal wasn't to hire 165 reps, it was to hire 165 effective reps. Most of the sales people and managers we recently hired and trained are excellent and are becoming a real asset to the company and to our clients. We are continuing to have success in attracting exceptionally productive new sales reps across a wide variety of markets.

For example, Justin [Gregore] from Washington came out of training in December and in his first seven months has sold $158,000 of annualized subscription revenue. Greg [Shellow] in Los Angeles came out of training in February and in his first five months has already sold $194,000 of annualized subscription revenue. In a smaller market, Sacramento, Steve Ward came out of training in March and his first four months has sold $53,000 in annualized subscriptions. Since coming out of training in April, Eric [Solway] in Salt Lake City has sold $31,000 of annualized subscription revenue in just three months.

Because of sales force expansion, we have also had a couple of sales executives who worked with us previously return to CoStar and pick up right where they left off. The most recent example is Tom [Viable] in Tampa, a top performer in 2005, 2006. Tom left us to head the research department for a client and returned just this month. In his first month back, he is already at $26,000 annualized net revenue growth.

Unfortunately, in growing the sales force so quickly, not all of our hires have been as successful and we have had to cull a number of reps or managers that were not meeting performance expectations. These actions have delayed the date by which we anticipate reaching 165 reps in the U.S. As of today, we have 140 field reps, which is in fact nearly twice the number we had at this point last year, but it is not the 165 we had targeted for July.

Though the process has required a significant investment in time and money, we remain committed to developing a significantly larger and more effective sales force in order to accelerate our revenue growth in the intermediate term. Our updated goal is to have 165 successful field reps in the U.S. by the end of this year.

At this point, our plan for 2008 is to focus our efforts on developing all 165 reps to their full potential, rather than increasing sales headcount. Generally, CoStar reps with less than a year of experience are far less productive than a rep with more than a year's experience. Because of the recent rapid hiring, approximately half of our sales reps have less than six months of experience and are making limited contributions to overall production. These reps require a significant amount of manager time and attention. This has caused some little friction, dragging the sales organization during the first and second quarters.

Despite the disruption caused by the sales force hiring search, we showed good sales results in the second quarter of 2007. Our renewal rate remained high for the quarter at 92%, underscoring the usefulness of our information and a central role in our subscribers' day-to-day mission-critical activities.

Sales to existing customers, excluding renewal increases, increased by 59% from the first to second quarter of 2007. The rate of growth of new subscribing firms increased by 88.6%, from the first quarter of 2007 and 22.3% from the second quarter of 2006. Our average contract value dropped 12% from $10,286 in the second quarter of 2006, to $9,064 in the second quarter of 2007. This occurred- - actually would have been, I think that's, no that's true, year-over-year. This occurred, because the dramatic increase in new sales reps who initially tend to sell lower valued contracts. New and inexperienced reps are not permitted to sell to larger prospects, those with five or more potential users, until they have sold $120,000 in annualized subscription.

It follows that temporarily, the majority of our reps can only sell to smaller accounts and our total bookings value dropped for the first quarter of 2007 to the second quarter of 2007, even though our total number of sales increased. The U.S. subscription contract bookings in the second quarter of 2007 were $6.4 million, down slightly from $6.7 million booked in the first quarter of 2007.

Approximately at the same time, CoStar embarked on our current and largest U.S. market expansion. The company also made two key investments to expand its operations in Europe, to establish the company as the number one commercial real estate information provider in Europe, just as it had in the United States.

During the first quarter of 2007, CoStar acquired Property Investment Exchange Limited, Propex, for approximately $22 million in cash and stock. Propex provides a web-based introduction platform that brokers use to introduce high value properties for sale to potential buyers. In addition, Propex has a robust U.K. retail website called Shop Property, and a London office information service called Screen Data.

The Propex acquisition followed shortly after the December 2006 purchase of Grecam, a leading provider of commercial property information, research and analytics in France, that we believe has the most comprehensive property database in Paris, which ranks in the order of New York and Los Angeles in terms of size.

