10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549
 

FORM 10-Q
 

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended: June 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from ________ to ________

Commission file number: 0-24531

COSTAR GROUP, INC.

(Exact name of registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of incorporation or organization) 52-2091509
(IRS Employer
Identification Number)

2 BETHESDA METRO CENTER
BETHESDA, MD 20814
(301) 215-8300

(Address, including zip code, and telephone number, including area code, of
registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] — No [ ]

As of August 6, 2002 there were 15,775,445 shares outstanding of the Registrant’s Common Stock, par value $.01.

COSTAR GROUP, INC.

TABLE OF CONTENTS

PART I –         FINANCIAL INFORMATION
Item 1 – Financial Statements
Condensed Consolidated Statements of Operations	3
Condensed Consolidated Balance Sheets	4
Condensed Consolidated Statements of Cash Flows	5
Notes to Condensed Consolidated Financial Statements	6
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 3 – Quantitative and Qualitative Disclosures About Market Risk	18
PART II –         OTHER INFORMATION
Item 1 – Legal Proceedings	19
Item 2 – Changes in Securities	19
Item 3 – Defaults upon Senior Securities	19
Item 4 – Submission of Matters to a Vote of Security Holders	19
Item 5 – Other Information	19
Item 6 – Exhibits and Reports on Form 8-K	20
Signatures	21

2

PART 1	FINANCIAL INFORMATION
ITEM 1	FINANCIAL STATEMENTS

CoStar Group, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)

		For the Three Months						For the Six Months
		Ended June 30,						Ended June 30,
		2002			2001			2002			2001
Revenues		$	19,539		$	18,073		$	38,600		$	35,427
Cost of revenues			6,937			7,516			14,033			15,506
Gross margin			12,602			10,557			24,567			19,921
Operating expenses:
	Selling and marketing		5,565			5,944			11,234			12,853
	Software development		1,385			1,357			2,782			2,586
	General and administrative		6,235			7,659			12,102			15,360
	Purchase amortization		898			1,907			1,791			3,697
			14,083			16,867			27,909			34,496
Loss from operations			(1,481	)		(6,310	)		(3,342	)		(14,575	)
Other income, net			214			374			453			949
Net loss before income taxes			(1,267	)		(5,936	)		(2,889	)		(13,626	)
Income tax benefit			–			41			–			82
Net loss		$	(1,267	)	$	(5,895	)	$	(2,889	)	$	(13,544	)
Basic and diluted net loss per share		$	(0.08	)	$	(0.38	)	$	(0.18	)	$	(0.87	)
Weighted average common shares			15,742			15,610			15,730			15,592

See accompanying notes.

3

CoStar Group, Inc.
Condensed Consolidated Balance Sheets
(in thousands)

		June 30,			December 31,
		2002			2001
ASSETS		(unaudited)
Current assets:
	Cash and cash equivalents	$	29,843		$	30,746
	Short-term investments		12,240			11,256
	Accounts receivable, less allowance for doubtful accounts of $2,342 and $2,483 as of June 30, 2002 and December 31, 2001		6,391			5,983
	Prepaid expenses and other current assets		380			957
Total current assets			48,854			48,942
Property and equipment			24,755			23,266
Accumulated depreciation and amortization			(13,688	)		(11,390	)
			11,067			11,876
Goodwill, net			26,177			25,745
Intangibles and other assets, net			32,847			36,726
Deposits			281			357
Total assets		$	119,226		$	123,646
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable and accrued expenses	$	9,224		$	11,095
	Deferred revenue		4,508			4,532
Total current liabilities			13,732			15,627
Stockholders’ equity			105,494			108,019
Total liabilities and stockholders’ equity		$	119,226		$	123,646

See accompanying notes.

4

CoStar Group, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

		For the Six Months
		Ended June 30,
		2002			2001
Operating activities:
Net loss		$	(2,889	)	$	(13,544	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
	Depreciation		2,108			2,496
	Amortization		3,937			6,938
	Provision for losses on accounts receivable		1,155			1,054
	Income tax benefit		—			(82	)
	Changes in operating assets and liabilities		(2,538	)		(1,526	)
Net cash provided by (used in) operating activities			1,773			(4,664	)
Investing activities:
Purchases of property and equipment, net			(1,579	)		(1,178	)
Goodwill, intangibles and other assets			(391	)		(131	)
Purchases and sales of short-term investments, net			(984	)		(1,842	)
Net cash used in investing activities			(2,954	)		(3,151	)
Financing activities:
Net proceeds from exercise of stock options			278			892
Net cash provided by financing activities			278			892
Net decrease in cash and cash equivalents			(903	)		(6,923	)
Cash and cash equivalents at beginning of period			30,746			43,925
Cash and cash equivalents at end of period		$	29,843		$	37,002

See accompanying notes.

5

COSTAR GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

     CoStar Group, Inc. (the “Company”) has created a comprehensive, proprietary database of commercial real estate information for metropolitan areas throughout the United States. Based on its unique database, the Company provides information to the commercial real estate and related business community and operates within one reportable business segment. The information in the Company’s database is distributed to its clients under license agreements, which are typically one to three years in duration.

2. SUMMARY OF CERTAIN SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

     The consolidated financial statements of the Company include the accounts of LeaseTrend, Inc. (“LeaseTrend”) acquired on January 8, 1999, Jamison Research, Inc. (“Jamison”) acquired on January 22, 1999, ARES Development Group, LLC (“ARES”) acquired on September 15, 1999, COMPS.COM, Inc. (“Comps”) acquired on February 10, 2000 and First Image Technologies, Inc. (“First Image”) acquired and merged into Comps on November 9, 2000. LeaseTrend and Jamison were merged into CoStar Realty Information, Inc. (“CoStar Realty”) on December 31, 1999 and ARES was merged into CoStar Realty on December 31, 2000. Comps was merged into CoStar Realty on December 31, 2001.

INTERIM FINANCIAL STATEMENTS

     The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. In the opinion of the Company’s management, the financial statements reflect all adjustments necessary to present fairly the results of operations for the three and six month periods ended June 30, 2002 and 2001, the Company’s financial position at June 30, 2002, and the cash flows for the six month periods ended June 30, 2002 and 2001. These adjustments are of a normal recurring nature.

     Certain notes and other information have been condensed or omitted from the interim financial statements presented in this Quarterly Report on Form 10-Q. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 and the Company’s Quarterly Reports on Form 10-Q for the periods ended June 30, 2001, September 30, 2001 and March 31, 2002.

     The results of operations for the three and six month periods ended June 30, 2002 are not necessarily indicative of future financial results.

CONSOLIDATION

     The consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany transactions.

USE OF ESTIMATES

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

RECLASSIFICATIONS

     Certain previously reported amounts have been reclassified to conform to the Company’s current presentation.

6

COSTAR GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

3. GOODWILL

     Goodwill consists of the following (in thousands):

	June 30,			December 31,
	2002			2001
Goodwill		37,400			36,968
Accumulated amortization		(11,223	)		(11,223	)
Goodwill, net	$	26,177		$	25,745

In connection with the Company’s acquisition of First Image Technologies, Inc. (“First Image”) on November 9, 2000, the Company made a cash payment of approximately $333,000 and issued 4,712 shares of common stock, par value $.01 per share, to the sole shareholder of First Image on June 7, 2002 in consideration for the completion of one of the earn-out conditions relating to the acquisition of First Image. The total additional consideration was valued for accounting purposes at approximately $432,000.

4. INTANGIBLES AND OTHER ASSETS

     Intangibles and other assets consists of the following (in thousands):

	June 30,			December 31,
	2002			2001
Capitalized product development costs	$	1,795		$	1,795
Accumulated amortization		(1,325	)		(1,173	)
		470			622
Building photography		4,701			4,643
Acquired database technology		17,949			17,949
Customer base		31,945			31,945
Tradename		4,198			4,198
Accumulated amortization		(26,416	)		(22,631	)
		32,377			36,104
Intangibles and other assets, net	$	32,847		$	36,726

7

COSTAR GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

5. NEW ACCOUNTING PRONOUNCEMENTS

     In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Standards. Other intangible assets will continue to be amortized over their useful lives. The Company applied the new rules on accounting for goodwill and intangible assets deemed to have indefinite lives beginning in the first quarter of 2002. During the second quarter of 2002, the Company completed the initial impairment test of goodwill and indefinite lived intangible assets, which did not indicate an impairment loss. The Company estimates that the effect of the new rules will be to decrease amortization expense related to goodwill by approximately $3.4 million for the year ending December 31, 2002.

     As required by the new rules, the results for the prior year (three and six months ended June 30, 2001) have not been restated. Reconciliations of previously reported net loss and net loss per share to the amounts adjusted for the exclusion of goodwill amortization net of the related tax effects are as follows:

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2002			2001			2002			2001
Reported net loss	$	(1,267	)	$	(5,895	)	$	(2,889	)	$	(13,544	)
Goodwill amortization, net of tax		—			832			—			1,640
Adjusted net loss	$	(1,267	)	$	(5,063	)	$	(2,889	)	$	(11,904	)
Basic and diluted net loss per share as reported	$	(0.08	)	$	(0.37	)	$	(0.18	)	$	(0.87	)
Goodwill amortization, net of tax		—			0.05			—			0.11
Adjusted basic and diluted net loss per share	$	(0.08	)	$	(0.32	)	$	(0.18	)	$	(0.76	)
Weighted average common shares		15,742			15,610			15,730			15,592

8

ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements,” which involve many risks and uncertainties that could cause actual results to differ materially from those discussed in these statements. Factors that could cause or contribute to such differences include, but are not limited to, successful adoption of our products, competition, general economic conditions, changes or consolidations in the commercial real estate industry, managerial execution, customer retention, development of our sales force, data quality, employee retention, changes in accounting policies or practices and our ability to adapt to technological changes. More information concerning these and other potential factors that could cause actual results to differ materially from those discussed in any forward-looking statements include, but are not limited to, those stated below under the heading “Risk Factors” and those included from time-to-time in our filings with the Securities and Exchange Commission. All forward-looking statements are based on information available to us on the date of this filing, and we assume no obligation to update such statements. The following discussion should be read in conjunction with our filings with the Securities and Exchange Commission and the unaudited condensed consolidated financial statements included in this report.

Overview

     CoStar is the leading provider of information services to the U.S. commercial real estate industry. We have created a digital marketplace where the members of the commercial real estate and related business community can continuously interact and facilitate transactions by efficiently exchanging accurate and standardized commercial real estate information. Our wide array of digital service offerings includes a leasing marketplace, a selling marketplace, comparable sales information, decision support, tenant information, property marketing, data hosting for clients’ Web sites, contact management, property data integration and industry news. Substantially all of our current services are digitally delivered over the Internet.

     We completed our initial public offering in July, 1998, and received net proceeds of approximately $22.7 million. We primarily used those net proceeds to fund the geographic and service expansion of our business, including three strategic acquisitions, and to expand our sales and marketing organization. In May, 1999, we completed a follow-on public offering and received net proceeds of approximately $97.4 million. We used a portion of those net proceeds to fund the acquisition of COMPS.COM, Inc. (“Comps”) and we expect to use the remainder of the proceeds primarily for development and distribution of new services, expansion of all existing services across our current markets, geographic expansion in the United States and international markets, strategic acquisitions and working capital and general corporate purposes.

     From 1994 through 2001, we expanded the geographical coverage of our existing services and developed new services. In addition to internal growth, this expansion included the acquisitions of Chicago ReSource, Inc. in Chicago in 1996 and New Market Systems, Inc. in San Francisco in 1997. In August, 1998, we expanded into the Houston region through the acquisition of Houston-based real estate information provider C Data Services, Inc. In January, 1999, we expanded further into the Midwest and Florida by acquiring LeaseTrend, and into Atlanta and Dallas/Fort Worth by acquiring Jamison Research, Inc. In September, 1999, we acquired ARES, a Los Angeles based developer and distributor of ARES for ACT!. In February, 2000, we acquired Comps. In November, 2000, we acquired First Image Technologies.

     Since our inception, the development of our business has required substantial investments for the expansion of services and the establishment of operating regions throughout the United States, which has resulted in substantial net losses on an overall basis. Throughout 1999 and 2000, we experienced a rapid expansion in the number of services that we offer and the number of regions in which we operate. By the beginning of 2001, we had substantially completed our goal of establishing a national platform of operating regions and service offerings in 50 market areas from which we believe we can appropriately meet the needs of the commercial real estate community for comprehensive national building specific information. During 2001, we focused on continuing to grow revenue while controlling and reducing costs, in an effort to reduce operating losses, and ultimately, move our business to profitability. As a result, the Company has generated positive earnings before interest, taxes, depreciation and amortization for the last four quarters. We believe that the opportunity to continue to grow revenue from our existing national platform and services is significant and that a large component of the operating cost structure of the Company consists of fixed operating costs. Therefore, based on expected revenue growth and continued cost control, we believe that during 2002 we can reduce our overall operating losses as compared to 2001 and generate positive operating cash flows.

9

     We may develop and distribute new services and expand existing services across our current regions and we may experience continued geographic expansion in the United States and/or international markets. The incremental cost of introducing new services in the future may reduce the profitability of a region or cause it to incur losses. Therefore, while we expect current services offerings in existing regions to remain generally profitable and provide substantial funding for our overall business, it is possible that further overall expansion could cause us to generate additional losses and negative cash flow from operations in the future.

     While our services continue to expand, our CoStar Property, CoStar Tenant and CoStar COMPS services currently generate the largest portion of our revenue. The CoStar Property, CoStar Tenant and CoStar COMPS subscription contracts generally have terms of one to three years and renew automatically. Upon renewal, many of the contract rates increase in accordance with contract provisions or as a result of contract renegotiations. To encourage clients to use our services regularly, we generally charge fixed amounts rather than fees based on actual system usage. We charge our clients based on the number of sites, organization size, the client’s business focus and the number of services to which a client subscribes.

     Our contract renewal rate historically has exceeded 90% on an annual basis. However, during 2001 many telecommunications companies, which represented approximately 6% of our revenues at their peak, cancelled our services as a result of discontinuing or curtailing their operations. Sales to telecommunications companies currently represent approximately 1% of our revenues. These cancellations, together with the impact of general economic conditions on our entire customer base, have resulted in renewal rates exceeding 85% over the past twelve months.

     Over 90% of our revenues arise from clients under subscription contracts. Our subscription clients pay contract fees on an annual, quarterly or monthly basis. We recognize this revenue over the life of the contract on a straight-line basis beginning with the installation or renewal date. Annual and quarterly advance payments result in deferred revenue, substantially reducing the working capital requirements generated by accounts receivable.

