CoStar Group Inc (CSGP) 2008 Q2 法說會逐字稿

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the CoStar Group's second-quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Mr. Trainor, you may begin your conference.

Thank you, Stephanie. Good morning, everyone. Welcome to CoStar Group's second-quarter 2008 conference call. Before I turn the call over to our CEO, Andrew Florance, let me state that certain portions of this discussion contain 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 include, but are not limited to, those stated in CoStar's second-quarter 2008 press release and in CoStar's filings with the SEC, including CoStar's Form 10-K for the period ended December 31, 2007 and CoStar's Form 10-Q for the quarter ended March 31, 2008 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. You can find a webcast of this conference call at www.costar.com\corporate\investor. Thank you again for joining us. I will now turn the call over to Andy.

Thank you, Tim. Welcome, everyone, to CoStar Group's second-quarter 2008 conference call. I am very pleased to report that CoStar posted another strong performance in the second quarter, one which we added a large number of new subscribing firms, continued to add net new individual subscribers and continue to generate very solid earnings growth.

In May, we launched our newest product offering, CoStar Showcase, which has surpassed even our most ambitious expectations in terms of market reception. Also during the quarter, the total number of commercial property listings marketed through CoStar exceeded one million for the first time and continues to grow. We believe that this is by far the most property listings available through a unified database in any website in the industry and represents a monumental achievement for our Company.

In addition, as we announced in our release today, we have made substantial progress on the commitment we made to investors 12 months ago to pursue accelerated earnings growth following the substantial investments we made over the past years to expand our market coverage in the US and the United Kingdom.

Having completed the transition last year from a period of heavy investment in our business to one in which we generate solid earnings growth, we set a goal following the second quarter of 2007 to dramatically increase our then companywide 9% EBITDA margin and achieve a 30% EBITDA margin within the US by the fourth quarter of 2008. With this quarter's results showing a 29% US EBITDA margin, we have almost reached that goal. As a result, we are again raising our earnings outlook for the rest of this year.

Having established a pattern of increasing profitability over the past four quarters, we intend to continue to pursue our current strategy of sequential earnings growth, further strengthening the Company's financial position. Based upon our current revenue growth rate, together with the demand we see for our core information products and newly launched Internet marketing service, CoStar Showcase, we are setting a new goal for the Company of doubling our EBITDA and generating $100 million in annualized EBITDA on a run rate basis by the end of 2010.

Net income for the second quarter increased 363% to $5.4 million or $0.28 per diluted share compared to $1.2 million or $0.06 per diluted share for the same period a year ago. Revenues for the second quarter of 2008 were $53.5 million compared to $47.8 million for the second quarter of 2007. Core US subscription revenue increased 2.9% from the first quarter to the second quarter of 2008, consistent with increases over the past several quarters.

EBITDA, earnings before interest, taxes, depreciation and amortization, for the second quarter of 2008 was $12.8 million, an increase of 204% compared to EBITDA of $4.2 million for the second quarter of 2007.

Demand for our information products remained quite strong in the second quarter. In total, we added 587 net new subscribing firms in the United States, the second highest number of new subscribers the Company has added in a single quarter. In addition, we added approximately 785 net new paying subscribers during the quarter for a total of 91,607 authorized users. CoStar's customer renewal rate for subscription-based services remained high at approximately 90%.

By far, the most significant event in the past quarter from a sales perspective was the May launch of CoStar Showcase, our innovative, new marketing service that makes the listings of CoStar Showcase subscribers automatically accessible to the tens of thousands of business professionals who are searching the Internet for commercial real estate each day.

CoStar Showcase taps the substantial traffic on our website and additional traffic from major search engines to provide commercial real estate professionals with an exceptional new opportunity for marketing their listings on the Internet and generating more leads for their properties.

Currently, orders for this new service are approximately $4 million, making it one of, if not the most successful new product launch in CoStar's 20-year history. Since we launched CoStar Showcase in mid-May, 574 subscribing firms have had their listings exposed to Internet searches from such leading companies as McDonald's, Pfizer, General Motors, OfficeMax, Coca-Cola, Delta Air Lines and Lockheed Martin among many, many others. I have been working closely with John Stanfill, our newly appointed Senior Vice President of Sales, to capitalize on the tremendous interest commercial real estate firms and brokers show in marketing their listings on CoStar's showcase.

CoStar's sales organization has been busy setting appointments and presenting the new CoStar Showcase service to thousands of prospects with listings across the US. Our sales team has scheduled thousands of additional CoStar Showcase presentations and follow-up meetings with prospects for the next two months. Many of our salespeople are booked up well into August. We expect a large number of these prospects to become CoStar Showcase subscribers.

As an incentive during the initial launch, we have been offering limited trial periods and cancellation options to CoStar Showcase subscribers. These incentives have been extremely effective, but they do not preclude us from including these subscription orders -- they do -- they do preclude us from including these subscription orders as revenue until they go firm. Therefore, we have not included these showcase contracts in our quarterly bookings number.

Partly because of this trial offer, the rest of our US subscription contract bookings were lower in the second quarter of 2008, totaling $3.1 million, down from the $3.7 million in the first quarter of 2008. However, we fully expect that number to increase as more trials convert into Showcase subscribers in the second half of the year. Already by the end of July, we believe we will have $1 million in recognizable annual billings from Showcase.

We believe that there are two primary factors that are contributing to the surge in interest we have seen for CoStar Showcase. The first is we believe CoStar Showcase provides a superior alternative to other solutions available. The second factor is that a significant competitor in this space has recently passed on a series of major price hikes, alienating many of its clients. We believe in an uncertain economic environment, commercial brokers resent these unreasonable price hikes even more and so are searching for a good alternative service that can provide them with quality leads from the Internet.

CoStar Showcase offers a more effective and convenient solution for both searchers and subscribers. For brokers who already have their listings in CoStar property, the process of adding their listings to CoStar Showcase is practically frictionless. For searchers, the process of searching and accessing listings on CoStar Showcase is also practically frictionless.