Grecam provides consulting services and a subscription-based data service to real estate professionals, including commercial property listings on approximately 14,000 Parisian office and industrial buildings.

CoStar first entered the U.K. market in 2003, by acquiring Focus Information Limited, a major U.K. provider of web-based access to verified commercial lease comparables, available space requirements, tenants, planning information and photos. And in 2004, we acquired the Scottish Property Network, which offers users on-line access to a comprehensive database of information for properties throughout Scotland, including available space, comparable sales and lease deals.

Our many global customers have told us that they would find a standardized international platform extremely valuable. Our goal is to become the preeminent source of commercial information in Europe, by building as strong a product offering in Europe as we've built in the United States.

As we have previously disclosed, CoStar is committed to investing significant systems resources in 2007, 2008, to integrate our European subsidiaries into a common software platform with its U.S. product offering. In addition, CoStar is in the process of doubling the size of the U.K. research operation to ensure the same level of comprehensive coverage in the U.K. as we offer in the U.S.

In order to cost effectively handle the tremendous growth in the U.K. research group, we opened a research operation center in Glasgow, rather than growin our existing research operations in a very expensive market like London. The Glasgow research center's startup is aided by the fact that we already have a small, but very strong research operation up there from our Scottish Property Network acquisition. We have a very talented group of professionals in the United Kingdom and I am sure as these disparate companies continue to integrate into one team, they will have the ability to make CoStar group the clear leader in the European market.

Since our acquisition of U.K.-based Focus in 2003, CoStar has operated in the U.K. under the Focus name. With our recent acquisitions of Propex, Shop Property, Screen Data, SSPAN and Grecam, we have now introduced the CoStar Group as the umbrella brand encompassing all of these companies in Europe. The strategy of bringing together and integrating our U.K. operations appears to be working very well, as prospects and customers alike now see clear consolidation in what had been a very fragmented information market in the U.K.

As previously stated, revenues attributable to our European operations for the second quarter of 2007 were $5.9 million, an increase of 90.4% over $3.1 million the second quarter of 2006.

During the second quarter of 2007, CoStar's operations in the U.K. and France represented approximately 12.4% of total CoStar revenue and are expected to be approximately 12% of total revenues for 2007. CoStar anticipates that integrating its U.S., U.K. and French information systems will require an incremental investment of approximately $4 million in operating costs during 2007.

The company is releasing significant software upgrades on both sides of the Atlantic this fall. In the U.S., we are adding some significant enhancements to our mapping capabilities and to our handling of shopping center information. Over the last two years, we have digitally traced the outlines of more than half a million building footprints. That's a lot of drawings. With our new mapping capabilities, users will be able to move their mouse over an aerial photograph of a commercial area, and information will appear on the properties that are under the mouse. We think that this enhancement and a dozen other mapping enhancements will add significant value to our service.

In addition, we have made some major structural changes to how our research systems and products represent the relationship between suites, buildings and shopping centers. To my knowledge, we are the first organization that can now accurately track information that is specific to one building within a shopping center, while still giving those users who only want to view the center as an entity as a whole the ability to do that.

This enhancement may not be intuitively obvious to you from my description, but I think it is one of those opaque mundane concepts that's critical to the ultimate success with our retail products.

While our plan is to have an international version of CoStar property become our flagship product in the U.K., we still intend to maintain a strong software development capability in the U.K. to keep our legacy products ahead of all competitors and develop new innovative products that might emerge in the European marketplace first.

I am really quite impressed with the work this London-based development team has been doing recently. They have a significant software upgrade ready for release in the fall that should dramatically strengthen our ability to reposition the U.K. company as the preeminent leasing information company. The team also has a major upgrade in the works for our French service, Grecam.