     We applied the new rules on accounting for goodwill and intangible assets deemed to have indefinite lives beginning in the first quarter of 2002. In accordance with Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. During the second quarter of 2002, we completed the initial impairment test of goodwill and indefinite lived intangible assets, which did not indicate an impairment loss. We estimate that the effect of the new rules will be to decrease amortization expense related to goodwill by approximately $3.4 million for the year ending December 31, 2002 compared to the previous year.

10

Three Months Ended June 30, 2001 Compared To
Three Months Ended June 30, 2002

      Revenues. Revenues grew 8.1% from $18.1 million in the second quarter of 2001 to $19.5 million in the second quarter of 2002. The growth was principally the result of further penetration of our services in our potential customer base across our national platform, as well as the successful cross-selling of our services into our existing customer base. Subscription based information products, including CoStar Property, CoStar Tenant, CoStar COMPS, CoStar Exchange and CoStar Connect, continue to account for over 90% of the Company’s revenues.

      Gross Margin. Gross margin increased from $10.6 million in the second quarter of 2001 to $12.6 million in second quarter of 2002. Gross margin percentage also increased from 58.4% to 64.5%. The increase in gross margin amounts and percentages resulted from revenue growth combined with a decline in the cost of revenues principally due to a $700,000 decrease in purchase amortization from the LeaseTrend, Jamison, ARES, Comps and First Image acquisitions, which was somewhat offset by an increase in research personnel costs compared to the same period in 2001.

      Selling and Marketing Expenses. Selling and marketing expenses decreased 6.4% from $5.9 million in the second quarter of 2001 to $5.6 million in the second quarter of 2002 and decreased as a percentage of revenues from 32.9% to 28.5%. Selling and marketing expenses decreased principally as a result of a reduction in marketing and advertising activities as well as a reduction in operating costs associated with our sales organization, including communications, travel, recruiting and decreased sales administration and advertising account executive personnel costs.

      Software Development Expenses. Software development expenses remained at $1.4 million for the second quarter of 2001 and the second quarter of 2002 and remained constant as a percentage of revenues at 7%. Software development expenses reflect development costs for the products we support including CoStar COMPS, CoStar Exchange and CoStar Connect, as well as the support of internal systems to manage the Company’s growth.

      General and Administrative Expenses. General and administrative expenses decreased from $7.7 million in the second quarter of 2001 to $6.2 million in the second quarter of 2002 and decreased as a percentage of revenues from 42.4% to 31.9%. General and administrative expenses decreased due to reductions in administrative headcount, communications, consulting, travel costs and outside services during 2002.

      Purchase Amortization. Purchase amortization decreased from $1.9 million in the second quarter of 2001 to $900,000 in the second quarter of 2002. Purchase amortization decreased primarily due to the adoption of the Statements of Financial Accounting Standards No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Standards. We estimate that the effect of the new rules was to decrease amortization expense related to goodwill by approximately $845,000 for the second quarter of 2002 as compared to the same period in 2001.

      Other Income, Net. Interest and other income decreased from $374,000 in the second quarter of 2001 to $214,000 in the second quarter of 2002. This decrease was primarily a result of lower average cash, cash equivalents and short-term investments balances from one period to another, and a decline in market interest rates for invested cash, cash equivalents and short-term investments.

      Income Tax Benefit. Income tax benefit decreased from $41,000 in the second quarter of 2001 to $0 in the second quarter of 2002 as a result of the reversal of the deferred tax liability incurred in connection with the amortization of identified intangibles assets acquired through acquisitions incurred in the second quarter of 2001.

11

Six Months Ended June 30, 2001 Compared To
Six Months Ended June 30, 2002

      Revenues. Revenues grew 9.0% from $35.4 million for the six months ended June 30, 2001 to $38.6 million for the six months ended June 30, 2002. The growth was principally the result of further penetration of our services in our potential customer base across our national platform, as well as the successful cross-selling of our services into our existing customer base. Subscription based information products, including CoStar Property, CoStar Tenant, CoStar COMPS, CoStar Exchange and CoStar Connect, continue to account for over 90% of the Company’s revenues.

      Gross Margin. Gross margin increased from $19.9 million for the six months ended June 30, 2001 to $24.6 million for the six months ended June 30, 2002. Gross margin percentage also increased from 56.2% to 63.6%. The increase in gross margin amounts and percentages resulted from revenue growth combined with a decline in the cost of revenues principally due to a $1.1 million decrease in purchase amortization from the LeaseTrend, Jamison, ARES, Comps and First Image acquisitions, which was somewhat offset by an increase in research personnel costs compared to the same period in 2001.

      Selling and Marketing Expenses. Selling and marketing expenses decreased 12.6% from $12.9 million for the six months ended June 30, 2001 to $11.2 million for the six months ended June 30, 2002 and decreased as a percentage of revenues from 36.3% to 29.1%. Selling and marketing expenses decreased principally as a result of a reduction in marketing and advertising activities as well as a reduction in operating costs associated with the sales organization, including communications, travel, recruiting and decreased sales administration and advertising account executive personnel costs.

      Software Development Expenses. Software development expenses increased from $2.6 million for the six months ended June 30, 2001 to $2.8 million for the six months ended June 30, 2002 and remained constant as a percentage of revenues at 7%. The increase in software development expenses reflects development costs for the increased number of products we now support including CoStar COMPS, CoStar Exchange and CoStar Connect, as well as the increase in support of internal systems to manage the Company’s growth.

      General and Administrative Expenses. General and administrative expenses decreased from $15.4 million for the six months ended June 30, 2001 to $12.1 million for the six months ended June 30, 2002 and decreased as a percentage of revenues from 43.4% to 31.4%. General and administrative expenses decreased due to reductions in administrative headcount, communications, consulting, travel costs and outside services during 2002.

      Purchase Amortization. Purchase amortization decreased from $3.7 million for the six months ended June 30, 2001 to $1.8 million for the six months ended June 30, 2002. Purchase amortization decreased primarily due to the adoption of the Statements of Financial Accounting Standards No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Standards. We estimate that the effect of the new rules was to decrease amortization expense related to goodwill by approximately $1.7 million for the six months ended June 30, 2002 as compared to the same period in 2001.

      Other Income, Net. Interest and other income decreased from $949,000 for the six months ended June 30, 2001 to $453,000 for the six months ended June 30, 2002. This decrease was primarily a result of lower average cash, cash equivalents and short-term investments balances from one period to another, and a decline in market interest rates for invested cash, cash equivalents and short-term investments.

      Income Tax Benefit. Income tax benefit decreased from $82,000 for the six months ended June 30, 2001 to $0 for the six months ended June 30, 2002 as a result of the reversal of the deferred tax liability incurred in connection with the amortization of identified intangibles assets acquired through acquisitions incurred during the six months ended June 30, 2001.

12

Liquidity and Capital Resources

     Our principal sources of liquidity are cash, cash equivalents and short-term investments. Our cash and cash equivalents balance was $29.9 million and $30.7 million, and our short-term investments balance was $12.2 million and $11.3 million, at June 30, 2002 and December 31, 2001, respectively. Total cash, cash equivalents and short-term investments were $42.1 million at June 30, 2002 an increase of $100,000 from $42.0 million at December 31, 2001. This increase was due principally to cash provided by operating activities of $1.8 million and $278,000 of proceeds from the exercise of stock options offset by cash purchases of property and equipment totaling $1.6 million and a cash payment of $333,000 in consideration for the completion of one of the earn-out conditions relating to the acquisition of First Image Technologies, Inc. on November 9, 2000.

     Net cash provided by operating activities for the six month period ended June 30, 2002 of $1.8 million compared to net cash used in operating activities of $4.6 million for the six month period ended June 30, 2001. This $6.4 million increase in net cash provided by operating activities was a result of revenue growth and a reduction in operating expenses, both of which contributed to a reduction of our net loss for the first six months of 2002 compared to the first six months of 2001.

     Net cash used in investing activities amounted to $3.0 million for the six months ended June 30, 2002 as compared to net cash used in investing activities of $3.1 million for the six months ended June 30, 2001. Net cash used in investing activities decreased by $100,000 during the first six months of 2002 compared to the first six months of 2001 primarily due to a decline in the purchases of short-term investments offset by an increase in the purchases of property and equipment.

     We have entered into numerous operating leases for office space throughout the country, including our headquarters, and have annual commitments for total rent payments ranging from $450,000 to $5,386,000 over the next nine years. As a result of the planned third quarter relocation of our San Diego office, we currently have commitments of approximately $1.5 million for capital expenditures, which we expect to incur during the third and fourth quarter of 2002.

     To date, we have grown in part by acquiring other companies, and we may continue to make acquisitions. Our acquisitions may vary in size and could be material to our current operations. We expect to use cash, stock, debt or other means of funding to make these acquisitions.

     During the first six months of 2002, we experienced overall losses combined with positive cash flow from operating activities. For the remainder of 2002, as the Company continues to emerge from a period of rapid product and geographical expansion, we expect continued sequential quarterly growth in revenue, which we believe will generally exceed growth in our cost structure, a large component of which consists of fixed operating costs. As a result, we expect continued reductions in the level of our overall operating losses in 2002 as compared to 2001 and continued cash flow provided by operating activities during 2002.

     Based on current plans, we believe that our available cash combined with positive cash flow provided by operating activities should be sufficient to fund our operations for the next 12 months.

     Although we have experienced losses to date, future profits, to the extent not offset by the benefits of loss carryforwards, would result in income tax liabilities. In addition, we have recorded a valuation allowance for the portion of the deferred tax assets related to tax loss carryforwards.

     We do not believe the impact of inflation has significantly affected our operations.

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Recent Accounting Pronouncements

     In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, “Business Combinations”, and No. 142, “Goodwill and Other Intangible Assets”, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Standards. Other intangible assets will continue to be amortized over their useful lives. We have applied the new rules on accounting for goodwill and intangible assets deemed to have indefinite lives beginning in the first quarter of 2002. During the second quarter of 2002, we completed the initial impairment test of goodwill and indefinite lived intangible assets, which did not indicate an impairment loss. We estimate that the effect of the new rules will be to decrease amortization expense related to goodwill by approximately $3.4 million for the year ending December 31, 2002.

Cautionary Statement Concerning Forward-Looking Statements

     We have made forward-looking statements in this Report that are subject to risks and uncertainties. Forward-looking statements include information that is not purely historic fact, including statements concerning our financial outlook for 2002 and estimates for the future, our possible or assumed future results of operations generally, and other statements and information regarding assumptions about our revenues, earnings per share, capital and other expenditures, operating losses, financing plans, cash flow, capital structure, amortization expense, impairment losses, legal proceedings and claims, future economic performance, operating income, management’s plans, goals and objectives for future operations and growth and markets for stock. The sections of this Report, which contain forward-looking statements, include the Financial Statements and related Notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

     Our forward-looking statements are also identified by words such as “believes,” “expects,” “anticipates,” “intends,” “estimates” or similar expressions. You should understand that these forward-looking statements are necessarily estimates reflecting our judgment, not guarantees of future performance. They are subject to a number of assumptions, risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. You should understand that the following important factors, in addition to those discussed in “Risk Factors,” could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements: successful adoption of our products; competition; general economic conditions; changes or consolidations in the commercial real estate industry; customer retention; development of our sales force; business combinations and strategic alliances by other industry participants; managerial execution; growth in commerce conducted over the Internet; changes in relationships with real estate brokers and other strategic partners; changes in accounting policies or practices; and legal and regulatory issues.

     Accordingly, you should not place undue reliance on forward-looking statements, which speak only as of the date of this Report. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events.

Risk Factors

     Our future profitability is uncertain. To date, we have not recorded an overall operating profit because the investment required for geographic expansion and new services has caused our expenses to exceed our profits. Our ability to earn a profit will largely depend on our ability to manage our growth, and to generate profits that exceed the expenses related to our investment in geographic expansion and new services. In addition, our ability to earn a profit, to increase revenues or to control costs could be affected by the factors set forth below. We may not be able to generate revenues or control expenses sufficient to earn a profit, to maintain profits on a quarterly or annual basis, or to sustain or increase our future revenue growth.

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     Our operating results may fluctuate significantly. Our operating results, revenues and expenses may fluctuate with general economic conditions and also for many other reasons, such as: successful adoption of the Company’s products; competition; loss of clients or revenues; changes or consolidation in the real estate industry; the development of our sales force; managerial execution; cancellations or non-renewals of our products; data quality; employee retention; our investments in geographic expansion; the timing of new service introductions and enhancements; the timing of investing the net proceeds from our offerings; acquisitions of other companies or assets; sales, brand enhancement and marketing promotional activities; client training and support activities; changes in client budgets; our ability to control expenses; or our investments in other corporate resources. In addition, changes in accounting policies or practices may affect our results of operations, including without limitation, changes requiring us to expense stock options.

     We may not be able to attract and retain clients. Our success and revenues depend on attracting and retaining subscribers to our services. The CoStar Property, CoStar Tenant and CoStar COMPS subscription contracts, which generate the largest portion of our revenue, generally range from terms of one to three years. Our clients may decide not to renew or to cancel their agreements as a result of several factors, including: a decision that they have no need for our products; a decision to use alternative products; pricing and budgetary constraints; consolidation in the real estate industry; data quality; technical problems; or economic or competitive pressures. If clients decide not to renew or cancel their agreements, and we do not attract new clients, then our revenues will be adversely affected.

     Our operating costs may be higher than we expect. Many of our expenses, particularly personnel costs and occupancy costs, are relatively fixed. As a result, we may not be able to adjust spending quickly enough to offset any unexpected revenue shortfall or increase in expenses. Additionally, we may experience higher than expected operating costs, including increased personnel costs, selling and marketing costs, occupancy costs, communications costs, travel costs, software development costs, outside services costs and other costs. If operating costs exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be adversely affected.

     Competition could render our services uncompetitive. The market for information systems and services in general is highly competitive and rapidly changing. The barriers to entry for Web-based services and businesses are low, making it possible for the number of competitors to proliferate rapidly. Our existing competitors, or potential new competitors, may have longer operating histories in the Internet market, greater name recognition, larger customer bases, better technology or data, lower prices, easier access to data, greater user traffic or greater financial, technical and marketing resources than we have. Our competitors may be able to undertake more extensive marketing campaigns, obtain more data, adopt more aggressive pricing policies, make more attractive offers to potential employees, subscribers, distribution partners and content providers and may be able to respond more quickly to new or emerging technologies and changes in Internet user requirements. Increased competition could result in lower revenues and higher expenses, which would reduce our profitability.