What is more, this new online service leverages our existing research operations and cost structure. All the property information is drawn from our listing database and online image libraries, therefore requiring little additional support or investment other than software development and a pay-per-click budget. It is a very efficient solution for our subscribers and a high-margin product for us. For all these reasons, we believe CoStar Showcase has the potential to be a significant contributor to our earnings growth later in the fourth quarter, next year and beyond.

Compared with our core subscription-based information sales, which tend to have a sales cycle of months, the sales cycle for CoStar Showcase appears to be a matter of weeks and the current average Showcase contract size of $7,826 annually compares favorably with our second-quarter average information contract value of $7,155 annually.

We couldn't be more pleased to offer our clients this compelling and extremely effective solution for marketing their listings on the Internet. Going forward, I expect Showcase to be one of the primary focuses of our sales organization.

Last call, I updated you on our first and second-quarter focus on strategically important, smaller sized firms that had a higher-than-average number of property listings. As part of this sales effort, we made a concerted effort to inform these prospects of CoStar's competitively priced, higher quality information and the fact that it may be more affordable than they perceived. We believe CoStar offers a compelling alternative to those firms who stand to benefit from the value of our higher quality, research-supported information.

In addition to expanding our customer base, sales to these smaller sized firms could also lead to long-term growth opportunities given our historical proven ability to renew and upsell firms that become subscribers. For these and other reasons, we thought it was an opportune time to pursue this market segment even though it limited our short-term ability to grow our bookings number.

I am pleased to report our efforts in this area over the past two quarters have been a major success, contributing to the record number of new subscribing firms we have added over the first two quarters of the year. And resulting in the conversions of thousands of listings to client listings, giving us higher-quality data overall, thereby increasing our value proposition to all of our clients and prospects.

Also, as I explained last call, we anticipate that the average contract value would begin to increase back towards historical levels once this sales initiative focusing on smaller sized firms wrapped up late in the second quarter and that has already begun to occur. The average new contract value increased from $6,864 in the first quarter of 2008 to $7155 in the second quarter of 2008. Our special focus on small firms is now completed and over.

At the end of the second quarter, the Company had 128 US subscription sales field reps, eight US advertising sales reps, eight in-house sales reps and 21 UK field sales reps for a total of 165 sales representatives. That compares with 171 on staff at the end of the first quarter of this year.

Our research department achieved a major milestone during the second quarter by adding the one millionth listing to CoStar's database. To the best of my knowledge, this represents the largest aggregation of commercial property information ever assembled within a unified database anywhere in the world. This aggregation represents a tremendous value for our subscribers who can now access and compare similarly researched and verified properties across markets coast-to-coast and it further strengthens CoStar's position as the leading provider of information and marketing services for the commercial real estate industry.

CoStar pioneered the concept of commercial real estate firms outsourcing their property research functions 20 years ago, fundamentally changing the way commercial real estate professionals access, use and share property information. The astounding number of listings now being accessed today across CoStar's information platform throughout the United States and United Kingdom is a clear indication of how much the industry has changed from the outmoded and efficient exchange of incomplete paper-based information to the much greater efficiency, increased productivity and cost savings that accrued to the firms and the individual brokers who used CoStar.

I have the distinct privilege of meeting the broker who recently provided the one millionth listing added to CoStar's network. His name is Cyrus Weiss and he works for Richie Commercial in San Francisco. He is a World War II veteran and served in the Coast Guard. He embarked on his career in commercial real estate while in his early 70s and a finer gentleman you will never meet. He is still vibrant and active in commercial real estate and also a long-time CoStar subscriber and active user.

When he recently won a new listing, he contacted a member of our research team, [Kristin Vanderloop], who properly verified the information and added his listing. It was a three-level, storefront retail and office building on Lombard Street in San Francisco, the structure originally built in 1908. With a single call to a CoStar researcher, Mr. Weiss, who describes himself as the oldest broker in America, add his listing for one of the oldest buildings in the city to what I consider to be the most advanced information system serving commercial real estate, making it almost instantly available to CoStar's professional industry audience, as well as to a massive potential business audience searching the Internet for commercial real estate each day.

The total number of listings available through our service continues to grow. Total research and verified commercial real estate listings in CoStar's US database grew 22% year-over-year from approximately 770,000 in the second quarter of 2007 to apparently 940,000 in the second quarter of 2008. In total, between both our US and international operations, the Company currently has approximately 1,040,000 listings in our database and the total gross building area tracked and maintained by CoStar is now approximately 60 billion square feet.

Our research team provides the core data that is the source of our value and identity as a company. They have done an outstanding job in researching all the markets we cover and they continue to demonstrate their value by aggregating more and more listings in an extremely efficient and timely manner.

While we have now completed the difficult and labor-intensive phase of adding new markets to our database to complete our coverage in the US and expand our coverage in the UK, we continue to add listings at a brisk pace. We have now taken appropriate steps to stabilize our cost structure and believe the costs associated with maintaining the information is now at a relatively fixed basis.

We continue to make progress in building as strong a UK product offering as we have in the United States and work towards the goal of becoming the preeminent source of commercial real estate information in the United Kingdom and eventually all of Europe.

Since introducing many of the same research processes and systems we have in place in the US, including field research vehicles, the UK research team has ramped up its overall productivity and is now in high gear. In fact, I believe that our Glasgow research center is developing into one of our best and most productive research centers globally.

The UK research team added more than 110 million square feet of available space during the second quarter to bring the UK availability database to approximately 1.1 billion square feet. The UK availability database is approaching the listing counts we would expect to see on a relative GDP basis.

One sure sign that we are delivering on our customer expectations is the increase in product usage we are seeing in the UK as clients continue to log into our system, run more queries, produce more reports and set up more alerts. Usage of our focused products in the UK has more than doubled year-over-year from the second quarter of 2007 to the second quarter of 2008. We firmly believe that the higher overall usage levels bode well for continued high customer renewal rates in the future.