Before I turn the call over to Brian Radecki, I want to reiterate that at this time the company's focus and direction is on transitioning from the previous period of heavy investment into one of leveraging these many investments to show consistent earnings growth over the next six quarters. For the rest of 2007 and 2008, the company is focused on developing our human resources to their fullest potential, pursuing customer service excellence, enhancing the already very high quality of the research we perform, enhancing further the cutting edge software we provide to our clients and reaching out and finding the tens of thousands of prospects out there that will find real value in the huge array of products we have produced.

I'd like to turn the call over to Brian Radecki, CoStar's new Chief Financial Officer, to talk a little bit more about our second quarter 2007 results. Brian?

Thank you, Andy. Today I'm going to focus principally on the sequential results of the second quarter of 2007, compared to the first quarter of 2007, and on our outlook for the third quarter in the year 2007.

Total revenues grew, sequentially, by 6.6% overall from Q1 to Q2 of 2007, increasing from $44.8 million to $47.8 million, including 4.7% in organic revenue growth.

Organic revenue growth for the quarter does not include revenue from Propex, which was acquired in February 2007.

Core U.S. subscription revenue increased by 4.3% from Q1 to Q2 of 2007, with renewal rates remaining high, at approximately 92% for the quarter.

Total subscription revenues for the company continue to account for approximately 95% of revenues during Q2 of 2007, with our international operations contributing 12.4% of total revenues.

Gross margin increased by $1.5 million, from $27 million in Q1 to $28.5 million in Q2 of 2007, on a $3 million increase in revenues. Although overall margin percentages decreased slightly from 60.2 in Q1 to 59.6 in Q2, U.S. margin percentage actually increased, while international margins decreased, as expected, due to the ramp up of research operations in the U.K. and a full quarter of purchase amortization from the Propex acquisition.

Overall, operating expenses increased $2.6 million, from $25.6 million in Q1 to $28.2 million in Q2, principally in the selling and marketing area, as a result of the seasonal increase in spending related to the annual ICSC trade show.

Also increase in general and administrative expense was principally due to increased costs related to our U.K. expansion, recruiting and personnel and communications expense.

As a result of the increased revenue offset by the seasonal market expense of approximately $1.8 million and overall increases in cost structure resulting from expansion activities, EBITDA decreased $800,000, from $5 million in Q1, to $4.2 million in Q2 of 2007 as expected.

GAAP basis net income decreased from $1.8 million, or $0.09 per share in Q1 of 2007, to $1.2 million, or $0.06 per share in Q2 of 2007.

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

Capital expenditures for Q2 of 2007 were approximately $2.3 million, well within our expected range for the quarter.

We closed the second quarter with approximately $154.5 million in cash, cash equivalents and short term investments, an increase of $4.1 million during the quarter. In addition to cash flow from operations, we generated $900,000 through the proceeds from stock option exercises for approximately 32,000 shares during the quarter.

Now, I'll discuss the outlook for the third quarter and the year 2007.

As indicated in our press release, we expect a sequential quarterly increase in revenue from the second quarter to the third quarter of 2007 of approximately 3.5 to 5%. For the full year of 2007, we expect overall revenue growth of approximately 22%, with organic revenue growth of approximately 18% over 2006.

We continue to believe that there is significant upside revenue growth potential later this year. This is largely dependent on the successful growth in the sales force side and productivity, as Andy mentioned.

Particularly in view of the revenue opportunities resulting from a momentum in established markets and the expected release of new markets in the third and fourth quarter, the retail offering and new international opportunities. For the third quarter of 2007, we expect fully diluted net income per share of approximately $0.12 to $0.15 as we begin to grow earnings from the U.S. operations.

Gross margin percentage is expected to remain fairly steady from Q2 to Q3 as we continue to leverage the U.S. platform while expanding our international operations.

Sales and marketing is expected to decline due to the reduction and seasonal marketing costs which may be slightly offset by a continued ramp up of the sales force.

As we continue to invest internationally, the mechanics of our effective tax rate calculation continue to be affected by our losses in the U.K., where we do not get an equivalent benefit to offset the U.S. corporate tax. This results in an overall high blended effective rate which may cause increases in our current rate.