     Downturns and consolidation in the commercial real estate industry could have an adverse effect on our business. Our business may be affected by conditions in the commercial real estate industry, including conditions affecting businesses that supply or invest in that industry. A decrease in the level of commercial real estate activities could adversely affect demand for our services. The traditional economic downturns in the commercial real estate industry could also harm our business. These changes could decrease new sales and increase cancellation rates, which could have a material adverse impact on our operating results. Also, companies in this industry are consolidating, often in order to reduce expenses. Consolidation could reduce the number of our existing clients, reduce the size of our target market and increase our clients’ bargaining power. Any of these factors could adversely affect our business.

     General economic conditions could have an adverse effect on our business. Our business and the commercial real estate industry are particularly affected by negative trends in the general economy. The success of our business depends on a number of factors relating to general global, national, regional and local economic conditions, including inflation, interest rates, perceived and actual economic conditions, taxation policies, availability of credit, employment levels, and wage and salary levels. Negative trends in any of these general economic conditions could adversely affect our business. For example, a significant increase in inflation could increase our expenses, which may not be offset by increased revenues. In addition, a downturn in the telecommunications industry in 2001 forced many of our telecom company clients to discontinue or curtail their operations, which resulted in an increased number of cancellations of our services. If other clients choose to cancel our services as a result of economic conditions, and we do not acquire new clients, our financial position could be adversely affected.

     If our data is not accurate, comprehensive or reliable, our business could be harmed. Our success depends on our clients’ confidence in the comprehensiveness, accuracy and reliability of the data we provide. The task of establishing and maintaining accurate and reliable data is challenging. If our data is not current, accurate, comprehensive or reliable, we could experience reduced demand for our services or legal claims by our customers, which could result in lower revenues and higher expenses.

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     If we are unable to hire, retain and continue to develop our sales force, it could have a material adverse effect on our business. In order to support revenue growth, we need to continue to develop, train and retain our sales force. Our ability to build and develop a strong sales force may be affected by a number of factors, including: our ability to integrate and motivate sales personnel; our ability to effectively train our sales force; the ability of our sales force to sell an increased number of products; the length of time it takes new sales personnel to become productive; the competition we face from other companies in hiring and retaining sales personnel; and our ability to manage a multi-location sales organization. If we are unable to hire, develop or retain the members of our sales force, or if our sales force is unproductive, it could have a material adverse effect on our revenues and expenses.

     We may not be able to successfully introduce new product or upgraded products. Our future business and financial success will depend on our ability to continue to introduce new products and upgraded products into the marketplace. Developing new products and upgrades to products imposes heavy burdens on our systems development department, product managers, management and researchers. In addition, successfully launching and selling a new product, such as CoStar Office Report, or an upgraded product such as CoStar Web Property, puts pressure on our sales and marketing resources. If we are unable to develop new products or upgrades to our products, then our customers may choose a competitive service over ours and our business may be adversely affected. In addition, if we incur significant costs in developing new products or upgrades to our products, or are not successful in marketing and selling these new products or upgrades, it could have a material adverse effect on our results of operations.

     Our business depends on retaining and attracting highly capable management and operating personnel. Our success depends in large part on our ability to retain and attract management and operating personnel, including our President and Chief Executive Officer, Andrew Florance, our officers and other key employees. Our business requires highly skilled technical, sales, management, Web-development, marketing and research personnel, who are in high demand and are often subject to competing offers. To retain and attract key personnel, we use various measures, including employment agreements, a stock option plan and incentive bonuses for key executive officers. These measures may not be enough to retain and attract the personnel we need or to offset the impact on our business of the loss of the services of Mr. Florance or other key officers or employees.

     We may not be able to adapt to the rapid technological changes to the Internet and Internet products. To be successful, we must adapt to the rapid technological changes to the Internet and Internet products by continually enhancing our products and services, and introducing and integrating new services and products to capitalize on the technological advances in the Internet. This process is costly and we cannot assure you that we will be able to successfully integrate our services and products with the Internet’s technological advances. The products that collect, store, manage and disseminate commercial real estate information from a centralized database on the Internet were developed recently and continue to evolve. Our market is characterized by rapidly changing technologies, evolving industry standards, increasingly sophisticated customer needs and frequent new product introductions. These factors are exacerbated by the rapid technological change experienced in the computer and software industries. Our business increasingly depends on our ability to anticipate and adapt to all of these changes, as well as our customers’ ability to adapt to the use of our existing and future services and products on the Internet. We could incur substantial costs if we need to modify our services or infrastructure in order to adapt to these changes, and our customers’ failure to accept these changes could have a material adverse effect on our revenues. If we incurred significant costs without adequate results or we are unable to adapt to rapid technological changes, it could have a material adverse effect on our business.

     Unsatisfactory Internet performance, interruption or failure could have an adverse effect on our business. Our business increasingly depends upon the satisfactory performance, reliability and availability of our Web site, the Internet and the World Wide Web. Problems with our Web site, the Internet or the Web may impede the development of our business for a number of reasons. As the number of Internet users or their use of Internet resources continues to grow, and as companies deliver increasingly larger amounts of data over the Internet, the Internet’s infrastructure must also grow. Growth in Internet usage that is not matched by comparable growth of the infrastructure supporting the Internet could result in slower response time, cause outright failure of the Internet, or otherwise adversely affect usage. In addition, if we experience technical problems in distributing our products over the Web, including interruption or failure of services provided by our local exchange carriers or Internet service providers, we could experience reduced demand for our products.

     Temporary or permanent outages of our computers, software or telecommunications equipment could have an adverse effect on our business. Our operations depend on our ability to protect our database, computers and software, telecommunications equipment and facilities against damage from potential dangers such as fire, power loss, security breaches and telecommunications failures. Any temporary or permanent loss of one or more of these systems or facilities from an accident, equipment malfunction or some other cause could harm our business. If we experience a failure that results in our not being able to deliver our products to clients, or to update our products, we could experience reduced demand for our products.

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     International expansion may result in new business risks. If we expand internationally, this expansion could subject us to new business risks, including: adapting to the differing business practices and laws in foreign commercial real estate markets; difficulties in managing foreign operations; limited protection for intellectual property rights in some countries; difficulty in collecting accounts receivable and longer collection periods; costs of enforcing contractual obligations; impact of recessions in economies outside the United States; currency exchange rate fluctuations; and potentially adverse tax consequences. In addition, the investment required for international expansion could exceed the profit generated from such expansion, which could adversely affect our financial condition.

     We may be subject to legal liability for displaying or distributing information. Because the content in our database is distributed to others, we may be subject to claims for defamation, negligence or copyright or trademark infringement or claims based on other theories. We could also be subject to claims based upon the content that is accessible from our Web site through links to other Web sites or information on our Web site supplied by third parties. Even if these claims do not result in liability to us, we could incur significant costs in investigating and defending against any claims. Our potential liability for information distributed by us to others could require us to implement measures to reduce our exposure to liability, which may require the expenditure of substantial resources and limit the attractiveness of our service to users.

     We may be unable to enforce or defend our ownership and use of intellectual property. The success of our business depends in large part on the intellectual property involved in our methodologies, database and software. We rely on a combination of trade secret, patent, copyright and other laws, nondisclosure and noncompetition provisions, license agreements and other contractual provisions and technical measures to protect our intellectual property rights. However, current law may not provide for adequate protection of our databases and the actual data. In addition, legal standards relating to the validity, enforceability and scope of protection of proprietary rights in Internet-related businesses are uncertain and evolving, and we cannot assure you of the future viability or value of any of our proprietary rights. Our business could be significantly harmed if we are not able to protect our content and our other intellectual property. The same would be true if a court found that our services infringe other persons’ intellectual property rights. Any intellectual property lawsuits in which we are involved, either as a plaintiff or as a defendant, could cost us a significant amount of time and money. In addition, if any intellectual property claims are adversely determined, this could result in a material adverse result on our financial position and our business.

     Litigation in which we become involved may adversely affect our business. Currently and from time to time, we are involved in litigation incidental to the conduct of our business. We cannot assure you that we will have insurance to cover our pending claims or our future claims. Any lawsuits in which we are involved could cost us a significant amount of time and money. If any pending claims or future claims are adversely determined, they could have a material adverse effect on our financial position or results of operations.

     Problems with our software could impair the use of our services. The software underlying our services is complex and may contain undetected errors. We have previously discovered errors in our proprietary software. Despite testing, we cannot be certain that errors will not be found in current versions, new versions or enhancements of our software. Any errors could result in adverse publicity, impaired use of our services, loss of revenues, cost increases and legal claims by customers. All these factors could seriously damage our business, operating results and financial condition.

     We may not be able to manage successfully our geographic expansion. Our future business and financial success will depend on our ability to manage our geographic expansion. Our efforts to manage expanded growth must occur while information technology is rapidly changing. These efforts impose additional burdens on our research, systems development, sales and general managerial resources. If we were not able to manage our expanded growth successfully, it would have a material adverse effect on our profitability.

     If we are unable to provide our clients with training and customer support, our business could be harmed. It is important that our clients find our products easy to use. To meet these needs, we provide client training and have developed a client support network that seeks to respond to client inquiries as soon as possible. If we do not maintain adequate training and support levels, we could experience reduced demand for our services.

     If there is a reduction in our supply of data from public record providers, our business could be harmed. We license a small portion of our data from public records providers and other data providers to enhance our products and services. If we are unable to enter into licensing agreements with these entities, if this data becomes unavailable for any reason, or if the costs for this data rise, we could experience increased costs and our financial position could be adversely affected.

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     Our increasing use of the Internet and the World Wide Web exposes us to regulatory and other uncertainties. Most of our clients currently receive their CoStar data via the Internet. This exposes us to various uncertainties arising from the future course of development of the Internet and the World Wide Web. Governments in the United States and abroad might adopt laws or regulations applicable to Internet commerce that could harm our business by, for example, regulating our transmissions over the Internet or exposing our business to new taxes in various jurisdictions. User concerns about the privacy and security of Internet-distributed communications might impede the growth of our business. We may need to expend substantial resources to protect against security breaches on our Web site or in our Internet communications.

     We face risks associated with legislation in the real estate industry. Real estate is a regulated industry in the United States. These laws and related regulations, and any newly adopted regulations, may limit or restrict our activities or could require us to expend significant resources to comply. As the real estate industry evolves in the Internet environment, legislators, regulators and industry participants may advocate additional legislative or regulatory initiatives. Should existing laws or regulations be amended or new laws or regulations be adopted, we may need to comply with additional legal requirements and incur resulting costs, or we may be precluded from certain activities. In addition, if we are found to be in violation of these regulations, we may incur penalties and legal costs or we may be precluded from certain activities.

     Our business depends on our management team’s ability to execute our business plan. Our business depends on the ability of our assembled management team to successfully execute our business plan. The inability of our management team to successfully execute our business plan could have an adverse effect on our operations.

     If we do not generate sufficient cash flows from operations, we may need additional capital. To date, we have financed our operations through cash from profitable operations in certain of our regions, the sale of our stock and borrowing money. If we do not generate enough cash from operations to finance our business, including any acquisitions, in the future, we will need to raise additional funds through public or private financing. Selling additional equity securities could dilute the equity interests of our stockholders. If we borrow money, we will have to pay interest and agree to restrictions that may limit our operating flexibility. We may not be able to obtain funds needed to finance our operations at all or may be able to obtain funds only on unattractive terms. If we require additional funds and are not able to obtain such funds, it would have a material adverse effect on our operations.

     Market volatility may have an adverse effect on our stock price. The trading price of our common stock has fluctuated widely in the past, and we expect that it will continue to fluctuate in the future. The price could fluctuate widely based on numerous factors, including: quarter-to-quarter variations in our operating results; changes in analysts’ estimates of our earnings; announcements by us or our competitors of technological innovations or new services; general conditions in the commercial real estate industry; developments or disputes concerning copyrights or proprietary rights; regulatory developments; and economic or other factors. In addition, in recent years, the stock market in general, and the shares of Internet-related and other technology companies in particular, have experienced extreme price fluctuations. This volatility has had a substantial effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of the specific companies.

     Stock ownership by executive officers and directors provides substantial influence over matters requiring a vote of stockholders. Our executive officers and directors, and entities affiliated with them, beneficially own a sufficient number of shares of our outstanding common stock to exercise substantial influence over the election of directors and other matters requiring a vote of stockholders. This concentrated ownership might delay or prevent a change in control and may impede or prevent transactions in which stockholders might otherwise receive a premium for their shares.

ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not have significant exposure to market risks associated with the changes in interest rates related to cash equivalent securities held as of June 30, 2002.

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PART II.      OTHER INFORMATION

ITEM 1 LEGAL PROCEEDINGS

     Currently and from time to time, we are involved in litigation incidental to the conduct of our business. We are not a party to any lawsuit or proceeding that, in the opinion of our management, is likely to have a material adverse effect on our financial position or results of operations.

ITEM 2 CHANGES IN SECURITIES

     In connection with the acquisition of First Image Technologies, Inc. (“First Image”), the Company issued to Joseph J. Klug, the sole shareholder of First Image, 4,712 shares of common stock, par value $.01 per share, on June 7, 2002 in consideration for the completion of one of the earn-out conditions relating to the acquisition of First Image. The shares were issued in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

ITEM 3 DEFAULTS UPON SENIOR SECURITIES

     None

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Annual Meeting of our stockholders was held on June 18, 2002. The following people were elected to our Board of Directors for a one-year term: Michael Klein, Andrew Florance, David Bonderman, Warren Haber, Josiah Low III, and Christopher Nassetta. The vote was as follows:

Name	Votes For	Votes Withheld
Michael Klein Andrew Florance David Bonderman Warren Haber Josiah Low III Christopher Nassetta	14,233,929 14,271,029 13,792,654 14,219,429 14,219,429 14,271,029	294,154 257,054 735,429 308,654 308,654 257,054

     The appointment of Ernst & Young, LLP as our independent public accountants for the fiscal year ending December 31, 2002 was approved upon the following vote: For 14,315,316 shares; against, 212,631 shares; and abstain 136 shares.

     The amendment to our 1998 Stock Incentive Plan, as amended, was approved upon the following vote: For, 13,101,611 shares; against, 1,416,618 shares; and abstain, 9,854 shares.