I would also like to briefly update you on the status of one of the lawsuits that we currently have pending against LoopNet. In November 2007, LoopNet filed a complaint over CoStar's use of listings forwarded to CoStar by brokers wishing to market their listings on CoStar.

Essentially, LoopNet claims that when a commercial real estate broker uploads their own listing to LoopNet's service, that listing becomes a "LoopNet listing" and then LoopNet has the right to restrict how that broker can further market, distribute or use his or her own listing information.

LoopNet's complaint appears to allege that a broker who authors and types a listing into LoopNet may not use the e-mail to a friend function available in LoopNet to send that listing to CoStar for inclusion in the CoStar database. Not only do we think that LoopNet's legal arguments are wrong, but we also think that the LoopNet customers would be dismayed to discover that LoopNet is claiming controls and may restrict the marketing and distribution of listings that the brokers themselves have won, photograph, uploaded, written and typed.

CoStar filed defenses to LoopNet's suit and filed a cross-complaint alleging among other things that LoopNet had violated and breached the terms of a settlement agreement entered into by the parties in September 2005 that clearly provides that CoStar may obtain and use listings from the public portion of LoopNet's website. LoopNet then filed a motion under California law asking the court to strike CoStar's cross-complaint on the grounds that it lacked merit.

On Friday, June 6, CoStar won the motion and the court denied LoopNet's motion to strike CoStar's counterclaims, concluding that CoStar had shown a reasonable probability of succeeding on the merits of its claims that LoopNet violated the settlement agreement. LoopNet has now appealed the California judge's decision.

Notwithstanding our expectation that CoStar will prevail on the merits of this case, as part of the discovery process, we have gone to the hundreds and hundreds of CoStar researchers and asked them to identify for us any listings they have entered that have been copied from the public portion of LoopNet's website. To date, we have heard back from virtually all the researchers and out of the one million plus active listings currently in our database, they have identified one listing that was obtained from the public portion of LoopNet's website in the absence of a direct request from a broker to have the listing added to the CoStar database. That is right -- one. We have confirmed that the broker currently responsible for that one listing wants it on CoStar's website. Again, our investigation to date shows that CoStar has not added listings from the public portion of LoopNet's website unless directed to do so by the broker that created the listing.

Ultimately, we believe that because LoopNet has been losing thousands of subscribers over the last few quarters and appears unable to stop that client exodus, they have, out of desperation, resorted to suing CoStar in a misguided attempt to salvage their clients and listings. We're very confident that LoopNet's lawsuit is completely frivolous and that the exorbitant amount of legal fees being spent by both parties and the courts has been and will continue to be a colossal waste of time and money.

Unfortunately, CoStar has been engaged in litigation on and off with LoopNet for nearly a decade and at this pace, we continue to be for the foreseeable future. Our related legal fees are treated as an ongoing regular expense item and so are reflected in our financials and unlike LoopNet are reflected in our EBITDA and our guidance. We are pleased with the court's recent favorable ruling and we are seeking to recoup our legal fees in our countersuit. We remain confident that LoopNet's lawsuit will not impact our ability to show consistent, sequential, quarterly earnings growth.

To read some of the recent pronouncements made in the media on the conditions in commercial real estate markets, one might think we are in the midst of the worst downturn in the past 25 to 50 years. But based on our analysis, the facts and statistics simply do not support the view that the commercial real estate market is falling into a severe downturn. Our latest analysis based upon the performance of a core set of major US markets found that the conditions with the office, retail and industrial real estate sectors during the second quarter remained mixed, but many of the most important metrics are well within range of conditions considered healthy by most interpretations.

Clearly, it appears that the transaction activity has slowed, especially on the sales side. However, many key industry indicators continue to reflect unprecedented strength. Rents are generally at multiyear highs. Construction activity is robust. Vacancy rates have risen, but are generally moderate across the majority of markets and well within the ranges considered healthy.

Overall, office absorption remained positive in the second quarter with a total of 7 million square feet net absorption, reflecting relatively strong demand. 27 of the core office markets we analyzed experienced positive absorption this past quarter while 16 saw a negative absorption.

But interestingly reflecting the mixed state of market conditions at midyear, 15 of the core office markets we analyze saw vacancy decrease over the past year, while office vacancy increased in 26 of the markets. Eight office markets have vacancy rates below 10%. The office market with the lowest office vacancy rate in the country is also the largest, New York City at 5.6%. A 5.6% vacancy rate is an indication of an extremely tight and strong commercial real estate market.

Another clear indication of market strength can be found in office rental rates, which continued to go up in the second quarter, the 10th consecutive quarterly increase in average office rents. I can tell you firsthand that office rents are more than holding their own. I just received several lease proposals in our sales office in Boston and from what I see, at least Boston rents are as healthy as I have ever seen them.

We are seeing a slowdown in commercial real estate sales activity, but we believe that CoStar has modest exposure to a slowdown in that section. The situation is much the same across industrial and retail property sectors. The fact is commercial real estate market conditions have remained fairly resilient.

We certainly have not witnessed the hallmarks of a true commercial real estate downturn characterized by consecutive quarters of clearly raising vacancy rates, falling rents, asset values, negative absorption or stalled construction activity. Rather, it appears capital for commercial real estate, both equity and debt, remains reasonably available under terms in 2008, especially compared with the true downturns we had in the early '90s.

Obviously market conditions are weaker than they were two years ago and could weaken further. More likely, individual markets will strengthen and weaken at different paces reflecting the underlying strengths of the local economies and their positions in the real estate supply cycle. I believe this only underscores the value of having access to comprehensive, research-verified property information that CoStar can provide.

Before turning the call over to Brian Radecki, our Chief Financial Officer, for a more in-depth discussion of our financial performance and outlook, let me reiterate that the Company is very focused on adding and retaining subscribers across the US and UK, controlling our costs and enhancing the high quality of research we conduct. We expect to continue to generate consistent earnings growth as we move into 2008 and into 2009 and beyond. We are very focused on our goal of doubling our EBITDA to achieve $100 million in annualized EBITDA run rate for the Company by the end of 2010.