We now expect 2007 fully diluted net income per share of approximately $0.50 to $0.55, as cost structures for the various investments in the U.S. operations are expected to remain relatively stable as we grow and leverage earnings.

Finally, we expect capital expenditures in the third quarter of approximately $2 to $4 million and we continue to expect capital expenditures for 2007 of approximately $12 million.

In conclusion, revenue growth remains solid and we expect substantial earnings growth in the core U.S. business during the second half of 2007 and 2008, along with the continued ramp up of investment in our international operations, which will position us for long-term growth opportunities in the U.K. and Europe.

Also, we continue to believe substantial upside exists in revenue growth at high incremental margins for both current established markets and new markets, which we expect to release later this year. We look forward to reporting this progress to you and with that, I open up the call for questions.

[Operator Instructions] Your first question comes from the line of Brandt Sakakeeny from Deutsche Bank.

Thanks. Good morning. Question for you. On the quarter-over-quarter organic sales growth, do you happen to have that figure?

Which figure is that? I'm sorry.

Sure, the organic quarter-over-quarter sales growth.

4.7% organic revenue growth, quarter-over-quarter.

Okay, great. And over time, I mean, it seems like, I guess, just vis-a-vis your cautious guidance for the back half on the revenue side, and it seems to me that you sort of suffered through the worse of the sales force disruption. Why wouldn't that, Andy, get better over the next couple of quarters?

Because we actually like to see it get better before we confirm any sort of improvement associated with it. And it's, you know, it's still a pretty challenging- - I'm comfortable where we are and I think we'll reach our goal and get the productivity we're looking for. But it's still, you know, a lot of noise, a lot of friction and it will really be in our rearview mirror by fourth quarter, late third quarter this year.

Okay. Fair enough. And I guess just the U.S. EBITDA margin pull back I think by about 50 bits, was that just do to sales force hiring and productivity, as well as some of the investments?

Yes, that's correct.

Okay. Okay, great. I think that's all I have. Thank you.

Thank you.

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

Hey, guys.

Hello, John Neff.

The, could you give us a little bit of color on what the total retail product annual subscription value is currently? And what the total number of contracts in force is? And I can do the math. Are you continuing to see a higher average contract size on that side of the business?

We are absolutely continuing to see a higher average contract size on that side of the business. The number is just under $4 million now in that area, and do you have the specific contract number?

I don't.

We don't have a number right here available for the specific number of retail contracts. At this year's ICSC show we did see smaller retailers and I think it was just more of a -- or we saw some smaller players. I think it was more of a coincidence of how the marketing ended up working. We did, I think it's possible that the Centers and Malls offering at ICSC had a negative impact on some of the bigger accounts on the ownership side. And the TRO came out after ICSC and we actually started picking up some bigger players post that TRO. So, I think that might have suppressed some of the bigger business during the show.

And that's who you're in litigation.

Right. But at this point, that product is no longer being offered in the marketplace.

Okay. And the, both you and LoopNet signed some deals with the CCIM Institute here in recent months. Can you just compare and contrast what each of you are providing?

Sure, I'd love to. I guess CCIM had a relationship with Catalyst up until recently and that relationship is no more, which created an opportunity for someone else to step into that relationship. To the best of my knowledge, what LoopNet is providing is for those listings in their system that are provided by CCIM members, they can be accessed from the CCIM website. So, it's sort of like a loop link for CCIM members on the CCIM website. So, it's a limited, very limited number of properties involved, I believe, at this point.

What we're doing here, and it's sort of, the timing was some real serendipity on the timing here. What we're doing is CCIM is communicating with its membership that they've arranged this agreement with CoStar Group where members can try to meet their information needs for their local market using CoStar Group's Listing Express product. This will put our lower end product in the hands of an awful lot of these smaller brokers or brokers in these expansion markets and it will put it in their hands from a channel or from the association they put a lot of pride in, CCIM.