ITEM 5 OTHER INFORMATION

     None

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ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K

     The Company did not file any reports of Form 8-K during the quarter ended June 30, 2002.

EXHIBIT NUMBER: EXHIBIT DESCRIPTION:

10.1	CoStar Group, Inc. 1998 Stock Incentive Plan, as amended.
10.2	Office Sublease, dated June 14, 2002, between CoStar Realty Information, Inc., CoStar Group, Inc. and Gateway, Inc.
99.1	Certification of Principal Executive Officer pursuant to 18 USC Section 1350.
99.2	Certification of Principal Financial Officer pursuant to 18 USC Section 1350.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	COSTAR GROUP, INC.
Date: August 13, 2002	By: /s/ Frank A. Carchedi
	Frank A. Carchedi
	Chief Financial Officer
	(Principal Financial and Accounting Officer
	and Duly Authorized Officer)

21 EX-10.1 3 w62833exv10w1.htm STOCK INCENTIVE PLAN

EXHIBIT 10.1

COSTAR GROUP, INC.
1998 STOCK INCENTIVE PLAN
(AS LAST AMENDED ON JUNE 18, 2002)

I.    Purpose

         CoStar Group, Inc., a Delaware corporation “CoStar” or the “Company”), wishes to recruit, reward, and retain employees and outside directors. To further these objectives, the Company hereby sets forth the CoStar Group, Inc. 1998 Stock Incentive Plan (the “Plan”) to provide options (“Options”) or direct grants (“Stock Grants” and, together with the Options, “Awards”) to employees and outside directors with respect to shares of the Company’s common stock (the “Common Stock”). The Plan is effective as of the effective date (the “Effective Date”) of the Company’s registration under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”) with respect to its initial public offering (“IPO”).

II.    Participants

         All Employees of CoStar and any Eligible Subsidiaries are eligible for Options and Stock Grants under this Plan, as are the directors of CoStar and the Eligible Subsidiaries who are not employees (“Eligible Directors”). Eligible employees and directors become “optionees” when the Administrator grants them an option under this Plan or “recipients” when they receive a direct grant of Common Stock. (Optionees and recipients are referred to collectively as “participants.” The term participant also includes, where appropriate, a person authorized to exercise an Award in place of the original optionee.) The Administrator may also grant Options or make Stock Grants to certain other service providers.

         Employee means any person employed as a common law employee of the Company or an Eligible Subsidiary.

III.    Administrator

         The Administrator will be the Compensation Committee of the Board of Directors of CoStar (the “Compensation Committee”), unless the Board specifies another committee. The Board may also act under the Plan as though it were the Compensation Committee.

         The Administrator is responsible for the general operation and administration of the Plan and for carrying out its provisions and has full discretion in interpreting and administering the provisions of the Plan. Subject to the express provisions of the Plan, the Administrator may exercise such powers and authority of the Board as the Administrator may find necessary or appropriate to carry out its functions. The Administrator may delegate its functions (other than those described in the Granting of Awards section) to officers or employees of CoStar.

         The Administrator’s powers will include, but not be limited to, the power to amend, waive, or extend any provision or limitation of any Award. The Administrator may act through meetings of a majority of its members or by unanimous consent.

IV.     Granting of Awards

         Subject to the terms of the Plan, the Administrator will, in its sole discretion, determine:

(a)	the participants who receive Awards,
(b)	the terms of such Awards,
(c)	the schedule for exercisability or nonforfeitability (including any requirements that the participant or the Company satisfy performance criteria),
(d)	the time and conditions for expiration of the Award, and
(e)	the form of payment due upon exercise, if any.

         The Administrator’s determinations under the Plan need not be uniform and need not consider whether possible participants are similarly situated.

         Options granted to employees may be nonqualified stock options (“NQSOs”) or “incentive stock options” (“ISOs”) within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended from time to time (the “Code”), or the corresponding provision of any subsequently enacted tax statute. Options granted to Eligible Directors must be NQSOs. The Administrator will not grant ISOs unless the stockholders have approved the Plan.

         The Administrator may impose such conditions on or charge such price for the Stock Grants as it deems appropriate.

         Substitutions.   The Administrator may also grant Awards in substitution for options or other equity interests held by individuals (i) as a result of their employment by or services to Realty Information Group, L.P. or (ii) who become Employees of the Company or of an Eligible Subsidiary as a result of the Company’s acquiring or merging with the individual’s employer or acquiring its assets. If necessary to conform the Awards to the interests for which they are substitutes, the Administrator may grant substitute Awards under terms and conditions that vary from those the Plan otherwise requires.

V.     Director Automatic Option Grants

         At the first meeting of the Board of Directors following each annual meeting of stockholders, the Chairman of the Board of Directors and each non-employee director serving on the Board of Directors shall receive an annual automatic grant of options to purchase 5,000 shares of Common Stock of the Company. These options shall have an exercise price equal to the Fair Market Value (as defined below) of the Common Stock on the date of grant, and one-fourth of the options will vest and become exercisable on each anniversary of the date of grant, as long as such director is still serving on the Company’s Board of Directors on such vesting date.

         In addition, at the first meeting of the Board of Directors following each annual meeting of stockholders, the Chairman of each Board committee of the Company shall receive an annual automatic grant of options to purchase 1,000 shares of Common Stock of the Company. These options shall have an exercise price equal to the Fair Market Value of the Common Stock on the date of grant, and one-fourth of the options will vest and become exercisable on each anniversary of the date of grant, as long as such director is still serving on the Company’s Board of Directors on such vesting date.

VI.     Date of Grant

         The Date of Grant will be the date as of which this Plan or the Administrator grants an Award to a participant, as specified in the Plan or in the Administrator’s minutes.

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VII.    Exercise Price

         The Exercise Price is the value of the consideration that a participant must provide in exchange for one share of Common Stock. The Administrator will determine the Exercise Price under each Award and may set the Exercise Price without regard to the Exercise Price of any other Awards granted at the same or any other time. The Company may use the consideration it receives from the participant for general corporate purposes.

         The Exercise Price per share for NQSOs may not be less than 100% of the Fair Market Value of a share on the Date of Grant. If an Option is intended to be an ISO, the Exercise Price per share may not be less than 100% of the Fair Market Value (on the Date of Grant) of a share of Common Stock covered by the Option; provided, however, that if the Administrator decides to grant an ISO to someone covered by Sections 422(b)(6) and 424(d) (as a more-than-10%-stock-owner), the Exercise Price of the Option must be at least 110% of the Fair Market Value (on the Date of Grant).

         The Administrator may satisfy any state law requirements regarding adequate consideration for Stock Grants by (i) issuing Common Stock held as treasury stock or (ii) charging the recipients at least the par value for the shares covered by the Stock Grant. The Administrator may designate that a recipient may satisfy (ii) either by direct payments or by the Administrator’s withholding from other payments due to the recipient.

         Fair Market Value. Fair Market Value of a share of Common Stock for purposes of the Plan will be determined as follows:

         (a)   if the Common Stock is traded on a national securities exchange, the closing sale price on that date;

         (b)   if the Common Stock is not traded on any such exchange, the closing sale price as reported by the National Association of Securities Dealers, Inc. Automated Quotation System (“Nasdaq”) for such date;

         (c)   if no such closing sale price information is available, the average of the closing bid and asked prices as reported by Nasdaq for such date; or

         (d)   if there are no such closing bid and asked prices, the average of the closing bid and asked prices as reported by any other commercial service for such date.

         For any date that is not a trading day, the Fair Market Value of a share of Common Stock for such date shall be determined by using the closing sale price or the average of the closing bid and asked prices, as appropriate, for the immediately preceding trading day.

         The Fair Market Value will be deemed equal to the IPO price for any Options granted as of the date on which the IPO’s underwriters price the IPO.

VIII.    Exercisability

         The Administrator will determine the times and conditions for exercise of or purchase under each Award but may not extend the period for exercise beyond the tenth anniversary of its Date of Grant (or five years for ISOs granted to 10% owners covered by Code Sections 422(b)(6) and 424(d)).

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         Awards will become exercisable at such times and in such manner as the Administrator determines and the Award Agreement, if any, indicates; provided, however, that the Administrator may, on such terms and conditions as it determines appropriate, accelerate the time at which the participant may exercise any portion of an Award or at which restrictions on Stock Grants lapse. For Stock Grants, “exercise” refers to acceptance of the Award or lapse of restrictions, as appropriate in context.

         If the Administrator does not specify otherwise, Options will become exercisable and restrictions on Stock Grants (other than the Director Formula Grants) will lapse as to one-third of the covered shares on each of the first, second, and third anniversaries of the Date of Grant.

         No portion of an Award that is unexercisable at a participant’s termination of employment will thereafter become exercisable, unless the Award Agreement provides otherwise, either initially or by amendment.

         Change of Control. Upon a Change of Control (as defined below), all Options held by current Employees and directors will become fully exercisable and all restrictions on Stock Grants will lapse. A Change of Control for this purpose means the occurrence, after the Company’s IPO, of any one or more of the following events:

         (a)      a person, entity, or group (other than the Company, any Company subsidiary, any Company benefit plan, or any underwriter temporarily holding securities for an offering of such securities) acquires ownership of more than 80% of the undiluted total voting power of the Company’s then-outstanding securities eligible to vote to elect members of the Board (“Company Voting Securities”);

         (b)      consummation of a merger or consolidation of the Company into any other entity — unless the holders of the Company Voting Securities outstanding immediately before such consummation, together with any trustee or other fiduciary holding securities under a Company benefit plan, hold securities that represent immediately after such merger or consolidation at least 20% of the combined voting power of the then outstanding voting securities of either the Company or the other surviving entity or its parent; or

         (c)      the stockholders of the Company approve (i) a plan of complete liquidation or dissolution of the Company or (ii) an agreement for the Company’s sale or disposition of all or substantially all the Company’s assets, and such liquidation, dissolution, sale, or disposition is consummated.

         Even if other tests are met, a Change of Control has not occurred under any circumstance in which the Company files for bankruptcy protection or is reorganized following a bankruptcy filing.

         The Adjustment Upon Changes in Capital Stock provisions will also apply if the Change of Control is a Substantial Corporate Change (as defined in those provisions).

IX.     Limitation on ISOs

         An Option granted to an employee will be an ISO only to the extent that the aggregate Fair Market Value (determined at the Date of Grant) of the stock with respect to which ISOs are exercisable for the first time by the optionee during any calendar year (under the Plan and all other plans of the Company and its subsidiary corporations, within the meaning of Code Section 422(d)), does not exceed $100,000. This

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limitation will be applied by taking Options into account in the order in which such Options were granted. If, by design or operation, the Option exceeds this limit, the excess will be treated as an NQSO.

X.     Method of Exercise

         To exercise any exercisable portion of an Award, the participant must:

         (a)      Deliver a written notice of exercise to the Secretary of the Company (or to whomever the Administrator designates), in a form complying with any rules the Administrator may issue, signed by the participant, and specifying the number of shares of Common Stock underlying the portion of the Award the participant is exercising;

         (b)      Pay the full Exercise Price, if any, by cashier’s or certified check for the shares of Common Stock with respect to which the Award is being exercised, unless the Administrator consents to another form of payment (which could include the use of Common Stock); and

         (c)      Deliver to the Administrator such representations and documents as the Administrator, in its sole discretion, may consider necessary or advisable.

         Payment in full of the Exercise Price need not accompany the written notice of exercise provided the notice directs that the stock certificates for the shares issued upon the exercise be delivered to a licensed broker acceptable to the Company as the agent for the individual exercising the option and at the time of closing of the sale of the Common Stock issued upon exercise of the Option, the broker will tender to the Company cash or cash equivalents acceptable to the Company and equal to the Exercise Price.

         If the Administrator agrees to payment through the tender to the Company of shares of Common Stock, the individual must have held the stock being tendered for at least six months at the time of surrender. Shares of stock offered as payment will be valued, for purposes of determining the extent to which the participant has paid the Exercise Price, at their Fair Market Value on the date of exercise. The Administrator may also, in its discretion, accept attestation of ownership of Common Stock and issue a net number of shares upon Option exercise.

XI.    Award Expiration

         No one may exercise an Award more than ten years after its Date of Grant (or five years, for an ISO granted to a more-than-10% shareholder). Unless the Award Agreement provides otherwise, either initially or by amendment, no one may exercise an Award after the first to occur of:

         Employment Termination. The 90th day after the date of termination of employment (other than for death or Disability), where termination of employment means the time when the employer-employee or other service-providing relationship between the employee and the Company ends for any reason, including retirement. Unless the Award Agreement provides otherwise, termination of employment does not include instances in which the Company immediately rehires a common law employee as an independent contractor. The Administrator, in its sole discretion, will determine all questions of whether particular terminations or leaves of absence are terminations of employment;

         Disability. For disability, the earlier of (i) the first anniversary of the participant’s termination of employment for disability and (ii) thirty (30) days after the participant no longer has a disability, where

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“disability” means the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than twelve months; or

Death.    The date twelve months after the participant’s death.

         If exercise is permitted after termination of employment, the Award will nevertheless expire as of the date that the former service provider violates any covenant not to compete in effect between the Company and the former employee. In addition, an optionee who exercises an Option more than 90 days after termination of employment with the Company and/or the Eligible Subsidiaries will only receive ISO treatment to the extent permitted by law, and becoming or remaining an employee of another related company (that is not an Eligible Subsidiary) or an independent contractor to the Company will not prevent loss of ISO status as a result of the formal termination of employment.

         Nothing in this Plan extends the term of an Award beyond the tenth anniversary of its Date of Grant, nor does anything in this Award Expiration section make an Award exercisable that has not otherwise become exercisable.

XII.    Award Agreement

         Option Agreements will set forth the terms of each Option and will include such terms and conditions, consistent with the Plan, as the Administrator may determine are necessary or advisable. To the extent the agreement is inconsistent with the Plan, the Plan will govern. The Option Agreements may contain special rules. The Administrator may, but is not required to, issue agreements for Stock Grants.

XIII.    Stock Subject to Plan

         Except as adjusted below under Corporate Changes, the aggregate number of shares of Common Stock that may be issued under the Awards (whether ISOs, NQSOs, or Stock Grants) may not exceed 3,750,000 shares and the maximum number of shares that may be granted under Awards for a single individual in a calendar year may not exceed 400,000 shares. (The individual maximum applies only to Awards first made under this Plan and not to Awards made in substitution of a prior employer’s options or other incentives, except as Code Section 162(m) otherwise requires.) The Common Stock will come from either authorized but unissued shares or from previously issued shares that the Company reacquires, including shares it purchases on the open market. If any Award expires, is canceled, or terminates for any other reason, the shares of Common Stock available under that Award will again be available for the granting of new Awards (but will be counted against that calendar year’s limit for a given individual).