Our first goal in the short term, intermediate term and long term earnings growth -- is our long-term earnings growth. I believe this quarter's results have clearly delivered on this goal and we remain confident in our ability to continue to deliver earnings growth throughout the rest of the year and the following. I want to thank all the staff of CoStar Group for turning in a tremendous quarter and at this point, I want to turn the call over to Brian Radecki to go into more detail on the quarter's numbers.

Thank you, Andy. CoStar posted another strong quarter of earnings growth at the midyear point. As Andy mentioned earlier and as we stated in yesterday's press release, net income increased 363% in the second quarter of 2008 to $5.4 million or $0.28 per diluted share compared to $1.2 million or $0.06 per diluted share for the second quarter of 2007.

EBITDA, which is earnings before interest, taxes, depreciation and amortization, for the second quarter of 2008 was $12.8 million, an increase of 204% compared to EBITDA of $4.2 million for the second quarter of 2007.

Today, I am going to principally focus on the sequential results for the second quarter of 2008 compared to the first quarter and on our outlook for the third quarter and full year 2008. Total revenues grew sequentially from $52.3 million in Q1 of 2008 to $53.5 million in Q2 of 2008. Core US subscription revenue increased by 2.9% from Q1 to Q2, which is consistent with the past several quarters and was slightly offset by lower nonsubscription or ad hoc revenue during the quarter. Subscription revenues continued to account for approximately 95.3% of our total revenue during the quarter.

Our 12-month trailing customer renewal rate remained strong at 90.9%. With subscription revenues accounting for approximately 95% of our total revenue and the majority of our subscribers on annual agreements, we consider our 12-month trailing customer renewal rate to be a good indicator.

Also for the second quarter, our customer renewal rate for subscription-based services remains solid at 89.7% or as we stated in the press release, approximately 90%. All in all, these are very healthy numbers based on where we are today in the economy.

International revenues increased 3% from Q1 to $6 million in Q2 of 2008. International operations contributed approximately 11% of total revenues in the quarter and international subscription revenues account for approximately 90% of this revenue. Year-over-year, international revenues modestly increased by approximately 2% due to the discontinuation of acquired product offerings that were duplicative, some of the clients in certain consulting revenues and an unfavorable impact on exchange rate changes. However, our year-over-year international subscription revenues increased at approximately 10%.

Again, let me remind everybody the Company has reported sequential revenue increases in every quarter since its IPO in 1998 and through several commercial real estate cycles since Andy founded the business over 20 years ago. We continue to expect that we will add new subscribers, renew current subscribers and grow our revenue and earnings through the current economic and real estate cycles.

Speaking of the IPO, that reminds me, on July 1, marked CoStar Group's 10-year anniversary of our IPO in becoming a publicly traded company on NASDAQ. A decade ago, I remember thinking of the daunting task ahead of us expanding by market-by-market across the US. Through that period of intense investment, we produced a consistent pattern of revenue and earnings growth market-by-market all across the US.

Now, a decade later, after completing the major investments required to research both the US and UK commercial real estate asset classes, we have leveraged our subscription-based business model over a relatively fixed cost structure to establish a pattern of increasing profitability, but now on a country level in the US quarter after quarter after quarter.

As Andy stated earlier after announcing a year ago in Q2 of 2007 our goal of achieving a 30% EBITDA margin in the US by the end of this year, we have nearly reached that goal after four quarters. Now, we have set a new goal of working towards doubling our EBITDA companywide to $100 million run rate by the end of 2010. We believe this goal is achievable based on our strong subscription-based business model and based on the current revenue growth rates in the current economic and commercial real estate environments.

Gross margin increased by $2.6 million from $32.5 million in Q1 of 2008 to $35.1 million in Q2 of 2008 on a $1.2 million increase in revenues and a $1.4 million decrease in cost of revenues. Approximately half the decrease in cost of revenues was directly related to permanent operational and efficiency gains, i.e. the elimination of excess leases across the Company, elimination of redundant data costs from recent acquisitions, etc., etc. The remainder of the decrease relates to variable timing differences with new hires, headcount and other related costs.

Overall, gross margin percentage expanded to $65.7 million in Q2 of 2008 from $62.3 million in Q1 of 2008. This increase in both gross margin dollars and percentage demonstrates the strength of our business model. Now that we have completed the previous step-ups in cost structure as I have stated several times, we expect the majority of revenue added during the quarter to drop directly to the gross margin line as we have seen for the past several quarters.

Overall, operating expenses increased $1.3 million during the quarter from $25.3 million in Q1 to $26.6 million in Q2 as expected. This increase was principally in selling and marketing with the seasonally high expenses from CoStar's participation in the ICSC tradeshow in May, along with the costs associated with the successful launch of CoStar Showcase.

In more detail, G&A also saw a slight uptick this quarter due to the termination of a lease and write-off of certain lease-hold improvements that are now saving the Company over $1.1 million over the remaining two-year term of the lease as we consolidated excess office space in Maryland, which we discussed last quarter.

In addition, legal expenses included in G&A also remained high in Q2 at approximately $900,000. As always, we follow GAAP basis accounting and report all of our legal expenses in our income statement, EBITDA number and on our earnings outlook for the year, unlike other companies I am aware of.

Throughout the remainder of 2008, we expect the Company's overall operating expenses to remain stable and relatively fixed. Our revenue growth of $1.2 million, coupled with overall expenses, cost of sales, plus operating expenses, were consistent from Q1 to Q2, resulting in EBITDA for the second quarter of $12.8 million, an increase of $1.3 million compared to EBITDA of $11.5 million in the first quarter of 2008. Reconciliation of EBITDA to all non-GAAP financial measures discussed on this call to GAAP basis results are shown in detail on our press release issued yesterday. The press release is available on our website at www.costar.com.

Capital expenditures for Q2 of 2008 were approximately $1.2 million. We ended the second quarter of 2008 with approximately $198.3 million in cash, cash equivalents, short-term and long-term investments. Also, we have no long-term debt.