So, it's coming from about as good a reference as you would want for a CCIM member. And it will give us time to develop a relationship with these people and where it goes next year, we'll explore it from there. But, it's a pretty good way to get an introduction to thousands and thousands of people we've had no prior contact with in cities like Albuquerque and Rochester and so on and so forth.

Also, another aspect of the arrangement was, as you may know, LoopNet doesn't really have anything like the proactive research organization we have or research capabilities or infrastructure. As part of this arrangement with CCIM, they turned over to us, first of all the list of all the CCIM members that we could prospect, but also all the content and data comps, lease listings, sale listings, lease deal information that CCIM members have been compiling over the years with Catalyst. And we can use that information in contacting CCIM members to further our research objectives. So, it should give us a real bump in our research quality depth and breadth and I'm sure it will end up giving us, leading us to thousands of new listings. So, particularly good time for something like this to happen right as we launch into these new markets.

Okay, great. With your spending plateauing, looking like for a while, any thoughts on your nearly $8 a share in cash, in terms of deploying that in some other way?

I think I'll turn that question over to Frank and Brian.

I think right now where we stand we're very comfortable with the amount of cash we have on the balance sheet for the size of the company. So, as of today, we're very happy with that and we'll see where that goes in the years to come.

We would like to be in a situation where we present our board with a discussion of what to do with excess cash in later '08.

Great. And then the, I was wondering, you talked about some of the softening you're seeing at the edges in terms of the industry. What's more important in terms of the demand for CoStar products? Is it for lease market, the health of the for lease market? The health, or the health of the for sale market?

I believe it's probably the health of the for lease market. In the for sale market, if you get a rapid adjustment, negative adjustment, the comps part becomes even more valuable, I believe, to a number of people.

The CLMS product, while it's a profitable good product for us, is less than 1% of our revenues or under a percentage point of our revenue. So, I don't -- it's a very low price point -- so I don't think that would be hurt by any sort of downturn. We wouldn't feel it materially. I think it's more the lease market.

So, we're seeing softening, but it's not -- it's a, it's still the kind of market that over the decades commercial real estate people dream of having.

Right. Good. And then, you mentioned, I just want to make sure I understood this right. You said the 21 new markets, the 21 recently new markets, that you launched finishing with Milwaukee, you said 40% EBITDA. I just wanted to make sure I understand that. And what's the revenue base on which that's being achieved?

I'm glad you asked that question, John. It is 40% EBITDA market margin and aggregate. And currently it's at $6 million revenue level and we expect that number to continue to climb for quite some time.

$6 million annually.

Pretty amazing. And, Brian, you had said something about the tax rate possibly going up from where it is at 45%?

I think right now the tax rate is obviously high and I've gotten a lot of questions on that. That's why I talked a little bit about that. I think we're comfortable where it is today, but obviously if we continue to invest in the U.K. and in Europe, that might, that might change over time.

Okay.

And it would not be going down.

Okay. Okay. Got it. Thank you.

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

Good morning.

Good morning, Jennifer.

I have a question regarding the level of ongoing investment spending you expect for 2008. I'm really trying to get a sense for the kind of nominal increase that we'll see and cost of goods sold and operating expenses versus margins.

Okay. Hi Jennifer, it's Brian.

Hi.

How are you doing?

Great.

I think if you listen to the kind of the guidance we put out there, I think you can figure out from looking at kind of stabilizing gross margin percentages, you can figure out the kind of the cost structure that we expect to increase from the second quarter to the third quarter. It's fairly nominal. Mostly will be in our U.K. and European operations. Most of the other cost lines will remain relatively stable, plus or minus a little bit, except for the selling and marketing line, which I guided to that decreasing due to not having the seasonality and the marketing costs for ICSC. That might be slightly offset as we continue to ramp up the sales force. But I think that gets you to where you're looking for.

Okay. When I'm looking to 2008 bill and beyond, would we see some leverage on the cost of goods sold side, as the cost of goods sold margin has increased over the past few years?