         No adjustment will be made for a dividend or other right for which the record date precedes the date of exercise.

         The participant will have no rights of a stockholder with respect to the shares of stock subject to an Award except to the extent that the Company has issued certificates for, or otherwise confirmed ownership of, such shares upon the exercise of the Award.

         The Company will not issue fractional shares pursuant to the exercise of an Award, but the Administrator may, in its discretion, direct the Company to make a cash payment in lieu of fractional shares.

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XIV.    Person Who May Exercise

         During the participant’s lifetime, only the participant or his duly appointed guardian or personal representative may exercise the Awards. After his death, his personal representative or any other person authorized under a will or under the laws of descent and distribution may exercise any then exercisable portion of an Award. If someone other than the original recipient seeks to exercise any portion of an Award, the Administrator may request such proof as it may consider necessary or appropriate of the person’s right to exercise the Award.

XV.    Adjustments upon Changes in Capital Stock

         Subject to any required action by the Company (which it shall promptly take) or its stockholders, and subject to the provisions of applicable corporate law, if, after the Date of Grant of an Award:

         (a)      the outstanding shares of Common Stock increase or decrease or change into or are exchanged for a different number or kind of security by reason of any recapitalization, reclassification, stock split, reverse stock split, combination of shares, exchange of shares, stock dividend, or other distribution payable in capital stock, or

         (b)      some other increase or decrease in such Common Stock occurs without the Company’s receiving consideration,

         the Administrator may make a proportionate and appropriate adjustment in the number of shares of Common Stock underlying each Award, so that the proportionate interest of the participant immediately following such event will, to the extent practicable, be the same as immediately before such event. (This adjustment does not apply to Common Stock that the optionee has already purchased nor to Stock Grants that are already nonforfeitable, except to the extent of similar treatment for all stockholders.) Unless the Administrator determines another method would be appropriate, any such adjustment to an Award will not change the total price with respect to shares of Common Stock underlying the unexercised portion of the Award but will include a corresponding proportionate adjustment in the Award’s Exercise Price.

         The Administrator will make a commensurate change to the maximum number and kind of shares provided in the Stock Subject to Plan section.

         Any issue by the Company of any class of preferred stock, or securities convertible into shares of common or preferred stock of any class, will not affect, and no adjustment by reason thereof will be made with respect to, the number of shares of Common Stock subject to any Award or the Exercise Price except as this Adjustments section specifically provides. The grant of an Award under the Plan will not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, or to merge or to consolidate, or to dissolve, liquidate, sell, or transfer all or any part of its business or assets.

         Substantial Corporate Change. Upon a Substantial Corporate Change, the Plan and any unexercised Awards will terminate unless provision is made in writing in connection with such transaction for:

         (a)     the assumption or continuation of outstanding Awards, or

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         (b)     the substitution for such options or grants of any options or grants covering the stock or securities of a successor employer corporation, or a parent or subsidiary of such successor, with appropriate adjustments as to the number and kind of shares of stock and prices, in which event the Awards will continue in the manner and under the terms so provided.

         Unless the Board determines otherwise, if an Award would otherwise terminate pursuant to the preceding sentence, participants who are then Employees or directors of the Company will have the right, at such time before the consummation of the transaction causing such termination as the Board reasonably designates, to exercise any unexercised portions of the Award, whether or not they had previously become exercisable. However, unless the Board determines otherwise, the acceleration will not occur if it would render unavailable “pooling of interest” accounting for any reorganization, merger, or consolidation of the Company.

A Substantial Corporate Change means the:

         (a)      dissolution or liquidation of the Company,

         (b)      merger, consolidation, or reorganization of the Company with one or more corporations in which the Company is not the surviving corporation,

         (c)      the sale of substantially all of the assets of the Company to another corporation, or

         (d)      any transaction (including a merger or reorganization in which the Company survives) approved by the Board that results in any person or entity (other than any affiliate of the Company as defined in Rule 144(a)(1) under the Securities Act) owning 100% of the combined voting power of all classes of stock of the Company.

XVI.    Subsidiary Employees

         Employees of Company Subsidiaries will be entitled to participate in the Plan, except as otherwise designated by the Board of Directors or the Committee.

         Eligible Subsidiary means each of the Company’s Subsidiaries, except as the Board otherwise specifies. For ISO grants, Subsidiary means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company if, at the time an ISO is granted to a Participant under the Plan, each of the corporations (other than the last corporation in the unbroken chain) owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. For NQSOs, the Board or the Committee can use a different definition of Subsidiary in its discretion.

XVII.    Legal Compliance

         The Company will not issue any shares of Common Stock under an Award until all applicable requirements imposed by Federal and state securities and other laws, rules, and regulations, and by any applicable regulatory agencies or stock exchanges, have been fully met. To that end, the Company may require the participant to take any reasonable action to comply with such requirements before issuing such shares. No provision in the Plan or action taken under it authorizes any action that is otherwise prohibited by Federal or state laws.

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         The Plan is intended to conform to the extent necessary with all provisions of the Securities Act of 1933 (“Securities Act”) and the Exchange Act and all regulations and rules the Securities and Exchange Commission issues under those laws. Notwithstanding anything in the Plan to the contrary, the Administrator must administer the Plan, and Awards may be granted and exercised, only in a way that conforms to such laws, rules, and regulations. To the extent permitted by applicable law, the Plan and any Awards will be deemed amended to the extent necessary to conform to such laws, rules, and regulations.

XVIII.    Purchase for Investment and Other Restrictions

         Unless a registration statement under the Securities Act covers the shares of Common Stock a participant receives upon exercise of his Award, the Administrator may require, at the time of such exercise or receipt of a grant, that the participant agree in writing to acquire such shares for investment and not for public resale or distribution, unless and until the shares subject to the Award are registered under the Securities Act. Unless the shares are registered under the Securities Act, the participant must acknowledge:

(a)	that the shares purchased on exercise of the Award are not so registered, and
(b)	that the participant may not sell or otherwise transfer the shares unless:

(1)	the shares have been registered under the Securities Act in connection with the sale or transfer thereof, or
(2)	counsel satisfactory to the Company has issued an opinion satisfactory to the Company that the sale or other transfer of such shares is exempt from registration under the Securities Act, and
(3)	such sale or transfer complies with all other applicable laws, rules, and regulations, including all applicable Federal and state securities laws, rules, and regulations.

         Additionally, the Common Stock, when issued upon the exercise of an Award, will be subject to any other transfer restrictions, rights of first refusal, and rights of repurchase set forth in or incorporated by reference into other applicable documents, including the Company’s articles or certificate of incorporation, by-laws, or generally applicable stockholders’ agreements.

         The Administrator may, in its sole discretion, take whatever additional actions it deems appropriate to comply with such restrictions and applicable laws, including placing legends on certificates and issuing stop-transfer orders to transfer agents and registrars.

XIX.    Tax Withholding

         The participant must satisfy all applicable Federal, state, and local income and employment tax withholding requirements before the Company will deliver stock certificates upon the exercise of an Award. The Company may decide to satisfy the withholding obligations through additional withholding on salary or wages. If the Company does not or cannot withhold from other compensation, the participant must pay the Company, with a cashier’s check or certified check, the full amounts required by withholding. Payment of withholding obligations is due before the Company issues shares with respect to the Award. If the Committee so determines, the participant may instead satisfy the withholding obligations by directing the Company to

9

retain shares from the Award exercise, by tendering previously owned shares, or by attesting to his ownership of shares (with the distribution of net shares).

XX.     Transfers, Assignments and Pledges

         Unless the Administrator otherwise approves in advance in writing, an Award may not be assigned, pledged, or otherwise transferred in any way, whether by operation of law or otherwise or through any legal or equitable proceedings (including bankruptcy), by the participant to any person, except by will or by operation of applicable laws of descent and distribution. If Rule 16b-3 then applies to an Award, the participant may not transfer or pledge shares of Common Stock acquired under a Stock Grant or upon exercise of an Option until at least six (6) months have elapsed from (but excluding) the Date of Grant, unless the Administrator approves otherwise in advance in writing.

XXI.    Amendment or Termination of Plan and Options

         The Board may amend, suspend, or terminate the Plan at any time, without the consent of the participants or their beneficiaries; provided, however, that no amendment will deprive any participant or beneficiary of any previously declared Award. Except as required by law or by the Corporate Changes section, the Administrator may not, without the participant’s or beneficiary’s consent, modify the terms and conditions of an Award so as to adversely affect the participant. No amendment, suspension, or termination of the Plan will, without the participant’s or beneficiary’s consent, terminate or adversely affect any right or obligations under any outstanding Awards.

XXII.    Privileges of Stock Ownership

         No participant and no beneficiary or other person claiming under or through such participant will have any right, title, or interest in or to any shares of Common Stock allocated or reserved under the Plan or subject to any Award except as to such shares of Common Stock, if any, that have been issued to such participant.

XXIII.    Effect on Other Plans

         Whether exercising or receiving an Award causes the participant to accrue or receive additional benefits under any pension or other plan is governed solely by the terms of such other plan.

XXIV.    Limitations on Liability

         Notwithstanding any other provisions of the Plan, no individual acting as a director, employee, or agent of the Company shall be liable to any participant, former participant, spouse, beneficiary, or any other person for any claim, loss, liability, or expense incurred in connection with the Plan, nor shall such individual be personally liable because of any contract or other instrument he executes in such other capacity. The Company will indemnify and hold harmless each director, employee, or agent of the Company to whom any duty or power relating to the administration or interpretation of the Plan has been or will be delegated, against any cost or expense (including attorneys’ fees) or liability (including any sum paid in settlement of a claim with the Board’s approval) arising out of any act or omission to act concerning this Plan unless arising out of such person’s own fraud or bad faith.

XXV.    No Employment Contract

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         Nothing contained in this Plan constitutes an employment contract between the Company and the participants. The Plan does not give any participant any right to be retained in the Company’s employ, nor does it enlarge or diminish the Company’s right to terminate the participant’s employment.

XXVI.    Applicable Law

         The laws of the State of Delaware (other than its choice of law provisions) govern this Plan and its interpretation.

XXVII.    Duration of Plan

         Unless the Board extends the Plan’s term, the Administrator may not grant Awards after May 8, 2008. The Plan will then terminate but will continue to govern unexercised and unexpired Awards.

11 EX-10.2 4 w62833exv10w2.htm OFFICE SUBLEASE

EXHIBIT 10.2

SUBLEASE

         THIS SUBLEASE (this “Sublease”) is made and entered into as of the 14th day of June, 2002, by and between GATEWAY, INC., a Delaware corporation (hereinafter called “Sublandlord”), as sublandlord, and COSTAR REALTY INFORMATION, INC., a Delaware corporation (hereinafter called “CRII”), and COSTAR GROUP, INC., a Delaware corporation (hereinafter called “CGI”; CRII and CGI are hereinafter collectively called “Subtenant”), jointly and severally, as subtenant.

W I T N E S S E T H:

         WHEREAS, by that certain Amended and Restated Lease dated as of April 15, 1999 (the “Original Lease”), as amended by that certain First Amendment to Amended and Restated Lease Agreement dated as of April 17, 2000 (the “First Amendment”; the Original Lease and the First Amendment are hereinafter collectively referred to with all amendments and agreements regarding same as the “Prime Lease”), a copy of which Prime Lease is attached hereto as Exhibit “A” and by this reference made a part hereof, Carramerica Development, Inc., a Delaware corporation (hereinafter, together with its successors and assigns, called “Landlord”), leased to Sublandlord the entirety of a building located at 4535 Towne Centre Court in San Diego, California containing approximately 41,551 gross rentable square feet (the “Premises” and sometimes also referred to herein as the “Building”); and

         WHEREAS, subject to the consent of Landlord, Subtenant desires to sublease from Sublandlord, and Sublandlord desires to sublease to Subtenant, the Premises, all upon the terms and subject to the conditions and provisions hereinafter set forth;

         NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and promises contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby mutually acknowledged, Sublandlord and Subtenant hereby agree as follows:

         1.     Demise; Use. Sublandlord hereby leases to Subtenant and Subtenant hereby leases from Sublandlord the Premises for the term and rental and upon the other terms and conditions hereinafter set forth, to be used and occupied by Subtenant solely for the purpose of general office purposes and for no other purpose.

         2.     Term. The term of this Sublease shall commence (the “Commencement Date”) on September 1, 2002 and, unless sooner terminated pursuant to the provisions hereof, shall terminate on the earlier of August 31, 2007 and the prior termination of the term of the Prime Lease. As used herein, the phrase “Lease Year” shall mean the twelve calendar month period commencing on the Rent Commencement Date (as hereinafter defined)(or, if the Rent Commencement Date is not the first day of a calendar month, then commencing on the first day of the calendar month during which the Rent Commencement Date occurs) and each anniversary thereof, except that (a) the last Lease Year may not be twelve calendar months and shall terminate on the last day of the term of this Sublease, and (b) the first Lease Year shall

include that period of time from the Commencement Date to and including the Rent Commencement Date. Notwithstanding the foregoing, solely for purposes of performing certain improvements, alterations and/or additions to the Premises, Subtenant shall be permitted access to the Premises following Landlord’s consent to this Sublease but prior to the Commencement Date (which Sublandlord and Subtenant anticipate as of the time of the full execution of this Sublease shall be on or about the date upon which this Sublease is fully executed and Landlord’s consent hereto is obtained); provided, however, (1) in no event shall the foregoing be deemed to be Sublandlord’s consent to any such alterations, additions and/or improvements, which such alterations, additions and/or improvements shall be performed in strict accordance with the terms and provisions of this Sublease, (2) in the event that Subtenant occupies any portion of the Premises for the conduct of its business operations therein prior to the Commencement Date, then the Commencement Date shall be deemed to have occurred on the date upon which Subtenant commenced the conduct of its business from the Premises, notwithstanding that the conditions set forth above for the occurrence of the Commencement Date have not been met, and (3) although Subtenant shall not be obligated to pay any Minimum Rent during such pre-term occupancy, Subtenant shall be responsible to comply with all of the other terms and conditions of this Sublease with respect to such pre-term occupancy, including, without limitation, the obligation to pay for any and all additional costs (including pass-throughs from the Prime Lease) and all utilities provided to the Premises during such period of time.