Now, I will discuss the outlook for the third quarter of 2008. As indicated in our press release, we expect a sequential quarterly increase in revenue from the second to the third quarter of 2008 of approximately 2% to 4% with fully diluted net income per share of $0.28 to $0.30 in the third quarter of 2008. We also expect to grow earnings from US operations through 2008 into 2009 and beyond as a result of the consistent core revenue growth coupled with our relatively fixed cost base.

Based on the current visibility and operation of our business, we are again raising the outlook for net income for the full year of 2008. The Company now expects a $1.10 to $1.15 per diluted share for the full year 2008.

We continue to believe there is upside revenue growth potential later in 2008. Revenue growth continues to be largely dependent on the successful management and productivity of the salesforce, particularly in view of the revenue opportunities resulting from momentum in established markets, new markets and the new Showcase offering.

Now if our sequential quarterly revenue growth rate does not accelerate as we expect, we continue to expect to meet our updated earnings outlook while possibly coming in at the bottom of our year-over-year annual revenue growth range, which we set for this year. For the full year 2008, we expect approximately $5 million to $6 million in pretax non-cash equity compensation charges related to the vesting of restricted stock options. Gross margin percentage is expected to improve slightly from Q2 to Q3 as we continue to leverage our stable US cost structure and identify operational efficiencies. Operating expenses are expected to be relatively fixed or decrease slightly from Q3 to Q2.

As we continue to invest internationally, the mechanics of our effective tax rate calculation continue to be affected by the amount of income or loss in the UK where we do not get an equivalent tax expense less benefit to offset the US corporate tax. This results in an overall blended effective rate that may increase or decrease over the current rate. We currently continue to expect our overall effective rate to be in the range of 43% to 45% for 2008.

In conclusion, we continue to expect earnings growth in our core US business operations to be the story for the remainder of 2008. Our Q2 results demonstrate that we are delivering on these expectations. We also expect our international operations to continue to move towards breakeven by the end of 2008 while we develop the next generation of international software, which we expect will position us for long-term growth opportunities in the UK and Europe later in 2009 and beyond.

As Andy stated earlier, the entire CoStar management team remains fully committed to achieving the 30% EBITDA margin in the US and breakeven in international operations by the end of 2008 and now working towards our new goal of $100 million in annualized EBITDA for the entire company by the end of 2010. We look forward to reporting that progress to you and with that. I will open up the call for any questions.

(OPERATOR INSTRUCTIONS). John Neff, William Blair.

A couple of questions for you. Number one, I guess I would start with and Andy maybe. You mentioned -- with the Showcase product, you mentioned a fair number of retailers that sounded like they were trying the product. Was that retailers trying it directly or through their brokers? Can you give us maybe an update on sort of the retailer appetite for the product and what you think it could mean as far as penetrating that market? And then can you give us an updated view on how you're thinking about capping the listings inventory available on Showcase?

Okay. I think the product retailers who have access to inventory that are trying to dispose, they would be interested in the product because it would -- typically a lot of those dispositions are going to be picked up by smaller, mom-and-pops or at retailers and Showcase is a great venue to reach a general business audience on the Internet.

Also retail in general, when you get outside the retailers, we are seeing about a third of the activity on Showcase is coming from retail real estate and that is a very fragmented part of the commercial real estate market, often underserved by the brokerage community. So a lot of the business community at the smaller end of retail is fending for themselves and CoStar Showcase is an ideal way for them to try to find opportunities. So we think it -- we do think that a big part of the growth story in retail and in Showcase will be around that whole retail segment. Now I was surprised to see that the retail segment for us in Showcase is larger, second only to the office segment. It is larger than the industrial segment.

What we intend to do, in the second part of your question, on capping how much we are putting in there, we intend to initially cap it at about half the listings and any given metropolitan market can go into Showcase and because of the really great response we have received for the product, there are some markets in which I believe we are approaching 30% of the listings being showcased. So in those markets, I anticipate we will bump up against the 50% cap. But generally across the United States, we would be in the -- I would not see us hitting the cap in a substantial number of markets for another year or two and by then, we would have an awful lot of revenue from the product. Does that answer your question?

Yes, that is great. Just one more Showcase question. The 587 new subscribing firms you added during the quarter, does that include Showcase, or is that for traditional kinds of products?

That is traditional.

And then with the international revenue growth, can you just remind us of the business lines or products that were discontinued? And also, Brian, remind us of why the sharp drop in looking at the EBITDA for international, why the sharp drop in corporate expense allocation from a year ago to $285,000 from $975,000.

Sure. As we talked about and I think if you went back to last year, you will see when we acquired the Propex acquisition in the second quarter of last year, they had a couple of product lines that were duplicative with product lines that we had. One in specific which I know we have mentioned on prior calls was [Screen Data].

So we essentially closed down that Screen Data and some other smaller product lines last year because they were duplicative with what we had. So when you look at kind of the quarter-over-quarter results, they are growing approximately where we are on the US platform. When you look at the year-over-year results, you are not really comparing apples to oranges because you had those numbers in the first half of last year which are no longer there this year.

And as far as the corporate allocation goes, sorry, but Andy is sitting right here, Andy spent an entire summer over there last year. So he is no longer there anymore. He is shaking his head, but I have got to tell it the way it is. So we are not -- we don't have -- we are not spending as much over there, so they are not getting as big of an allocation.

(inaudible).

Sorry.

Some of the other Propex kind of products, the deal introduction platform and the auction platform, are those part of subscription revenue or are those part of non?

Those are part of subscription revenue.

Yes.

There is some marketing components of the Propex.

There are, there are some marketing components, and if you look at -- I have mentioned it this time in the call, I am not sure if I have mentioned it before, but the international side -- it is not much, but they are at only at about 90% subscription revenue, so they do have a little bit more variability. So the Propex component has mainly a subscription piece, but there is a small nonsubscription piece that goes along with it. So I think because the UK numbers are a little smaller than the US and the fact that they are slightly less subscription-based, it is still 90%, which is high. They are a little bit more subject to variability on the nonsubscription or ad hoc type areas.