Correct. I would expect as it dipped last quarter, if we expect to see that stabilize in the third quarter, I would expect to see that slowly increase moving forward.

Okay. And just a little bit about your new client growth. Can you talk about who is your new clients and any sort of change in demographic over the past year or so?

Over the last quarter, we've continued to have good success with a number of institutional clients, national consumers and pension fund advisers and investor banks, that sort of thing. We have again picked up two of the five biggest honors in retail real estate. Both of those owners signed a non-disclosure with us, so we can't use their names.

And again, because of this very, very disproportionate mix of the sales force towards new, we don't like to have a new sales person go in on their first demo and presentation or product ever go into the biggest potential prospect in a given city. So, they're constrained to selling to smaller firms. So, we have in this particular quarter and possibly next quarter, we have an unusually large demographic shift towards the three person, four person brokerage shops in a lot of these cities. That will go away as the sales force gains experience. It's more of a temporary phenomena.

So, productivity over the next 18 to 24 months should ramp up significantly as your sales people progress up to the more lucrative, bigger clients?

That would be our hope.

Right.

And expectation.

And just perhaps an update on the competitive landscape. Is there anyone out there, any smaller regional firms starting to get more aggressive? Or are there any other emerging competitors?

We are really unaware of any emerging new competitors that are direct competitors to CoStar Group. And have not had a meaningful radar return from any of the small regional competitors in quite some time, though we have very powerful radar systems.

Thank you very much.

You're welcome.

Your next question comes from the line of Kyle Evans of Stephens, Inc.

Hey, guys. Good afternoon.

Hi, Kyle.

Hey, Kyle.

Most of my questions have been answered. A couple of quick follow ups, though. Sounds like you had some defective hires in sales and that's understandable, given how fast you were adding them. Have you ratcheted back your ramp rate expectations per new sales person at all as a result of this? Or did you just trim the lower producing people and move ahead?

We have a quota system which is driven by your time and experience and the sort of market you're in. So, we would expect someone to sell more in a New York than in a New York -- we expect to sell more in New York than you would in, say, Portland, Maine. So, we really match the incoming sales people against those expectations. And those that we really couldn't coach to those expectations in a reasonable time frame, we just vetted those people out.

We've not changed those expectations for the sales force. We think they're realistic and we think that we can recruit, hire and train people to meet and exceed those expectations. The real delay here is just not a big surprise. We're prepared for it, should it happen. It's just a question of hiring five people and getting three and a half good ones. And frankly, within our organization, I think frankly the vast majority of people we're hiring, if they apply themselves, can actually make those cuts. So, we're not going to lower the expectations for the sales people are doing. It just might take us until the end of the year to get the 165 people we wanted.

Got you. So, when you get three and a half, you're rounding down, is what you're saying? Okay. Can you help me understand the U.S. subscription contract booking numbers kind of going 06 '08, 06 '07, 06 '04, and for the last three quarters?

Again, the number of contracts were signing in the United States are up consistently each quarter. Every quarter they're going up. I think it was 9% or so quarter-over-quarter growth, 8.9% quarter-over-quarter growth. But the problem is that with this large mix of new sales people, the average contract value dropped. So, it's sort of the mechanics of contract count times average value.

I do not expect that to be a long-term trend. I expect that those numbers will continue to rise. I think we've got a lot of potential still in the retail, I mean, we're really at the very beginning of the retail information product opportunity, especially with these new upgrades in the software coming out and the reduction in competition there, as Centers and Malls continues to be absent from that scene.

So, I think the, I think it's really just this question of new sales people and their --

I can understand why the average contract booking would go down, but it would seem to me, given the number of sales people that you've added, that ought to be incremental, unless something is going on in the existing -- the existing 70 to 80 sales people that are there.

Well, every time we, it's not every time, but the, in the past, it's not unusual that when you bring in a lot of new sales people, it takes a disproportionate amount of time from the management team. So, the managers are reading thousands of interviews, conducting hundreds of -- reading thousands of resumes, conducting hundreds of interviews and spending a lot of time with these new people to bring them up to speed, which I believe is a good investment.