3. Base Rent.

         (a) Commencing on the Rent Commencement Date, Subtenant shall pay to Sublandlord base annual rental (hereinafter called “Minimum Rent”) for the Premises as follows:

	Annual Minimum
	Rent Rate Per		Annual Minimum Rent
	Rentable Square		(based on 41,551		Monthly
Time Period	Foot		Rentable Square Feet)		Installments
1st Lease Year	$	20.64	$	857,612.64	$	71,467.72
2nd Lease Year	$	21.26	$	883,374.26	$	73,614.52
3rd Lease Year	$	21.90	$	909,966.90	$	75,830.58
4th Lease Year	$	22.55	$	936,975.05	$	78,081.25
5th Lease Year	$	23.23	$	965,229.73	$	80,435.81

Annual Minimum Rent shall be due and payable in twelve equal installments. Each such installment shall be due and payable in advance on the fifth day prior to the first day of each calendar month of the term hereof. If the term of this Sublease commences on a day other than the first day of a month or ends on a day other than the last day of a month, Minimum Rent for such month shall be prorated; prorated Minimum Rent for any such

2

partial first month of the term hereof shall be paid on the date on which the term commences. Notwithstanding anything in this Sublease to the contrary, Subtenant shall pay to Sublandlord the first monthly installment of Minimum Rent due under this Sublease upon the execution and delivery of this Sublease by Subtenant to Sublandlord.

         (b) All Minimum Rent and additional rent shall be paid without setoff or deduction whatsoever and shall be paid to Sublandlord at its office at the following address: Real Estate Administration, Gateway, Inc., 610 Gateway Drive Y91, North Sioux City, South Dakota 97049 or at such other place as Sublandlord may designate by notice to Subtenant.

         (c) Sublandlord and Subtenant acknowledge and agree that so long as Subtenant is not then in default under this Sublease, Subtenant shall be entitled to an abatement of the Minimum Rent due and owing under this Sublease for the first sixty (60) days of the term of this Sublease following the Commencement Date (the expiration of such sixty (60) day period is hereinafter referred to as the “Rent Commencement Date”); provided, however, during such abatement period, Subtenant shall remain responsible to pay under this Sublease any and all amounts due and owing for additional rent due hereunder (including all pass-throughs from the Prime Lease) and all utilities provided to the Premises.

4. Additional Rent; Payments; Interest.

         (a) Except for “Base Rent” (as such term is defined in the Prime Lease and for the payment of which Subtenant shall have no obligation under this Sublease), Subtenant shall also pay to Sublandlord all other amounts payable by Sublandlord under the Prime Lease which are attributable to the Premises or attributable to Subtenant, its agents, employees, customers or invitees, including without limitation, the Operating Cost Share Rent, the Tax Share Rent, the Parking Rent, if any, and the Additional Rent (as such terms are defined in the Prime Lease). By way of example and not by way of limitation, charges by Landlord for furnishing air conditioning or heating to the Premises at times in addition to those certain times specified in the Prime Lease, costs incurred by Landlord in repairing damage to the Building caused by an employee of Subtenant, increased insurance premiums due as a result of Subtenant’s use of the Premises, and amounts expended or incurred by Landlord on account of any default by Subtenant which gives rise to a default under the Prime Lease would be amounts payable by Subtenant pursuant to this Subsection 4(a).

         (b) Each amount due to Sublandlord pursuant to Subsection 4(a) above and each other amount payable by Subtenant hereunder, unless a date for payment of such amount is provided for elsewhere in this Sublease, shall be due and payable on the fifth day following the date on which Landlord or Sublandlord has given notice to Subtenant of the amount thereof, but in no event later than the date on which any such amount is due and payable under the Prime Lease.

         (c) All amounts other than Minimum Rent payable to Sublandlord under this

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Sublease shall be deemed to be additional rent due under this Sublease. All past due installments of Minimum Rent and additional rent shall bear interest from the date due until paid at the rate per annum equal to five percent (5%) in excess of the Prime Rate (as hereinafter defined) in effect from time to time, which rate shall change from time to time as of the effective date of each change in the Prime Rate, unless a lesser rate shall then be the maximum rate permissible by law with respect thereto, in which event said lesser rate shall be charged. For the purposes of this Sublease, the term “Prime Rate” shall mean the rate of interest announced from time to time by Bank One, N.A. as its prime or corporate base rate.

         (d) Subtenant shall pay Landlord on the due dates for services requested by Subtenant which are billed by Landlord directly to Subtenant rather than Sublandlord.

         (e) In addition to the Minimum Rent payable pursuant to Section 3 above, from and after the Commencement Date, for each calendar year of the term, Subtenant, as additional rent, shall pay Subtenant’s Percentage Share (which Sublandlord and Subtenant acknowledge and agree is equal to 100%) of Operating Cost Share Rent, Tax Share Rent, Parking Rent, if any, and Additional Rent payable by Sublandlord for the then current calendar year. Sublandlord shall give Subtenant written notice of Sublandlord’s estimate of the amount of additional rent per month payable pursuant to this Subsection for each calendar year following Sublandlord’s receipt of Landlord’s estimate of such amounts payable under the Prime Lease. Thereafter, the additional rent payable pursuant to this Subsection shall be determined and adjusted in accordance with the provisions below.

         (f) The determination and adjustment of additional rent contemplated under Subsection 4(e) above shall be made in accordance with the following procedures:

         (1) Upon receipt of a statement from Landlord specifying the estimated Operating Cost Share Rent, Tax Share Rent, Parking Rent, if any, and Additional Rent to be charged to Sublandlord under the Prime Lease with respect to each calendar year, or as soon after receipt of such statement as practicable, Sublandlord shall give Subtenant written notice of its estimate of additional rent payable under Subsection 4(e) for the ensuing calendar year, which estimate shall be prepared based on the estimate received from Landlord (as Landlord’s estimate may change from time to time), together with a copy of the statement received from Landlord. Sublandlord’s estimate of additional rent to be paid by Subtenant pursuant to this Sublease shall not exceed Subtenant’s Percentage Share of Landlord’s estimate delivered to Sublandlord pursuant to the Prime Lease (as Landlord’s estimate may change from time to time). On or before the first day of each month during each calendar year, Subtenant shall pay to Sublandlord as additional rent one-twelfth (1/12th) of such estimated amount together with the Minimum Rent.

         (2) In the event Sublandlord’s notice set forth in Subsection 4(f)(1) is not given in December of the calendar year preceding the calendar year for which Sublandlord’s notice is applicable, as the case may be, then until the

4

calendar month after such notice is delivered by Sublandlord, Subtenant shall continue to pay to Sublandlord monthly, during the ensuing calendar year, estimated payments equal to the amounts payable hereunder during the calendar year just ended. Upon receipt of any such post-December notice Subtenant shall (i) commence as of the immediately following calendar month, and continue for the remainder of the calendar year, to pay to Sublandlord monthly such new estimated payments and (ii) if the monthly installment of the new estimate of such additional rent is greater than the monthly installment of the estimate for the previous calendar year, pay to Sublandlord within thirty (30) days of the receipt of such notice an amount equal to the difference of such monthly installment multiplied by the number of full and partial calendar months of such year preceding the delivery of such notice.

         (3) Within thirty (30) days after the receipt by Sublandlord of a final statement of such costs from Landlord with respect to each calendar year, Sublandlord shall deliver to Subtenant a statement of the adjustment to be made pursuant to Section 4(f) hereof for the calendar year just ended, together with a copy of the statement received by Sublandlord from Landlord. If on the basis of such statement Subtenant owes an amount that is less than the estimated payments for the calendar year just ended previously paid by Subtenant, Sublandlord shall credit such excess to the next payments of rent coming due or, if the term of this Sublease is about to expire, so long as Subtenant is not in default under this Sublease, promptly refund such excess to Subtenant. If on the basis of such statement Subtenant owes an amount that is more than the estimated payments for the calendar year just ended previously made by Subtenant, Subtenant shall pay the deficiency to Sublandlord within thirty (30) days after delivery of the statement from Sublandlord to Subtenant.

         (4) For partial calendar years during the term of this Sublease, the amount of additional rent payable pursuant to Subsection 4(f) that is applicable to that partial calendar year shall be prorated based on the ratio of the number of days of such partial calendar year falling during the term of this Sublease to 365. The expiration or earlier termination of this Sublease shall not affect the obligations of Sublandlord and Subtenant pursuant to this Section 4, and such obligations shall survive and remain to be performed after any expiration or earlier termination of this Sublease.

5. Condition of Premises and Construction of Improvements.

         Subtenant hereby acknowledges and agrees that it is to demise the Premises in an “as-is” condition and Subtenant’s taking possession of the Premises shall be conclusive evidence as against Subtenant that the Premises were in good order and satisfactory condition when Subtenant took possession. No promise of Sublandlord to alter, remodel or improve the Premises, and no representation respecting the condition of the Premises have been made by Sublandlord to Subtenant. Upon the expiration of the term hereof, or upon any earlier termination of the term hereof or of Subtenant’s right to possession, Subtenant shall surrender the Premises in at least as good condition as at the

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commencement of the term of this Sublease, ordinary wear and tear excepted.

6. The Prime Lease.

         (a) This Sublease and all rights of Subtenant hereunder and with respect to the Premises are subject to the terms, conditions and provisions of the Prime Lease. Subtenant hereby assumes and agrees to perform faithfully and be bound by, with respect to the Premises, all of Sublandlord’s obligations, covenants, agreements and liabilities under the Prime Lease and all terms, conditions, provisions and restrictions contained in the Prime Lease except:

         (i) for the payment of “Base Rent” (as such term is defined in the Prime Lease);

         (ii) that Subtenant shall not have any obligations to construct or install tenant improvements except as may be provided herein; and

         (iii) that the following provisions of the Prime Lease do not apply to this Sublease: any provisions in the Prime Lease allowing or purporting to allow Sublandlord any rent concessions or abatements or construction or refurbishment allowances, any provisions allowing Sublandlord to extend or renew the term of the Prime Lease (including, without limitation, Section 30 of the Prime Lease), any provisions of the Prime Lease granting any option to purchase or lease the Building or any other space in the Building or Project (including, without limitation, Section 39 of the Prime Lease), Section 17.E. of the Prime Lease, Section 26.J. of the Prime Lease, Section 28.H. of the Prime Lease, and Section 36 of the Prime Lease.

         (b) Without limitation of the foregoing:

         (i) Subtenant shall not make any changes, alterations or additions in or to the Premises except as otherwise expressly provided herein. In connection therewith, Sublandlord and Subtenant acknowledge and agree that Subtenant may desire to make certain alterations, additions and/or improvements to the Premises following its occupancy thereof (hereinafter referred to as the “Subtenant Work”). Such Subtenant Work shall be performed at the sole cost and expense of Subtenant and shall strictly conform to all the terms and provisions of the Prime Lease. Subtenant shall obtain the approval of both the Landlord and Sublandlord with respect to any and all aspects of the Subtenant Work prior to commencing same;

         (ii) If Subtenant desires to take any other action and the Prime Lease would require that Sublandlord obtain the consent of Landlord before undertaking any action of the same kind, Subtenant shall not undertake the same without the prior written consent of Sublandlord. Sublandlord may condition its consent on the consent of Landlord being obtained and may require Subtenant to contact Landlord directly for such consent;

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         (iii) All rights given to Landlord and its agents and representatives by the Prime Lease to enter the premises covered by the Prime Lease shall inure to the benefit of Sublandlord and their respective agents and representatives with respect to the Premises;

         (iv) Sublandlord shall also have all other rights, and all privileges, options, reservations and remedies, granted or allowed to, or held by, Landlord under the Prime Lease;

         (v) Subtenant shall maintain insurance of the kinds and in the amounts required to be maintained by Sublandlord under the Prime Lease. All policies of liability insurance shall name as additional insureds the Landlord and Sublandlord and their respective officers, directors or partners, as the case may be, and the respective agents and employees of each of them; and

         (vi) Subtenant shall not do anything or suffer or permit anything to be done which could result in a default under the Prime Lease or permit the Prime Lease to be canceled or terminated.

         (c) Notwithstanding anything contained herein or in the Prime Lease which may appear to be to the contrary, Sublandlord and Subtenant hereby agree as follows:

         (i) (A) Subtenant shall not, without the prior written consent of Sublandlord, assign, mortgage, pledge, hypothecate or otherwise transfer or permit the transfer of this Sublease or any interest of Subtenant in this Sublease, by operation of law or otherwise, or permit the use of the Premises or any part thereof by any persons other than Subtenant and Subtenant’s employees, or sublet the Premises or any part thereof. Sublandlord shall not unreasonably withhold, condition or delay its consent to any such transfer; provided, however, it shall not be unreasonable for Sublandlord to withhold its consent to such transfer if (1) Subtenant is then in default under any of the terms and conditions of this Sublease, (2) the proposed transferee is not sufficiently creditworthy, in Sublandlord’s sole determination, and (3) the proposed transferee is a competitor of Sublandlord or is a governmental agency (the foregoing reasons are not meant to be an exhaustive list of the bases upon which Sublandlord may withhold its consent to such a transfer);

               (B) Notwithstanding the foregoing, in no event shall Subtenant be obligated to obtain the consent of Sublandlord in connection with any sub-sublet of all or any portion of the Premises to any entity which is in control of, under common control, or controlled by, Subtenant (any such entity is referred to herein as an “Affiliate”) or an assignment of Subtenant’s interest hereunder to any Affiliate of Subtenant or in connection with the merger, consolidation or reorganization of Subtenant with any other entity or the sale of all or substantially all of Subtenant’s

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stock or assets provided the following conditions are met: (1) to the extent that the Landlord’s consent under the Prime Lease is required in connection with such a transfer, Subtenant obtains same at its sole cost and expense and provides evidence of same to Sublandlord, (2) Subtenant provides written notice to Sublandlord and Landlord not less than ten (10) business days prior to the effectiveness of such transfer, (3) in the case of a sub-sublet or actual assignment of this Sublease (as opposed to a transfer by operation of law, such as a merger), such sub-subtenant or assignee enters into an agreement in form and content reasonably satisfactory to Sublandlord assuming all of the obligations of the Subtenant hereunder, whether accruing prior to or after the effectiveness of the transfer, (4) there is no release of the Subtenant in connection with any such transfer, (5) the net worth of the Subtenant entity which is liable for the terms and provisions of this Sublease immediately following such transfer is satisfactory to Sublandlord, and (6) no default has occurred under this Sublease beyond applicable notice and cure periods (the transfers noted in this clause (B) are referred to herein as “Permitted Transfers”);