And then, Andy, I was looking for maybe an update on the salesforce, if you could update us on the average tenure experience of the salesforce, had some time to absorb some of the new folks, your view on sort of headcount growth going forward and maybe an update on turnover.

Okay. I don't have hard numbers right here on average sales tenure or turnover. What I can tell you anecdotally having just spent the five weeks with about 18 salespeople in training per week, advanced training or ongoing training of the Showcase product in the last five weeks, I would say that we are seeing, beginning to see a clear maturation of the salesforce. It is actually fairly unusual to have a new salesperson come into one of these training classes. So I would think that our average tenure has probably gone up by eight months or so over the last year, which is a very good thing.

And I would say that our turnover is down this year over last year and while we are down a little bit quarter-over-quarter in the headcount in sales, I would anticipate that number would fluctuate up and down a little bit and be fairly stable. And what we are focusing on is doing exactly what we are doing, which is continuing to put more training into the existing players that are there, bring that tenure up and build their experience level. So I am pretty comfortable with where that group is and what they are achieving at this point.

Great. Thanks so much. I'll get back in queue.

Jon Maietta, Needham & Co.

Hey, thanks very much. The first question I had was for you, Brian, with regard to cash flow, kind of that bogey of $100 million revenue EBITDA run rate for year-end 2010. It implies some healthy cash flow growth. How should we think about a proxy for cash flow growth? Is that EBITDA growth kind of the best proxy?

I think the EBITDA growth is the best proxy and I think if you just took modest revenue growth figures, which we have been seeing here in the past few quarters, and you look at the fact that a high percentage of those revenue dollars are dropping to the bottom line, so you would be looking at 70%, 80% of that dropping to the bottom line. You can fairly easily calculate on a pretty high level getting to the $100 million annual EBITDA before the end of 2010. And that is how we look at it internally, so that is how I would expect a lot of investors to be looking at that. It is also, I hate to say it, but I know we can pull up our proxy, it is our bonus too. So that is what the Company is focused on.

Yes, and that really is a base case scenario because I mean you are basically saying as the market stays today X improvement in macro growth and things like that.

Correct. I mean I think we are looking at where we are today and what is happening today and we feel obviously very good about it. We have raised guidance twice this year. Our business model is healthier than anything else I have seen. I mean it seems like every time I pick up the paper, we are bombarded with negative news of other companies reducing guidance, losing customers, going out of business, trying to raise more capital and to be honest with you, I mean our business is just performing exceptional and is healthy as it has ever been. So we are very pleased.

And then, Brian, I may have missed it. Did you disclose what the cash flow from operations number was for the quarter? I got cutbacks, but not cash.

I don't think I talked about it. It was about $8 million.

Okay. Got it. Then the other thing I think I missed, you had talked about kind of a sequential increase in revenue in Q3 and Q4. But did you reaffirm kind of that 14% to 16% number for the full year?

I didn't reaffirm it. I think what I said was that I think we are in the 2% to 4% range and that is where we have been the last couple of quarters, so I think we are kind of still in that 2% to 4% range until we see us come out of that. I think obviously the economy and those types of things are going to be a factor in there, but I think that is a good range that we are going to be into for quite some time.

Got it. Okay. And then Andy, with regard to John coming on board and running the salesforce, is it pretty much the same game plan in terms of running the ball and do you plan any changes to the salesforce compensation or anything like that?

I don't foresee at this time any material change in salesforce compensation other than the typical periodic incentives and special initiatives, but I think it is more of a switching of leadership and leadership style rather than an issue of big restructuring.

Got it. Okay. Thanks very much.

Brett Huff, Stephens Inc.

Good morning, guys. Nice quarter.

Thank you very much.

Thanks, Brad.

I have two questions. One, last call, you talked about trying to step up retention efforts and obviously it looked like that worked pretty well with keeping retention flat at 90%. Can you just talk a little bit more about that and also the dynamics of how the sort of marginal smaller commercial brokers' health is because I think that is part of that dynamic?

As we came into the first and second quarter, we had implemented some changes to the salesforce's compensation plan at the end of '07, very beginning of '08 that we felt would begin to take effect as the year went on where we were putting more emphasis on their proactively driving usage up across their book of business. And they have been doing that and I think that by and large the vast majority of folks in the salesforce are in good contact with their clients and that is keeping the retention at a good level.

I can tell you that I have discussed the fact that the -- looking at the statistics for what the statistics say in commercial real estate, you do not see evidence of any sort of disaster anywhere. The possible exception being a slow-down in investment sales, financing on large projects. But when you are listening to large numbers of sales calls and sort of the atmosphere out there, you do have extreme anxiety and just pick up the newspaper and read it and the small brokerage firms can read those newspapers too and they are anxious about the outlook.

So you have got people who are more likely to cancel as a precautionary measure to control their expenses in the event of a downturn and so it is making a slightly more challenging environment and in particular to the low end. It is still one, two, three-person shops who are perhaps taking down their shingle and going back into a larger shop or going into insurance sales or something. So we are holding a reasonably solid retention rate given the psychology of the market right now and interestingly, our gross sales number, our ability to sell product is still pretty strong.

Okay, thanks. And then just one other sort of color on the reversal of the average sales price or I forget what you guys call the metric, but the change from $6800 to $7100 per firm. When you look forward, what are the major drivers of that continuing to go up over the second half and sort of into '09?

Well, that special incentive program ended mid-May. So that is going -- with the elimination, that special focus on small firms, that is going to bring the average number back up. And then we are enjoying a period here where we are signing up some larger dollar Showcase deals, which is driving it up as well. And then the salesforce is becoming more mature, which would also drive it up and you could have some smaller Showcase accounts where salespeople are going into their existing customers who don't have a lot of listings, but are good customers and selling them Showcase, which could be a $100 a month sale. So as an individual addendum to a contract, it is a small number, but the overall account value would continue to grow. So I would expect the average number to be moving up in the third and fourth quarter, in line with what we thought in the first quarter.