It generally, adding a lot of new sales people does bring down often the productivity of the existing sales force for a brief period of time. So, in effect we have seen in the past and it unfortunately appears to be happening in the second quarter to a degree. But we think it basically, it works itself out over the next two quarters.

Okay. Thanks a lot, guys.

Thank you.

Our next question comes from the line of Jim Wilson with JMP Securities.

Hello, Jim.

Oh, thanks. Good morning. How are you?

Doing fine.

I was wondering and I was off and on a few calls all at the same time, so in case you went over this. But on the retail side of new customers, could you go a little bit over terms, structure, how many seats your tending to get, the kind of pricing relative to the normal product for brokers? Just to put it in perspective.

Sure. The, I believe that the average retail contract is still more than 250% of the average contract. So, the average retail contract still 250% of the average contract. So, it's still very high. We are doing a little bit more of our institutionalized styling pricing strategy with some of these bigger players, where we're selling them their first five seats. So, like when a Goldman Sachs signs up for our product, they might start up with licensing, a minimum of five users. And then they add additional seats pretty consistently over time as they spread the use of the product through more and more areas of the organization. We're doing a little bit of that with some of the bigger, bulge bracket size retail owners. But it's fairly similar to what we've seen in the past. So, it's tracking about the same. And we'd expect it to keep doing that for quite some time.

Okay. And then, I guess the other question would be then on the database build out of the new markets, I know it varies a lot by city. Could you color a little bit how much- - let's see, I guess, how much of data so far you've gathered is retail versus all your conventional commercial product? Just contrast that with the older more mature markets.

Sure. I think the, I think what we're seeing in the mix in these new markets, the retail component as a percentage of the inventory we're collecting would be very similar to what we saw in the 21 market expansion we finished in '06. It would be very similar.

When you compare it to the older or more established markets, the maybe hundred or so established markets we came into '05 with, it's going to more, maybe ten percentage points more on the retail side. Some of these markets we're going into now, now that we've actually been researching them for a year or so, we're actually surprisingly large, some names that you would have thought might be smaller cities appear to be pretty large in inventory.

For instance, Louisville, Kentucky has more than 285 million square feet of inventory, which would make it larger than most or many of the markets we did in the 21 expansion markets. We're seeing some slightly higher vacancy rates in some of these 81 markets, but again, 3.6 billion feet of inventory and that will continue to grow. I think it will, before we're done with the year, I wouldn't be surprised if that number didn't cross over 4.5 billion of inventory. But these are, these are some pretty substantive markets, many of them are substantive markets. A couple of them are teeny. But many of them are good quality prospects for us.

Okay, very good. Thanks.

Thank you, Jim.

[Operator Instructions] You have a follow up question from Brandt Sakakeeny with Deutsche Bank.

Thanks. Hi, sorry. I just had one more minor question.

No problem.

Do you have, I think Andy or Brian, you gave the U.S. sales headcount. Do you have the total headcount in the mix between, are there any telemarketers left?

Yes, I do. We've got, I think as Andy mentioned, we ended the quarter with about 49 field AEs. Currently, we have 139. It's reduced a little bit in the past month. We have approximately 10 people in kind of the telesales area, which would be in addition to that.

Okay. So, 149 total headcount, is that right?

Yes and the role of that telesales group is to largely receive incoming prospect inquiries, qualify them and pass them onto the right field rep. We also have approximately 20 sales people in the United Kingdom and probably just under 10 in our advertising sales area.

Okay. Great. Thank you.

Thank you.

Thanks, Brandt.

At this time, there are no further questions.

Well, we'd like to thank everybody for joining us on this second quarter 2007 earnings call. I would like to thank Frank Carchedi for doing an excellent job at the last 36 earnings calls. And look forward, Brian and myself and Tim, look forward to updating you guys again on the progress the company's making in the third quarter call. Thank you.

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