         (C) Further, other than in connection with any Permitted Transfers, in the event of any assignment of this Sublease or sub-sublease of the Premises by Subtenant, Subtenant shall pay to Sublandlord fifty percent (50%) of any consideration received by Subtenant for such assignment or sub-sublease, as the case may be, in excess of the rent payable under this Sublease and the reasonable actual out-of-pocket cost incurred by Subtenant solely for brokerage commissions, legal fees and any costs of alterations necessary to effect such transfer, such payment to be provided to Sublandlord no later than thirty (30) days after the determination thereof and the date such excess rent is received by Subtenant;

         (ii) neither rental nor other payments hereunder shall abate by reason of any damage to or destruction of the Premises, the premises subject to the Prime Lease, or the Building or any part thereof, unless, and then only to the extent that, rental and such other payments actually abate under the Prime Lease with respect to the Premises on account of such event;

         (iii) notwithstanding clause (c)(ii) above, in the event that Sublandlord receives an abatement of rent due under the Prime Lease pursuant to the provisions of Section 4.F. thereof, then Subtenant shall be entitled the same abatement of rent under this Sublease;

         (iv) Subtenant shall not have any right to any portion of the proceeds of any award for a condemnation or other taking, or a conveyance in lieu thereof, of all or any portion of the Premises;

         (v) If the Prime Lease gives Sublandlord any right to terminate the

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Prime Lease in the event of any casualty or condemnation of the Premises, so long as (1) Subtenant is not in default under this Sublease beyond applicable notice and cure periods, and (2) such right to so terminate the Prime Lease is then effective and applicable, Subtenant shall be entitled to the same right to so terminate this Sublease as afforded to Sublandlord under the Prime Lease except that Subtenant shall be required to give notice to Sublandlord of such election to so terminate this Sublease with sufficient time so as to provide Sublandlord with not less than ten (10) business days following Sublandlord’s receipt of such written notice of Subtenant’s election to so terminate this Sublease to permit Sublandlord to elect to terminate the Prime Lease pursuant to the terms and conditions of the Prime Lease;

         (vi) Notwithstanding anything contained in Section 22.J. of the Prime Lease, following a written request from Subtenant, Sublandlord shall subordinate any statutory or contractual lien and security interest it may have on Subtenant’s equipment, furniture, moveable trade fixtures or other personal property owned by Subtenant and kept at the Premises to the lien of any bona fide vendor or institutional lender providing financing for Subtenant to acquire such equipment, furniture, moveable trade fixtures or other personal property, such subordination to be pursuant to an instrument which is reasonably satisfactory to Sublandlord;

         (vii) Subtenant shall not have any right to exercise or have Sublandlord exercise any option under the Prime Lease, including, without limitation, any option to extend the term of the Prime Lease or lease additional space; and

         (viii) In the event of any conflict between the terms, conditions and provisions of the Prime Lease and of this Sublease, the terms, conditions and provisions of this Sublease shall, in all instances, govern and control.

         (d) It is expressly understood and agreed that Sublandlord does not assume and shall not have any of the obligations or liabilities of Landlord under the Prime Lease and that Sublandlord is not making the representations, warranties or indemnifications, if any, made by Landlord in the Prime Lease. With respect to work, services, repairs and restoration or the performance of other obligations required of Landlord under the Prime Lease, Sublandlord’s sole obligation with respect thereto shall be to request the same, upon written request from Subtenant, and to use reasonable efforts, at Subtenant’s sole cost and expense, to obtain the same from Landlord. Sublandlord shall not be liable in damages, nor shall rent abate hereunder, for or on account of any failure by Landlord to perform the obligations and duties imposed on it under the Prime Lease. Sublandlord and Subtenant acknowledge and agree that any repair, maintenance and/or replacement obligations with respect to the Premises which are the responsibility of the Sublandlord, as tenant under the Prime Lease, shall be performed by Subtenant at Subtenant’s sole cost and expense. In the event that a condition exists in the Premises that Landlord is obligated to repair under the terms of the Prime Lease, Subtenant shall so advise Sublandlord, and Sublandlord, in turn, shall promptly advise Landlord thereof. At Subtenant’s request, in the event that Landlord fails to fulfill any repair or maintenance obligation under the terms of the

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Prime Lease with respect to the Premises, Sublandlord shall use its good faith, due diligent and commercially reasonable efforts to have Landlord fulfill such repair and maintenance obligations, all of which reasonable efforts shall at be Subtenant’s sole cost and expense. All such amounts which are payable by Subtenant hereunder shall be deemed additional rent due under this Sublease. Sublandlord and Subtenant acknowledge and agree that the provisions of Section 26.J. of the Prime Lease provide the “Tenant” under the Prime Lease certain self-help and offset rights under the Prime Lease in the event of a default thereunder by the Landlord. In connection therewith, in the event of such a default by the Landlord under the Prime Lease, upon written request by Subtenant, Sublandlord shall be entitled (but shall have no obligation) to take such steps as are reasonably necessary and permitted under the Prime Lease to effect such self-help and offset rights under the Prime Lease. Subtenant hereby covenants and agrees that it shall be responsible to reimburse to Sublandlord any and all of the costs and expenses incurred by Sublandlord in effecting such cure, to the extent same are not offset against the rent owed by Sublandlord under the Prime Lease. Such amounts shall be deemed additional rent due and owing under this Sublease. Alternatively, Sublandlord may elect to have Subtenant perform such self-help rights under the Prime Lease upon the following terms and conditions: (i) such rights are exercised by Subtenant at its sole cost and expense, (ii) Subtenant obtains the prior written approval by Sublandlord of the acts to be taken by Subtenant with respect to such self-help rights and (iii) Subtenant performs such self-help rights in strict accordance with the terms and provisions of the Prime Lease. In the event that Subtenant performs such self-help acts in accordance with the foregoing terms and provisions and as a result thereof, Sublandlord receives an offset of the rent due under the Prime Lease, then Subtenant shall receive the same offset against the rent due under this Sublease.

         (e) Nothing contained in this Sublease shall be construed to create privity of estate or contract between Subtenant and Landlord, except the agreements of Subtenant in Sections 10 and 11 hereof in favor of Landlord, and then only to the extent of the same.

         (f) Sublandlord hereby represents and warrants as to the following: (i) as of the date of Sublandlord’s execution of this Sublease, Sublandlord has received no notice of default under the Prime Lease from Landlord, (ii) as of the date of Sublandlord’s execution of this Sublease, Sublandlord has not forwarded any notice of default to Landlord under the Prime Lease which has not been cured, and (iii) as of the date of Sublandlord’s execution of this Sublease, to Sublandlord’s actual knowledge (with no investigation or inquiry), Sublandlord has received no notice that the Premises is not in compliance with applicable laws, codes, rules and/or regulations of applicable governing authorities.

         (g) Subject to the terms and provisions of the Prime Lease and this Sublease, so long as Subtenant shall perform all of its obligations under this Sublease, Subtenant shall enjoy peaceful and quiet possession of the Premises in accordance with the terms and provisions of this Sublease against any party claiming through or under Sublandlord. In addition to the foregoing, Sublandlord hereby covenants and agrees that it shall not enter into any modification or amendment to the Prime Lease which materially and

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adversely affect Subtenant’s rights under this Sublease.

7. Default by Subtenant.

         (a) Upon the happening of any of the following:

         (i) Subtenant fails to pay any Minimum Rent within five (5) days after the date it is due;

         (ii) Subtenant fails to pay any other amount due from Subtenant hereunder and such failure continues for three (3) days after notice thereof from Sublandlord to Subtenant;

         (iii) Subtenant fails to perform or observe any other covenant or agreement set forth in this Sublease and such failure continues for seven (7) days after notice thereof from Sublandlord to Subtenant; or

         (iv) any other event occurs which involves Subtenant or the Premises and which would constitute a default under the Prime Lease if it involved Sublandlord or the premises covered by the Prime Lease;

Subtenant shall be deemed to be in default hereunder, and Sublandlord may exercise, without limitation of any other rights and remedies available to it hereunder or at law or in equity, any and all rights and remedies of Landlord set forth in the Prime Lease in the event of a default by Sublandlord thereunder.

         (b) In the event Subtenant fails or refuses to make any payment or perform any covenant or agreement to be performed hereunder by Subtenant, Sublandlord may make such payment or undertake to perform such covenant or agreement (but shall not have any obligation to Subtenant to do so). In such event, amounts so paid and amounts expended in undertaking such performance, together with all costs, expenses and attorneys’ fees incurred by Sublandlord in connection therewith, shall be additional rent hereunder.

         8.     Nonwaiver. Failure of Sublandlord to declare any default or delay in taking any action in connection therewith shall not waive such default. No receipt of moneys by Sublandlord from Subtenant after the termination in any way of the term or of Subtenant’s right of possession hereunder or after the giving of any notice shall reinstate, continue or extend the term or affect any notice given to Subtenant or any suit commenced or judgment entered prior to receipt of such moneys.

         9.     Cumulative Rights and Remedies. All rights and remedies of Sublandlord under this Sublease shall be cumulative and none shall exclude any other rights or remedies allowed by law.

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         10.     Waiver of Claims and Indemnity.

                  (a) Subtenant hereby releases and waives any and all claims against Landlord and Sublandlord and each of their respective officers, directors, partners, agents and employees for injury or damage to person, property or business sustained in or about the Building or the Premises by Subtenant other than by reason of gross negligence or willful misconduct and except in any case which would render this release and waiver void under law.

         (b) Subtenant agrees to indemnify, defend and hold harmless Landlord and its beneficiaries, Sublandlord and the managing agent of the Building and each of their respective officers, directors, partners, agents and employees, from and against any and all claims, demands, costs and expenses of every kind and nature, including attorneys’ fees and litigation expenses, arising from Subtenant’s occupancy of the Premises, Subtenant’s construction of any leasehold improvements in the Premises or from any breach or default on the part of Subtenant in the performance of any agreement or covenant of Subtenant to be performed or performed under this Sublease or pursuant to the terms of this Sublease, or from any act or neglect of Subtenant or its agents, officers, employees, guests, servants, invitees or customers in or about the Premises. In case any such proceeding is brought against any of said indemnified parties, Subtenant covenants, if requested by Sublandlord, to defend such proceeding at its sole cost and expense by legal counsel reasonably satisfactory to Sublandlord.

         11.     Waiver of Subrogation. Anything in this Sublease to the contrary notwithstanding, Sublandlord and Subtenant each hereby waive any and all rights of recovery, claims, actions or causes of action against the other and the officers, directors, partners, agents and employees of each of them, and Subtenant hereby waives any and all rights of recovery, claims, actions or causes of action against Landlord and its agents and employees for any loss or damage that may occur to the Premises or any improvements thereto, or any personal property of any person therein or in the Building, by reason of fire, the elements or any other cause insured against under valid and collectible fire and extended coverage insurance policies, regardless of cause or origin, including negligence, except in any case which would render this waiver void under law, to the extent that such loss or damage is actually recovered under said insurance policies.

         12.     Brokerage Commissions. Each party hereby represents and warrants to the other that other than Julien J. Studley, Inc. and BRE Commercial Real Estate (whose commissions shall be paid by Sublandlord) it has had no dealings with any real estate broker or agent in connection with this Sublease, and that it knows of no real estate broker or agent who is or might be entitled to a commission in connection with this Sublease. Each party agrees to protect, defend, indemnify and hold the other harmless from and against any and all claims inconsistent with the foregoing representations and warranties for any brokerage, finder’s or similar fee or commission in connection with this Sublease, if such claims are based on or relate to any act of the indemnifying party which is contrary to the foregoing representations and warranties.

         13.     Successors and Assigns. This Sublease shall be binding upon and inure to the benefit of the successors and assigns of Sublandlord and shall be binding upon and inure to the benefit of the successors of Subtenant and, to the extent any such assignment may be approved,

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Subtenant’s assigns. The provisions of Subsection 6(e) and Sections 10 and 11 hereof shall inure to the benefit of the successors and assigns of Landlord.

         14.     Entire Agreement. This Sublease contains all the terms, covenants, conditions and agreements between Sublandlord and Subtenant relating in any manner to the rental, use and occupancy of the Premises. No prior agreement or understanding pertaining to the same shall be valid or of any force or effect. The terms, covenants and conditions of this Sublease cannot be altered, changed, modified or added to except by a written instrument signed by Sublandlord and Subtenant.

         15.     Notices.

                  (a) In the event any notice from the Landlord or otherwise relating to the Prime Lease is delivered to the Premises or is otherwise received by Subtenant, Subtenant shall, as soon thereafter as possible, but in any event within twenty-four (24) hours, deliver such notice to Sublandlord if such notice is written or advise Sublandlord thereof by telephone if such notice is oral.

         (b) Notices and demands required or permitted to be given by either party to the other with respect hereto or to the Premises shall be in writing and shall not be effective for any purpose unless the same shall be served either by personal delivery with a receipt requested, by overnight air courier service or by United States certified or registered mail, return receipt requested, postage prepaid; provided, however, that all notices of default shall be served either by personal delivery with a receipt requested or by overnight air courier service, addressed as follows:

if to Sublandlord:	c/o GATEWAY, INC. Real Estate Administration 610 Gateway Drive Y91 North Sioux City, South Dakota 97049
and	c/o GATEWAY, INC. 14303 Gateway Place Poway, California 92064 Attn: General Counsel
if to Subtenant:	COSTAR REALTY INFORMATION, INC. 4535 Towne Centre Court San Diego, California Attn.: Facility Manager
and	COSTAR GROUP, INC. 2 Bethesda Metro Center, 10th Floor Bethesda, Maryland 20814 Attn: Director of Facilities

Notices and demands shall be deemed to have been given two (2) days after mailing, if mailed, or, if made by personal delivery or by overnight air courier service, then upon

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such delivery. Either party may change its address for receipt of notices by giving notice to the other party.

         16.     Authority. Subject to Section 19 hereof, each party represents and warrants to the other that this Sublease has been duly authorized, executed and delivered by and on behalf of such party and constitutes the valid, enforceable and binding agreement of such party.

         17.     Limitation on Liability. Sublandlord shall not be liable for personal injury or property damage to Subtenant, its officers, agents, employees, invitees, guests, licensees or any other person in the Premises, regardless of how such injury or damage may be caused; provided, however solely as such waiver relates to claims of property damage, the foregoing shall not limit or restrict any liability which may arise solely and directly due to the gross negligence or willful misconduct of Sublandlord. Any property of Subtenant kept or stored in the Premises shall be kept or stored at the sole risk of Subtenant. Subtenant shall hold Sublandlord harmless from any claims arising out of any personal injury or property damage occurring in the Premises, including subrogation claims by Subtenant’s insurance carrier(s) except to the extent noted in the first sentence of this Section 17.