And then last question, Brian, can you just repeat the -- or maybe, Andy, you said this, the number that you are going to recognize in revenue from Showcase you said it was $1 million. Was that for 3Q or 2Q? I just missed that statistic.

That is the number that, by the end of July, it appears that we will have achieved an annualized recognizable run rate of $1 million. So over the next 12 months, what we do in July will be -- we are able to call recognizable revenue in July where the trials expired, the contract is firm, the one year to two-year contracts. So at that point, we have a high confidence on $1 million of revenue. The number -- there is not a lot of trials expiring in August and then there is a large number of trials expiring in September and October, a lot of revenue going firm in September and October.

So Brett, what that is is it is not like $1 million drops in from those contracts. I mean what that is is that those cancellation provisions pass that the client decides that they are getting a lot of value for the new service. So that number will then come in over two or three months or something like that. So it is not like it is all going to drop in in one month. So there will be kind of a ramp-up as those come, but obviously the more and more we pass those cancellation provisions and clients continue to go firm, obviously you start to build on that and I think that is where you could see some upside late in the year as you build on that number.

And is that ratably -- is the $1 million ratable over a year or does it come in differently than that?

No, it is the same as our subscription-based services. So once they go firm, depending on the month it is, they come in as a monthly subscription-based subscriber. I think that is why it is important that you pass those trial periods obviously and then once you do, it becomes just like any other subscription-based service that we sell and we will include those numbers in our total, we would say, 95.3% of subscription-based services will be included in that number once they pass that trial period.

Okay, thank you very much.

Vance Edelson, Morgan Stanley.

Hey, thanks for taking the questions. First, I am just trying to get a feel for how the selling and marketing expense trends from here. I may have missed it, but I didn't hear too much on that specific portion of OpEx. There was a little step-up in the second quarter. Is that sort of a one-time bounce-back following the first quarter's lull in marketing or is that increase more permanent would you say going forward?

Well, as I put in my script, Vance, there was kind of a one-time Q2 probably about $700,000, $750,000 for ICSC. Otherwise, I think it would be relatively stable. Now it could -- so you could see it decrease a little bit because that is only a one-time thing during the second quarter that doesn't happen the rest of the year, but that will be somewhat offset on a pay-per-click budget and some other marketing efforts surrounding the new Showcase offering. So you could see a slight decline, but I wouldn't count dollar for dollar that coming off of there. But otherwise, besides ICSC, I think you are at a pretty nice level that you're going to be at for a while.

And you would see that ICSC bump again in second quarter '09?

Correct. Every second quarter, you will see a very similar number for ICSC between $700,000 to $800,000.

Okay, that's helpful. And I just want to dig a little bit more on the reduction in the net new subscribers, which was I think a little bit more than 2000 last quarter, down to the 785 level this quarter. And since the retention rate was generally flattish, I guess that indicates a drop in gross new subs as well. Can you comment on kind of what drove that decline? Is that mainly just broader market conditions would you say?

No, it is actually -- I would actually focus on the fact that the number of firms coming on, the net firms coming on is actually fairly stagnant, about the same number, which is the second highest we have seen ever. So the number of net new firms coming on is the second-highest ever. I think what happened as much as anything is, in the United Kingdom, with the integration of our shop property product into our general information product, our retail product was integrated into our general product, as well as we were cleaning up with the acquisition of these 12, 13 different companies being blended together in the United Kingdom, we are getting a lot of consolidation going on.

So you have got the screen data office information product being superseded by the focus office information product, the shop property information product being encompassed into the focus information product. So a lot of that is going on in the UK that dropped those accounts.

Then the other thing that is going on, which is sort of somewhere between a subscription revenue product and a one-off revenue product, but we are counting it in our authorized user account, the market for lower cost for sale information, our CLMS product, that market is weak. People who are traditionally paying us $29 a month, it is or lowest cost product of all, people are paying us $29 a month for information only on for-sale properties, particularly like in California and Florida. Those folks are going away. So if you have exposure to low end for-sale players, that is weak.

Now the good news is those folks -- where there is those folks falling off, they are probably an 1/8 of our average authorized user value. So I think the number was weak, but elements of it in the United Kingdom were purely mechanical and then if you had to choose some reduction area, it would be CLMS because of the low value. And I expect CLMS to be under the same kind of pressure until Fannie Mae and Freddie Mac stock comes back up to what it was last year.

Right, okay, that makes sense.

And just so you know, the CMLS is barely over $1 million in total revenue and it is not subscription-based. It is pretty ad hoc, so I think we have very, very little exposure in that area as a company.

Okay, that's helpful. And just a final follow-up on the salesforce question earlier with the total number of sales reps down just a bit. Could you provide a little more color on the decline there? Is that entirely voluntary departures or are you doing any kind of trimming of the lower performers for example?

The Company will always look at trimming folks who -- this is just not a good fit for them. That will happen. So that is part of that normal process that goes on. And then I think we have got probably 1/3 of it is we are proactively trimming people that perhaps would be more successful somewhere else. 1/3 is probably people that understand that is on the horizon. 1/3 is probably people who voluntarily choose to pursue other options. And typically those folks go into brokerage working for our customers. So I would say the 1/3 that voluntary left, they are all probably CoStar users know now.

Yes, and if you look at that number, it is still fairly consistent. It only dropped by a few bodies.

And then we didn't want to have a bunch of new training classes while we're bringing in 100 some people for advanced training in July.

Correct.

Okay, got it. Thanks a lot, guys.

Jim Wilson, JMP Securities.

Good morning, guys.

Good morning, Jim. I thought you were going to break your streak of 20 straight calls.

No, never. Even though I am not in the office, I find a way to call in. Two questions. The first was, as you are finding new customers and signing people up on Showcase, have you had any success or what would be your strategy or the opportunity of trying to kind of cross-sell them other CoStar products and do you see levels of interest or is it a little early in those kind of discussions?