         18.     Consents and Approvals. In any instance when Sublandlord’s consent or approval is required under this Sublease, Sublandlord’s refusal to consent to or approve any matter or thing shall be deemed reasonable if, among other matters, such consent or approval is required under the provisions of the Prime Lease incorporated herein by reference but has not been obtained from Landlord. Except as otherwise provided herein, Sublandlord shall not unreasonably withhold or delay its consent to or approval of a matter if such consent or approval is required under the provisions of the Prime Lease and Landlord has consented to or approved of such matter. If Subtenant shall seek the approval by or consent of Sublandlord and Sublandlord shall fail or refuse to give such consent or approval, Subtenant shall not be entitled to any damages for any withholding or delay of such approval or consent by Sublandlord, it being agreed that Subtenant’s sole remedy in connection with an alleged wrongful refusal or failure to approve or consent shall be an action for injunction or specific performance shall be available only in those cases where Sublandlord shall have expressly agreed in this Sublease not to unreasonably withhold or delay its consent.

         19.     Consent of Landlord. The obligations of Sublandlord and Subtenant under this Sublease are conditioned and contingent upon the Landlord consenting hereto. In the event Landlord’s consent is not obtained within thirty (30) days after the date hereof this Sublease shall automatically terminate and become null and void, and neither Sublandlord nor Subtenant shall have any further obligations or liability hereunder or to each other with respect to the Premises. Sublandlord hereby covenants and agrees to use its commercially reasonable efforts to obtain Landlord’s consent to this Sublease as promptly as reasonably possible following the full execution and delivery of this Sublease.

         20.     Examination. Submission of this instrument for examination or signature by Subtenant does not constitute a reservation of or option for the Premises or in any manner bind Sublandlord, and no lease, sublease or obligation on Sublandlord shall arise until this instrument is signed and delivered by Sublandlord and Subtenant and the consent of Landlord is obtained as described in Section 19 above.

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         21.     Security Deposit. Subtenant concurrently with the execution of this Sublease, shall deposit with Sublandlord the sum of $284,440.41 (which Sublandlord and Subtenant acknowledge and agree is equal to three (3) months’ gross rent due under this Sublease) as security for the faithful performance by Subtenant of all terms, covenants and conditions of this Sublease in the form of a letter of credit as more particularly set forth below. Such letter of credit shall be in a form consistent with that form of letter of credit attached to this Sublease as Exhibit “C” and issued upon a bank with a minimum long term capital rating of “AA”, with a branch in San Diego, California for purposes of Sublandlord’s ability to draw thereon and shall otherwise be satisfactory to Sublandlord (in its sole and absolute discretion). Further, such letter of credit shall be irrevocable, “evergreen”, “clean” and in the full amount required naming Sublandlord as beneficiary, and providing for partial and multiple draws and shall otherwise be satisfactory to Sublandlord as set forth hereinabove. Such letter of credit shall be held by Sublandlord as security for the faithful performance by Subtenant of all terms, covenants and conditions of this Sublease. Subtenant agrees that Sublandlord may apply (or draw upon, as the case may be) the security deposit to remedy any failure by Subtenant to repair or maintain the Premises or to perform any other terms, covenants and conditions contained herein or make any payment owing hereunder, all following the expiration of applicable notice and cure periods. If Subtenant has kept and performed all terms, covenants and conditions of this Sublease during the term, Sublandlord will, within thirty (30) days after the expiration hereof, promptly return the security deposit to Subtenant or the last permitted assignee of Subtenant’s interest hereunder. Should Sublandlord use (or draw upon, as the case may be) any portion of the security deposit to cure any default by Subtenant hereunder, Subtenant shall forthwith replenish the security deposit to the original amount. Sublandlord shall not be required to keep the security deposit separate from its general funds, and Subtenant shall not be entitled to interest on any such deposit. Subtenant hereby acknowledges and agrees that Sublandlord may draw upon such letter of credit at such time as Sublandlord is permitted to do so under this paragraph 21 or if Subtenant fails to provide Sublandlord with a replacement letter of credit no later than thirty (30) days prior to the expiration date of any then held letter of credit in Sublandlord’s possession. In the event Sublandlord draws down such letter of credit, then Sublandlord shall hold such cash security deposit in accordance with the terms and provisions of this paragraph 21.

         22. Furniture. Sublandlord and Subtenant acknowledge and agree that Subtenant shall be entitled to use, at no additional cost, fee or charge to Subtenant imposed by Sublandlord, the furniture currently located within the Premises and scheduled on Exhibit “B” hereto (the “Furniture”) during the term of this Sublease, and any extensions thereof. During the term of this Sublease, Subtenant shall be responsible, at Subtenant’s sole cost and expense, to maintain such Furniture in good condition and repair and shall surrender same to Sublandlord upon the expiration of the term of this Sublease or earlier termination hereof in good condition and repair, subject to reasonable wear and tear from Subtenant’s use of such Furniture during the term of this Sublease. Subtenant acknowledges and agrees that it shall accept such furniture in its “as-is” condition and in no event does Sublandlord make any representation or warranty of any kind with respect to the Furniture or its adequacy for Subtenant’s purposes and Sublandlord hereby disclaims the delivery of any such warranties, including any warranty of merchantability, fitness for a particular purpose or any thing or nature whatsoever.

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         23.     Security System. Sublandlord and Subtenant acknowledge and agree that there is currently located within the Premises a security system servicing the Premises (except that Sublandlord acknowledge and agree that the data processing equipment (the “Data Equipment”) for such security system is located in a building adjacent to the Premises. Subtenant shall be entitled to use, at no additional cost, fee or charge to Subtenant imposed by Sublandlord, the security system currently located within the Premises and scheduled on Exhibit “B-1” attached hereto (the “Security System”) during the term of this Sublease, and any extensions thereof. Subtenant shall be responsible, at Subtenant’s sole cost and expense, to surrender such Security System to Sublandlord upon the expiration of the term of this Sublease or earlier termination hereof in the condition and in the manner required under the Prime Lease. Subtenant acknowledges and agrees it shall accept such security system in its “as-is” condition and that in no event does Sublandlord make any representation or warranty of any kind with respect to the Security System or its adequacy for Subtenant’s purposes and Sublandlord hereby disclaims the delivery of any such warranties, including any warranty of merchantability, fitness for a particular purpose or any thing or nature whatsoever. Further, Subtenant hereby acknowledges and agrees that in no event shall Subtenant have any right to use or access the Data Equipment.

         24.     Server Infrastructure Network. Sublandlord and Subtenant acknowledge and agree that there is currently located within the Premises server room hardware, air conditioners and a fire suppression system (and related furniture). Subtenant shall be entitled to use, at no additional cost, fee or charge to Subtenant imposed by Sublandlord, such server room hardware, air conditioners and a fire suppression system (and related furniture currently located within the Premises and scheduled on Exhibit “B-2” attached hereto (the “Server Infrastructure Network”) during the term of this Sublease, and any extensions thereof. Subtenant shall be responsible, at Subtenant’s sole cost and expense, to surrender such Server Infrastructure Network to Sublandlord upon the expiration of the term of this Sublease or earlier termination hereof in the condition and in the manner required under the Prime Lease. Subtenant acknowledges and agrees it shall accept such Server Infrastructure Network in its “as-is” condition and that in no event does Sublandlord make any representation or warranty of any kind with respect to the Server Infrastructure Network or its adequacy for Subtenant’s purposes and Sublandlord hereby disclaims the delivery of any such warranties, including any warranty of merchantability, fitness for a particular purpose or any thing or nature whatsoever.

         25.     Parking. During the term of this Sublease, so long as Subtenant is not in default under this Sublease, Subtenant and its employees shall be entitled to use Subtenant’s Percentage Share of the parking rights granted to Sublandlord, as Tenant, under the Prime Lease, including, without limitation, the terms and provisions of Section 4.G. of the Prime Lease. Subtenant acknowledges and agrees that its right to use such parking area shall be upon the terms and conditions set forth in the Prime Lease, including, without limitation, any and all regulations promulgated by Landlord with respect thereto.

         26.     Signage. Sublandlord and Subtenant hereby acknowledge and agree that so long as Subtenant is not in default under this Sublease, Subtenant shall be granted the right provided to Sublandlord, as Tenant under the Prime Lease, to install the Building Sign as set

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forth in Section 31 of the Prime Lease, subject to the following terms and conditions: (i) in no event shall Subtenant be permitted to install such Building Sign unless and until Subtenant obtains any and all necessary approvals in connection therewith, including, without limitation, the approval of Landlord, Sublandlord and any necessary governmental entity or agency having jurisdiction over the Premises; and (ii) Subtenant shall comply with all the terms and provisions of the Prime Lease and this Sublease in connection with the installation of same. Further, Sublandlord and Subtenant acknowledge and agree that subject to approval by Sublandlord (such approval not to be unreasonably withheld, conditioned or delayed) and Landlord, Subtenant shall have the right to utilize Subtenant’s Percentage Share of the remaining signage rights granted to Sublandlord under the Prime Lease, at Subtenant’s sole cost and expense. Such signage rights shall be subject to clauses (i) and (ii) set forth hereinabove with respect to the Building Sign. Any and all signage installed by Subtenant at the Premises shall be the responsibility and at the sole cost of Subtenant to repair, maintain, replace, and remove upon the expiration of the term of this Sublease or earlier termination hereof. Subtenant shall repair any damage caused to the Premises as a result of any such repair, maintenance, placement and/or removal of such signage.

         27.     Option to Extend. Sublandlord and Subtenant acknowledge and agree that Subtenant shall have the right to extend the term of this Sublease through August 31, 2012 (which is the expiration of the term of the Prime Lease) upon the following terms and conditions: (i) Subtenant shall provide Sublandlord with prior written notice of Subtenant’s election to so extend the term of this Sublease not less than nine (9) months prior the expiration of the then current term of this Sublease, time being of the essence; (ii) all of the terms and conditions of such extension term shall be the same as during the initial term of this Sublease except that the Minimum Rent shall be equal to the then current fair market rental rate for the Premises as agreed to between Sublandlord and Subtenant in their reasonable and good faith determination (if Sublandlord and Subtenant are unable to agree upon the then current fair market rental rate for the Premises within thirty (30) days following Sublandlord’s receipt of Subtenant’s exercise of its option to extend the Sublease term as set forth herein, then the parties shall submit such dispute to arbitration in accordance with the then current rules of the American Arbitration Association in order to resolve such dispute, with each party bearing one-half (1/2) of the cost of such arbitration); and (iii) Subtenant shall have no right to extend the term of this Sublease (a) if upon the exercise thereof by Subtenant and/or on the date upon which such extended term is to begin Subtenant is in default under this Sublease and/or (b) if Subtenant has assigned this Sublease or sublet all or any portion of the Premises to any party other than an Affiliate (as defined in Section 6(c)(i) of this Sublease).

         28.     Counterparts; Execution; Joint and Several Liability. This Sublease may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts taken together shall constitute but one and the same instrument. Signature pages may be detached from the counterparts and attached to a single copy of this Sublease to physically form one document. This Sublease may also be delivered by telefacsimile and any signature of a party on a telefacsimile copy shall be binding. Any party delivering an executed counterpart of this Sublease by telefacsimile shall also deliver by overnight service to the other party or parties an original counterpart of this Sublease, provided the failure to deliver an original counterpart shall not affect the validity, enforceability and binding effect of this Sublease. The obligations of CRII and CGI shall be

17

joint and several and each of CRII and CGI shall be fully liable for the obligations imposed on the Subtenant under this Sublease regardless of the obligations of the other party. In no event shall Sublandlord be required to proceed against one of the parties comprising Subtenant hereunder prior to proceeding under this Sublease against the other party comprising Subtenant hereunder.

         IN WITNESS WHEREOF, Sublandlord and Subtenant have executed this Sublease as of the date aforesaid.

		SUBLANDLORD:
ATTEST:		GATEWAY, INC., a Delaware corporation
By:		By:  /s/  Stephen Smurthwaite
		Its:  Vice President
Its:
		SUBTENANT:
ATTEST:		COSTAR REALTY INFORMATION, INC., a Delaware corporation
By:      Its:	/s/  Carla Garrett   Secretary	By:  /s/  Andrew Florance    Its:  Chief Executive Officer
ATTEST:		COSTAR GROUP, INC., a Delaware corporation
By:      Its:	/s/  Carla Garrett   Secretary	By:  /s/  Andrew Florance    Its:  Chief Executive Officer

18 EX-99.1 5 w62833exv99w1.htm CERTIFICATION OF CHIEF EXECUTIVE OFFICER

EXHIBIT 99.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350:

     In connection with the accompanying Quarterly Report on Form 10-Q of CoStar Group, Inc., for the quarter ended June 30, 2002, I, Andrew C. Florance, Chief Executive Officer of CoStar Group, Inc., hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     1) such Quarterly Report on Form 10-Q of CoStar Group, Inc., for the quarter ended June 30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     2) the information contained in such Quarterly Report on Form 10-Q of CoStar Group, Inc., for the quarter ended June 30, 2002, fairly presents, in all material respects, the financial condition and results of operations of CoStar Group, Inc.

Dated: August 13, 2002	By: /s/ Andrew C. Florance
	Andrew C. Florance
	Chief Executive Officer
	(Principal Executive Officer
	and Duly Authorized Officer)

EX-99.2 6 w62833exv99w2.htm CERTIFICATION OF CHIEF FINANCIAL OFFICER

EXHIBIT 99.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350:

     In connection with the accompanying Quarterly Report on Form 10-Q of CoStar Group, Inc., for the quarter ended June 30, 2002, I, Frank A. Carchedi, Chief Financial Officer of CoStar Group, Inc., hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     1) such Quarterly Report on Form 10-Q of CoStar Group, Inc., for the quarter ended June 30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     2) the information contained in such Quarterly Report on Form 10-Q of CoStar Group, Inc., for the quarter ended June 30, 2002, fairly presents, in all material respects, the financial condition and results of operations of CoStar Group, Inc.

Dated: August 13, 2002	By: /s/ Frank A. Carchedi
	Frank A. Carchedi
	Chief Financial Officer
	(Principal Financial Officer
	and Duly Authorized Officer)

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