Jim, I am waiting with bated breath for exactly that. So initially, a lot of our primary focus is going into our best existing customer base and selling them Showcase as an add-on to their existing contract and that is, for complicated reasons, that would be to them a potential cost savings to buy Showcase.

Secondarily, we are going into the 10,000 best potential new prospects who don't currently buy anything from CoStar Group and we are going in there using a marketing hook, a lead generation hook, in the form of CoStar Showcase and our hope would be that maybe they initially weren't thinking about information product, but once we got in there and began to develop a client relationship with them on the Showcase side, they find value in it, our reps can establish a relationship with them and we could begin a cross-sell upsell process using the marketing as an entry point instead of the traditional tack of using the information.

I will tell you right now in an environment where people are a little more anxious, it is absolutely serendipity that we have the ability to switch from saying we can help you with information products that enable you to efficiently handle high volumes of transactions. We can switch our pitch and our salesforce too -- we can keep your lead flow coming in the door using Showcase to capture the tens of thousands of businesses searching for commercial real estate on the web. So we are shifting to a revenue increase story off of an efficiency streamlining story. So it is great from that perspective and they are receptive.

Okay, good.

I know you didn't ask that question, but thank you for listening.

Then the other question is of the total growth, revenue growth for the quarter, how much came from existing customers adding new marks to products and how much came from new customers?

I think it is probably very similar to what we have seen in the past, although I think Andy and I probably would expect that number to start coming more towards from our current clients kind of skewing our historical average a little bit, which we have always said has been about 50/50 because of Showcase because, as Andy said, we are targeting our best clients first. So I think as you move towards the back half of the year, that number might move a little bit more towards current clients. But I think in this quarter, it was probably about the same we have seen for the past decade.

So I would anticipate that over the next two quarters that would probably be the highest the ratio ever goes skewing towards revenue growth from existing customers.

Okay. And could part of that be I guess maybe your existing customer base or probably the bigger and stronger players in those markets and probably obviously therefore financing in better shape and easier for them to spend money than the small guys who aren't doing so well?

That is certainly true. You look at the -- we are fortunate that our core customer base is at the upper end of the pyramid and they are benefiting to some degree from the weeding out that is going on where a lot of the smaller entrepreneurial folks that started up in the last year or two are losing their nerve and a CB Richard Ellis or a Jones Lang LaSalle, a premier brand, when the transaction volume goes down 25%, those premier brands can go poach business from the marginal players and keep their share stable. And that is what we are seeing. So they are the easiest ones to sell to right now.

Okay, thanks a lot, guys.

Christopher Mammone, Deutsche Bank.

Thanks. Hi, guys. Just back to the sequential revenue growth. You are currently at the lower end of the range now. I guess could you expand on maybe what factors maybe beyond Showcase could help you maybe get back to the higher end of that range in the back half of the year?

Well, I would say that -- yes, so we are at basically the middle of the range of the guidance and similar to what we had last time and I would say that any way you look at it, Showcase appears to dramatically exceed our expectations. And that would move us up to the upper end of the range if it continues to do that the way it looks like it is doing.

If that goes -- (inaudible) you are looking at your more traditional business, but it is what it is. I think right now, we have I would say the highest number of pending demonstrations, sales meetings we have ever had as a company and I would not be surprised if -- like I think we have got something like 2000 sales presentations scheduled for July and beginning of August, which is by far the largest number we have ever had and that is Showcase.

Okay. I guess as a follow-up, I guess it has been several months now since you guys rolled out the 80 additional markets in the US that gave you pretty ubiquitous coverage basically in the US. Have you sold all those additional markets into your national accounts yet or are there still some of your best and brightest clients that haven't taken those on and I guess how is that going?

Well, Chris, we actually -- if you are one of our major national customers, we basically just flow that data through to you the day that we brought it online. So if you were already an institutional customer that subscribed to the first 80 markets, and as we added the additional 80 markets, they just showed up. So it is more of the same way for a national customer. Every single day, even in our oldest cities like Washington DC, we are discovering more and more buildings. So we probably add a couple hundred buildings a month that we discover in Washington every single month and those buildings just flow into the information system for all the clients in Washington automatically and we don't charge for them.

The same thing is true as we add Reno, Nevada into the network for the institutional national customers. That just blows in. Now some customers where they don't subscribe for the whole country -- an example of that would be a CB Richard Ellis and that megadeal we did with them, the $100 million plus deal, that would be specifically where they wanted to step up and get all those markets in one step. They are our biggest customer and they are now on board with those 80 markets and I know that our major accounts team is moving through various other customers and one of the other top two players out there -- one of the semi-peers to CB actually expressed interest in doing a similar kind of deal to what CB did. So we are sort of moving through it, but it is probably a relatively early stage on that.

Thanks, guys.

Michael Grossman, MFS Investment.

So just looking at your balance sheet with $200 million in cash and generating kind of $50 million to $60 million a year in free cash flow and it doesn't sound like given your 2010 EBITDA target that you are going to be making any kind of major investment in the interim period. What do you plan to do with the excess cash here? It's kind of burning a hole I guess at a pretty low interest rate right now on returns.

The interest rate certainly is not exciting out there right now and in real terms, it is negative. So obviously it is exactly the kind of problem a CEO likes to wrestle with, which is too much cash and we are at each quarterly board meeting, we are looking at the options, the alternatives, share buyback, dividends and the like and the Board is considering them.

In the uncertain environment, I think the Board expressed a view that they wanted to move slower rather than quicker in making a decision with what to do there and we also cannot rule out potential acquisitions where CoStar Group could acquire the operations of another company and create or make significant cost cuts and come up with some very accretive acquisitions. And those acquisitions could potentially, both domestically and internationally, run anywhere from $50 million to well in excess of $100 million. So we like to have a strong balance sheet to continue to keep those options open.

Thanks.

Thank you. I want to thank everyone for joining us on this second-quarter 2008 conference call and again, I want to thank the staff for turning out an outstanding performance in the second quarter and giving us a really good quarter. Thank you.

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